Businesses need to be ready for EU’s carbon rules

The European Commission is considering the expansion of the CBAM’s scope to include a broader range of goods currently under the EU ETS, as well as products such as glass, paper and chemicals. — Bloomberg

OVER the last year, we have seen the rollout of sustainability policies and strategies by the Malaysian government, including the New Energy Transition Roadmap (NETR).

The NETR will be accompanied by various complementary plans including the Long-Term Low Emissions Development Strategies (LT-LEDS), the Carbon Pricing Instrument and various other industry masterplans and roadmaps.

From a tax-policy perspective, we are waiting to see whether there will be changes to the tax-incentives regime in the upcoming Budget 2024 announcement to encourage and support decarbonisation activities by local businesses as well as to attract foreign investments in the targeted activities.

The prime minister had previously announced that a carbon tax is not on the cards in the near future and, to date, there has not been an announcement on any mandatory carbon market (such as a regulated emissions trading scheme), though Bursa Malaysia has launched the Bursa Carbon Exchange, an international marketplace for the trading of verified high-quality carbon credits

Notwithstanding the lack of specific local tax policies, Malaysian businesses need to be aware of, among others, the impact of international carbon pricing developments.

One key development occurred in May this year, when regulations for the EU Emission Trading System (EU ETS) reform and the new EU Carbon Border Adjustment Mechanism (CBAM) entered into force, as part of the EU’s “Fit for 55” legislative package to help the EU reduce at least 55% of emissions by 2030 (compared to 1990 levels).

During a transitional period for CBAM from Oct 1, 2023 to Dec 31, 2025, quarterly emissions reporting requirements are imposed on EU importers (or direct/indirect customs representative if the importer is not based in the EU) of in-scope goods.

From 2026, in-scope businesses will be required to purchase and surrender CBAM certificates based on the level of embedded carbon and other greenhouse gas emissions in imported in-scope goods. The cost of these certificates will have an impact on product margins.

At the moment, the CBAM applies to the import of six goods, identified in a list by industry sector based on the Harmonised System (HS) for Tariff Classification. The six goods are steel and iron, aluminium, cement, fertilisers, electricity and hydrogen.

The European Commission (EC) is considering the expansion of the CBAM’s scope to include a broader range of goods currently under the EU ETS, as well as products such as glass, paper and chemicals.

Affected businesses will need to get ready to comply with the new compliance and reporting requirements starting this month and begin to assess the medium to long-term process and cost implications.

The CBAM obligations are imposed on relevant entities importing goods into the EU.

From the perspective of a Malaysian (and other non-EU) business, the implications may be significant, especially for those which are immediate exporters of the in-scope products.

Compliance obligations

Malaysian businesses with operations in the EU will need to assess whether their EU entities are subject to such reporting and compliance obligations, and note that such obligations may be applicable regardless of the industry they operate in.

For example, a food manufacturer may be considered as importing steel or aluminium products if it acquires certain types of equipment or parts for its business from outside the EU.

From Oct 1, 2023, Malaysian exporters of in-scope products will need to provide their EU customers (who are subject to the CBAM obligations) with data on their installations and production processes, the carbon price paid in Malaysia, and calculated embedded emissions in their products, and will need to consider how this will affect pricing and overall competitiveness.

These exporters will also need to start considering both their capability in collating the emissions data required for their facilities, as well as the feasibility of investing in new technologies to reduce carbon emissions.

Alternatively, they may need to consider if it is necessary to restructure their supply chain.

Calculating and providing data on embedded emissions will be a new experience for many businesses, particularly small and medium enterprises (SMEs).

The EC has presented a methodology for calculating embedded emissions for the transitional period, while allowing some derogations at the beginning of the effective period.

In addition, the EC will provide default values which can be used under certain conditions to fulfill reporting obligations during the transitional period.

These default values will be determined globally for each of the products under the CBAM, without distinction by location or manufacturing process, and are expected to be higher than actual values.

The EC has stressed that reporting actual emissions will be more beneficial to importers. This means affected exporters to the EU may prefer to provide actual data to their EU customers, to remain competitive.

Similarly, Malaysian businesses that do not export to the EU but are suppliers to other businesses who export in-scope products to the EU will also need to consider the implications, such as the need to provide emissions data, and the impact on their pricing and competitiveness.

Potential benefits

Businesses investing in carbon emissions reduction technologies should ensure that they have maximised the potential benefits available such as tax incentives, as well as considered the viability of green financing options, such as the Low Carbon Transition Facility available for domestic SMEs, and the possibility of generating carbon credits for sale.

It is expected that the list of in-scope products under the CBAM will be expanded and hence, businesses exporting to the EU as well as those within a supply chain to or through the EU will need to monitor and, where necessary, react to developments in this space.

From a policy perspective, it is expected that more jurisdictions may be announcing carbon pricing mechanisms or similar carbon border tax regimes as part of their macro sustainability policies.

For example, Australia has announced that it is currently studying the feasibility of introducing a CBAM, including the imposition of a “carbon tariff” on the import of selected commodities from countries with weaker emissions reduction policies.

Further, it should be noted that under the EU’s CBAM, where products have been subjected to a robust regime of carbon pricing in the country of origin under a national carbon tax prior to import, and documentary evidence is available to support this, the price paid may reduce the applicable EU CBAM charges.

This may to some extent influence carbon pricing policy developments in other jurisdictions, including those in which exporters are expected to be substantially affected by CBAM’s roll-out.

In Malaysia, we are awaiting the proposed rollout of a carbon pricing mechanism championed by the Finance Ministry and the National Resources, Environment and Climate Change Ministry.

Against a rapidly developing policy landscape, businesses need to ensure that they stay up-to-date and adapt their strategies accordingly, particularly in relation to carbon pricing and carbon taxes.

Failure to comply or adapt may result in disruptions or lack of competitiveness, thus impacting the sustainability of businesses.

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

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