THE FIGHT against global climate change reached the next level this February when the Kyoto Protocol came into effect. Under the international treaty, the European community agreed to cut its greenhouse gas (GHG) emissions by 8 percent below its 1990 levels starting in 2008. One of the elements of the EU's combat strategy in this environmental effort is emissions trading.
Emissions trading is a scheme whereby companies are allocated allowances for their GHG emissions according to the overall environmental ambitions of their government. Emitters keeping their emissions below the level of their allowances are allowed to sell their excess allowances at a price determined by the market. Facilities exceeding their emission limits will have a choice between taking measures to reduce their emissions, such as investing in more efficient technology or using a less carbon-intensive energy source, buying the extra allowances they need at the market rate, or a combination of the two, whichever is cheapest.
The EU Emissions Trading Scheme (EU ETS) was introduced on January 1, 2005. The scheme should allow the EU to achieve its Kyoto target at a cost of between €2.9 and €3.7 billion annually. Without the scheme, compliance costs could reach up to €6.8 billion a year. The legal framework for the EU ETS is set by a European Commission directive (2003/87/EC). More detailed regulations are currently being prepared.
Legal framework for local trading
The legal framework for the Slovak emissions trading scheme was created by Act No. 572/2004 on emissions trading, effective from November 1, 2004. The act implements the EC directive. The core of emissions trading is emission allowances or quotas. The Environment Ministry is to allocate the allowances to installations producing more than 0.5 percent of the overall Slovak GHG emissions in accordance with the National Allocation Plan that the EC approved in October 2004.
In its National Allocation Plan, Slovakia was allocated 30.5 million tonnes of carbon dioxide (CO2) per year or 91.5 million tonnes for the period between 2005 and 2007. The assigned allowances for individual installations can be found at the official Web page of the Ministry of Environment(http://www.enviro.gov.sk/servlets/files/10057). Given the fact that Slovakia, contrary to its original proposal, came to an agreement with the EU to reduce its initial aggregate emissions, some emitters were assigned less than they expected. Allowances were allocated free of charge and based upon prior negotiations with emitters.
Though only the installations covered by the National Allocation Plan will be given allowances for 2005 to 2007, anyone else - individuals, institutions, non-governmental organizations - can participate in trading. An operator of an installation may sell the emissions allowance granted after obtaining a permit from the district environment office. Any other person who wants to participate in the trading scheme has to file an application with the Environment Ministry for registration in the allowance trading register and obtain an allowance trading account. The law does not set any conditions for trading or levy any administrative fees. The transfer of allowances will be registered in the trade allowance register maintained by the Environment Ministry and supervised by the Central Register of the ETS. The market, however, is not limited only to Slovakia. The allowances can be traded with other participants in the ETS, as well as in schemes of other Kyoto Protocol signatory countries.
By March 15th of each year, installations will have to submit a report on the number of allowances equivalent to their verified CO2 emissions in that year. The report will be verified by "auditors" qualified by the Environment Ministry. Used allowances will then be cancelled by April 30th. Those that have not produced enough allowances to cover their emissions will have to pay a fine for each excess tonne emitted. In the initial phase of 2005 to 2007, the penalty will be Sk1,600 (€40.8) per tonne. From 2008 on, it will rise to Sk4,000 (€101.9). Regardless of the paid penalty, operators will have to obtain allowan-ces to make up for the shortfall the following year, and they will be "named and shamed" by having their names published.
The International Financial Reporting Interpretations Committee (IFRIC) issued a draft interpretation under which emission allowances are treated as intangible assets (IAS 38) and should be recorded at fair (market) value. The allocation of allowances for a price lower than their market value is recognized as a government grant (IAS 20), which is released into the revenues within the period to which the allowances relate. Due to the specific character of allowances, their treatment under the Slovak accounting standards (SAS) is unclear. There are several possibilities of classifying them (for instance as intangible assets, similarly as securities), but no classification meets all the criteria for the respective type of assets described in the SAS. The most suitable classification seems to be recognized purchased allowances as intangible assets on the balance sheet of the purchaser, similarly to their classification for IFRS purposes. Examining the description of the various types of intangible assets in the SAS, the substance of allowances is close to the definition of valuable rights, which are accounted for in account No. 014 (assuming that their useful life is more than one year). However, only assets purchased for consideration can be entered in this account. Thus, the accounting recognition (if any) of allowances allocated for free by the Environment Ministry is questionable.
The approach of recognizing allowances as intangible assets also prevails in the Czech Republic, where pertinent accounting principles resemble those applied in the Slovak Republic.
Another open issue is how to treat the depreciation and revaluation of allowances in terms of accounting. If treated as intangible assets, they should be amortized over their expected useful life within a maximum of five years from the date of acquisition. However, decreasing the assets' value through depreciation could be inadequate in a situation where the market value of the allowances rises. A revaluation to real value seems to be more appropriate, but this approach is possible only for certain types of assets, such as securities and derivatives.
The tax impact
The unclear accounting treatment brings about uncertainties in the area of taxation as well. Allowances would not fall within the definition of intangible assets as defined in the Slovak Income Tax Act. The Income Tax Act does not provide any specific tax rules for the treatment of allowances, so their tax treatment should be accounting driven. However, if they are recognized as securities or other types of assets, the tax legislation contains various limitations for tax treatment.
In the terms of the Slovak Value Added Tax (VAT) Act, transfers of emission allowances are considered a supply of services, subject to the standard 19 percent VAT rate.
In cross-border transactions, the transfer of allowances qualifies as intangible services subject to the so-called reverse-charge mechanism. Hence, where allowances are transferred to a foreign entity, they are generally not subject to Slovak VAT. On the other hand, if a Slovak entity purchases them from a foreign entity that is based in another EU-member state or in a "third" country, it will be required to "self-assess" 19 percent Slovak VAT, i.e. to report VAT on the purchase in its VAT return and pay this tax to the authorities.
As results from the above, allowances bring a lot of questions as to their legal, accounting and tax treatment that requires more detailed analysis. Let's see what the future discussions and practice will bring in these respects.
Attorney Silvia Belovičová and Tax Advisor Miriam Galandová both work at White & Case. Due to the general nature of the discussion, this article should not be regarded as legal advice. Copyright 2005, White & Case.
18. Apr 2005 at 0:00 | Silvia Belovičová and Miriam Galandová