The document discusses carbon credits and the taxation of income from their transfer in India. It provides background on the Kyoto Protocol's carbon credit mechanisms, including the Clean Development Mechanism (CDM) which allows projects in developing countries to earn certified emissions reductions (CERs). There has been debate around whether income from CER transfers is taxable as business income in India. While some courts have held it to be capital receipt, others treat it as business income. The Finance Bill 2017 proposes to specifically tax such income at 10%, without deductions, to encourage environmental protection. However, it does not amend the definition of "income" to explicitly include CER transfer receipts.

1. Mr. Milin Mehta (Senior
Partner K. C. Mehta & Co.)
Ms. Dhwani Shah (Senior
Manager K. C. Mehta & Co.)
Carbon Credits
Increased human industrial and commercial activities involving use of fuels
emitting Green House Gases (“GHGs”) has been causing increase in global mean
temperature (“global warming”) since the era of industrial revolution in 18th
century. Rising global warming has led to increasing awareness of need for
reduction in emission of GHG concentrations in the atmosphere to ‘a level that
would prevent dangerous anthropogenic interference with the climate system’.
To achieve this objective as laid by United Nations Framework Convention on
Climate Change (“UNFCC”), countries across the globe adopted an international
treaty, “Kyoto Protocol” (“the Protocol”) on December 11, 1997 at Japan. The
Protocol, which entered into force in February 2005, commits its signatories to
internationally binding emission reduction targets.
The Protocol provides a mechanism for measuring the reduction of GHGs known as
‘Carbon Credits’, wherein, reduction in emission of one metric tonne of carbon
dioxide is equivalent to one carbon credit. The Protocol also created mechanism
for trading of carbon credits with an intention to incentivize industries for
reduced emission of GHGs, including carbon-dioxide, in the process of
industrialization. Industries can achieve the same by several ways including
switch over to wind and solar energy, forest regeneration, installation of energy
efficient machinery, landfill methane capture, recycling, etc.
The Protocol provides for three mechanisms for carbon credit:
International Emissions Trading (IET) [ Article 17]
Joint Implementation (JI) [Article 4 and Article 6]
Clean Development Mechanism (CDM) [Article 12]
IET and JI mechanisms involve acquiring of emission units or joint emission
reduction projects only amongst countries committed under the Protocol. Thus
only countries with commitments under the Protocol can participate under IET and
JI Mechanisms and countries like India, which do not have any commitments under
the Protocol can avail carbon credits only under the CDM mechanism.
Taxation of Carbon Credit
Date: Tue, 02/07/2017 - 17:07
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2. The CDM allows emission-reduction (or emission removal) projects in developing
countries, including countries which are not committed parties. To calculate the
compliance of environmental target fixed for participating countries a measure for
calculation is adopted in the form of Certified Emissions Reduction (CER) units,
each equivalent to one tonne of CO2.
These CERs can be traded and sold, and used by industrialized countries to a
meet a part of their emission reduction targets under the Protocol. The CDM
projects need to qualify through a rigorous and public registration and issuance
process designed to ensure real, measurable and verifiable emission reductions
that are additional to what would have occurred without the project.
Entities in countries like India are thus entitled to trade in CER earned from
reduction in GHGs with entities in countries with commitments under the
Protocol, for a price arrived through set mechanism.
Taxability – Current Provisions
Taxability of receipt on transfer of CER has been subject matter of significant
debate in the past. While taxpayers have claimed the same to be capital receipt
not chargeable under the provisions of the Indian Income tax Act 1961 (“Act”), tax
authorities have been contending the same to be business income chargeable to
tax as ‘Profits and gains from business or profession’.
