The National Treasury has released its long-awaited discussion paper on phase 2 of South Africa's carbon tax regime, proposing adjustments that will be implemented from 2026 to 2035.
While this provides South Africa's businesses with much-needed clarity on the effective carbon tax rates they may face, there are concerns the proposed adjustments would put undue strain on the economy.
The Treasury notes in its discussion paper the total explicit carbon-based taxes generated about R14.3bn in tax revenue in 2023/2024.
The document advocates for a gradual reduction in the basic tax-free allowance afforded to businesses, which would see their effective carbon tax rates increasing.
The first phase of South Africa's carbon tax, introduced in 2019 at a headline rate of R120 per tonne of carbon dioxide equivalent (t/CO2e), provided significant tax-free allowances ranging from 60% to 95% to “ensure a cost-effective transition”.
The Treasury proposed that the 60% basic tax-free threshold, which applies to all emissions, be reduced by 10 percentage points in 2026, followed by an annual reduction of 2.5 percentage points from 2027 to 2030.
Duane Newman of EY tax consultants said the big-step change from 2025 to 2026 was unexpected, as tax changes are normally phased in over a gradual period.
“I think they also want to give a signal to the market, because there is a lot of commentary that the effective tax rate is too low. I think that’s the wrong approach — it should be gradual, so that businesses can adapt,” said Newman.
Added to this was a 15 percentage point increase in the carbon offset allowance for fuel combustion and process emissions. Newman said the big-step change was good news for carbon offset projects.
“We need to create liquidity in the local carbon offset market to trade carbon credits. Currently, the market is too small — there is not enough interest to develop carbon credits in the South African market.”
Liquidity
To create more liquidity in the market, Newman said the carbon offset allowance should be higher and increase gradually to compensate for the phasing out of the basic tax-free allowance.
To balance out the increases in carbon offset allowance, the Treasury also proposed the complete removal of the trade exposure allowance for combustion emissions, a move Newman said needed to be challenged, given the industry’s exposure to trade.
The Treasury also proposed the removal of the carbon budget allowance — which provides incentives for companies to report their carbon budgets — take place from 2026 rather than the previous target of 2025 — meaning companies could continue to benefit from this allowance next year.
“Currently, you get that allowance if you submit a carbon budget to the government, but they are going to effectively replace it with a carbon budget penalty,” said Newman.
This means businesses will now go through a process of setting a cap on their emissions, subject to government approval, and face a carbon budget penalty of R640t/CO2e if they exceed that limit. However, the details of how this carbon budget penalty would be implemented were unclear, said Newman.
Another notable development was that the electricity levy applied to non-renewable electricity generation could be removed and replaced with the carbon tax.
“From a carbon border adjustment mechanism perspective, that is good news for businesses — such as in the aluminium and steel sector — which export to Europe and the UK, because that legislation says you can only get credit for explicit carbon taxes, which does not include the electricity levy.”
Replacing the electricity levy with the carbon tax would enable businesses to get a credit for the electricity levies they pay. However, that increase in carbon tax is likely to have to be passed through in the electricity price, said Newman.
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