Services

Climate Change Alert: Do your contracts allow you to pass on the cost of the carbon tax? 10 May 2012

When the carbon tax comes into effect in less than two months, the largest emitters of carbon dioxide will be required to pay $23 per ton for every ton emitted. While this is expected to directly impact only 248 companies (view the list of companies here), the indirect effects of the price on carbon will be felt far more widely throughout the country as the costs of raw, carbon intensive materials and services increase, and providers look to pass on any increases in costs to their customers.

Now is the time to review your current long-term contracts (including leases and building agreements) to determine whether you can pass on any increases in costs or can contractually oppose any cost increases.

Here, partner Michele Muscillo and solicitor Ben Ricketts explain how businesses can pass on the cost of the carbon tax in their contracts.

Key points

  • The carbon tax (via the Clean Energy Act 2011) comes into effect on 1 July 2012.
  • To the extent that your business will be subject to increased costs, your contracts should contain a clause allowing you to pass through any increase in costs as a result of the implementation of a price on carbon. You should review your contracts now to see if they enable you to pass on any price increases.
  • Contracts should contain a clause that provides for periodic review of the costs associated with a price on carbon, and also deal with aspects such as passing on administrative costs and the impact of free carbon units.
  • Commercial property owners and parties to building agreements may see a significant increase in costs following the implementation of the carbon tax, and may like to review their contracts to see if they are able to pass on those costs.

Is the carbon tax really a tax?

As a supplier of goods and services, your long-term contracts should contain a clause allowing you to pass through any increase in costs as a result of the implementation of a price on carbon.

Many contracts contain a standard clause that allows for the passing on of costs due to tax changes or legislative change, or contain a general annual review clause. However, whether those clauses are effective in allowing a supplier to pass on the costs will depend on interpretation of the clauses. Many of these clauses were drafted well before the Clean Energy Act was enacted, and may not have been drafted widely enough to cover the final design of the legislation.

Additionally, despite being commonly referred to as a 'carbon tax', there is some significant doubt over whether the price on carbon is actually a 'tax' - which would therefore potentially prevent companies from relying on standard 'tax pass through' provisions in their contracts.

As a result, even if your contracts already have a standard change in tax clause, you shouldn't assume that you can safely pass on any increase in costs. It's best to have that clause reviewed to ensure you can legally pass on costs.

Even if you have a change in law clause, the Clean Energy Act implementing the carbon tax was enacted on 19 November 2011, so it may be too late to rely on that clause for contracts entered into after 19 November 2011.

Companies will need to continually monitor any costs imposed on them. Although the price on carbon will start out at $23 per ton, it will rise to $24.15 and $25.40 in the second and third years respectively. However, by 2015, the floating price emissions trading scheme will be in place, with no set price on each ton of carbon. The price will be determined by the market forces of supply and demand.

The Government has set a floor price of $15 per ton to encourage investment in green energy, and an upper limit of $20 above the international carbon unit price. As a result, if you make a one-off price adjustment to your current contracts based on a carbon price of $23 per ton, that may not be sufficient from year-to-year as costs continually flux. Ideally, any long-term contracts should contain a clause that provides for periodic review of the costs associated with a price on carbon.

Ongoing considerations

You may also incur additional costs associated with annually administering and reviewing the carbon price and dealing with the Government Regulator. You may not be able to pass on these costs if your contracts are limited to changes in the carbon price, and don't include the ability to pass through administrative costs associated with dealing with the carbon price.

If you have a fixed price contract which deals only with a carbon price of $23 per ton, you should review whether that contract extends beyond 1 July 2015. If so, you will need to carefully consider the effect of the emissions trading scheme on your contract when the carbon price of $23 per ton no longer applies (and could drop as low as $15 per ton).

Under the Federal Government's Jobs and Competitiveness Program, certain industries will receive a certain percentage of free carbon permits, meaning that the full cost of the carbon tax will be heavily subsidised. Contracts you have should take into account the allocation of any free carbon units in the prices that are passed on to you or that you pass on to your customers.

Leases

The carbon tax will primarily affect heavy industry, miners and electricity producers. However, other industries will be affected, as commercial property generally consumes a large amount of electricity to power intensive air-conditioning systems and office equipment. Aside from electricity, commercial property owners may also be affected by an increase in day-to-day operating costs associated with holding the property - for example, if council increases rates due to additional costs of its land fill facilities. Accordingly, commercial property owners will be looking to pass on these costs to tenants.

Investors and existing commercial property owners and tenants should consider whether the leases for the building or complex are net leases (where the tenant pays the rent plus a proportion of the building/complexes outgoings such as council rates, water rates, land tax and management costs) or gross leases (where the rent includes all of these outgoings (except possibly for direct charges such as electricity, depending on the metering system) and the landlord is responsible for all outgoings payable for the premises).

Net leases allow landlords to pass on the increase in operating costs flowing from the carbon tax to their tenants. There are, of course, limitations to pass on increases in outgoings if the lease is a retail shop lease under the Retail Shop Leases Act 1994.

It is important that you review your leases now to determine liability for any increase in costs and whether those can be passed on to you or your tenants.

Building agreements

Building agreements are often based on Australian Standard forms of general conditions, which are then read in conjunction with a formal instrument of agreement as prepared by the parties. For design and construction work, two of the more common Australian Standards are AS4300, and AS4902 General Conditions of Contract for Design and Construct.

AS4902 already contains, at clause 11.2, a basic provision that allows for any legislative change to be assessed or added or deducted from the contract sum by the Superintendent. While AS4300 contains a provision related to change in legislation, you will need to consider whether that clause is comprehensive enough to include an increase in costs due to a carbon price.

Given the building and construction industry's reliance on such energy intensive items as aluminium, concrete and steel, it is critical that you review your building agreements to determine whether any increase in cost as a result of the carbon tax can be passed through.

For more information about the carbon tax, including reviewing contracts, leases or building agreements to pass on carbon costs, please contact HopgoodGanim's Climate Change team.