Major Change to the VAT Treatment of Carbon Credits Due to Suspected VAT Fraud

The French tax authorities have announced that, with effect from Monday 8 June, trading in carbon credits (including permits under the EU Emissions Trading Scheme and Certified Emissions Reductions) will be exempt from VAT in France, eliminating the previous 19.6% VAT charge on transactions in these credits.

The move comes amid suspicion that fraudsters may be using carbon credits as the latest "product" to trade across the EU as part of a wider VAT fraud. Such fraud has been widespread in the last few years, known as "missing trader" or "carousel" fraud, severely impacting industries such as trade in mobile telephones and microchips. The fraud is most successful with products that are high value and easily traded across EU member states, making carbon credits potentially an ideal tool for VAT fraudsters.

The VAT fraud involves purchasing a product from a seller in another EU member state without the need to pay a VAT charge (this works because the VAT due is self-assessed by the purchaser, which, as it is also recoverable, results in no cash outflow) and then selling the product on to a local customer with a VAT charge. The customer pays the VAT charge to the fraudster, who, instead of remitting this to the tax authorities, pockets the amounts itself.

This move by the French tax authorities is the first step to combat the potential for VAT fraud in the secondary carbon markets. As noted above, the fraud relies on generating a VAT charge that subsequently goes unpaid. This potential disappears if no VAT is payable. However, the majority of EU member states will continue to levy a VAT charge on transactions in carbon credits, so the risk of fraud in the industry persists.

Impact for businesses trading in carbon credits

For businesses based in France that trade in the newly VAT exempt carbon credits, systems will need to be adjusted in order to deal with the change in the VAT treatment. In principle, consideration should be given to the subsequent impact on the recovery of VAT on costs that relate to the now VAT exempt transactions, as VAT on costs (including overhead costs) that relate to VAT exempt transactions is irrecoverable. Nevertheless, we understand that the new VAT exemption should remain neutral for French based operators.

For businesses based outside of France, there will be minimal impact at this stage, as the VAT treatment of transactions in carbon credits in countries outside of France has not been changed.

Problems for the industry in the future?

VAT fraud has already had a significant impact on legitimate trade in the mobile telephone and microchip industries. To combat VAT fraud, measures such as a domestic "reverse-charge" and joint and several liability for VAT for parties in a transaction chain have been introduced. This latter measure, which can deny VAT recovery for a legitimate trader who knew, or should have known, that it was a party in a chain of transactions that results in VAT fraud, has been a constant battle ground in the UK between traders and the UK tax authorities.

If the fears about trading in carbon credits resulting in VAT fraud materialise, it is possible that such prevention measures could be extended to businesses trading in carbon credits. If this is the case, affected businesses will be required to take proactive steps to identify the counterparties they trade with, with a view to confirming the credibility, integrity and legitimacy of those parties.

Regardless of whether such fraud prevention measures are introduced, it is prudent for traders in carbon credits to carry out necessary Know Your Client checks on trade counterparties. We are able to assist in advising on the "hallmarks" of VAT fraud, including the checks that the UK tax authorities recommend as best practice for taxpayers, so that these may be incorporated into existing KYC checks.

Potential for other EU member states to follow suit

It remains to be seen whether the action taken by the French tax authorities will be matched by other EU member states in the near future. As every other EU member state continues, so far, to apply VAT to carbon trading, the potential for VAT fraud in the industry will remain.