Tax and Malaysia's carbon neutrality ambition

The government announced that carbon pricing instruments will be introduced, in the form of carbon tax and a domestic emissions trading scheme (DETS).

DURING the recent unveiling of the 12th Malaysia Plan (12MP), the government announced an ambitious goal for Malaysia to achieve carbon neutrality by 2050.

Among others, the Prime Minister emphasised on the acceleration of green economy growth and energy sustainability as the core elements for socio-economic development.

He also affirmed the government’s commitment to factor in environmental, social and governance (ESG) principles in its decision-making process.

Against this backdrop, we can expect to see various tax developments that will be critical for Malaysia to achieve carbon neutrality, either in the upcoming Budget 2022 or in the next few years.

Carbon pricing

The government announced that carbon pricing instruments will be introduced, in the form of carbon tax and a domestic emissions trading scheme (DETS).

These tools essentially set a value or price on greenhouse gas (GHG) emissions to be paid by the parties responsible, and effectively make it a necessity for businesses to reduce emissions to remain competitive and sustainable.

Ernst & Young partner Sharon YongErnst & Young partner Sharon Yong

Under a carbon tax framework, emitters would pay a tax or price for every tonne of GHG released.

Under a “cap and trade” model, the DETS sets a cap on the GHG emissions permitted for each business, and low-carbon emitters would be able to sell their excess credits or permits to businesses which have exceeded the cap.

Under a carbon tax regime, the carbon price is fixed but the environmental outcome (GHG emissions) will remain a variable, whereas under the DETS, the outcome is essentially fixed through the cap, but the carbon price will be determined by market.

A combination of a carbon tax and DETS allows a “middle-of-the-road” approach, and this has been implemented in other countries like Canada.

Careful deliberation is required to formulate and implement carbon pricing policies, including an assessment of the cost impact on businesses, particularly during this period of post-pandemic recovery.

The government will also need to take into account other elements such as the availability and credibility of data on GHG emissions, whether taxes collected are used in driving decarbonisation activities and the level of public awareness and knowledge.

It is therefore important to have wide-reaching engagement and consultation with key stakeholders, including the business community, industry bodies, impacted groups in society, regulators and administrators, to avoid any major unanticipated impact, which would require backtracking or resolution.

As such, we do not expect details of the carbon tax and DETS to be unveiled in Budget 2022 but perhaps in the following year.

Area of focus

For Malaysian businesses with cross-border trade activities, internal carbon pricing would be an increasingly crucial area of focus.

As of April 2021, there were 64 active carbon pricing instruments around the world.

Many other countries and regions are in the process of implementing carbon pricing policies in their respective jurisdictions.

Businesses with geographical footprints outside Malaysia would need to take into account the carbon pricing impact across their assets, operations and proposed investments in other jurisdictions.

One example is the proposed European Union (EU) Carbon Border Adjustment Mechanism, which is essentially a border tax that would impact Malaysian and all other exporters into EU in certain sectors, if these exporters are less carbon efficient than their EU counterparts.

Tax and non-fiscal incentives

To encourage local businesses to shift towards decarbonisation, there would be a need for incentives which are centered around three focus areas, ie, reducing the consumption of non-renewable natural resources, switching to alternative fuels and renewable energy sources and innovation.

In addition, there is a need to ensure the development of a talent pool with the right knowledge and skillset to take up “green jobs” related to sustainability focus areas.

Currently, Malaysia has various sustainability-related tax incentives, mainly in the form of a Green Income Tax Exemption (GITE) for green technology services and a Green Investment Tax Allowance (GITA) for green technology projects or the purchase of certified green technology assets.

There are also certain tax incentives for Sustainable and Responsible Investment sukuk and bonds, which are approved by the Securities Commission.

With GITE and GITA currently covering various green activities, we can expect a further coverage of activities which may include carbon capture technologies, plastics and sustainable packaging, sustainability services, “green jobs” and training, and the development of a talent pool with green technology skills.

Spurring R&D

While there are some tax incentives available for general research and development (R&D) activities, there are no specific tax incentives targeting R&D and innovation, and the existing R&D tax incentives may be somewhat limited in practical application.

The government may consider reviewing the existing incentive regime to spur R&D and innovation activities, by providing funding in the form of cash grants, loans or subsidised financing for innovation activities, or assistance to businesses to access available funding from international organisations for sustainability efforts.

In addition, there needs to be a deliberate focus on helping small and medium enterprises or SMEs to turn environmental challenges into opportunities, as part of their economic recovery journey.

To complement the proposed DETS, the government may also consider reinstating the income tax exemption on sale of carbon credits which has since expired.

There will be significant changes in the Malaysian tax landscape in tandem with other policy developments related to climate action and the environment.

These changes, coupled with growth in new business models, have the potential to stimulate new economic growth areas while putting Malaysia on track towards achieving the nation’s ambition of carbon neutrality by 2050.

We expect decarbonisation and other sustainability measures to continue to be a key theme in Budget 2022 and the coming years.

Sharon Yong is a partner in Ernst & Young Tax Consultants Sdn Bhd. The views expressed here are the writer’s own.

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