EU ETS Ruling: Hungary CO₂ Tax Deemed Unlawful

When Nitrogénművek Vegyipar, one of the biggest Hungarian chemical companies, found itself facing a multibillion-forint tax bill tied to CO₂ emission allowances, it did not simply accept that paying was the only option. On the contrary, it fought back and raised questions that reach far beyond one company's balance sheet or one EU country.

At the heart of this case lies a fundamental question: can a national government impose its own tax or similar financial levy on top of the EU's carefully engineered carbon trading system, and does doing so quietly undermine the entire architecture of the EU's climate policy? Notably, the case also touches on several of the EU's most foundational principles, including non-discrimination, freedom of establishment, and even allegations of unlawful State aid.

Background of the Case 

In December 2023, Nitrogénművek Vegyipar, a company that is subject to a tax related to CO₂ emission allowances, attempted to reduce its tax burden by filing a supplementary tax return for a specific period in 2023, claiming a substantial reduction of HUF 2.56 billion (approximately EUR 7 million). The Hungarian Tax Authority denied the request at both the initial and appeals levels, resulting in the company's appeal before the High Court.

In its appeal, the company claimed that the tax undermines the purpose of the EU Emissions Trading System established under Directive 2003/87 (ETS Directive). Moreover, the company stated that the tax effectively imposes an additional financial burden on emission allowances that are meant to function as a market-based environmental tool. 

Furthermore, the company argued that the Government Decree, which introduces this tax, violates key principles of EU law, including non-discrimination and fundamental freedoms such as the freedom of establishment and the freedom to provide services, and may even amount to unlawful State aid interference. As a final argument, the company claimed that the measure infringes on property rights.

After reviewing the merits and the facts of the case, the High Court was uncertain whether this national tax is compatible with EU law, particularly with the ETS Directive. Also, the Court noted that the existing case law from the Court of Justice of the European Union (ECJ) does not clearly resolve this issue, because previous decisions dealt with different types of measures. Consequently, the Court sought clarification from the ECJ.

Main Questions from Request For Ruling

The High Court referred four questions to the ECJ for a preliminary ruling. With the first question, the Court asked whether the EU Emissions Trading System allows EU countries to impose a retrospective tax on emissions linked to allowances, especially free allowances. Additionally, the Court raised concerns about discrimination and questioned whether Hungary’s measure unfairly targets a specific category of operators covered by the ETS, treating them more harshly than others without a valid public interest justification.

Thirdly, the Court asked whether the measure unlawfully restricts core internal market freedoms under the Treaty on the Functioning of the EU, namely the freedom of establishment and the freedom to provide services. Finally, the Court questioned whether the tax violates property rights protected under EU and human rights law by effectively confiscating the economic benefits derived from emission allowances.

Applicable EU EST Directive Article

Given that at the core of the dispute are rules relating to the EU Emissions Trading System, Recitals 5, 7, and 20 of Directive 2003/87, and Articles 1, 3, 10, and 10a of the same Directive are highlighted as the most relevant for answering the raised questions. 

While the Recitals clarify the broader objectives behind the Directive, including the EU's commitment to meet international climate commitments under the Kyoto Protocol, the outlined articles establish a market-based system for trading greenhouse gas emission allowances across the EU, define key concepts, and define how allowances are distributed.

Hungary National ETS Rules

Regarding Hungarian national law, the ECJ interpreted Article 195 of the Law No CL of 2017 on tax procedure, and a provision from Government Decree No 320/2023, adopted under emergency powers in the context of the war between Russia and Ukraine, which specifically targets operators receiving significant free emission allowances under the EU ETS framework established by the ETS Directive.

Importance of the Case for Taxable Persons

In this case, the ECJ addresses one of the most important issues for taxable persons, which is whether EU countries may impose their own national taxes on top of the EU ETS framework. This question is essential, particularly when considering the cost of acquiring emission allowances, whether through purchase or by managing their allocation of free allowances. Thus, for any operator receiving free allocations, the ruling will clarify whether that benefit is genuinely protected or remains vulnerable to domestic fiscal measures. 

Analysis of the Court Findings

The ECJ first recalled that under the general principle of EU procedural law, its role is not merely to answer the questions exactly as formulated, but to provide guidance that is genuinely useful to the national court so it can decide the dispute before it. In this case, the ECJ used this right to reformulate the questions and focus on the essence of the dispute, which is the legality of Hungary’s Government Decree No 320/2023 introducing a tax on CO₂ emission allowances.

