European Parliament approves EU Emission Trading System reform and new EU Carbon Border Adjustment Mechanism

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EY Global

20 Apr 2023
Subject Tax Alert
Jurisdictions European Union
  • The European Parliament has approved key legislative elements of its "Fit for 55" package: EU Emission Trading System (EU ETS) reform and the new EU Carbon Border Adjustment Mechanism (CBAM).
  • The EU ETS will be extended in the aviation and maritime sectors; new ETS II will cover fuels for transportation and heating.
  • Free allowances under the EU ETS will be phased out starting in 2026.
  • A transitional period will apply for EU CBAM from 1 October 2023 to 31 December 2026, with quarterly reporting obligations only; from 2026 onward, purchasing CBAM certificates will be required.
  • Businesses are advised to assess the potential impact and prepare for new CBAM reporting obligations starting later this year.

Executive summary

On 18 April 2023, the European Parliament approved key legislative elements of the "Fit for 55" legislative package: European Union Emission Trading System (EU ETS) reform and the new EU Carbon Border Adjustment Mechanism (CBAM). Affected businesses will need to understand new requirements and upcoming reporting obligations.

The EU's "Fit for 55" legislative package, initially announced in July 2021, is viewed as a key enabler for helping Europe reduce emissions by at least 55% by 2030 (from 1990 levels). These targets are enshrined in the European Climate Law and are part of the wider European Green Deal strategy to achieve climate neutrality by 2050.

"Fit for 55" contains (i) comprehensive changes to the EU ETS, (ii) a proposal for a CBAM and (iii) revisions to the Effort Sharing Regulation (ESR), all setting emissions-reduction targets, as well as (iv) directives governing renewable energy, energy efficiency and energy taxation, to mention just a few. Over the past months, various components have progressed through the legislative process.

On 18 April 2023, the European Parliament voted in favor — with a significant majority — of revising the EU ETS and implementing the CBAM. The next step will be for the texts to be endorsed by the EU Council and published in the EU Official Journal 20 days later.

Key principles of CBAM

The CBAM is a climate measure that aims to address the risk of carbon leakage by ensuring equivalent carbon pricing for imports and domestic (EU) production that is subject to carbon costs under the EU ETS. While the EU ETS applies to installations based in the EU and to certain production processes and activities, CBAM will apply to certain goods imported to the EU.

Scope of goods covered

CBAM will cover the following product categories:

  • Kaolin and other kaolinic clays, calcined
  • Cement, aluminous cement, cement clinkers etc.
  • Fertilizers, also including e.g. ammonia, nitric acid, sulphonitric acids
  • Agglomerated iron ores and concentrates
  • Certain ferro-alloys
  • Screws, bolts, nuts, coach screws, screw hooks, rivets, cotters, cotter pins, washers (including spring washers) and similar articles of iron and steel
  • Other articles of iron or steel
  • Aluminum structures and parts of structures
  • Certain aluminum reservoirs, tanks, vats, containers
  • Stranded wire, cables, plaited bands and the like, of aluminum, not electrically insulated
  • Other articles of aluminum
  • Hydrogen
  • Electrical energy

This product list has significantly increased, compared to the list in earlier drafts of the regulation; downstream products are included, not just raw and semi-finished materials. Therefore, the list will apply to a larger number of businesses.

Political discussions seem to favor extending CBAM, by 2030, to cover all product categories that are subject to the EU ETS. This would include polymers, diverse chemicals, mineral oil products, paper and pulp, among other categories.

Transition period: 1 October 2023 through 31 December 2025

Between 1 October 2023 and 31 December 2025, transitional provisions will apply. Only quarterly reporting will be required and purchasing CBAM certificates will be optional. Instead, importers (customs declarants, indirect representatives) will have to report, on a quarterly basis, embedded emissions in goods imported during that quarter of the calendar year, detailing direct and indirect emissions as well as any carbon price effectively paid in a third country.

Notably, from 31 December 2024, importers must have an "authorized CBAM declarant" status to qualify for the import of in-scope goods.

How it will work

Under new CBAM rules, importers are required to report total verified greenhouse gas (GHG) emissions embedded in goods imported in a given calendar year. Following the transitional period (at the end of 2025), the financial impact of CBAM will gradually grow, with a progressive phase-in of CBAM costs until 2034. Carbon cost paid at origin can be deducted from the payable CBAM charges (provided that evidence of the cost can be provided).

