DUANE NEWMAN: New carbon tax rules in February budget could hurt SA industry

As the US shifts its focus away from climate change under Donald Trump's administration, promoting fossil fuel extraction and withdrawing from the Paris Agreement, the SA government remains steadfast in its commitment to achieving net-zero emissions through a just transition.

In SA the carbon tax serves as a critical mechanism for incentivising industries to reduce emissions, alongside reporting requirements, regulations and incentives. The carbon tax was implemented in June 2019, with the first phase set to conclude at the end of 2025, followed by the introduction of phase 2 on January 1 2026.

While proposed future tax rates have been disclosed, the industry is eagerly awaiting final details regarding the allowances firms can claim to alleviate their carbon tax liabilities in phase 2. Concerns are mounting that these liabilities could double, starting in 2026, exacerbated by intended tax rate increases and proposed adjustments to allowances.

On November 13, the Treasury initiated consultations with stakeholders to discuss not only the proposed changes to carbon tax allowances in phase 2 but also carbon offsets, the electricity levy, the renewable energy premium and the energy efficiency savings tax incentive. This consultation is being expedited to enable finance minister Enoch Godongwana to present the new phase 2 carbon tax framework during the upcoming February budget speech.

In January, both written submissions and a virtual round-table discussion were conducted, facilitated by the Treasury officials. Officials have clarified that the carbon tax rates for 2026 to 2030 are non-negotiable, having already been announced by the finance minister.

These rates are set to rise significantly, increasing from R236/tCO2e to R462 by 2030, with an initial annual increase exceeding 30%, averaging out to 19% over a five-year period.

While feedback on allowances will be considered, discussions will focus solely on the pace of the changes to be implemented. The Treasury has categorised its measures for phase 2 into two groups: incentives and disincentives.

Incentives include various allowances, potential support for green hydrogen production and the possible extension of support for energy efficiency projects currently available under the section 12L tax incentive, which may be extended beyond its expiration at the end of this year.

Conversely, disincentives encompass reductions in carbon tax allowances, alignment with carbon budgets, and modifications to trade exposure thresholds. The industry is particularly apprehensive about proposed changes to the basic allowance and the carbon offset allowance.

The basic allowance, a free allowance available to all liable for carbon tax, currently provides a 60% discount on a company’s carbon tax bill until December 2025. The Treasury’s discussion document suggests this basic allowance will decrease from 60% to 50% starting January 2026, with further reductions of 2.5% each year until 2030.

The anticipated abrupt reduction in basic allowance relief on January 1 2026 — a 16% decrease — poses significant challenges for the industry, especially in light of the 30% increase in the carbon tax rate. If reductions in this critical allowance are necessary, a more gradual approach should be considered, particularly for hard-to-abate sectors, with any reductions postponed beyond 2030.

The carbon offset allowance enables companies to lower their carbon tax liability by utilising carbon offsets, currently allowing for a reduction of up to 10% of taxable emissions. The Treasury aims to increase this allowance by 15%, facilitating a potential 20%-25% reduction in the headline tax rate.

While this initiative is intended to invigorate the carbon credit market, which is welcomed, the market remains small, and offset projects often require years to develop, limiting uptake. Additionally, carbon offsets entail costs as investments are necessary for new green projects.

Concerns persist within the industry regarding the cost and complexity of applying for the carbon offset allowance, with a preference for a more gradual implementation of these changes.

The Treasury’s discussion paper also raises the question of whether to maintain the electricity levy of 3.5c per kilowatt-hour or effectively convert it into a carbon tax. There are apprehensions that this latter approach could undermine the government’s assurance of revenue neutrality regarding changes in electricity taxation.

A clear distinction exists between an electricity levy and a carbon tax, and if the latter is pursued it is challenging to foresee how Eskom would refrain from passing this cost onto its customers. Concrete assurances will be essential to prevent this outcome.

The discussion document also suggests the Treasury may extend the 100% depreciation allowance for solar photovoltaic systems to encompass green hydrogen gas production. However, concerns have been raised about the perception of this measure as a subsidy for oil and gas companies.

The carbon tax specifically targets certain industries, predominantly affecting heavy sectors such as chemicals, steel, and aluminium. Some proposed changes in the Treasury’s consultation document could adversely affect these struggling sectors.

The measures outlined in the phase 2 consultation document are deemed too drastic; if implemented from January 1 2026 they could in effect double the carbon tax liabilities of many of the country's most vulnerable industrial firms.

The SA industry has voiced its concerns and called for a more gradual approach. We will learn on Wednesday — budget day — whether the finance minister has addressed these issues.

• Newman is sustainability tax partner at EY SA.