The draft Phase Two of the Carbon Tax has recently been released for public comment by National Treasury. It is expected that Phase 2 of the Carbon Tax Act will come into effect from 1 January 2026.
Commentary to National Treasury is due by close of business on 13 December 2024.
The draft Phase 2 of the Carbon Tax proposes the following changes from a Carbon Tax and Revenue Recycling/Tax Incentives point of view:
1. Carbon Tax
i. Basic tax-free allowance
Currently, the 60% basic tax-free threshold applies to all emissions, below which the tax will not be payable.
National Treasury recommends a reduction in the basic tax-free allowance by 10% in 2026, and by 2.5% per year thereafter from 2027 to 2030. This will increase the effective carbon tax rate over time. A reduction of the basic tax-free allowance by at least 2.5% per year from 2031 will be considered.
The reduction in the basic tax-free allowance will be offset by the increases to the carbon offset allowance and the performance allowance for combustion emissions effective from 2026.
ii. Performance allowance
This tax-free allowance, currently set at 5% for combustion emissions, was introduced as a transitional measure to reward companies that implemented mitigation measures (before the introduction of the carbon tax) and encourage firms to reduce the carbon intensity of their production processes relative to their peers.
To encourage the implementation of mitigation plans by companies, it is proposed that mitigation plans, as required under the recently enacted Climate Change Act, must be approved by the Department of Forestry Fisheries and the Environment (“DFFE”) and implemented by companies in order to qualify for the performance allowance. Where companies fully implement measures set out in the mitigation plans and perform better than the agreed benchmarks, they would qualify for the full performance allowance and if companies do not comply, the performance allowance would be forfeited.
National Treasury is also proposing an increase in the performance tax-free allowance by 5% to 10% effective from 2026 for combustion emissions.
To enable electricity generators to benefit from the performance allowance, a benchmark of 0.94 tCO2e/MWh has been developed for the electricity sector, based on the emissions intensities of the existing coal power stations. A benchmark in the range of 0.6 to 0.9 tCO2e/MWh is proposed from 2031.
iii. Carbon offset allowance
The current offset allowance provides flexibility to firms to reduce their carbon tax liability by claiming a carbon offsets allowance of either 5% or 10% of their total greenhouse gas (“GHG”) emissions through investment in projects that reduce their emissions outside their taxable activities.
National Treasury is proposing an increase in the offset allowance by 15% to a maximum of 20% for process or fugitive emissions and 25% for combustion emissions from 2026 to stimulate domestic carbon market activities.
To ensure sufficient supply of credits in the domestic market and maintain the environmental integrity of the carbon offset scheme, it is proposed that the utilisation period for offsets from projects approved and registered under the eligible standards before the introduction of the carbon tax, including renewable energy projects, is extended for an additional three years from 31 December 2025 until 31 December 2028.
The Section 12L Energy Efficiency Savings tax incentive comes to an end in December 2025. To assist industries in the short term and to encourage innovation and additional investments in energy efficiency measures, it is proposed to allow eligible energy efficiency projects including those developed under the 12L tax incentive under the carbon offset scheme.
iv. Local carbon offset standards
Due to the barriers of high financial cost and bureaucratic processes for developing carbon offset projects under the international standards (Clean Development Mechanism, Verified Carbon Standard, and Gold Standard), a framework is being finalised by DFFE, the Department of Energy and Electricity, and National Treasury for the implementation of local offset standards. The framework is expected to be finalised and published before the end of the 2025 financial year.
The approved standards will be included as eligible standards for purposes of carbon offsets under the carbon tax and necessary changes will be made to the Carbon Offset Regulations.
v. Carbon budget allowance
National Treasury proposes the removal of the 5% carbon budget tax-free allowance as carbon budgets become mandatory from 1 January 2026. The allowance will be replaced with an equivalent increase in the carbon offset allowance.
An extension of the carbon budget allowance for an additional year until 31 December 2025 is proposed for voluntary participation by companies in the carbon budget system.
