Hello and welcome once again to The Pinsent Masons Podcast, where we try to keep you abreast of the most important developments in global business law, every second Tuesday. I’m Matthew Magee and I’m a journalist here at Pinsent Masons, and this week we find out about an infrastructure obstacle to Australia’s green energy future, and we investigate a tiny tax issue that, with the explosive growth in the trading of carbon credits, could become a problem for investors and companies. It’ll be the last Pinsent Masons podcast for a little while – we’re taking a little August break – but do subscribe and share, and we’ll talk to you again in September. For now, here is some business law news from around the world:
Prohibited AI practices ‘should be an initial focus for EU businesses’ Permanent patent injunction issued in UPC first And New UK government publishes business legislation priorities
Organisations have been urged to check whether their use or marketing of artificial intelligence (AI) systems will fall under an EU ban that takes effect in early 2025. Nils Rauer of Pinsent Masons said publication of the EU AI Act in the Official Journal of the EU (OJEU) last week should spur organisations to undertake the review. The EU AI Act, dubbed the world’s first AI law, will introduce a new risk-based approach relating to AI systems applied in certain areas, under which some AI practices will be entirely prohibited. Article 5 of the EU AI Act lists a whole range of prohibited AI practices, which Rauer said should be an initial focus of businesses seeking to ensure compliance with the new legislation. The law prohibits the use or selling of AI systems that can subliminally influence, or purposefully manipulate or deceive people. It also bans selling or using systems that create or expand facial recognition databases through the untargeted scraping of facial images from the internet or CCTV footage. Rauer said he expects these provisions to take on “profound importance”.
A local division of the Unified Patent Court (UPC) in Germany has banned a business from selling certain shower tray products in seven other countries. It is the first substantive decision of the UPC since it began operating last year. Patent litigation specialist Maud van Imhoff of Pinsent Masons said the ruling by the local division of the UPC in Dusseldorf provides some important lessons for businesses in relation to litigating before the UPC, which is a dedicated judicial system for litigating new unitary patents and existing European patents that have not been specifically opted-out of the UPC’s jurisdiction. Businesses acting in multiple national markets should be aware of the reach of the UPC and act quickly when cease and desist actions are started, she said. The UK government has published its legislative priorities after 14 years in opposition. It includes laws to support the building of new housing and other infrastructure, and promote investment in renewable energy generation. 40 new legislative initiatives were announced in the speech on Wednesday. Experts at Pinsent Masons said the legislative agenda that has been set reflects the five ‘missions’ that the new governing Labour party placed at the heart of its manifesto for the recent UK general election. The five missions are to kickstart economic growth; make Britain a clean energy superpower; address serious violent crime and raise confidence in policing; reform childcare and education systems; and build and NHS fit for the future. Public policy specialist Mark Ferguson and public law and legislation expert David Thorneloe said the government will face “practical challenges” in delivering such a “packed” agenda during just one parliamentary session.
Australia has long relied largely on coal for generating electricity but, like most countries, is looking to a greener future where power comes from the sun or the wind rather than the burning of fossil fuels. But this can only happen if it’s possible to get power from where it’s generated to where it is used, and that is a challenge that threatens the viability of the country’s green energy plans. If it can meet that challenge it will be able to provide clean energy to millions and possibly be a major exporter of clean hydrogen. But if it fails the risks are significant, with ageing coal power stations likely to stop working by 2035. How big is the problem? Well in a country the size of Australia it’s pretty huge – 10,000km of energy transmission lines are needed to accommodate its green energy plans, according to Australia’s energy market operator, or AEMO. Melbourne-based Leanne Olden told me what AEMO has been saying about Australia’s needs.
Leanne Olden: AEMO, or the Australian energy Market operator, publishes what they call an integrated system plan each two years, which is really AEMO's assessment of what they see our national electricity market looking like into the future. It's a forecasting really of what AEMO sees as the future of Australia's grid. Australia has historically largely relied on coal-fired power generation for its electricity needs, and so those assets are now largely coming to the end of their life and I think the latest reporting is that around 90% of our coal generation is expected to come offline by 2035. There's a saying that's been adopted by most of the market in Australia that there's no transition without transmission and that is very true. So the ISP forecasts a requirement of around 10,000km of new transmission lines to be able to support the transition to renewable energy, and that intermittent renewable energy in particular. And for Australia, historically, because of the reliance on coal-fired power, the transmission network here is very strong in some places where it connects large cities to the regions where coal-fired power plants are located and there's also some very strong interconnection between the states but into regions where you might source renewable energy where there's the highest renewable resources, historically there has been very little need to build out the transmission network in that area and so in many respects it is somewhat behind where it needs to be to support the growth of renewable energy in Australia.
Matthew Magee: Building big infrastructure is never easy, but a combination of geography, timing and competition for resources makes for a particularly challenging situation.
