Carbon offsetting of woodlands and peatlands: what are the tax implications?

Senga Prior

Senga Prior

Tax Senior Manager

This article first appeared in Farm North East.

As the UK moves towards its target of Net Zero by 2050, investment activity in the rural marketplace is increasing, given the many schemes being introduced in Scotland and UK- wide to help achieve the Government targets for a decarbonised economy. 

The Woodland Carbon Code is one such scheme administered in Scotland by Scottish Forestry. Owners of new planting schemes calculate the total carbon sequestration over the lifetime of the trees planted, which then requires verification. Grants may be available to offset the cost of creating these new woodlands.

How does it work?

Once verified, Pending Issuance Units (PIUs) are issued. These are converted over time to Woodland Carbon Units (WCUs) which may be sold to third parties looking to offset their carbon emissions. The PIUs can also be sold but cannot be used to offset emissions until they are converted. A WCU is equivalent to one tonne of carbon captured by the woodland. The area of plantation required to generate the carbon capture varies depending on factors such as tree species and soil type.

Woodland Carbon Code schemes can last between 35-100 years so typically long-term contracts are in place between the owner and the purchaser. As of 31 March 2022, 698 projects are underway in Scotland over 49,563 hectares. We have seen values of land with potential for woodland planting already on the increase.

What are the tax implications of these transactions?

Most Commercial Woodland owners are familiar with the concept of Woodlands Income and Income Tax and Corporation Tax Reliefs for qualifying woodlands. Similarly, qualifying growing timber is exempt from capital gains tax (CGT). This means that if an area of woodland is sold, the sale proceeds must be split between the value of the timber and the value of the land (solum), with the timber element exempt but the land subject to the usual CGT rules. Various Inheritance Reliefs may also be available such as Agricultural Property Relief (APR) and/or Business Property Relief (BPR).

However, HMRC has still to clarify the tax treatment of transactions involving PIUs and WCUs. It’s possible that these sales could be covered by the Commercial Woodlands exemptions, but clarification is currently being sought. We must therefore meantime go back to basic principles, but still questions will arise as landowners look to structure inward investment and lock into existing schemes.

For example, if PIUs are sold, what has actually been sold? Is this a part-disposal of the woodlands, a sale of a right, or is it trading income, and if so what can we offset against this disposal? If an owner wishes to gift woodland, would Gift Holdover Relief be available on the value of the PIUs? Is APR and/or BPR available on the increase in land value due to the existence of PIUs? The sale of WCUs would seem more akin to trading income but if taxable, what costs, if any, are deductible? The sale of voluntary carbon credits is currently outside the scope of VAT.

The Peatland Code

A similar scheme is the Peatland Code which also involves PIUs and this time Peatland Carbon Units (PCUs). Peatlands can accumulate carbon in the form of peat at approximately 1mm a year. However, degraded peatland could be emitting carbon at a higher rate than it is storing carbon. By restoring and maintaining peatlands, through the scheme, to revegetate and/or rewet the peatland, landowners may be able to reduce carbon emissions to create PCUs. The Scottish Government has made funding available through various agencies to assist with the cost of restoration. The minimum project duration is 30 years.

The taxation issues are similar to those of the Woodland Carbon Code without, however, the possible Commercial Woodlands exemption.

These schemes can run for decades so ensuring you have the correct structure in place from the outset is essential to maximise tax reliefs and succession planning. It’s likely that more carbon offset schemes will arise and clear guidance from HMRC on the tax treatment of such schemes will become essential. Due to the long-term nature of these schemes, tax rules could change significantly between inception and sale.

Get in touch

If you would like assistance on how best to structure inward investment to acquire or lease existing land, don’t hesitate to get in touch with our experienced Rural team and Renewable Energy team. We can also provide guidance on how both the accounting and tax treatment flows from this and other natural capital schemes.

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