Manifold Times | WFW: MI and SI are proposing a Carbon Tax – contract consideration | Instant News


Daniel Pilarski and Richard Stephens Partner at the international law firm Watson Farley & Williams, on Tuesday, March 23 published an article analyzing the implications of a proposed carbon tax on ships by the Marshall Islands (MI) and Solomon Islands (SI):

The Marshall Islands and Solomon Islands have proposed that the International Maritime Organization (“IMO”) impose a levy on carbon emissions by ships. The proposed levy will be charged at a rate of US $ 100 per tonne of carbon dioxide released, and will come into effect in 2025, with the potential for tariff increases over time. Although other carbon tax proposals have been made in the past (including proposals by IMO itself), the Marshall Islands and Solomon Islands proposals are notorious for being “state-led” carbon tax plans that explicitly address shipping.

BACKGROUND: WHY CARBON TAXES?

In recent years, the global shipping industry has focused on transitioning to a more environmentally conscious fuel ship model by reducing emissions of greenhouse gases such as carbon dioxide, methane and nitrous oxide. As evidenced by our Environmental, Social and Governance (“ESG”) Survey: The Sustainability Imperative, reducing shipping’s carbon footprint is a top priority for the maritime industry. It follows the Poseidon Principles, which establish a global framework for assessing and disclosing greenhouse gas emissions by ships.

The Marshall Islands and Solomon Islands are lowland island states, particularly vulnerable to sea rise caused by global warming, and therefore have a strong stake in efforts to limit greenhouse gases. The participation of the Marshall Islands is noteworthy, as they are also home to the third largest shipping register in the world.

While solutions to the industrial decarbonization challenge are widespread and varied, a common question arises – “Who will pay the bills?” Carbon tax is one option.

IMO will be invoiced by collecting and withdrawing taxes. The Marshall Islands and Solomon Islands have suggested that at least 51% of the tax revenues collected are used for climate change adaptation and mitigation costs, while the remainder is for decarbonization and administrative research & development costs. Exactly how tax revenue will be channeled remains to be seen.

It is also possible that the tax proposal could be modified in a number of ways. For example, taxes cannot be assessed for all carbon emissions, but for all carbon emissions above a set standard, with a subsidy being paid for vessels whose emissions are below the standard. The income effect can be created by raising the tax rate above the target standard. Such a proposal would punish the vessels with the worst pollution, as well as reward the cleanest ships. Taxes can also be imposed on other greenhouse gases, not just carbon. However, the Marshall Islands and Solomon Islands proposals have effectively set a benchmark (US $ 100 per tonne of carbon dioxide, implemented by IMO, from 2025) with which to assess other proposals.

CONTRACTUAL CONSIDERATIONS

IMO will be invoiced by collecting and withdrawing taxes. The Marshall Islands and Solomon Islands have suggested that at least 51% of the tax revenues collected are used for climate change adaptation and mitigation costs, while the remainder is for decarbonization and administrative research & development costs. Exactly how tax revenue will be channeled remains to be seen.

It is also possible that the tax proposal could be modified in a number of ways. For example, taxes cannot be assessed for all carbon emissions, but for all carbon emissions above a set standard, with a subsidy being paid for vessels whose emissions are below the standard. The income effect can be created by raising the tax rate above the target standard. Such a proposal would punish the vessels with the worst pollution, as well as reward the cleanest ships. Taxes can also be imposed on other greenhouse gases, not just carbon. However, the Marshall Islands and Solomon Islands proposals have effectively set a benchmark (US $ 100 per tonne of carbon dioxide, implemented by IMO, from 2025) with which to assess other proposals.

It is debatable whether the new carbon tax will qualify as a “tax” for contractual purposes, unless a broad definition is intentionally included in the contract. “Taxes” are traditionally defined as mandatory contributions charged by governmental authorities. It is not at all clear whether the IMO (which is the specialized agency of the United Nations) is the governmental authority for this purpose.

It is possible that the standard tax provisions in a charterparty could include a future “carbon tax”, but if the parties are to reduce ambiguity, it is helpful to make it clear in the agreement that any carbon tax (whatever it may be) is borne by the agreed party. It may also be important to balance a particular language with a qualification broad enough to cover alternatives to current proposals. For example, if the agreement refers only to a “carbon” tax, but the tax is calculated on other greenhouse gases, one party could argue on technical grounds that the agreement does not cover any other taxes. This problem of expected but uncertain future rule changes has greater significance for long-term contracts. That fees are intended to drive behavior change means they must have the potential to significantly alter the economics of the charter agreement, and that cost allocation is a major issue. An additional question concerns the timing of taxation. For example, assuming the lessee has agreed to be responsible for tax, if tax is only collected after the lease term has terminated, should the expected tax be collected as part of the lease (with potential rebates for overcharging), or should it be collected only after being assessed? Another question is which party should collect subsidies to beat emission targets (if any).

CONCLUSION

The proposal by the Marshall Islands and Solomon Islands has the potential to be a breakthrough in its efforts to tax the shipping industry’s greenhouse gas emissions. Although there are still many uncertainties regarding the implementation of taxes, parties should carefully consider their current and future contracts to determine how a potential carbon tax can be handled.


Photo source and credit:
WFW
Published: April 1, 2021



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