Carbon Border Adjustment Mechanisms (Cbam) And The Impact On International Trade – Challenges For Exporters Legal, Tax And Compliance

Likely the most impactful new trade regulation from a climate perspective introduced over recent years, the EU’s CBAM was implemented in 2023 to prevent carbon leakage and ensure a level playing field between EU production (which bears a carbon price via ETS) and foreign producers. Effectively, CBAM prices the carbon content of imported goods, imposing on those goods an amount reflecting the costs faced by EU producers under the ETS. And while it is widely accepted the environmental rationale for such a regulation, CBAM also creates a host of legal, taxation, and compliance challenges for non-EU exporters trading with the EU market.

Any exporter hoping to retain access to or continue doing business in the EU after implementation of the CBAM regime would be well advised to understand it. The CBAM framework CBAM entered into force in 2023, initially in a phased “transition period” that lasts until the end of 2025. During this transitional phase, CBAM mandates the reporting of embedded carbon emissions in specified goods. However, there is no financial charge at this stage. By 2026, the system will enter its final “definitive phase”, when importers will be required to purchase and surrender CBAM certificates equivalent to the declared emissions.

The cost of these certificates will track the weekly average prices of allowances under the EUETS. The initially identified products subject to CBAM are iron and steel, aluminium, cement, fertilisers, electricity, and hydrogen, with a possibility of expansion over time. For exporters, the transition from purely reporting obligations to one that carries a direct financial burden underpins the urgent need for compliance preparedness. legal issues and WTO compliance There are some fundamental legal questions surrounding the CBAM and the WTO regime. Because it is a border adjustment mechanism, CBAM’s differentiation of imported goods based on their production process and carbon policies in their countries of origin lies at the heart of those questions.

There is a sound case to be made that CBAM may breach the WTO’s most favoured nation provision (Article I of GATT) because it could result in more favourable treatment for products originating from countries with “equivalent” climate policies than for others. Similarly, it may run afoul of the national treatment principle (Article III of GATT) by imposing a price based on EU ETS allowances for the carbon content of products that EU producers do not have to pay in precisely the same way as ETS allowances. The EU’s counterargument is that CBAM is an environmental measure, and thus exempt from WTO rules under the exceptions provided in GATT Article XX (such as protection of human, animal, or plant life or health, or conservation of exhaustible natural resources, provided there is no “arbitrary or unjustifiable discrimination”).

The EU’s careful design – including provisions allowing for the credit of a carbon price “paid” in the country of export, and linkage of CBAM to the ETS price – will undoubtedly be used in its defence of the CBAM in any challenge at the WTO. Nonetheless, exporting firms will need to live with legal uncertainty, particularly in the absence of any directly relevant WTO case law, given that several major EU trading partners have already expressed strong concerns and the prospect of trade disputes at the WTO if they feel their international competitiveness is affected. There will also be challenging proof of a carbon price “paid” in the exporting country that effectively meets the requirements set out by the EU, essentially forcing commercial operators and/or their governments into a quasi-judicial role. Potential legal consequences include trade countermeasures or retaliatory action taken by a home government to defend its national industries or conflicting obligations arising between home-country and EU rules tax and fiscal exposure Although it has been presented by the EU as a climate regulation and not a customs duty or tax, CBAM has very clear tax-like characteristics.

Essentially, it is another landed cost on products exported to the EU– a cost that will either be absorbed by the EU importer or manufacturer, or will be passed back down the supply chain. Where a country exporting to the EU has no carbon tax or emissions trading regime in place, CBAM will add to the landed cost. Where a country does have one of these, the exporter will be able to claim credit for this, but will need to “prove” that it was paid in accordance with EU standards. One of the difficulties here is that the carbon cost may effectively double, at least from a practical perspective (although technically not a tax “double”), by means of the country imposing a carbon cost on export which CBAM will not recognize entirely. Beyond landed cost, the tax and fiscal implications of CBAM could also involve the application of transfer pricing rules, and complex reallocation of CBAM costs throughout the supply chain.

International tax advisors will likely work with their legal and sustainability colleagues to establish the total fiscal exposure for any given exporting company, verify eligible home-country credits, and re-invoice or otherwise reallocate costs where possible. For many, CBAM will represent a completely new type of trade tax risk, distinct from the tax planning they have historically undertaken around customs duties compliance challenges and burden of proof Arguably the most significant compliance issue for exporters outside the EU will be proving and documenting, under strict EU-led criteria, the embedded carbon content of their goods. In the transitional phase, it is expected that defaults will be permitted where there is not yet adequate or real data. But in the final phase, from 2026 onwards, data will need to be based on actual emissions and likely using methods that are more granular than those used domestically by some exporters.

It will require exporters to implement or refine carbon monitoring systems across their supply chains – no mean feat, particularly for complex products such as steel and aluminium, where inputs can come from multiple sources. The obligation to have emissions verified by an EU- accredited verifier will also impose an additional layer of costs on exporters. Non-EU verifiers will not automatically have EU-accreditation. Record keeping must be exceptionally thorough and penalties will be comparable to those imposed for customs fraud. CBAM will have a register where certificates are purchased and surrendered. An authorized EU-based declarant will be responsible for managing the register and will be responsible for the accuracy of information submitted, and that information will primarily come from the exporter. Failure by the exporter to supply accurate, timely and verified information to the EU declarant could result in penalties and effectively preclude that exporter from the EU market.

SMEs and businesses in developing economies may well feel the burden of these new compliance requirements more keenly than larger EU-based multinationals. Implications for International Trade flows The CBAM is already prompting a shift in trade flows and business decisions globally. For countries lacking a carbon price regime, there will be strong incentives to develop one, not only to avoid the cost of CBAM certificates but to ensure revenues remain within their economies rather than going to the EU. CBAM could, over time, play an important role in driving the global climate agenda. For now, however, it imposes new costs on accessing the EU market for exports from countries without equivalent schemes, and will also heighten trade tensions surrounding the principle of “common but differentiated responsibilities” at the UN climate framework. Many developing countries already view CBAM as a protectionist barrier rather than an environmental tool that recognizes historical emissions or economic development levels. The threat of dispute resolution under WTO agreements and free trade agreements is real. Even if the EU manages to make a case for CBAM under WTO law in proceedings that take many years, exporters need to address these immediate commercial issues.

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