Leanne: The volume of new transmission that's required is large. I think I've read estimates that Australia currently can build around 250 to 300 kilometres of new transmission line per year, and when you multiply that out, that's going to take a number of years to get to 10,000 kilometres. This transition is happening globally and so there are a large number of countries looking to effectively do the same thing that Australia is looking to do. So there's quite a lot of competition for supply of componentry, for supply of goods, for workforce and so that makes it quite tricky to ramp up. It makes it very expensive to build the projects. It makes it very hard to get the right kind of people to build the projects, which means that you often end up with issues coming up along the way because you might not necessarily have the right level of experience in the workforce. You might have delays in getting highly specialised componentry into Australia because, you know, manufacturers are supplying globally and there's a lot of competition for their supply. So it does put a lot of pressure, both in terms of a practical sense about how you actually get enough people and enough of the you know, kit. But yes, it also adds a significant cost component to those projects.
Matthew: Developers also face opposition from some of the people who live near proposed transmission lines and will have a job to do to persuade them to accept the new power lines.
Leanne said that unfortunately there isn’t a quick, neat solution to these problems, that they’ll have to be tackled one by one.
Leanne: There's obviously a need to increase the labour force, you know, retrain people where required from to be able to work in this sector from road or rail, where Australia has traditionally had high volumes of workforce in those areas. You know, it's going right back to encouraging people to have those careers, you know, at the university and school level. The supply chain issues are tricky because it needs to be really dealt with on a global basis, and there's lots of sort of macroeconomic issues that are that are facing global supply chains. It's not only Australia that's facing these issues. And so I think really the only thing that's within our control is the timing of planning for some of these things, and the sooner the better in terms of both engaging with suppliers, engaging with workforce, engaging with community, you know, the offering in terms of what life on a construction site looks like is attractive, of what living next to a transmission project looks like is attractive that we have. You know, broad the economic settings right to make Australia an attractive place to do business so that suppliers are incentivized potentially to supply to Australia over our competitors. But those are things which are really needing to be managed at a government level.
Matthew: These pinch points are having an impact on how deals are structured to do the construction work on transmission lines. The contractors who are responsible for providing the labour and materials are in a stronger position to negotiate and are using this to restructure who carries the significant risks inherent in such large projects.
Leanne: I guess one of the bigger concerns is managing cost overruns because there is a lot of volatility in the cost of some of the componentry, the cost of the impact of things like delays caused by needing to manage landowner relationships, needing to manage community relationships, all of those sorts of things across a sort of 900 kilometre transmission project. Even down to things like managing weather across 900 kilometres of transmission project, the weather at one end of the transmission line is going to be very different to the weather at the other, so makes them very difficult projects to price at a lump sum. And so we're starting to see in the market a trend towards what we call incentivized target cost contracts, where there is a risk sharing when it comes to cost overruns so that some of the kind of unique risks of transmission can be managed more equitably between contractors and project proponents. You know the economic environment here is volatile and uncertain at times. The labour resources are stretched and the supply chain is stretched and it doesn't help anyone for a contractor to go insolvent partway through a project. It may seem that offering a more collaborative arrangement with contractors is not to the project proponents favour. In fact, I think often it does allow for a smoother project delivery.
Two global policy objectives – tax harmonisation between countries and climate mitigation – are combining in an unusual way to cause uncertainty and confusion in the world of voluntary carbon credits.
Voluntary carbon credits are a mechanism for passing around the virtue of contributing to climate change mitigation. If a company does something that helps the climate – plants a forest, captures some emissions – they get credit for it. Other companies can then buy those credits, allowing them to do more climate-damaging activity, such as burning fossil fuels.
Supporters say they help climate-saving projects get funded that otherwise just wouldn’t happen. Critics say they give allow big polluters to avoid changing their ways. What is undeniable is that their use and trading activity associated with them is now big business. And where there is big business there are tax authorities.
London based Tax expert Eloise Walker has watched tax authorities’ attitudes to carbon credits change as quickly as the volume of them being traded has risen.
Eloise Walker: Particularly the voluntary carbon credit market has been exploding in the last couple of years and there's a lot more projects going on there, a lot more third party investment, consequently, a lot more credit suddenly floating around. So from being a very small market, it's suddenly kind of going into sort of explosion, particularly on a global basis now where you have income tax authorities will naturally get interested in taxing it and what's of particular interest is that a lot of tax authorities around the globe are now focusing specifically on this area where they might not necessarily you know they might hear to have seen more as a charitable endeavour, but suddenly they're focusing on it very hard going well, hang on a second, you're generating these credits, you're selling these credits, you're making, in some cases, a lot of profit out of that, which is then going back to your investors and your shareholders. You know surely that activity should be taxed, taxed in different fashion. When you're looking at something like voluntary carbon credit, when the market is incipient, there's not much going on, the tax story doesn't care about it too much. But once you start to see a solid throughput of a growing market in exchanging carbon credits, you start to think about, OK, what are these things and how should we treat them for tax purposes?
