100225 CRC the new Tax

article written for RICS Commercial Property Journal

CARBON REDUCTION COMMITMENT (CRC) and the Property Market

The full name of the CRC is the Carbon Reduction Commitment Energy Efficiency Scheme.  This monolithic bureaucratic structure, conceived originally as a carrot and stick mechanism to promote better behaviours and greater energy efficiency, is a monumentally inefficient means of taxing owners of properties and/or businesses in occupation.

But wait! Do we not already have a tax on ownership or occupation of commercial properties?  Do we not also have other measures built in to the transaction process to measure buildings (EPCs)?  What about the Climate Change Levy already imposed on fuel bills?  Surely there must be a more efficient way of levying a tax on the emissions of CO2.

The key concept of CRC is that it is meant to drive better behaviour through the potential adverse impact on corporate reputation if businesses failed to improve relative to their competition or their customers’ expectations.

This concept is a noble one and it has more than half of its merits founded in good economic principles.  For example, the intangible value of a brand is (simplistically) the surplus of share price after capitalising net assets.  For some brands this can be a very large number and anything that put reputation at risk would be aggressively managed by the company’s board.

The problem is that the legislation and, more particularly, the regulations are overcomplicated and institutionalise a major schism between the organisation responsible for reducing carbon and the people operating the facilities and equipment that emit the carbon.

That fundamental gap is large enough in a simple organisation where the operator is an employee of the company.  For landlord and tenant relationships (with existing legacy agreements in place) this represents a fundamental failure on the part of firstly DEFRA and subsequently DECC to understand how leases work.

The remoteness of the parent company of a property investment company from the operator employee of a tenant in one of its buildings is one issue; the inability for a landlord to influence the energy efficiency in the normal flow of a tenant’s business is another.  Clearly a landlord could volunteer to invest capital in the building infrastructure to make it more efficient; it would have to justify its investment by securing a return on investment from the tenant.  There is no mechanism in traditional leases to enable a landlord to make an investment in such a way and, in any event, how would this operate at rent review?

Furthermore, if a tenant in a sparsely-populated office sought to assign its lease to a call-centre operator or dealing floor, could the landlord withhold consent to the assignment on the grounds that the new tenant’s energy use would be much greater and that this could lead to reputational risk and even cost under the CRC scheme?

There is no good reason to believe that most CRC Organisations will be either inclined or motivated to invest in major improvements as there will be more than 5,000 organisations in the league table and the marginal benefits are by no means clear.

Unfortunately, this inertia translates into a lack of evidence of any increase in rental or capital value accruing from the greening of buildings and it is time for a rethink.

Part of the problem is the lack of good, auditable and replicable data to show what (irrespective of the economic arguments may be) the carbon return on carbon investments may be.  This concept sounds, perhaps, like a theoretician’s delight.

One way of looking at this is that, if it is energy use that is being taxed, all fuel and energy suppliers should be required to express their invoices in terms of both the units used today and kgCO2.  Any Carbon Tax could be applied by the suppliers and paid as CCL is today through the utility bills.

As to the reputational piece, it seems ridiculous that we have not all been required to complete annual Display Energy Certificates to highlight how well we perform (and these need to be couched in terms that respect the use and space-use density to which the property is put).  This would encourage tenants to require an EPC from the landlord and to engage in discussions about how to improve the performance of that particular building or space.

Equally, it seems to me there is some scope for aligning EPCs and DECs (assuming the latter has some measure of intensity applied to it) such that a coefficient of DEC over EPC can be developed and can effectively become a ‘greenness’ indicator.  If this were robust enough, this coefficient could be used to charge poor performers more than better performers – say, by taking carbon tax and multiplying it by the coefficient.  A business that uses a lot of energy but which takes substantial measures to reduce its carbon emissions could pay much less than a wasteful competitor.

In practice, it may even be possible to see a situation where, if carbon is the new cash (as witnessed by the increasing propensity for taxes to be raised against its use), carbon should be accounted for in a similar way to that in which cash is reported – namely, through a Balance Sheet, Profit & Loss Account and a Statement of Sources and Applications.

In this context, a building that has an expected life of forty years and which uses 40,000 tonnes of carbon to construct and an annual operating CO2 of 2,000t would show initially as an Asset on the Balance Sheet of 40,000t, depreciated at 1,000t per year.  Each year, therefore, 1,000t would be transferred to the P&L account and added to the annual running energy use to give a total of 3,000t per year.

This annualised carbon cost of 3,000t could be compared to alternatives where, say, the carbon cost of refurbishing a fully carbon-amortised building were 10,000t but where the annual operating carbon use would be 2,500t.   Here, the amortised annual carbon cost would be 250t per year which would be added to the 2,500t operating use to make a total of 2,750t per year.

The Statement of Sources and Applications would record the actual use of carbon – so, in year one of the first example, there would be an ‘acquisition’ of 40,000t and a ‘disposal’ of 3,000t.

It would be a relatively short step – having encouraged the accurate measurement and counting of carbon in and out of an organisation – to charge taxes based on the amount of carbon added to the product or service by the company (we could call that Carbon-Added Tax).

These may be flights of fancy, at least until we have good carbon measurement, but almost anything would be better than the CRC tax with its distortions and bureaucracy, and we are likely to see new tax innovations as we combat the combined climate change targets and the economic deficit.

 

Julian Lyon MBA (distinction) FRICS – 25th February 2011.

Julian is a member of the Corporate Occupier Group of the RICS.

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