Emissions Trading Scheme and the tax implications
13 December 2022
Forestry business owners who are considering boosting their cashflow by realising gains sitting in their Forestry New Zealand Emissions Units, or FNZUs, need to be aware of the tax implications of these decisions.
A FNZU is an emissions unit, generally issued to a forester by the Crown, to recognise carbon embedded in forests. The tax rules as they apply to the issue, sale and purchase of FNZUs are complex and can be confusing.
To simplify these tax rules, we outlined below a general guide. However, specific advice should always be sought for individual circumstances.
These are not taxable on issue to the forest owner. Since they were issued to compensate for the loss in capital value of the forest land as a result of the introduction of the Emissions Trading Scheme, they are generally on capital (non-taxable) account in the hands of the landowner to whom they were issued.
These are also not taxable on issue to the forest owner. However, they do carry tax consequences as they are deemed to be revenue account property (i.e. on taxable account) for income tax purposes. The effect of this, and other relevant tax rules, is that the sale of these FNZUs generally gives rise to taxable income with no cost base. If FNZUs are sold at other than market value, they are deemed to be disposal of at market value for income tax purposes.
Pre-1990 or post-1989 FNZUs, surrendered to meet deforestation obligations, are treated as a disposal at zero.
Post-1989 FNZUs also fall into the rules for excepted financial arrangements meaning that their value must be accounted for at year end, similar to trading stocks. The status of the post-1989 FNZUs determines their value:
FNZUs allocated by the Crown for carbon stored in forests are valued at zero at the end of the year because the landowner has received a free allocation of units, rather than providing consideration in monetary terms. This is consistent with the clear policy intention to not tax FNZUs when allocated and held making FNZUs allocated by the Crown and on hand at a person’s year end at zero value, so no tax consequences arise.
FNZUs purchased to replace FNZUs issued by the Crown that were subsequently sold are also valued at zero at year end. These FNZUs are known as “replacement” FNZUs.
FNZUs purchased to increase the number of FNZUs held, or purchased and held for potential gain (meaning not replacement FNZUs), must be valued at cost at year end.
Selling post-1989 FNZUs gives rise to taxable income. The whole of the sale price is usually the taxable amount unless the forester has purchased the units over and above the number of Crown allocated units, in which case the cost of those units is deducted when sold.
If the FNZUs purchased are replacing post-1989 FNZUs sold, then these are valued at year end at zero, giving a deduction when purchased. If the FNZUs purchased are not replacing post-1989 FNZUs sold, the cost of FNZUs held at a person’s year end will represent income and effectively postpone the deduction for their cost to the year of sale.
How this could impact you
For example, a farmer’s trust decided to sell its standing timber, forest land and post-1989 FNZUs to a family-owned company. The sale of the 10,000 FNZUs at $80 gives rise to $800,000 taxable income. The FNZUs transferred to the company are no longer post-1989 FNZUs issued by the Crown, or “replacement units,” meaning the farmer’s company would not get an offsetting tax deduction of $800,000 as was expected. To be considered “replacement units,” the seller and the purchaser need to be the same entity. In this scenario, an overall tax cost of $264,000 would be incurred for shifting the units from the farmer’s trust to his family company.
This shows how tax can bite when a forester sells post-1989 FNZUs. In this scenario, if the farmer’s NZUs were pre-1990, then the sale would not be taxed to the selling entity. However, the emission’s units would no longer be pre-1990 units in the purchasing entity making them taxable if sold with a deduction for cost at that time.
If you are participating in the Emissions Trading Scheme, it is highly advisable to know the tax implications. Findex can review your business and offer specialised help. Get in touch today with our Tax team.