Businesses must prepare ahead of new UK carbon border adjustment mechanism

The UK government published draft legislation for the proposed UK CBAM on 25 April. The draft legislation follows the government’s announcement in November that it would introduce a UK CBAM from 1 January 2027 – one year after the EU’s CBAM is due to become fully operational.

The UK CBAM will impose a carbon price on certain imported goods from sectors at risk of ‘carbon leakage’ – whereby businesses shift production and associated emissions to countries that apply no or low carbon pricing to avoid UK carbon costs. The mechanism ensures that imported goods bear a comparable carbon cost to those produced domestically under the UK emissions trading scheme (UK ETS) and aims to support UK decarbonisation by preventing emissions being offshored.

The draft legislation (52-page / 1,749 KB) imposes a tax charge on imports of specified goods in the aluminium, cement, fertilisers, hydrogen, and iron and steel sectors and listed in schedule 1 of the draft legislation – known as CBAM goods. The CBAM charge will apply on the amount of embodied greenhouse gas emissions in the imported goods.

It is proposed that a CBAM charge will arise when CBAM goods are imported into the UK. In most circumstances, UK CBAM will be payable by the importer, who will be responsible for registering with HMRC as a CBAM declarant; submitting quarterly CBAM returns detailing the quantity and embodied emissions in imported goods; and ultimately paying any CBAM charge that is due.

The charge will apply from 1 January 2027, with a deadline of 31 May 2028 for reporting and payment obligations covering the first 12 months of CBAM. Following the initial 12-month period it is intended that accounting will move to a quarterly basis with a two-month period for reporting and payment after each quarter. CBAM will not apply where the importer is importing CBAM goods with a value of less than £50,000 over a 12-month period.

The CBAM charge will be calculated by multiplying the quantity in tonnes of embodied emissions – both direct and indirect and including embodied emissions in precursor goods used to produce the CBAM goods – in the imported goods by the relevant UK CBAM rate for the sector within which the goods fall. The UK CBAM rate which will be based on the average price per tonne of specified emissions under the UK ETS, and CBAM rates per sector will be published quarterly.

A credit will be given for any explicit carbon price already paid in the country of origin to avoid double taxation, and the person liable to pay the CBAM charge will need to hold verified evidence of that explicit carbon price.

HMRC will have the power to issue penalties for non-payment of CBAM. Unless independently verified evidence of the actual embodied emissions is available, the CBAM charge will be based on default emissions values for the relevant CBAM goods.

Those at the end of supply chains who may ultimately find CBAM costs paid by importers passed on to them in the form of higher prices for CBAM goods should consider checking they are purchasing goods where actual embodied emissions data and verified data of any applicable explicit carbon price was available.

The draft legislation is subject to a technical consultation that ends on 3 July and HMRC is expected to publish guidance in the coming months.

Dr. Totis Kotsonis, a trade law expert at Pinsent Masons, welcomed the draft proposals, but cautioned that “the position regarding UK CBAM and its application remains uncertain, which is unhelpful for many contractors and other parties involved in infrastructure and real estate projects that may need to import CBAM goods under existing contracts.” He said that further details are expected to be released this summer after the consultation on the draft legislation closes.  

Since publication of the draft legislation, the UK and EU have announced their intention to link the EU ETS and UK ETS and introduce mutual CBAM exemptions following the signing of a historic UK-EU trade deal in May. Further details have not yet been announced. It also remains unclear how the UK’s alignment with the EU on CBAM and the ETS might impact the UK's relationship as a key energy trade partner with the US.

Kotsonis said that there needs to be further clarification on how the respective EU and UK ETS will work and how this might impact the carbon price for UK CBAM. He said confirmation on the “mutual exemption mechanism for EU/UK CBAM” was also urgently needed to help businesses prepare and avoid potential “trade friction”.

The EU’s CBAM scheme came into effect in October 2023 on a phased basis and is due to come fully into force from January 2026. Earlier this month the European Council and European Parliament provisionally agreed a proposal which they say will reduce costs and compliance burdens for all importers of CBAM above a single mass-based threshold of 50 tonnes of imported goods per importer per year and which will delay payment dates by a short period, although this does not affect the periods for which payment is due.

Siobhan Cross, a property, climate and sustainability expert at Pinsent Masons, said it was important that contractors in the construction industry and developers were keeping abreast of the proposed UK CBAM and other developments related to the legislation. “Despite the uncertainty, major construction contracts are being signed now that will still be in place in 2027 when the CBAM is expected to come into force, since construction contracts often span projects that last 10-15 years,” she said.

Cross said that many of these projects will also involve importing CBAM goods into the UK. “On this basis, despite the uncertainty, contractors and developers still need to be thinking about UK CBAM, how it will affect the cost of goods and projects and how CBAM issues should be managed under the contract,” she said. “Where imports are required, it becomes increasingly attractive to source low carbon versions of CBAM goods to minimise the likely cost increases which higher carbon versions would entail.”

For construction contracts already executed prior to CBAM coming into effect, companies will be required to consider which party is liable for the risk of higher prices for CBAM goods.

For fixed price contracts, the burden of price increases will sit with the contractor unless, as is more common in complex projects, the contract contains a price adjustment mechanism which responds to supply chain cost increases. Parties should consider what early warning obligations and notice requirements they have in relation to an impact on their ability to deliver on their obligations under the contract, and early engagement with contracting parties and the supply chain will assist in understanding and mitigating this risk.

Change in law clauses typically address the impact of new laws and amendments to existing laws on the contract. Careful attention should be given to whether they limit the change in law to the law of the contract or territory in which the contract is delivered and whether there is a limit to changes in law that are “unforeseeable”.

For future contracts, consideration should be given to what “unforeseeable” means. Specific carve-outs for the impact of future CBAM costs may be sought to either expressly bring them within the category of a change in law that will entitle the contractor to claim increased costs or to expressly exclude them.

For construction contracts under negotiation, either now or in the future, parties should pay particular attention to how the proposed UK CBAM will impact each party. Parties will want to consider various types of clauses – namely any price adjustment, force majeure or change in law clause – in detail and ensure that it addresses the price increase risk of the proposed CBAM.

In a related consultation published on 3 June, the government is seeking views on a policy framework to grow the UK market for low carbon industrial products with a focus on steel, cement and concrete. This, coupled with the announcement made earlier this week for support to reduce energy prices for energy-intensive industries, may mean a plentiful supply of low carbon versions of these key building materials will be available domestically in the years to come. By virtue of this, contractors and developers may not need to be so concerned with UK CBAM, Cross said.