Sharon Yong, partner at Ernst & Young Tax Consultants Sdn Bhd.
OVER the last few years, Malaysian businesses have had to familiarise themselves with the tax aspects of sustainability and environmental, social and governance (ESG) considerations.
This underpins a shift from the traditional tax function, which was mainly focused on income and indirect tax compliance and planning, to broader and more strategic matters.
One of the most discussed developments in environmental and sustainability-related tax topics is whether (or perhaps, when) Malaysia will introduce a carbon tax and/or an emissions trading scheme (ETS).
Partly hastened as a policy response to the European Union’s (EU) Carbon Border Adjustment Mechanism (CBAM), which will be fully effective from 2026 onwards, the concept is as follows:
> If the carbon tax is designed and implemented in a way that meets EU requirements, then carbon tax imposed in Malaysia on in-scope products to EU can be offset against the CBAM.
This means that the CBAM carbon price paid by importers is reduced by any carbon price already paid in Malaysia, so that the total carbon price is equal to that paid by EU producers.
> Therefore, from a policy perspective, the introduction of carbon tax in Malaysia would mean that the country effectively gets to “earn” some of the carbon price revenue arising from the CBAM.
While this makes sense, the development and implementation are proving to be rather difficult:
> Designing a carbon tax/ETS regime that meets EU requirements such that this can be offset against the CBAM levy is of utmost importance.
No credit would be allowed if the local regime is not aligned with EU requirements, potentially resulting in double taxation and hence, increased costs for the affected businesses.
> At the onset, the EU CBAM covers six products (including steel and aluminium), with the coverage widely expected to be expanded over the next few years to include most products.
Other jurisdictions, like Australia, are also looking into launching their own CBAM-equivalent regime.
The challenge is to design a carbon tax regime that is right-sized (ie, not just targeted at certain sectors or products) but which does not end up overburdening businesses, especially small and medium enterprises (SMEs).
> The revenue collected from the carbon tax/ETS should be channelled back into effectively reducing carbon emissions.
An effective regime should target emissions reductions, rather than serve merely as a means for revenue collection.
If the rate is too low, there may not be meaningful motivation for companies to take steps towards emissions reduction, and if it is too high, it becomes a burden to businesses.
> An important element of a carbon pricing regime is the availability and reliability of emissions data.
Depending on the scope and coverage of the carbon pricing regime, particularly if it involves transactions by SMEs, there is a need to provide assistance to the affected businesses in enhancing their systems and processes to collate and monitor their emissions, based on which the carbon pricing will be administered.
> Carbon pricing instruments are but one of the components in climate policy development and there needs to be holistic and wide-ranging measures working in tandem to ensure Malaysia is on track to meet its climate ambition.
For example, the Thai Climate Change Bill was recently released, and the draft legislation includes a proposed carbon tax on certain products (essentially making an adjustment to excise tax to reduce the impact) and a proposed ETS.
Indonesia has also introduced legislation on carbon tax. However, its implementation has been postponed to an undetermined date.
In the absence of a local carbon tax or carbon price on relevant exports, it is expected that Malaysian businesses affected by EU’s CBAM will explore cost-efficient ways to reduce carbon emissions and gain competitive advantage.
They could also explore new markets with perhaps less stringent requirements.
However, this would not be a long-term solution given that more and more jurisdictions are expected to introduce measures similar to CBAM.
Given the above challenges faced by businesses, it is hoped that the government (and the Inland Revenue Board or IRB) can provide some relief or, at least, certainty in tax treatment, including:
> Budget 2024 also proposed a (limited) tax deduction up to RM50,000 for each year of assessment on certain expenditure incurred on ESG-related expenditure (until year of assessment 2027), including enhancements to the sustainability reporting framework, Tax Corporate Governance Framework and transfer pricing documentation, among others.
It is hoped that IRB will provide definitive guidance or confirmation that certain expenses related to sustainability efforts will in fact be regarded as expenses wholly and exclusively incurred in the production of income, and hence deductible under general tax deductibility provisions, as well as clarify the tax treatment relating to voluntary carbon market activities.
Sharon Yong is a partner at Ernst & Young Tax Consultants Sdn Bhd. The views expressed here are the writer’s own.
