Regulation (EU) 2023/1115 of the European Parliament and of the Council of May 31, 2023, is on making available in the European Union (EU) market and the export from the EU of certain commodities and products associated with deforestation and forest degradation.
The avowed objective of the Regulation — referred to as ‘Deforestation Rules’ or ‘Rules’ in the ensuing narrative — is to minimise the EU’s contribution to deforestation and forest degradation worldwide, with the consequential benefits of reducing the EU’s contribution to greenhouse gas emissions and global biodiversity loss.
The Regulation, as stated in Article 1, lays down rules regarding products, as listed in Annex I, containing, or have been fed with or have been made using, relevant commodities. The relevant commodities are cattle, cocoa, coffee, oil palm, rubber, soya and wood. However, it does not apply to goods that are produced entirely from material that has completed its life-cycle and would have otherwise been discarded as waste.
The thrust of the article is to bring home the risks faced by exporters from India into the EU. The preamble somewhat pre-empts any future claims that these are violative of the WTO fair trade framework. Noting that Indian exports of agri-commodities are currently running at $50 billion and likely to expand, the Rules may have a significant impact in India’s future plans.
What is prohibited
Article 3, ‘Prohibition’, states that ‘relevant commodities and relevant products shall not be placed or made available on the market or exported, unless all the following conditions are fulfilled: (1) they are deforestation-free; (2) they have been produced in accordance with the relevant legislation of the country of production; and (3) they are covered by a due diligence statement’.
In order to understand the implication of the words ‘deforestation-free’, one must look at the meaning of the word ‘deforestation’ which per Article 2(3) is defined as the ‘conversion of forest to agriculture use, whether human-induced or not’. ‘Agriculture use’ is defined per Article 2(5) as inclusive of agricultural plantations, set-aside agricultural areas, and for rearing livestock.
Going further to 2(13), the clause defines ‘deforestation-free’ as meaning: (a) the relevant products contain, have been fed with or have been made using the relevant commodities that were produced on land that has not been subject to deforestation after December 31, 2020; and (b) in the case of wood, that the wood had been harvested without inducing forest degradation after December 31, 2020.
It is noteworthy that the corresponding Indian statute, the Forest (Conservation) Act, 1980 as amended by the Forest (Conservation) Amendment Act, 2023 states that provisions of this clause shall not apply to such land, which has been changed from forest use to use for non-forest purpose on or before December 12, 1996. It should also be noted that the definitions of ‘forest’ are not aligned and that should anyone wish to do business with the EU, then the EU Regulation will have to be followed.
Conversion of forests
The crux of the matter, therefore, is whether forests were converted for non-permissible uses after December 31, 2020. As defined by Article 2(27), plot of land means a single real-estate property that allows an evaluation of the aggregate level risk of deforestation and forest degradation associated with the relevant commodities produced on the land.
Further, there is a need for establishing the ‘geolocation’ with reference to the plot of land with the relevant latitude and longitude coordinates. This is one of the most difficult conditions to satisfy since the evidence has to go back to December 31, 2020. The Frequently Asked Questions (FAQ) published gives an array of information, clarifications and advice on tech-based solutions for establishing the status of land as at December 31, 2020.
It is important to note that in (a) above, the word ‘deforestation’ has been used whereas in (b) the key words are ‘forest degradation’. Article 2 (7) defines ‘forest degradation’ as meaning structural changes to forest cover taking the form of the conversion of primary forest or naturally regenerating forests into plantation forests, wooded land or into planted forests.
It is, therefore, clear that in the case of deforestation, there has to be a conversion of forests into agricultural use for the rules to apply whereas in the case of wood and its usage, even conversion of forests into plantation forests, wooded land, and planted forests is prohibited. This is to ensure that the indigenous people who live off the land in forests are protected whereas, presumably, wood is associated with commercial interests.
Operators and traders
The rules place a heavy responsibility on operators and traders in the EU. An operator is defined by Article 2(15) as a person (including a legal person) who in the course of a commercial activity ‘places’ relevant products on the market or exports them. A trader is defined per Article 2(17) as a person (including a legal person) in the supply-chain other than the operator who in the course of a commercial activity ‘makes’ relevant products available on the market for distribution, consumption or use. It therefore follows that a trader is a step-down entity unless, of course, the operator acts as a trader as well. A branch/subsidiary owned by an Indian-entity in the EU will, therefore, be considered an operator or trader depending on the manner of functioning.
The responsibilities of the operator extend to conducting due diligence with regard to all relevant products supplied by each supplier. For this purpose, the operator should collect information, verify it and analyse the data and documents needed to support the conclusion that the products are deforestation-free per the requirements of Article 9. The operator should also carry out a risk assessment as to whether there is any non-compliance per Article 10 and take steps for risk mitigation per Article 11 prior to placing the relevant materials on the market. SMEs (per EU definition) have different rules.
Penalties
Exporters of commodities and products should be concerned with these developments in view of the penalties that can be invoked by the operators placing these products in the EU. Corrective actions will mean preventing the relevant product from being placed, withdrawing the product from the market and recalling it if sold. There are also huge penalties on the operators which will eventually be passed on to the Indian exporters who in addition face the risk of being blacklisted. Noting that the bulk of the rules including Article 3 ‘prohibition’ will become effective from December 30, 2024 (other than SMEs to whom different rules will apply), there isn’t much time left. One immediate development will be the rewriting of trade agreements.
Another issue that can come up is whether the principles of revenue recognition need to be changed since it raises the question of when the transfer of goods happens with the attendant tax implications. Accountants and auditors will need to address this issue immediately.
The writer is a chartered accountant