Matthew: This interest from tax authorities doesn’t happen in a vacuum – it is partly driven by events and policies elsewhere in the tax world where developing countries feel that a tax harmonisation plan designed to give them a bigger share of tax revenue has not delivered on its promises.
Eloise: It's particularly interesting when you step outside the G20, for example, to look at other areas of the world, because a lot of tax authorities and a lot of areas of the world at the moment are very disappointed with the current state of the global tax regime. There's been a project ongoing for quite some time now, hosted by the OECD whereby they said, OK, well look, we've had in place our current tax system for the last sort of 150 years in relation to how big multinational enterprises get taxed, when they're in different jurisdictions, we think we should overhaul this. And there are about 147 countries involved in looking at this framework so it was a big global initiative and it is still ongoing. The problem is it stalled and as part of that, a lot of countries, particularly countries which are still in a more of a development phase and they're going OK, fine, well where can we get more tax revenue and you therefore look at what's going on in your country and you look for example, at the fact that, you know, mangrove Groves are being restored and you know other voluntary carbon credit generative industries are ongoing and you look at those, you go hang on a second we're not really taxing those. We're treating them as some sort of intangible. Maybe we can treat them something else that will give us some more money.
Matthew: So companies undertaking carbon credit-earning projects, or those funding them by promising to buy the credits, should be aware that there may be a new, unforeseen and unpredictable tax liability that could affect their returns.
The tax authorities have to be careful about double taxation – if the buyer and seller of carbon credits are both French, for example, and paying tax on their income in France, it can’t be taxed again simply as income in Belize where the project is. So authorities are looking for other ways to think about and define carbon credit-related activity.
Eloise: There's a whole worldwide group of double tax treaties, which basically say that if you've got a multinational enterprise, let's say they here in the UK, but they're funding or they're doing or they're buying some carbon credits somewhere else normally that double tax treaty will look at that under established principles and go no, no, only the UK can tax that. You, Ghana, Indonesia, wherever can’t. So part of the problem is there's lots and lots of different ways of taxing carbon credits. So you know you can view them as effectively part of your trade. You can view them as an intangible asset, so they might be subject to an intangible regime, either you know for the buyer or the seller, or indeed the jurisdiction where the credit is rising, or you can treat them as a potentially as attached to the land and the difficulty you've got is that you can have three different jurisdictions, all of whom treat voluntary carbon credits differently and so the possibility is that you could end up with, you know, different taxes applicable in different jurisdictions and actually to different parties in different jurisdictions without any necessary consensus across the board as to how these things should be taxed. So one of the problems of it being such a growing and burgeoning area is all of that is kind of, you know, it's going to take maybe the next decade or so for all of that to settle down for people have some certainty around what the tax treatment is going to be.
Matthew: Eloise says that this is a growing issue, and that any company involved in generating, buying or trading voluntary carbon credits needs to plan ahead in an uncertain environment.
Eloise: A lot of people got used to the idea of, particularly in the world of voluntary carbon credit, you don't need to really worry too much about tax, you know, in jurisdiction you worry about, you know, the entities who are buying and selling them most of whom may well be outside the jurisdiction where the project is taking place. First of all don't forget to ask your local jurisdiction what the tax treatment of the voluntary carbon credits is and sort of tease out the answer to make sure. But particularly in some countries where this is a very new and burgeoning industry, the person you're asking the question or might go, I kind of I don't understand the question, what do you mean? So you might have to sort of tease and ask a few different questions and sort of ask around it a bit to make sure that you're absolutely happy that for example, it won't be treated as an interest in land and you weren't there for me to have a have a tax bill in wherever the project might be. The second thing I'd say is because this is very much in flux as a second practical point, remember I said that many of these projects are very, very long standing you know it could be 10 years, 20 years, 30 year project and it's going to be throwing off credits you know over a long period of time, when you are entering into some of these, you know secondary contracts to buy the voluntary carbon credit quite often you'll be buying them to on sell them over a long period of time. And so when you are doing your contract, try to do a little bit of crystal ball gazing and make sure that your contract terms are such so that it's very clear if there is a change in law and suddenly these things become taxable in a different way that you have built in, who is going to take the cost of that tax be it the buyer or the seller or be it or be it the project company itself. Because otherwise you could for example, find yourself locked into a contract you know, buying these over a period of time and suddenly discover that your rate of return is dropping because you've got some unexpected tax leakage in the project jurisdiction.
Matthew: That's all from us. Thanks for listening. In fact, that's all from us for a little while. We'll take a break in August and we'll be back to bringing you the most up-to-date news and analysis on business law developments every fortnight from September. In the meantime please do rate, review, share, subscribe, tell your friends, tell your colleagues about the Pinsent Masons Podcast. For a little while then, goodbye and do tune back in again in September. The Pinsent Masons Podcast was produced and presented by Matthew Magee for international professional services firm Pinsent Masons.
