Carbon Border Adjustment Mechanism - EU & UK

EU CBAM Background

Over the past years, Europe has worked on a sustainability agenda that has been slowly evolving into specific policies. Europe is developing comprehensive sustainability disclosure requirements and incentivising private sector decarbonisation by charging companies for their carbon emissions. Businesses are requested to allocate capital towards decarbonisation practices and to comply with reporting requirements on emissions. 

In basic terms, the EU is imposing tax on emissions which makes it uncomfortable for businesses to continue using fossil-fuels and encourages them to transition towards cleaner alternatives or to adopt more energy-efficient practices. 

As international relations go, less regulated countries would have potentially given foreign businesses a competitive advantage in international markets. And so CBAM - being an extension of the Emissions Trading System (ETS) that is already applied to domestic EU products - was put in place in order to avoid “carbon leakage” which occurs when industries move their production to regions with less stringent climate policies, thereby evading emission reduction requirements. CBAM is designed to protect domestic industries from unfair competition and maintain a level playing field. Imported goods are, therefore, subject to the same conditions as the domestically produced. 

The current transitional period will demonstrate the capacity of the businesses to properly report emissions, before any direct import taxes are charged to businesses.

EU CBAM Timeframes

On 1 October 2023, the CBAM entered into application in its transitional phase, with the first reporting period for importers ending 31 January 2024. The deadline for the first quarterly report was 31 January 2024 through CBAM Transitional Registry online, where the records to be submitted are for October, November and December 2023. An extension has been allowed for 30 days upon request. Amendments are allowed until July 2023. 

The data can be reported in the following manner: 

1. full reporting according to EU method

2. reporting based on an equivalent method (3 options) or

3. reporting based on default reference values published by the EU Commission for each industry and the relevant commodity codes (until July 2024).

Default values are supposed to be revised regularly after the end of the first reporting period for Q4 of 2023, to take into account data collected in that first reporting period as well as feedback from EU industry and from non-EU producers of CBAM goods. This, however, is unlikely as these things tend to take time and when these policies are drafted the time estimates are usually off because they do not really account for system errors and difficulty with which the whole process is monitored on all-EU members-level.

I have already shared the default values in the excel sheet sent on Tuesday. These refer to direct and indirect emissions based on the Customs classification of the goods. 

[ ! ] As of 1 January 2025, only the EU method will be accepted and default values can only be used for 20% of embedded emissions for complex goods. Using default values will qualify as ‘estimation’.

In 2 years’ time, in 2026, CBAM will be imposing a carbon price on imported goods based on the carbon emissions associated with their production. Importers or their representatives would need to purchase emission certificates or pay a tariff that reflects the carbon content embedded in the imported products. The exact framework and process will be further explained in the future when the EU have tested/analysed the data reported. In a nutshell, however, specific industries are expected to aggressively change their approach as free allocation of allowances will be phased out by 2034. Thereafter, payment will be expected in proportion to emissions. 

The current list of industries extends to products or components made of cement, iron, steel, aluminium, fertilizers, hydrogen or electricity. By 2026 the list will be extended and by 2032 all goods within the EU ETS will be included. 

The objective of the transitional period is to serve as a pilot and learning period for all stakeholders (importers, producers and authorities) and to collect useful information on embedded emissions to refine the methodology for the definitive period.

UK CBAM

UK is also developing a similar UK CBAM to be introduced in January 2027. It is anticipated that while there will be similarities between both policies, considering that UK was part of the discussions prior to Brexit and will possibly wish to link the UK ETS with the EU ETS to facilitate trade - the EU and the UK are still implementing their respective CBAM schemes in different ways.

 In the UK, it is intended that the CBAM will be a tax, which will be administered by HMRC and will result in an additional payment due at importation.

The administration of CBAM bears a striking resemblance to VAT. There will be quarterly CBAM returns, with a threshold for registration (£10,000) and the registration test will be based on both a look forward test (import more than £10k of CBAM goods in the next 30 days) and a look back test (import more than £10k of CBAM goods in the last 12 months).

It is proposed that there will be 7 rates for UK CBAM, one for each sector of goods within the scope of CBAM. The Government is also proposing a CBAM penalty regime that is similar to the VAT penalty regime. Penalty points will be issued for late submissions and payments as well as a general penalty for non-compliance with any CBAM obligations, e.g. record keeping, failure to register etc.

With respect to both EU and UK CBAM, you are advised to keep an eye on the progress related to any policy updates and speak to an expert on reporting obligations. Please feel free to contact us for a consultation.

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