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THE CARBON OFFSET SYSTEM IN SOUTH AFRICA: THE REGULATORY FRAMEWORK

CONTEXTUALISING CARBON CREDITS: CARBON TAX IN SOUTH AFRICA

The Carbon Tax Act (“the Act”), which imposes tax obligations on companies proportionate to their emission of greenhouse gases, was enacted in 2019 as part of South Africa’s suite of policy and legislative considerations to domestically implement its global commitments under the Paris Accord, address climate change and curb emissions.


The Act is based on the Polluter Pays Principle, with a view to charging polluters for the cost of environmental harm in hopes of changing their behaviour to adopt greater mitigation measures and practices.


In applying this principle, the Act imposes a tax on any person conducting an activity in South Africa (“listed activity”) which results in greenhouse gas emissions equal to or above the threshold determined for the listed activity by schedule 2 of the Act. The greenhouse gases identified by the Act comprise six pollutants (including carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride), each differing in their degree of harm to the global environmental cause. The greater the harm, as assessed by the Intergovernmental Panel on Climate Change, the higher the potential tax imposed on a company.


Companies affected by the tax include a wide range of sectors and listed activities ranging from brick manufacturing, to mining and transportation.


IMPLEMENTING THE CARBON TAX

Government has sought to implement the tax in three phases. The first phase, which was set to expire at the end of 2022, has been extended to December 2025. The extension of the first phase announced by Treasury means that the tax (currently set at a rate of R144 per ton of carbon dioxide equivalent emissions) will only increase annually at a rate of CPI plus 2 percent until 2025.


In line with South Africa’s COP26 commitments, the rate will increase more substantially in the second phase (set to start in 2026) to reach USD30 per ton of carbon dioxide equivalent emissions by 2030.


Given the additional costs placed on companies by the introduction of carbon tax, government has developed seven allowances which seek to reduce the tax burden or at least incentivise a reduction. One such incentive is the development of carbon credits, as regulated by section 13 of the Act.


WHAT ARE CARBON CREDITS AND HOW DO THEY WORK IN SOUTH AFRICA?

A carbon credit system, which is also commonly referred to as carbon offsets, is a mechanism within the carbon tax regime which is designed to assist carbon emitters to reduce their carbon tax liabilities while investing in mitigation projects at a lower cost.

In other words, companies who are unable to reduce their emissions on site can leverage the mechanism by investing in a mitigation project (like clean energy or forestation projects, for example) and gain carbon offset credits by doing so. In large part, these projects not only seek to reduce a company’s tax liability but promote further social and environmental benefits to surrounding communities.


Further details regulating the implementation of carbon offsetting in South Africa are outlined in the Carbon Offset Regulations, also published in 2019 (“the Regulations”).

The Regulations provide for permissible offsets against approved projects, subject to the nature and duration of the project, including clean development mechanisms, verified carbon standard projects and projects that comply with the eligibility requirements issued by the Gold Standard.


Some projects, including those which are subject to a power purchase agreement (as defined in the Electricity Regulations on New Generation Capacity), renewable energy generated at certain capacities, and nuclear energy, are ineligible to claim an offset allowance.


The Regulations are the subject of a review in light of global developments arising from COP26, resulting in the Draft Framework for Approval of a Domestic Standard being published in January 2022 (“the Framework”). While the terms thereof have only been published for comment (the due date of which has already expired), the Framework seeks to develop eligible domestic carbon offset standards which are in line with international standards.


WEIGHING UP THE COST

In South Africa, carbon offsets can account for 5 to 10 percent of a company’s total tax allowance. In practice, therefore, a company emitting greenhouse gasses can invest in an approved project and claim credits to reduce its tax liability by at least 10 percent. At the current rate, this means an effective reduction of between R7,20 and R14,40 per ton.

Companies would need to weigh the cost up of investing in approved projects against the potential cost saving afforded by the offset allowance. While it may not be useful for some companies to look to offsets alone to minimise their carbon tax liability, the allowance structure may collectively benefit such companies.


The potential cost saving benefit that a company could leverage by using offsets will therefore depend on the nature of the activity which emits greenhouse gasses (for example, combustion emissions will likely save more than fugitive emissions which provides for a lower maximum offset allowance) and the price of the offset.


While implementation of the second phase has been extended, Treasury has warned companies that they may experience a significant tax difference should they fail to implement plans to reduce their carbon footprint in the coming years. This is particularly true for large emitters, who should look to leverage on the allowances currently available to them. Companies will do well to take heed of Treasury’s call as South Africa’s carbon reduction project, in line with its global contributions, continues to take effect.

As part of a broader series of briefs focusing on the impact of South Africa’s climate change response on companies, the next article will consider the process for obtaining approval of projects for carbon credits.


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