Environment protection is the need of the hour. Every organization of repute is contributing to environment protection in its own way. For instance, the energy saved can be traded (internationally) with another entity which is likely to consume more energy. This energy is popularly known as ‘Carbon Credits’ or Certified Emission Reductions (CER). Like coal, diamonds, stocks and bonds, carbon credits are an internationally recognized commodity. It has an established international market, exchanges and involves high voluminous transactions.
The exchange of carbon credits, though intended for protecting the global environment, is not a charitable activity alone. It is, perhaps, a combination of good intent combined with executing profitable projects. Quite naturally, Governments of all countries propose to tax carbon credits in their respective jurisdictions.
With this background, let’s proceed to understand the taxability of carbon credits in India.
What are carbon credits?
The necessity of reducing carbon emissions was first recognized at the Kyoto Protocol of the United Nations Framework on Climate Change signed in 1997 wherein the member countries, including India, committed to limit and reduce the greenhouse gas emissions. The Kyoto Protocol provides for trading of Carbon Credits, i.e., emission reduction units through Clean Development Mechanism (CDM).
Under CDM, specified parties engaged in project activities resulting in Certified Emission Reductions (CERs) may trade in such CERs. The purchasers of CERs may use such CERs to comply with part of their quantified emission limitation and reduction commitments. The unit associated with CDM is the CER; where one CER is equal to one metric tonne of carbon dioxide equivalent.
Developed countries with emission reduction targets can simply trade in the international carbon credit market. This implies that entities of developed countries exceeding their emission limits can buy carbon credits from those whose actual emissions are below their set limits. Carbon credits can be exchanged between businesses/ entities or can be bought and sold in the international market at the prevailing market price.
Whether carbon credits are considered as capital receipt or revenue receipt?
Taxation under the Income tax Act, 1961 (the ITA) depends on whether the income is a revenue receipt or a capital receipt. As a general rule, revenue receipts are chargeable to tax unless specifically exempted and capital receipts are exempted from tax unless specifically held to be chargeable.
Prior to FY 2017-18, there was a lot of uncertainty on whether ‘carbon credits’ are revenue receipts or capital receipts. The Revenue treated income from carbon credits as revenue receipt1 and sought to tax the same as business income. The taxpayers, on the other hand, succeeded in establishing that income from carbon credits are capital receipts2. Consequently, the Revenue has not been able to tax the income from carbon credits till date.
Taxation of carbon credits under section 115BBG
To address the litigation on the taxation of carbon credits in India, the Finance Act, 2017 introduced section 115BBG under the ITA “in order to bring clarity on the issue of taxation of income from transfer of carbon credits and to encourage measures to protect the environment.”
On a plain reading of section 115BBG, the following points emerge:
• This is a specific provision applicable to the taxation of income from the transfer of carbon credits. Consequently, such income from carbon credits shall not be taxed under the general provisions of the ITA.
• The said income shall be taxed at 10%.
• Though the section uses the term income, which generally means revenue less expenditure, clause 2 specifically prohibits deduction of any expenditure / allowance in calculating the tax base under this section. This implies that the rate of 10% shall be applicable on the gross receipts on the transfer of carbon credits.
• The section does not specify whether it is applicable to a resident assessee or a non-resident assessee. Consequently, it is applicable to non-resident taxpayers as well. However, in the case of non- residents, taxability arises only to the extent it is attributable to the business connection/permanent establishment in India. Tax treaty benefits would also be available.
In the case of non-resident taxpayers, the OECD Publication on Tax Treaty Issues Related to Emissions Permits/Credits3 provides that:
• Income from carbon credits may be taxed as business profits or as capital gains.
• Business profits are taxed in the source country if the non- resident taxpayer has a permanent establishment in the source country (otherwise, in the country of residence). Further, business income must be determined as per the domestic law of the source country.
Section 115BBG was introduced to mitigate the tax litigation on taxability of income from carbon credits. Whether it has achieved the desired objective or not, is something only time will tell. As of date, all jurisprudence in the matter pertains to the years prior to the introduction of section 115BBG. Taxability under section 115BBG may be challenged on the following grounds:
• The section does not specifically categorize income from carbon credits as a capital receipt or a revenue receipt. In the absence of a clear categorization, the existing judgments in the matter, which have clearly established that income from carbon credits is a capital receipt, may still hold true.
• There is no amendment to the definition of ‘income’ under section 2(24) of the ITA. For instance, where the Revenue intended to tax the receipt of property for an inadequate consideration as income, a specific amendment was made to the definition of income. Alternatively, there is no amendment to section 28 of the ITA defining ‘Profits and gains of business or profession’. In other words, the computation mechanism under section 115BBG may fail in the absence of a charging mechanism under sections 2(24) or 28 of the ITA.
Taxability of the carbon credits is still a contagious issue in India. In a well- reasoned Tribunal judgement of Shri Pramod Kumar in the case of Kalpataru Power Transmission Ltd.4, it was held that “the gains on sale of CERs, though taxable in nature, could only have been taxed at the point of time when these CERs were actually transferred to the foreign entity. Accordingly, the value of CERs, even though quantifiable, cannot be brought to tax by the reason of accrual simplictor”. The decision has been approved by the Gujarat High Court5.
A similar matter in the case of Lanco Tanjore Power Corporation Ltd.6 is pending for adjudication before the Apex Court. The Apex Court is pondering over the issue of taxability of the carbon credit in India as it would have a far-reaching impact on the future industries.