In the context of the global Copenhagen Climate Change negotiations, the OECD says that tradeable emission permits have emerged as an "essential policy tool." The European Emission Trading System (EU ETS) established in 2005 already covers about half of total greenhouse gas emissions coming from Europe.

"With similar schemes under active consideration by a number of other countries, the share of total emissions from rich countries covered by 'cap and trade' or other tradeable permit regimes could triple in a few years. Addressing the treatment of emission permits and offsets in both direct and indirect taxation is therefore vital," the OECD stated.

The Organization added:

"There is considerable uncertainty about how much it will cost to reduce greenhouse gas emissions, and one reason for opting for cap and trade schemes is that they should provide greater certainty about levels of emissions. Such schemes would also establish a visible market price for carbon emissions, and they should be able to achieve a targeted reduction in the level of emissions over time, whatever happens to the prices of fossil fuels."

"To date, most analysis of tradeable permit regimes have ignored the role of corporate and personal income tax and value-added tax, implicitly assuming that tradeable permits would be outside these taxes or that the impact of the taxes would be neutral."

"In practice, however, keeping tradeable permits outside the tax system could give rise to distortions through the costs of acquiring permits, and proceeds from selling them, being treated differently from other business decisions."

"A more realistic assumption is that tradeable permits would be accommodated within existing tax regimes. The question is how best to do this, given the environmental objectives outlined above and considerations about good tax policy design."

"Tax administration and compliance regimes can 'piggy-back' on the administration of the tradeable permits markets, but the risk of fraud and other abuses may require particular attention to avoid giving emission trading a bad image and to protect the revenue base."

"For its part, business will be looking for tax rules that are stable and predictable, as many investments to abate emissions are capital-intensive or have long pay-back periods."

"Some of these investments to abate emissions could take place in developing countries and this raises further risks of tax obstacles distorting decisions. Similar considerations apply in relation to the tax treatment of domestic offset projects compared with other investments to abate emissions."

"How permits are originally allocated – for free or via auction – has important implications for government revenue. For example, permits issued under the European Emission Trading System cover nearly 2 billion tonnes of carbon emissions annually. At a carbon price of EUR13-15 per tonne, the fiscal revenue from auctioning one year’s emission permits would exceed EUR25bn or 0.2% of GDP."

The OECD’s Committee on Fiscal Affairs has initiated a project to develop a statement of best practices for the tax treatment of tradeable emission permits. Given the inter-disciplinary character of the issue, the OECD’s Joint Meetings of Tax and Environment Experts have a key role to play along with other working parties with competence in areas such as international tax treaties and the economics of climate change.

A side event at the COP15 Copenhagen summit will look at how carbon allowances are treated by, for example, corporate income taxes and how carbon markets can integrate globally. The discussion will cover:

• Aims to create a uniform price of carbon emissions across sectors, sources etc. and the way tax treatment of carbon allowances affects the net-of-tax carbon price and incentives to invest in abatement etc. faced by different emitters; and
• Tax treatment of carbon allowances arising when carbon markets go across national borders and tax jurisdictions; adjustments, if any, needed to pave the way for a well-integrated global carbon market.

The OECD wants to engage in a discussion with all interested countries, to build viable global solutions and report to member countries and other interested parties in early 2011.