A higher carbon tax rate of R640/tCO2e on GHG emissions exceeding the allocated carbon budget in terms of the Climate Change Act is proposed from 1 January 2026. Proposed legislative amendments to the Carbon Tax Act will be published either in the 2025 or 2026 Taxation Laws Amendment Bill for public comment. This will be done after the Climate Change Act comes into effect and the carbon budget and greenhouse gas mitigation plan regulations are gazetted by the DFFE.
vi. Trade exposure allowance
The allowance is currently provided to address any potential adverse impacts on industry competitiveness due to the carbon tax, with companies within sectors with trade intensities of 30% or higher qualifying for the full trade exposure allowance of 10%.
National Treasury is proposing an adjustment to the trade intensity threshold for maximum trade exposure allowance from 30% to 50% from 2026 as announced in the 2022 Budget.
Sectors with trade intensities greater than or equal to 50% will qualify for the full 10% trade exposure allowance while sectors with trade intensities between 20% and 50% will qualify for an allowance of between 4% and 9.8%. Sectors with a trade intensity of less than 20%, such as the Electricity, Gas and Water Supply SIC major divisions, will not qualify for the allowance.
vii. Process and fugitive emissions allowance
To allow industry a longer transitional period for the “hard-to-abate” sectors, no changes are proposed to the process and fugitive emissions allowances of 10% for the period 2026 to 2030. A continuation of this allowance beyond 2030 will be considered.
viii. Maximum tax-free allowance
From 2026 to 2030, changes to the maximum tax-free allowance will be aligned with adjustments to the basic, carbon offset and performance allowances.
ix. AFOLU and Waste
The agriculture, forestry and other land use (“AFOLU”) and waste activities’ emissions are excluded from the carbon tax net due to lack of appropriate methodologies to accurately determine GHG emissions and monitor and verify emissions.
Due to challenges with accurate methodologies to quantify GHG emissions from the AFOLU and waste sector activities, it is proposed that the blanket exclusion and provision of the 100% basic tax-free allowance be retained.
x. Sequestration
Following consultations with the DFFE, it is proposed to place a cap of 70% on the amount of sequestered emission removals that would be eligible for the tax deduction. This will preserve the environmental integrity of the carbon tax and provide an emissions buffer where there are high uncertainties around removal estimates. Going forward, there might be a need to replace the sequestration deduction with the carbon offset allowance.
2. Revenue Recycling and Tax Incentives
i. Section 12L tax incentive
To encourage energy efficiency investments, it is proposed that the 12L incentive is allowed to lapse at the end of December 2025 and the carbon offset mechanism is expanded to include energy efficiency projects such as eligible 12L projects approved under the SANS 50010 Energy Efficiency Savings standard. This will promote investments in energy efficiency measures, reduction in scope 2 electricity emissions and job creation.
ii. Tax incentive for green hydrogen
National Treasury proposes the extension of the 100% depreciation allowance for solar PV to green hydrogen production in line with the recommendations from the Green Hydrogen Commercialisation Strategy approved by Cabinet in 2023.
iii. Electricity price neutrality
National Treasury is recommending the removal of the electricity generation levy and implementation of the carbon tax proposals for Phase Two. The carbon tax would replace the electricity levy from 2026 and will be revenue neutral. Electricity generators can continue to deduct a portion of the renewable energy premium from their carbon tax liability where there would have been a difference between the carbon tax and electricity levy. This will help to reduce the impact of higher electricity prices on consumers.
iv. Support for Strategic Priorities
Although the carbon tax and other environmental taxes are not earmarked, as the carbon tax rate is increased over the short to medium term there could be revenue-raising potential. Taking into account fiscal constraints, targeted support could be considered as part of revenue recycling measures, such as reskilling workers’ programmes; free basic electricity support targeted to renewable-based energy; targeted support for disaster risk reduction; and support for enhancing public transport infrastructure, among others.
We encourage carbon taxpayer to get in touch with us if you are interested to comment or submit responses to National Treasury before the deadline of 13 December 2024 in response to the published draft Phase Two of the Carbon Tax.
Please contact Catalyst Solutions if you would like to discuss the proposed phase 2 Carbon Tax, the development of mitigation plans, latest updates on carbon budgets and the development of carbon offset projects.
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