The Decree primarily targets operators participating in the EU Emissions Trading System established under the EU ETS Directive who receive significant free allowances. The tax applies only to installations that meet specific thresholds, including high annual emissions and a substantial proportion of free allowance allocation compared to their total emissions. Based on that data, it is apparent that the measure is directed at the large industrial emitters that are heavily involved in the ETS and benefit from free allocation under EU rules.

In the end, the ECJ focused on answering whether EU law, specifically Articles 1 and 10a of the ETS Directive, when read together with the objectives of the Directives, prevents an EU country from introducing a national tax that applies to operators receiving significant free emission allowances and is calculated based on their CO₂ emissions.

The main concerns are whether such a tax undermines the purpose of free allocation by effectively cancelling out its intended economic benefit, and whether it conflicts with the broader EU objectives of maintaining competitiveness and avoiding carbon leakage.

The ECJ emphasizes that the fundamental ETS principle is to establish a system designed to reduce greenhouse gas emissions in a way that is both economically efficient and cost-effective. As such, the system is meant to balance environmental protection with economic considerations, which is central to assessing whether national measures interfere with that balance. 

Regarding the Directives' objectives, the ECJ recalled that under the established case law, reducing greenhouse gas emissions is the primary objective. Nonetheless, this objective is not pursued in isolation and must be balanced with several secondary objectives and implemented through specific policy tools. One of those sub-objectives is to reduce emissions through technological improvements, such as the use of more energy-efficient technologies producing less emissions per unit of output.

To achieve these goals, the ETS system is built around the economic value of emission allowances, which creates a financial incentive for companies to reduce emissions. The system allows companies to use the allowances allocated to them or trade them on the market, where they can gain financial benefits depending on their emissions performance. The established market-based mechanism is essential to the system's effectiveness, as it translates environmental obligations into economic incentives.

The main reason for the free allocation of emission allowances is to prevent EU industries from becoming less competitive as a result of carbon pricing. If such protection does not exist, companies might relocate production to countries with less strict environmental rules, a phenomenon known as carbon leakage. 

Article 10a of the ETS Directive allows limited flexibility for EU countries when implementing these EU-wide and fully harmonized rules. For example, an EU country may introduce financial measures to support sectors exposed to carbon leakage risks, particularly where higher electricity prices indirectly increase costs due to emissions pricing. Nevertheless, measures must comply with EU State aid rules and must not distort competition within the internal market.

Given that the ETS system is harmonized, it sets clear criteria for how this harmonization should be achieved, notably through sector-specific benchmarks that apply consistently across industries. By standardising how free allowances are allocated across sectors, the EU ensured that companies operating in different EU countries compete under comparable conditions, preventing national differences from undermining market unity.

The ECJ noted that while the ETS Directive does not explicitly prevent EU countries from adopting national fiscal measures that may affect the economic consequences of emission allowances, such measures are not unrestricted. Moreover, such measures must not undermine the fundamental objectives of the EU ETS system.

Court's Final Decision

After carefully analyzing how the Hungarian measure operates in practice, and what the legal effect of this structure is, the ECJ ruled that the ETS Directive provision must be interpreted as preventing Member States from introducing national legislation of the kind at issue in Hungary.

In other words, the EU ETS system does not allow the establishment of a national system where operators that receive significant free emission allowances under the EU ETS are required to pay a tax directly linked to their CO₂ emissions from installations covered by those allowances, if that tax effectively removes the economic benefit intended by the free allocation system.

Regarding questions two to four, the ECJ found that it is not necessary to answer them, given the answer to the first question.

Conclusion

Besides ruling in this delicate case, the ECJ also established a decisive condition for EU countries regarding the flexibility available to them when implementing ETS EU-wide and fully harmonized rules. That condition is that any national legislation is incompatible with EU law where it neutralizes the compensatory function of free allowances.

Simply put, if a national tax effectively cancels out the benefit of free allowances and distorts the balance between environmental incentives and industrial competitiveness, it must be treated as contrary to EU ETS rules and regulations.

Source: Case C‑519/24 - Nitrogénművek Vegyipari Zrt. v National Tax and Customs Authority – Appeals Directorate, Hungary, Directive 2003/87/EC