Earlier in the year, we were very pleased to be able to share our thoughts and insights with an online audience on the current state of the natural capital market in the United Kingdom, and the ways in which this may develop in the coming years. For those who were not able to watch on the day the recording of the webinar can still be accessed. The presentations covered land rights, tax implications, the operation and challenges of the current carbon codes and what might be coming down the track in the UK natural capital sector.
The key takeaways were:
- The nature of the project and landowner circumstances will largely determine choice of legal agreement. For peatland projects the common model is for the project developer to carry out the work on land in third party ownership. A lease will invariably be a more expensive option but provides greater certainty and security than a personal contract – standard securities can be used to bolster personal contractual rights but can be impractical if there is a secured loan facility and/or the grant providers have their own security requirements.
- Be aware of third party interests and the impact this can have on financial return. Recent experience suggests that a landowner should expect to share up to 50% of the income form a peatland project with crofters holding common grazing rights over the restoration area. The costs of preparing and negotiating legal agreements to regulate such arrangements will also impact on net return.
- There is no specific tax legislation for carbon markets and units and the sector is reliant on general tax legislation. Where a commercial occupier of woodland receives income for units then this is generally being treated as akin to forestry income and therefore outside scope of income tax and corporation tax. Conversely, income from peatland projects is within the tax system but this does mean that costs incurred can be offset.
- A new working group has been set up to consider the specific taxation of natural capital. The group, with the snappy title of "Environmental Land Management and Ecosystem Service Markets Working Group" has a remit to look at natural capital taxation issues and is made up of tax experts, industry representatives and HMRC personnel.
- If a landowner sells land with unsold carbon units then capital gains tax will be a consideration. However, there is an obvious argument that for woodland projects the "carbon price" is intrinsically related to growing trees and therefore exempt from capital gains tax.
- VAT treatment is changing. With effect from 1 September 2024 VAT will be charged on the price for pending issuance units and verified carbon units. The default rate will be 20% but sales on terminal markets VAT can be zero-rated. This change should be generally well-received as sellers of units can offset VAT incurred on project costs, and it is anticipated that VAT-registered buyers should be able to recover VAT paid on unit prices.
- Inheritance tax changes are in the pipeline for 2025. At present HMRC accept that land which is being actively used for a UK carbon scheme can qualify for IHT business relief. Changes to IHT agricultural property relief, designed to give limited support to landowners who let to scheme operators should come into effect in 2025.
- There are inherent challenges to scaling of carbon markets but progress is being made. The ongoing FIRNS project should help introduce consistency in contracts, which will in turn promote landowner and buyer confidence. Development of affordable insurance products will also help unlock latent potential.
- Land is key to delivery and value should not be underestimated. As well as ensuring that they are properly remunerated for carbon sequestration and biodiversity benefits, rural landowners should be careful to preserve future natural capital value. We expect several nature codes to be brought to the market over the next few years and control of land is key to deriving economic and environmental value from these codes.
- Land Reform will be a growing influence. Natural capital has been a consistent theme in all discussions and consultations around land reform in Scotland. The provisions in the draft bill relating to Land Use Tenancies and controls on land disposal have natural capital opportunity at their core, specifically a political will to encourage wider community participation in this sector.
If there is anything in this article or webinar that you would like to discuss then please contact Graeme Leith or your usual Brodies contact.
Contributors
Graeme Leith
Partner
Bob Langridge
Partner