How can Malaysia design an effective carbon tax that drives sustainability without burdening businesses?

As Malaysia prepares to introduce a carbon tax in 2026, Sharon Yong outlines the need for clear policy design, robust data systems and inclusive support for SMEs to facilitate effective carbon pricing and competitiveness ahead of Budget 2026.

In brief

• Malaysia plans to roll out a carbon tax in 2026, with details expected in its Budget 2026 proposals to guide business readiness and compliance.
• Policymakers must consider clarity, data accuracy and alignment with international frameworks, such as the EU Carbon Border Adjustment Mechanism (CBAM).
• Support for SMEs and broader ESG-related tax deductions are crucial to make carbon pricing fair, practical and growth-driven.

AS Malaysia prepares for Budget 2026 amidst an evolving landscape of carbon pricing and carbon markets, like other countries, there is a need for a policy rollout both from a sustainability perspective (in meeting our Sustainable Development Goals) as well as economic reasons, for example, in anticipation of the European Union (EU) carbon border adjustment mechanism (CBAM) entering its definitive phase in January 2026.

Malaysia is set to introduce a carbon tax in 2026.

To date, apart from the sectors covered (initially iron, steel and energy), there is no information available on the scope, rate and collection mechanism of the new carbon tax.

It is hoped that details will be made available in the Budget 2026 announcement to allow time for the affected businesses to prepare, not just in terms of compliance but also budgeting and making financial and strategic decisions.

For example, Singapore’s carbon tax applies to facilities emitting 25,000 tonnes or more of CO2 equivalent annually, effectively covering about 50 industrial facilities that account for approximately 80% of the country’s total greenhouse gas emissions.

Granted, the Malaysian industrial landscape is much wider and more fragmented and requires thought in designing a scope that can balance the coverage of emissions and overall setup and compliance costs.

There is also no news yet on whether Malaysia will introduce any emissions trading scheme (ETS) in parallel with the carbon tax.

As we have seen in many countries, the scope and mechanism of the ETS can vary, for example, specific to geographical locations, sectors or a combination of both.

Starting from January 2026, the EU CBAM will require importers to purchase CBAM certificates based on embedded carbon emissions. 

Malaysian exporters of steel, aluminum, cement, fertilisers, electricity and hydrogen must have accurate emissions data, proper harmonised system code classification and close collaboration with EU buyers to adhere to compliance needs, as well as negotiate with their customers on which party will bear the CBAM costs.

It’s important to understand how Malaysia’s carbon tax (and any emissions trading system) interacts with the EU’s CBAM, which starts in 2026.

In particular, we need clarity on whether Malaysia’s carbon tax can help offset CBAM charges.

This depends on whether both systems are aligned in terms of carbon pricing. If they are, it could reduce tax leakage for Malaysia and prevent Malaysian exporters from additional tax burden.

It would be reasonable to expect the government to announce a low tax rate at the onset of the carbon tax rollout to avoid inflationary impact and to allow monitoring and refinement of its implementation.

At the same time, the government should continue with subsidy reforms, particularly for diesel and cooking oil.

Carbon tax is generally imposed on emissions, and the implementation of such tax is underpinned by accurate and reliable information on carbon and greenhouse gas (GHG) emissions.

This in turn necessitates a robust measurement, reporting and verification system for accuracy and reliability. 

It is expected that the scope of carbon tax will eventually be expanded to cover other sectors. At the same time, other developments need to be considered.

These include requirements driven by financial institutions, initiatives like the National Sustainability Reporting Framework, and international standards on sustainability reporting.

This means most businesses would be required to track and disclose their carbon and GHG emissions.

Ultimately, carbon tax, apart from being a revenue source for the country, is also a policy lever to drive behavioral changes, including for businesses to innovate and act in reducing their emissions.

While larger businesses have the resources to invest in emissions tracking and reduction technologies and innovation, small and medium enterprises (SMEs), which form a very large part of the Malaysian economy, often operate with limited budgets and may not have access to technical capacity.

Hence, the administrative burden of understanding and complying with new carbon pricing policies can be difficult for SMEs, which may not have dedicated sustainability teams and resources to interpret complex regulatory requirements.

Currently, certain environmental, social and governance (ESG)-related expenses are given tax deductions.

These include costs relating to certain ESG reporting, technology and software systems for ESG metrics and GHG calculation, as well as tracking and capacity building. 

However, it should be noted that such deductions are limited to a combined cap of RM50,000, together with other expenses for e-invoicing and transfer pricing documentation.

Also, tax deductions are limited to financial institutions and companies listed on Bursa Malaysia.

To support businesses, especially SMEs, it is hoped that the deduction is extended to SMEs, with a higher deduction for ESG expenses.

The inclusion of SMEs in the national carbon pricing strategy is essential for equitable and effective climate action.

There is a need for carbon tax implementation that does not disproportionately burden smaller businesses, instead fosters innovation and competitiveness across all sectors.

We look forward to seeing how the Budget 2026 announcements will make Malaysia more competitiveness in this space and support compliance by Malaysia businesses.