Tax treatment of ecosystem services – HMRC guidance issued

HMRC has at last published guidance on the taxation of income and expenses for providing certain nature or ecosystem services.

This covers statutory schemes such as biodiversity net gain (BNG) and nutrient neutrality in England, as well as carbon sequestration projects under the government’s voluntary woodland and peatland carbon codes, which apply across the UK.

The guidance was issued on 14 May, following a consultation in 2023 which established a working group on the subject last year.

See also: BNG market set to gather pace as big projects come into play

It does not answer every question or cover all circumstances but provides helpful clarity on the core tax principles applying to the main ecosystem service markets, says Peter Harker, a partner in accountant Saffery, who was involved in discussions with HMRC in development of the guidance.

While the guidance helps, Peter stresses that there are many different structures and types of agreement, including joint ventures for some nature services, so advice on the tax and other implications should be sought before setting up a project or entering any agreement.

Landowner income

Payments received by landowners for ecosystem services – both for the sale of units and for managing and maintaining the habitats and land where they are produced – will generally be taxable and most often treated as trading income as part of an existing farming or land‑based trade, or as a deemed trade through commercial occupation of land.

Treatment as trading income depends on the core business being largely trading: where a landowner receiving payments for ­eco­systems services has a farming trade on land which includes the land where the units or credits were created, then if that land continues to be farmed (for example, through conservation grazing or orchard production), the receipts will form part of the farming trade.

If the land relating to the ecosystem services income is no longer farmed, then as long it is not a substantial part of the land on which the overall farming trade is carried on, the receipts are still likely to form part of the farming trade.

The tax rules that apply to farming (such as averaging) will apply to farming trades which include income from the provision of ecosystem services, says the HMRC guidance.

“There are other arrangements such as the letting of land to habitat bank operators where the tax treatment may be different and advice should be sought,” Peter says.

Landowner expenses

The costs involved in creating BNG units or other ecosystem services – for example, land works, planting, seed costs, hedge and tree guards, professional advice and legal costs – are generally likely to be allowed as trading expenses depending on how the land is used, he says.

Where they are part of a trade, they will be set off against trading income, while capital allowances may be available for qualifying plant and machinery.

Woodlands

Specific rules apply to woodlands. Income from commercially occupied woodlands is generally outside the scope of income tax, although this exemption can be lost depending on how the land is used, says Peter.

“The guidance confirms that this woodlands exemption extends to all ecosystem service income derived from the commercial occupation of woodland (that is, occupation and use with a view to timber production).

So the income from the sale of BNG woodland units may well fall outside the scope of income tax.”

However, this also means that money spent on the creation of units in woodland will not be allowable as a trading expense.

Other taxes

VAT

Sales of BNG units are subject to VAT at the standard rate where the seller is VAT registered, which is likely to be the case for the vast majority of sellers. Most voluntary carbon credits are also subject to VAT.

Stamp duty land tax

This tax will not generally apply to the sale of ecosystem services, but as in other land transactions involving a change of ownership, the tax may apply where land changes hands for an environmental project, or where interests in land are acquired.

Inheritance tax

Since 6 April 2025, land under qualifying environmental management agreements – for biodiversity unit creation, nutrient mitigation, and under the peatland and woodland carbon codes – can continue to benefit from agricultural property relief from inheritance tax, subject to conditions.

Further detail

Peter says: “The guidance, as a standalone document, does not provide any further detail.

“However, it’s very important to review the legislation when considering this relief; it does not apply to all land in environmental schemes.”

For example, land under private market arrangements for nature conservation may not qualify for APR.

Questions remain on some aspects of ecosystem service payments, including:

Accounting treatment

Income from the provision of ecosystem services such as the sale of BNG units should follow normal accounting practice, which is either on a cash basis for qualifying unincorporated businesses, or under UK Generally Accepted Accounting Practice (GAAP) where income is accrued for.

However, the guidance does not give any opinion as to what this treatment should be under UK GAAP, says Peter, and the long-term nature of these projects makes the accounting complex and highly technical.

Saffery is working with the Institute of Chartered Accountants of England and Wales to draft guidance on accounting for the sale of BNG units, which it hopes to publish later this year.

VAT

There are still aspects of VAT treatment where HMRC has not formally given an opinion, says Peter.

These include questions on the ability to recover VAT on costs incurred where the relevant output has been sold many years earlier – for example, on land used to create biodiversity units which are sold but costs to maintain the habitat are still going to be incurred for the next 30 years. 

“The new guidance specifically covers BNG and carbon units but doesn’t make any specific reference to VAT treatment on the sale of any other ecosystem services.

“We would generally expect the treatment for these to follow that of the guidance released for voluntary carbon credits, which are subject to VAT at the standard (20%) rate, but advice should be taken,” he says

Louise Speke, chief tax adviser at the Country Land and Business Association, describes the guidance as a useful first step, which will need to evolve as the market does.

“Biodiversity units and carbon credits are relatively well established, but there is ongoing evolution in government policy and market demands that may change what is needed and how it’s delivered in the future,” she says.

“This tax guidance therefore cannot be treated as ‘job done’. We encourage HMRC to continue working with us to keep the guidance up-to-date, relevant, and workable in practice.”