BNG and other Ecosystem Service markets – was the official tax guidance worth the wait?

First promised in the Spring Budget 2024, the Government’s Technical Note on Ecosystem Service markets was finally published on 14 May, but how much clarity has actually been provided, and was it worth the long wait?

Ecosystem service markets broadly refer to payments made by property developers and others to landowners for delivering environmental benefits, such as biodiversity enhancement, nutrient reduction, or carbon sequestration.

These arrangements are no longer niche. Developers have mandatory Biodiversity Net Gain (BNG) and Nutrient Neutrality requirements and, alongside the previously established carbon offset activity, the markets are becoming a mainstream part of land management strategy.

However, until now, there has been no official guidance as to how the payments made under these various schemes were to be treated for tax purposes.  This created huge uncertainty, and may have discouraged take-up amongst landowners.

So, does the new official guidance provide the clarification that was needed?

It provides confirmation in some areas

For developers: where expenditure is required to meet BNG or nutrient neutrality obligations, it will generally be deductible for corporation tax or income tax purposes as part of trading costs, as long as the land is held as trading stock.

For those purchasing carbon credits: if the credits are to be used in a trade (e.g. offsetting emissions), this will usually be tax-deductible expenditure; otherwise it will depend on the purpose behind the purchase and the length of time held.

Receipts from ecosystem services will be taxed as income: as had increasingly come to be expected, the guidance confirms that the receipts will normally be taxed as income.

So far, all very much as expected…

Does the guidance tell us anything new?

Exceptionally, the receipts may be treated as “capital”. The guidance is helpful in setting out the conditions in which, exceptionally, the receipts may be treated as capital, rather than income. 

This would be where a payment compensates for permanent loss of land use, or effectively “sterilises” the land. Guidance is given as to some of the factors that would be considered.

Farms: Clarification is provided as to when the payments for ecosystem services on farmland will form part of the existing farming trade, which is important for farmers averaging.

Woodland: There is confirmation that the woodlands exemption will apply, such that the ecosystem receipts will not be taxable where the receipt relates to woodlands that are managed on a commercial basis – as long as this isn’t changed by the activity relating to the creation of units or credits.  The associated costs are not allowable.

The use of intermediaries: There is a recognition that, in practice, many arrangements involve intermediaries (such as a habitat bank).  It confirms that, with the possible exception of commercial woodland, the payments made to the landowner by the intermediary will be taxable as income.  Their exact nature will be determined by such factors as whether the intermediary takes an interest in the land, and whether the landowner receives any payment for land management.

Inheritance Tax: there is a clear statement that the extension of Agricultural Relief to land subject to an environmental management agreement from April 2025 will include the ecosystem services covered by the guidance note.

VAT: the circumstances in which the sale of both BNG units and Carbon Credits will be either in or outside the scope of VAT are clearly set out.

Charities: there is confirmation that, where the landowner is a charity, the tax exemption for profits of a charitable trade will apply, as long as the activities fall within the primary purpose of the charity.

What areas are still unclear?

When the income will be taxed:  One of the big questions has always been, if the receipts are to be taxed as income, when will that income be taxed, and how is tax relief obtained for the ongoing project costs.  The payments are often received upfront, but the project can last for 30+ years for BNG, longer for Nutrient Neutrality arrangements.

The guidance says that when the cash basis is being used, the income will be taxed on receipt.

If, however, the landowner is using accruals basis, the tax position will be determined by general accounting principles (GAAP).  This may require the income to be recognised upfront and/or to be spread over the life of the agreement, depending on the facts.

Tax relief for expenditure: similarly, the guidance around the tax relief for expenditure essentially just refers to general accounting principles with reference to how the receipts were taxed eg trade, rental of capital.

More complex structures: many landscape-scale projects involve multiple landowners, joint ventures and other complex structures, which the guidance does not address at all.

As a result, there is still significant uncertainty around the accounting treatment and its tax implications. Given the wide range of schemes, structures and arrangements already in the market, this was probably inevitable.

So, has the guidance provided the long-awaited clarification?

It has certainly helped, but there are many areas that are still very much open to interpretation and no doubt we will see what stance HMRC take on some of these issues as time progresses.

This is likely to be a continually evolving area, with possible future changes to the BNG requirements as well as potentially new markets developing, and the tax guidance around it will inevitably evolve too.

This remains a very complex area and appropriate professional advice should always be sought. For more information, please contact our team here.