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UK Government consults on Carbon Emissions Tax

September 23, 2020


Following the end of the implementation period, the UK will no longer participate in the European Union Emissions Trading System (EU ETS). In order to maintain a robust carbon price in the UK, the Government has consulted on alternatives (see our blog post: The future UK carbon pricing after the end of the implementation period: consultation outcome). Whereas the UK’s preferred approach to carbon pricing after the end of the implementation period is an emissions trading system linked to the EU ETS, a carbon emission tax (the Tax) is being considered as an alternative, along with a standalone UK ETS in the event that a linked system is not established. It should be noted that emissions from electricity generation in Northern Ireland that, under the terms of the Northern Ireland Protocol, remain within the EU ETS from 1 January 2021 would not be subject to the Tax.

Powers to establish the Tax were introduced in the Finance Act 2019 (the Act). The Government published a consultation on the detailed operation of the Tax on 21 July 2020 (the Consultation). The Consultation closes on 29 September 2020.

For the purposes of the Consultation, it is assumed that the Tax would be introduced from 1 January 2021 and would be reviewed in 2022, with possible adjustments from 2023 onwards. The Tax would apply to almost one-third of UK emissions.

While some aspects of the Tax have already been covered by the Act (such as its scope, who is liable to pay and the basis for calculating tax liability), the calculation methodology and a number of operational aspects are still open. These are now subject of the Consultation, along with possible future changes to the Tax.


To ensure business continuity, it is intended that the installations covered by Phase III of the EU ETS as “main scheme installations” and “small emitters” would be subject to the Tax.

It is proposed that Tax for an installation would be calculated by HMRC, using the information from the annual emissions reports submitted by operators to the regulator, thus obviating the need for a separate tax return.

Each installation would be issued a tax emission allowance, representing the number of tonnes of CO2 equivalent the installation would be entitled to emit free of tax, with any emissions above the limit being subject to the Tax.

For the first two years, the tax emission allowance would be set at a level broadly corresponding with the allocation of free allowances or targets under the EU ETS. The installations not eligible for free allocation under Phase IV of the EU ETS would have a tax emission allowance of zero, making them liable to pay tax on all their emissions. This would include most electricity generators.

An installation would not be able to transfer any part of its allowance to any other installation, even if owned by the same business. In this regard, the tax is less flexible than an emissions trading scheme.

A separate regime, consistent with the EU ETS, is proposed for the small emitters.

EU Allowances (whether free, bought at auction or traded) would not be acceptable in settlement of the Tax.


The following formula is being proposed for calculating a tax emission allowance:

𝑇𝑎𝑥 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛 𝑎𝑙𝑙𝑜𝑤𝑎𝑛𝑐𝑒 = ℎ𝑖𝑠𝑡𝑜𝑟𝑖𝑐𝑎𝑙 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝑙𝑒𝑣𝑒𝑙 × 𝑏𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘 × Carbon Leakage Exposure Factor

The CLEF would be determined using the Phase IV Carbon Leakage List for each sub-installation and an installation’s tax emission allowance would be the aggregate of all its sub-installations’ tax emission allowances.

A Carbon Emission Tax rate would be set using EU ETS price data.

Indicative rates for 2021 and 2022 would be based on the average December 2021 and 2022 EU ETS allowance futures prices, adjusted upwards, to allow for the potential for actual EU ETS prices exceeding the average futures price.

If the indicative rates for 2021 and 2022 ended up higher than the average EU ETS auction clearing prices in these years by £1 or more, the rates would be adjusted downward (to the EU ETS prices) in early 2022 and 2023 respectively. Conversely, there is no proposal for an upward adjustment.

The amount of Tax due would be calculated using the following formulae:

Total emissions - tax emission allowance = taxable emissions

Taxable emissions x £xx (the confirmed tax rate) = Carbon Emissions Tax due

Bills would be sent in August of each year starting from 2022, with payment due within 30 days, after which penalties and interest for late payment would apply.

Payments system to reward decarbonisation

The Government is proposing a payments system to reward installations for achieving emission reductions beneath their tax emission allowance, which would otherwise not benefit from tax savings.

Payments under the system would be capped at the level of the unused tax emission allowance, with the payment rate expressed as a percentage of the overall tax rate (e.g. the rate for 2021 could be 50% of the confirmed 2021 Tax rate) and payments would start from 2023.

Possible future changes to the Tax

In order for the UK to achieve net zero by 2050, the Tax would need to evolve in the medium term.

The Consultation is seeking stakeholders’ views on potential broadening of the scope of the Tax, by including additional sectors (such as shipping and aviation) and whether the Tax could be used to support deployment of negative emissions technologies, such as direct air capture or bioenergy with carbon capture and storage.

Although aviation is already within the aviation EU ETS, it enjoys significant free allocation. Government is seeking views as to how a carbon price could support the transition to less carbon-intensive operations.

Shipping emissions are not currently subject to a carbon price and the Consultation seeks views as to whether applying one to domestic shipping might incentivise a switch to lower carbon fuels.


If the Government decides to opt for the Tax, the Act would be amended, with changes to be included in a Finance Bill in autumn 2020, with secondary legislation to follow in late 2020, 2021 and 2022.