What is CBAM?
“CBAM” stands for Carbon Border Adjustment Mechanism and is one of the key elements of the European Union’s (“EU”) “Fit for 55”-package. The CBAM’s main objectives are to avoid carbon leakage, contribute to the EU’s goal to be climate neutral and encourage partner jurisdictions to “decarbonize” their production processes by leveling the playing field in carbon-pricing between the EU and third-country producers. The CBAM is a border adjustment mechanism for CO2-emissions that aims to ensure that the cost of those emissions is adequately reflected in the price of products imported into the EU [here’s a link to the EU’s explainer].
One of the main objectives is to avoid carbon leakage. Carbon leakage occurs when companies based in the EU move carbon-intensive production to a non-EU country where less strict climate policies are in place, or when EU products get replaced by more carbon-intensive import products. By designing a border tax, it will impose costs on other economies and therefore create an incentive for other countries to align closely with the EU’s climate goals.
The CBAM is designed to function in parallel with the EU’s Emissions Trading System (“EU ETS”). The EU’s ETS is the world’s first international emission trading scheme and the EU’s flagship policy to combat climate change. EU’S ETS sets a cap on the greenhouse gas emissions (GHG) that can be released from industrial installations in certain sectors. The CBAM focuses on imports into the EU whereas the ETS prioritizes goods that are produced within EU borders. Therefore, the importation of high carbon leakage risk goods from all non-EU countries is covered by the CBAM-regulations unless the goods are imported from certain third-countries that participate in the ETS or have an emission trading system similar to the Union’s. Goods that are produced in countries that participate in the ETS or have a similar system, already compensate for the carbon impact of their goods. Thus, goods originating from the European Economic Area and Switzerland, which are imported into an EU-country, are not covered by the CBAM-regulation.
The CBAM will initially apply to a selected number of goods that have a significant carbon impact and that have the most significant risk of carbon-leakage, such as: iron, steel, cement, fertilizer, aluminum, hydrogen and electricity (“CBAM-goods”). Importers of those goods will have to, individually or through a representative, register to participate in the CBAM and buy CBAM-certificates. CBAM-certificates are certificates that importers have to buy before importing the CBAM-goods into the EU and will compensate the CO2 as if the CBAM-goods were made in the EU. The CBAM-certificates are not linked to the EU ETS-system but will mirror the price of these allowances to ensure a coherent approach to the pricing under the EU ETS.
Entry into force
The CBAM-regulation entered into force after its publication in the EU Official Journal in May 2023. First, there is a transition period, from the 1st of October 2023 until 31st of December 2025. During the transition period, importers will have to submit a CBAM-report containing information on the goods within the scope of the CBAM but there is no financial adjustment to be made by the importers. Hence, the importers don’t have to surrender CBAM-certificates. The definite system becomes fully operational in 2026, whereas the imports will have to buy CBAM-certificates and compensate for the CO2 of the CBAM-goods.
(Reporting) obligations per 1st of October 2023
As of the 1st of October 2023, importers of CBAM-goods are required to submit quarterly reports. The deadline for the report is one month after the end of each quarter, therefore the first report is due in January 2024. The CBAM-reports must -at least – include the following content: 1) quantities of CBAM-goods imported during the quarter, specified per country of origin per production site, 2) the embedded direct and indirect greenhouse gas emissions (GHG), and 3) the carbon price due in the country of origin.
The main objective for the first (transition) period is to serve as a pilot and a learning period for all stakeholders (importers, producers and authorities) and to collect useful information on embedded emissions to finetune the methodology for the definitive period.
During the transition period, there is some flexibility regarding the reporting methods, in the first year the importers may choose between three ways of reporting. The importers can choose between:
- Full reporting according to the new methodology (EU-method);
- Reporting based on equivalent third-country national systems;
- Reporting based on reference values.
As of January 2025, only the EU method will be accepted. The EU-method calculates the embedded emissions based on the source streams or based on the emission sources. The source streams-calculation calculates the embedded emissions on the basis of activity data and laboratory analysis and the emission source-calculation calculates the embedded emissions by measuring the concentration of the relevant greenhouse gas.
Obligations per 1st of January 2026
The full scope of the CBAM-regulation will enter into force on 1st of January 2026. From that moment on importers will need to 1) obtain authorization in order to import CBAM-goods (and become an “authorized declarant”), 2) declare the quantity of CBAM-goods imported into the EU and their embedded greenhouse gas emissions on a annual basis, and 3) hand in CBAM-certificates to cover the declared emissions. If importers can prove, based on verified information from third-country producers, that a carbon price has already been paid during the production of the imported goods, the corresponding amount can be deducted.
Importers of CBAM-goods must purchase CBAM-certificates, where one CBAM-certificate must equal one tonne of GHG emissions measured in the concerned CBAM-goods. In essence, the number of CBAM-certificates must equal the total embedded emissions in the CBAM-goods imported. The price of the CBAM-certificate will be based on the average trading price of EU ETS allowances in the week prior to the import. If importers can prove that a carbon price has already been paid during the production of the imported CBAM-goods, the corresponding amount can be deducted.
The CBAM-certificates are valid for two years from the date of purchase. To benefit from fluctuations in the price and for flexibility in the CBAM-obligations, importers can re-sell CBAM-certificates to the competent national authorities. The number of certificates subject to resale is limited to one-third of the total CBAM-certificates purchased by all the importers during the previous calendar year. This is a big difference compared to the ETS, it’s not possible to trade the CBAM-certificates with other importers of CBAM-goods.
Does the CBAM qualify as tax-legislation?
From a legal point of view, the CBAM is not a customs duty or an import tax but a measure to ensure that imported goods include a price for their carbon emissions. The payment is made through an obligation to purchase CBAM-certificates upon importation. The CBAM is actually a new resource from the EU levied on goods that cross the EU-border. The CBAM is similar to customs duty and import tax because it’s a levy on goods and it triggers a payment by releasing imported goods into the EU’s territory.
Importers who are going to import CBAM-goods into the EU territory must:
- Apply for authorization from the local authorities before they start importing CBAM-goods;
- Submit a quarterly CBAM-declaration for the imported CBAM-goods.
The importers will need to provide the following data:
- The quantities of the imported goods;
- The associated commodity codes;
- The countries of origin;
- The production location details, identified by the United Nations Code for Trade and Transport Location (UN/LOCODE). Such as: address and geo-location data;
- The production routes used;
- The specific (in)direct emissions;
- The carbon price paid in the country of origin and any rebates or other forms of compensation to that price.
Penalties for non-compliance can be imposed if the importers don’t file their quarterly CBAM-reports. The fines will be between EUR 10 and EUR 50 for each tonne of unreported embedded emissions.
What steps to take?
The CBAM-regulation comes with a complex administrative process. Unfortunately, this is nothing unusual for the EU. It’s important for importers who fall within the scope of the CBAM to take action as soon as possible as the first reporting period starts on the 1st of October. The first reports must be filed before the last day of January 2024. Importers must be ready to account for and report the embedded emissions and be able to buy the CBAM-certificates in 2026. In addition, we advise importers of non-CBAM goods to keep a watchful eye on the CBAM-legislation. The reason is that the main objective of the CBAM is to decarbonize the EU’s economy and turn Europe into the world’s first climate-neutral continent by 2050. As a result, it is likely that the CBAM-legislation will be expanded rapidly to other product categories that undergo complex manufacturing processes as well as finished products.
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