The tax aspects of innovative financial instruments, with special consideration to environment-related securities

Abstract

It is proposed to consider some of the various fiscal aspects on the transfer of financial instruments created in terms of the Kyoto Protocol ('KP'). The KP created various market-based mechanisms with a view to allow parties to the Protocol to reduce emissions at the lowest cost possible. The core mechanism of the KP is the transferability of rights to pollute but this also gives rise to a number of income tax and VAT issues even though it was never the intention of the KP to raise tax revenue from the transfer of such rights. On the contrary, it is the efficient transfer of rights to pollute that minimises the overall cost of carbon mitigation. This study will investigate various aspects of income tax legislation applicable to the transfer of the aforementioned instruments, including the investigation of whether gains or losses derived from the transfer of a right to pollute is of a capital or trading nature, whether such gain is chargeable to income tax in Malta or otherwise and whether expenditure incurred by entities to purchase a right to pollute is deductible against the chargeable income of the entity. The provisions of the OECD Model Tax Convention with respect to Taxes on Income and on Capital will also be discussed in the context of the cross border transfer of emission rights. Various VAT issues will be also discussed, including the VAT implications arising on the issue, the transfer and the surrender of such a right to pollute. It is the large polluting entities that are usually required to mitigate their carbon footprint in terms of the KP. However, it is not uncommon that other unregulated entities voluntarily reduce their carbon footprint. These types of entities generally do so by purchasing instruments that represent a reduction of carbon dioxide undertaken by another entity. In this respect, this study will also investigate the fiscal implications arising on the issue and transfer of such instruments. This study will show that the same countries that ratified the KP did not consider the impact of their fiscal regimes on the application of the KP mechanisms.