Lawyers push for clarity over taxation of carbon credits

The failure by Kenya Revenue Authority to categorise carbon credits as either goods or services, is creating an uncertainty on how to effect Value Added Taxes, legal experts now say.

Corporate Commercial lawyer and Partner at Cliffe Dekker Hofmeyr Alex Kanyi argues that carbon credits remain undefined under the country’s Value Added Tax (VAT) regime, a scenario likely to create risks for project developers, investors and traders.

Speaking during a session on the taxing carbon revenues, Kanyi said that despite Kenya’s progress in regulating carbon markets, the VAT treatment of carbon credits remains unclear — a gap that could affect pricing, cash flow and compliance across the sector.

Under Kenya’s VAT Act, goods and services that are not expressly exempt or zero-rated are subject to VAT at the standard rate of 16 per cent.

However, he points out that carbon credits are not explicitly classified as either goods or services, leaving project developers uncertain about whether VAT should apply to carbon credit transactions.

“But what we are learning and from my experience in dealing with tax on carbon projects, there is really a gap in terms of then how to look at taxing carbon credit revenues,” said Kanyi.

“And this gap becomes even more clear when you look at how transactions in the carbon market space are structured. You will find multiple entities doing different things in that particular space.”

CDH environmental law consultant Clarice Wambua, added that Kenya is one of Africa’s leading carbon credit producers, having issued more than 52 million credits by 2024.

Projects range from forest conservation and sustainable agriculture to clean cookstoves and renewable energy initiatives.

But experts caution that without a clear statutory definition, disputes with the Kenya Revenue Authority remain possible. They further added that Kenya’s emerging carbon market needs incentives rather than punitive taxation if firms are to meaningfully participate in climate action.

The issue gained prominence following a recent decision by Kenya’s Tax Appeals Tribunal in the Wildlife Works Sanctuary Limited case, which focused on corporate income tax and transfer pricing but did not address whether carbon credits constitute goods or services for VAT purposes.

KRA had issued tax assessments amounting to Sh6.9 billion for the period between 2018 and 2021, arguing that carbon credit revenues accrued in Kenya and that the Kenyan entity performed the core functions of the project, thereby justifying corporation tax and withholding tax on what it treated as deemed dividends.

However, the Tribunal found that Wildlife Works Sanctuary Limited acted strictly as a service provider, while the risks, funding, marketing, and revenue recognition related to the carbon credits rested with Wildlife Works Carbon LLC in the United States, effectively dismantling the tax authority’s transfer pricing adjustments.

While the Tribunal ruled in favour of the taxpayer, the experts caution that the decision does not exempt carbon revenues from taxation in Kenya, but rather highlights procedural and evidentiary gaps in how the assessments were applied.

“Carbon projects operate on tight margins and long timelines. Unexpected VAT assessments can significantly affect project viability, particularly where pricing assumptions were made years earlier,” said Wambua.

Kenya has in the past two years put in place a growing legal and regulatory framework aimed at positioning the country as a key player in global carbon markets, following a series of legislative and policy reforms introduced over the past two years.

 In June 2023, Kenya sold a record 2.2 million tons of carbon credits to Saudi firms (including Aramco and Saudi Electricity Company) for approximately $6.27 (Sh808) per metric ton, in one of the largest single transactions globally.