Payment of CBAM charges will be facilitated through the purchase and surrender of CBAM certificates, which will be priced at the weekly averages of EU ETS allowances auctions.

During the calendar year, the importer must ensure that the number of CBAM certificates in its CBAM registry account at the end of each quarter corresponds to at least 80% of the embedded emissions in imported products since the beginning of the calendar year. The importer must surrender CBAM certificates in the exact number corresponding to emissions embedded in goods imported in the calendar year, in addition to submitting an annual CBAM declaration.

Definition of embedded emissions

CBAM charges correspond to embedded emissions in the named product categories and the definition of embedded emissions to be declared has been extended to indirect emissions. The declaration of emissions can be made based on actual emissions, which need to be determined based on a schema provided by the EU regulators, the details of which are not yet finalized; additional implementing legal acts containing details will be published.

If actual emissions are used, they must be accredited by independent verifiers. If no actual emissions are available, standard "default" values must used that reflect average emissions for a certain product manufactured in a specific country or region. If no reliable data to determine such standard values is available, the EU Commission will determine default values based on the worst-performing EU installations. Details will be subject to additional legal guidance documents, which are yet to be published.

Exemptions and extended circumvention practices

CBAM will not apply to goods of non-preferential origin in Switzerland, Liechtenstein, Iceland and Norway. There are only a small number of exemptions, including for low-value consignments up to EUR 150 and certain military imports.

Examples of circumvention practices have been slightly extended in what is now an open catalogue of practices that may consist of, but are not limited to:

  • Slight modification of goods to change Combined Nomenclature classification
  • Artificial split of shipments to benefit from CBAM exceptions described above
Key changes to the EU ETS

One significant change to the current system is the phase-out of free allowances. Effectively, from 2026 to 2034, the free allowances granted to EU manufacturers will fade on a progressive curve, consequently increasing the cost of manufacturing for businesses if processes remain the same.

The following phase-out rates for free allowances will apply:

Year 2026 2027 2028 2029 2030 2031 2032 2033 2034
Rate 2.5% 5% 10% 22.5% 48.5% 61% 73.5% 86% 100%

Furthermore, revisions of EU ETS will include the following changes:

  • Increase the overall goal for emissions reductions: 62% reduction by 2030 (compared to 2005 levels)
  • Increase the speed of annual reduction rate of the cap: 4.3% per year from 2024 to 2027, and 4.4% from 2028 to 2030
  • Reduce the EU-wide quantity of allowances of 90 Mt CO2 equivalents in 2024 and 27 Mt in 2026
  • Reinforce the mechanism on excessive price fluctuations, including providing for an automatic release of allowances from the Market Stability Reserve (MSR) to the market; 24% of all EU ETS allowances will be placed in the MSR to address possible imbalances between the supply of and demand for allowances in the market
  • Reinforce conditionality requirements for installations benefiting from free allowances, notably energy audits and, in some cases, climate neutrality plans
  • Remove derogation for installations for electricity generation, instead used for Modernization Fund to support decarbonization of energy sector
  • Extend application of the EU ETS in the aviation sector:
    • EU ETS will apply for intra-European flights (including departing flights to the United Kingdom and Switzerland), while CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation) will apply to extra-European flights to and from third countries participating in CORSIA from 2022 to 2027
    • When global aviation emissions under CORSIA offsetting reach levels above 85% of 2019 levels, European airlines will have to offset their proportionate share with corresponding carbon credits, invested in emissions reductions in countries participating in CORSIA offsetting
    • Free allocations of allowances to the aviation sector will be phased out by 2026; the gradual mechanism plans a decrease of 25% in free allocations for 2024 and 50% for 2025
  • Reserve, from 1 January 2024 through 31 December 2030, 20 million allowances to be allocated to cover part of the remaining price differential between fossil kerosene and the eligible aviation fuels for individual aircraft operators
  • Extend the scope of the EU ETS to maritime transport from 2024:
    • Gradual phase-in: 40% of verified emissions from 2024, extending to 70% for 2025 and 100% for 2026
    • Most large vessels will be included from the start in EU ETS, with other vessels included in "MRV regulation" (monitoring, reporting and verification of CO2 emissions) and included at a later stage in EU ETS
    • Agreement takes into account geographic specificities
    • Non-CO2 emissions (methane and nitrous oxide) will be included in the MRV regulation from 2024 and EU ETS from 2026
  • Analyze, by 2026, the feasibility of including municipal waste incineration installations in the EU ETS from 2028
  • Implement a carbon market (EU ETS II) to cover buildings and road transport by 2027 (or 2028 depending on market conditions):
    • Applies to distributors supplying fuels to heat buildings, conducting road transport and certain other sectors
    • Gradual increasing of linear reduction rate: 5.10% from 2024 and 5.38 from 2028
    • Some "frontloading" anticipated in the first year
    • Possibility for delay by one year in the case of carbon prices per ton exceeding €90
    • Anticipated prices will be capped at €45 per ton until at least 2030
    • Temporary exemption possible if suppliers are subject to a carbon tax at a national level equal or higher than auction price for allowances
    • Simplified requirements for smaller suppliers

It is important to note there will be no export rebates or refunds of carbon payments. All revenues generated by the carbon market will be spent on climate and energy-related projects.

In addition, a new EU Social Climate Fund will be set up in 2026:

  • Designed to support vulnerable households, micro-enterprises and transport users who are particularly affected by energy and transport poverty, to ensure a fair and socially inclusive climate transition
  • Funded from auctioning ETS II allowances up to an amount of €65 billion, with an additional 25% covered by national resources
  • Estimated total of €86.7 billion
Implications for businesses

CBAM and the reform of the EU ETS will affect businesses both in the EU and across the globe, from an operational perspective and in terms of strategic decision-making. Impacts may be either direct or indirect. A holistic approach across the value chain and supply chain is recommended.

EU-based operators subject to EU ETS must plan for increasing carbon costs if usage of conventional fuels is continued. Consequently, increased costs may affect competition on the EU and global market for emission-heavy businesses. With the new EU ETS II, the price of conventional fuels will further increase and may catalyze the need for transformation in this sector. It is worth noting the EU and the EU Member States nationally provide large, diverse programs of grants and incentives to support businesses in the transition. Additional revenues from the carbon market will bring further funding opportunities as part of the EU Innovation Fund, especially for businesses investing in innovative low-carbon technologies.

Immediate steps to take

The transition phase for CBAM is planned to be effective from 1 October 2023 and requires immediate action to prepare for new reporting obligations.

Initial steps include:

  • Assigning internal responsibility for management of the regime
  • Reviewing the EU import footprint and potential (cost and process) impacts considering the new proposed scope of CBAM
  • Starting to prepare to comply under the transitional-period requirements (includes reviewing required data (e.g., on embedded emissions and carbon price at the location of manufacturing), identifying potential gaps and gathering information)

Furthermore, from a strategic point of view, businesses should assess the potential financial impact of CBAM and EU ETS based on the current supply chain and take appropriate actions to mitigate the financial impact. Other anticipated changes in the energy and electricity taxation areas (e.g., revisions to the Energy Taxation Directive) may also be worth considering.

Activities could involve rethinking supply chain structures, sourcing strategies, merger and acquisition activity, production planning and investment planning to achieve technical improvements to reduce embedded emissions in imported products.

It will be important for businesses to monitor developments as the legislative process continues for CBAM and the closely interlinked EU ETS reform.


For additional information with respect to this Alert, please contact the following:

Carbon Border Adjustment Mechanism
  • Richard J. Albert, Leipzig
  • Alwyn Hopkins, London
  • Derek Leith, Aberdeen
  • Kasia Klaczynska-Lewis, Warsaw
  • Slawomir Czajka, Warsaw
  • Ashish Sinha, Zurich
  • Aron Nagy, Budapest
  • Franky de Pril, Diegem
  • Martijn Schippers, Amsterdam
  • Milen Raikov, Sofia
  • Alessandra di Salvo, Rome
  • Pedro Gonzalez-gaggero, Madrid
  • Marguerite Trzaska, Paris
  • Zoran Dimoski, Stockholm
  • Ilona von den Eijnde, New York
Emission Trading System
  • Kasia Klaczynska-Lewis, Warsaw
  • Dariusz Kryczka, Warsaw
  • Boris Scholtka, Berlin
  • Sebastian Helmes, Berlin
  • Eric-Holger Glattfeld, Berlin
Innovation Fund
  • Ingo Bunzeck, Diegem
  • Philippe Lesage, Diegem
EMEIA Sustainability Tax Services
  • Alenka Turnsek, London
  • Maike Moore, Berlin

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.