As the urgency to address climate change intensifies globally, Australia has commenced detailed policy analysis on implementing a carbon border adjustment mechanism (CBAM) — following the European Union's (EU's) lead. In a marked change from the previous Government, Australia's Minister for Climate Change and Energy, the Hon Chris Bowen, has made clear that efforts to combat carbon leakage by regulating supply chains is "a key consideration in the development of climate policy."

This stems from Australia's reforms to its Safeguard Mechanism, which commenced at the start of this financial year on 1 July 2023 and sets limits on emissions at Australia's largest industrial facilities. The proposed introduction of an Australian CBAM aims to level the playing field for domestic producers that are subject to carbon pricing and the Safeguard Mechanism and face competition from foreign producers' imported products that not subject to the same rules. A CBAM could do this by applying a "carbon tariff" at the border on imports of certain commodities, such as steel and cement, from countries with weaker emissions reduction policies.

The EU's CBAM has gained attention for its attempt to address this "carbon leakage" challenge, wherein industries shift production to countries with less stringent climate policies, undermining global emissions reduction efforts. The EU CBAM imposes a levy on industries with significant emissions, such as cement, iron and steel, aluminium, fertilizer and electricity. The goods captured by the CBAM's scope are identified based on the Harmonized System (HS) for Tariff Classification, a standardized global framework for categorizing traded goods, and are correlated with what importers would have paid under the EU's emissions trading scheme.

The EU's experience offers valuable lessons for Australia. The EU's CBAM has faced concerns and criticism from trading partners (e.g., China, South Africa, Brazil and India) that view it as a discriminatory trade barrier and could face a challenge at the World Trade Organization. The Australian review will therefore likely focus on finding the appropriate balance between its national net-zero ambitions, its trading relationships, consistency with international trade rules and possible interoperability with other CBAM schemes.

The development of policy options and the feasibility of an Australian CBAM is due to be finalized by October 2024.

To prepare for the potential implementation of a CBAM or similar carbon tariff, Australian businesses should consider:

• Undertaking an assessment of exposure and impacts by identifying the goods and sectors that could be affected by the tariff and estimating the potential financial impact on their operations
• Implementing further emission tracking and reporting to verify the carbon emissions associated with their products
• Prioritizing carbon reduction and diversification strategies to reduce reliance on high-emission products
• Evaluating existing trade relationships, proactively initiating dialogue to address concerns and exploring ways to minimize tensions
• Engaging and collaborating with businesses, industry associations and government bodies to help shape a harmonized approach to carbon pricing and trade

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For additional information with respect to this Alert, please contact the following:

Ernst & Young New Zealand

• Paul Smith, Partner, Indirect Tax, Global Trade & Sustainability Taxes | Paul.Smith@nz.ey.com

Ernst & Young Australia

• Luke Branson, Partner, Global Trade Advisory | luke.branson@au.ey.com
• Peira Shannon, Director, Global Trade Advisory | Peira.Shannon@au.ey.com

Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor