On 9 June 2016, the South African Revenue Service (SARS) issued Binding Class Ruling 053 (Ruling), which deals with the application of s12K of the Act in the context of a Clean Development Mechanism (CDM) project. The parties to the Ruling are a non-profit association of green energy producers (Applicant), the project developer and sponsor of the registration of the CDM project with the Executive Board of the United Nations Framework Convention on Climate Change (UNFCCC) (Project Developer) and the owners of the CDM projects registered under the programme of activities (CPA owners).
The Applicant is a non-profit organisation which aims to raise awareness and facilitate the transition to a climate resilient society within South Africa. It achieves its objectives through, amongst other things, providing an independent platform for the hosting of programmes of activities (CPAs) for CDM projects registered under the Kyoto Protocol and acts as the coordinating and management entity for these CPAs. The Applicant and the Project Developer, who is also a CPA owner, have established a CDM project in a programmatic form, contemplated in Article 12 of the Kyoto Protocol, which is registered with the CDM Executive Board. The CPA owners intend to produce CER credits under the CPA which will be sold to industrialised countries, in terms of emission reduction purchase agreements. The relationship between the parties will be governed by a CPA agreement which states, amongst other things, the following:
The CPA is to be registered with the CDM executive board together with the first CDM project undertaken by the Project Developer. Other potential CPA owners who wish to participate in the CPA will be invited to do so upon payment of an inclusion fee and will be added by way of supplemental deeds of inclusion to the CPA as provided for by the CDM rules.
The Applicant will do a number of things, including acting as the coordinating and management entity for the CPA and managing the CER credits sales process and collecting the revenue (carbon revenue) in its capacity as manager of the CPA on behalf of the CPA owners. It will receive a fee for services rendered as manager of the CPA.
The Project Developer will fund the development phase budget to establish the CPA. All CPA owners will pay an annual fee to cover expenses of the CPA.
The CER credits generated by the CPA will be jointly owned by the Project Developer and the CPA owners on the basis that ownership of a certain specified percentage of the gross CER credits will accrue to the Project Developer as the project sponsor and the balance will be jointly owned by all CPA owners and accrue to each CPA proportionally according to its contribution of CER credits in the relevant period.
The Applicant will pay all the expenses related to the running of the CPA from the inclusion fees, annual fees and carbon revenue, if required, and will distribute the surplus to the CPA owners according to their proportional share of revenue calculated based on the CER credits contributed in the relevant period.
Background to section 12K
Section 12K of the Act came into effect on 11 February 2009 and according to the Explanatory Memorandum on the Taxation Laws Amendment Bill, 2009 (2009 Explanatory Memorandum) the reason for this was the limited uptake of CDM projects within South Africa. The 2009 Explanatory Memorandum states that CDM was created by the Kyoto Protocol as a mechanism to ensure that developed countries can meet their carbon emission reduction targets, while also ensuring that developing countries can participate in a global reduction market. In this regard, the Kyoto Protocol makes it possible for CDM projects to yield CERs which are technically saleable to and usable only by developed countries.
According to the 2009 Explanatory Memorandum, the limited uptake of CDM projects within South Africa stems from the high financial (and bankable) hurdle rates due to the risks associated with CDM project activities (CPAs). Financial hurdle rates include, amongst other things, the high cost involved in financing CPAs. The South African government recognised that climate change requires a considered international and domestic policy response and as part of South Africa’s domestic policy response to climate change, tax relief in the form of s12K was introduced to overcome the market failure associated with environmental protection.
The provisions of section 12K
Section 12K(2) states that any amount received by or accrued to or in favour of any person in respect of the disposal by that person of any CER derived by that person in the furtherance of a qualifying CDM project carried on by that person. Section 12K(1) states that for a CDM project to constitute a “qualifying CDM project”, the designated national authority (DNA) must issue a letter of approval as contemplated in the Regulations establishing the DNA. Secondly, the CDM project must be registered in terms of the modalities and procedures for a clean development mechanism as defined in Article 12 of the Kyoto Protocol.
SARS ruled that:
The CPA will be a “qualifying CDM project” as defined in s12K(1) of the Act.
The CPA owners and the first CDM project owner will be the persons carrying on the “qualifying CDM project”.
The carbon revenue generated by the CPA will be exempt from income tax under s12K(2) of the Act in the hands of the CPA owners. The exemption is not affected by the fact that the carbon revenue will be received by the Applicant acting in its capacity as manager of the CPA.
Only carbon revenue from the CER credits that the first CDM project owner derives from conducting its own CDM project of activities will qualify for exemption under s12K(2) of the Act and the carbon revenue from the disposal of the extra CER credits accrued in terms of the CPA agreement will not be exempt from normal tax under s12K(2) of the Act.
The CER credits need not be accounted for as “trading stock” as defined in s1(1) of the Act.
The sale of CER credits to non-resident purchasers will be subject to VAT at a zero rate under s11(2)(l) of the VAT Act, No 89 of 1991 provided all the requirements of that section are complied with.
It should be noted that in terms of the current Draft Regulations to the Draft Carbon Tax Bill, a CDM project, similar to the one discussed in the Ruling, can generate carbon offsets. The carbon credits generated by such project will have to be surrendered to SARS to make use of the carbon offset allowance. As the Draft Regulations to the Draft Carbon Tax Bill currently stand, it appears that it might be possible for carbon credits generated by a “qualifying CDM project” in terms of s12K, to be used by a taxpayer to receive an offset allowance in terms of the Draft Carbon Tax Bill. However, we will only have clarity once the legislation regarding carbon tax has been finalised.