A beginner's guide to carbon taxes
Duane Newman, EY Tax partner
Carbon taxes have become an important tool in the fight against climate change, designed to curb emissions by placing a price on carbon pollution. This beginner's guide unpacks what carbon taxes are, how they work, and why they matter for businesses and individuals aiming to reduce their carbon footprint.
Rising carbon levels are speeding up global warming, reshaping climates and triggering severe and abnormal environmental events. For example, who could have predicted severe flooding and snow blizzards hitting KwaZulu-Natal at the times they did? These climate shifts are hitting our economies too, disrupting industries like agriculture and fisheries, and driving up infrastructure repair costs, especially in vulnerable regions. To curb this, the United Nations set a target to keep global warming below two degrees Celsius above pre-industrial levels this century, a commitment that most countries, including South Africa, have pledged to support.
South Africa's outsized carbon footprint
South Africa's reliance on coal energy makes it one of the largest emitters of carbon dioxide in the world. According to Statista, South Africa produced 397 million metric tons of carbon dioxide (MtCO2) from fossil fuel combustion and industrial processes in 2023. Countries use various mechanisms to help meet global warming goals, actively supporting and encouraging their largest carbon emitters to shrink their carbon footprints. Legislators, for example, can regulate emissions by offering incentives for meeting specific carbon targets or by outlawing certain levels or types of emissions. Positive and negative tax incentives are also on the table. In most developed markets today, businesses above a certain size or in high-carbon sectors must report their carbon emissions.
Tracking carbon emissions
Three categories of carbon emissions have been developed to help governments understand and manage the specific sources of carbon in each national environment. Scope 1 emissions, for example, include all the carbon emitted directly on the site of any premises directly owned or operated by an organisation or business. These typically include emissions associated with fuel combustion or process emissions. Scope 2 emissions include indirect emissions, like the carbon indirectly emitted when using Eskom electricity produced from coal. Scope 3 emissions take all your suppliers' carbon footprints into account as well.
For example, a vehicle manufacturer in South Africa has a relatively small Scope 1 carbon footprint from its buildings and assembly operations. Consuming Eskom's electricity generated from fossil fuels, however, means that it will certainly be responsible for Scope 2 carbon emissions. The bulk of its iron, steel and aluminium inputs, however, are produced by extremely carbon-intensive metals smelting processes. The manufacture of its battery and electronic components are also extremely carbon intensive. These emissions will form part of the business's Scope 3 footprint even though these emissions are not generated on site.
Taxing carbon emissions
Since 2019, South African businesses exceeding industry-specific carbon tax thresholds are required to report their carbon emissions to the Department of Forestry, Fisheries and Environment and are taxed on these emissions.
From 2019 to 2023, businesses exceeding these thresholds were taxed at a rate of R120 to R159 per tonne. This rate increased to R190 per tonne in 2024. Some business, such as those producing Ammonia, for example, do not benefit from a threshold at all and are liable to pay carbon tax regardless of their emissions profile or production capacity.
For now, however, very few businesses actually pay the full R190 per tonne of carbon dioxide equivalent (CO2e)1 above the threshold. This is because carbon emitters currently receive rebates of up to 95% of their tax liabilities (85% if one considers the cost of carbon offsets as a tax cost itself and excludes the demanding performance benchmark). This is due to a combination of:
- A basic allowance for fuel combustion of up to 60% or a basic process allowance of up to 70%
- Allowances for trade exposure of up to 10%
- A performance benchmark of up to 5%
- A carbon budget allowance of 5%
- A carbon offset allowance of 10% for fuel combustion and 5% for process emissions
In the meantime, National Treasury has indicated that it will increase carbon taxes at rates above CPI inflation up to 2030 and beyond. In parallel, National Treasury has also proposed for a reduction in the basic tax allowance in 2026, with a gradual further phasing out over time. By 2030, South African businesses above the carbon tax threshold will be paying in the region of R462 per tonne of CO2e annually.
True cost of carbon to your business
Unfortunately, understanding the full cost of carbon in your business doesn't end with calculating carbon tax.
- Additional fossil fuel costs
South African businesses are not currently taxed on their Scope 2 and 3 emissions. In many other jurisdictions, however, businesses are made responsible for direct and indirect emissions. It is anticipated that, in time, South African legislation will conform with global best practice, developing a domestic mechanism to make businesses account for their Scope 2 and 3 emissions as well.
For now, Eskom, which is subject to pay a Scope 1 carbon tax on its production of electricity from coal, is able to offset its tax liability through an environmental levy charged to customers. From January 2026, however, Eskom's Scope 1 carbon tax is expected to exceed the revenue it collects from the environmental levy, which will also fall away. Eskom will be allowed to add the costs of its carbon tax to its electricity price, effectively passing on Eskom's carbon costs to consumers.
- Allowances phased out
From 2026, South Africa's current and very generous carbon tax allowances will begin falling away. Existing allowances mean that some businesses currently receive a rebate of up to 95% on their carbon taxes. As these allowances are withdrawn, businesses will be paying significantly more. In addition, when businesses are eventually made accountable for their Scope 2 and 3 emissions as they are in other jurisdictions, the carbon tax implications for South African businesses will increase exponentially.
- European carbon tax double whammy
Businesses exporting to Europe face a double whammy. From 2026, those businesses will be required to pay the carbon price differential between South Africa's lighter carbon tax regime and Europe's more stringent one. In 2026, when the European Union's Carbon Border Adjustment Mechanism (CBAM) kicks in, European carbon taxes are expected to be around €85 (around R1,630) per tonne of CO2e. This is 15 times higher than our carbon taxes, which are expected to be set at €5.5 (around R105) in 2026, after taking tax allowances into account. It is estimated that CBAM threatens R52.4 billion of South African exports.
Decarbonisation as a tax mitigation strategy
Electricity costs aside, the huge future tax liability presented by carbon emissions is focusing attention on the technologies and organisational and financial incentives to decarbonise a business' entire ecosystem. From accurately accounting for carbon emissions, producing or sourcing clean energy, to identifying carbon-neutral suppliers, decarbonisation is being adopted by South African business leaders as the most urgent and pressing tax risk mitigation strategy.
1Carbon dioxide equivalents (CO2e) are a measurement of the impact of greenhouse gases on the environment. This measurement works by showing the total amount of greenhouse gas emissions in terms of the equivalent measurement of carbon dioxide.
Other greenhouse gases, like methane, have different global warming potentials (a measurement of the potential impact a greenhouse gas has on global warming over a given period) compared to carbon dioxide. By converting all greenhouse gas emissions into CO2e units, it becomes easier to compare the impact of different types of emissions and to create strategies for reducing GHG emissions.