There are judicial decisions holding that receipt from transfer of CERs arises due
to world concern and awareness for reduced GHG emissions and thus cannot taxed
be as business income of the taxpayer. The decisions held that the amount so
received has no element of profit or gain and it being capital receipts cannot be
subjected to tax in India in light of the provisions of sections 2(24), 28, 45 and 56
of the Act. The same has been discussed at length in the decision of Hyderabad
ITAT in the case of My Home Power Ltd. [TS-820-ITAT-2012(HYD)] which was
affirmed by Andhra Pradesh High Court [46 taxmann.com 314] which was followed
in various judicial decisions, including:
Subhash Kabini Power Corporation Ltd. [TS-236-HC-2016(KAR)]
Adisankara Spinning Mills (P.) Ltd. [TS-6067-ITAT-2014(CHENNAI)-O]
Arun Textiles (P.) Ltd. [TS-5692-ITAT-2015(CHENNAI)-O]
L.H. Sugar Factory Ltd [TS-5077-ITAT-2002(LUCKNOW)-O]
Shree Cement Ltd. [TS-35-ITAT-2014(JPR)]
While the above decisions uphold the view that the receipt from CER is not an
offshoot of business, a contrary view is taken by Tribunals in the case of
Kalpataru Power Transmission Ltd. [2016] 68 taxmann.com 237 (Ahmedabad Trib.)
and Apollo Tyres Ltd. [2014] 47 taxmann.com 416 (Cochin Trib.) holding that
income on transfer of CERs should be considered as benefits or perquisites under
Section 28(iv) chargeable to tax as profits and gains of business or profession.
In our view, there is a good case for holding that the receipt on account of carbon
credits is a capital receipt on the ground that the entities would not have been
entitled to CERs and would not have been remunerated for “carrying on its
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3. business in an environment friendly manner” but for the Protocol and global
concerns and awareness of the necessity of environment protection. Substantial
reduction in emission of GHGs can be achieved only by business enterprises and
not by individual households and accordingly, there will always be some business
activity, and more likely manufacturing activity wherein an enterprise would try to
achieve reduction in emission of GHGs. However, without global concern for
environmental protection, there will be no value of such CERs. Accordingly, CERs
are certainly obtained and entitled due to world concerns and while it involves
business processes it is not as an outcome of business carried on by a person.
Accordingly, since the benefit arises from world concerns and not from the
business carried on by the enterprise, the same cannot fall within the provisions
of Section 28. Accordingly, receipts from transfer of CERs, being capital receipts,
in our view, should not be charged to tax in India in absence of specific provisions
in this regards.
Minimum Alternate Tax
As per Guidance Note on Accounting for Self-Generated Certified Emission
Reductions (CERs) issued by Institute of Chartered Accountants of India to
provide guidance on accounting for carbon credits, states that CERs should be
recognized in books when those are created by UNFCCC and/or unconditionally
available to the generating entity. Accordingly, CERs are generally credited to
profit and loss account. However, considering that receipts from CERs are capital
in nature, various judicial decisions in the cases of Shree Cement Ltd. (supra) and
L.H. Sugar Factory Ltd. (supra) have held that the same needs to be excluded from
computation of book profit u/s 115JB of the Act.
Finance Bill 2017
The Finance Bill 2017 proposes to insert new Section 115BBG from Assessment
Year 2018-19 in relation to taxation of carbon credits, which reads as under:
“115BBG. (1) Where the total income of an assessee includes any income by way of
transfer of carbon credits, the income-tax payable shall be the aggregate of––
(a) the amount of income-tax calculated on the income by way of transfer of carbon
credits, at the rate of ten per cent.; and
(b) the amount of income-tax with which the assessee would have been chargeable
had his total income been reduced by the amount of income referred to in clause
(a).
(2) Notwithstanding anything contained in this Act, no deduction in respect of any
expenditure or allowance shall be allowed to the assessee under any provision of this
Act in computing his income referred to in clause (a) of sub-section (1).
Explanation.––For the purposes of this section “carbon credit” in respect of one unit
shall mean reduction of one tonne of carbon dioxide emissions or emissions of its
equivalent gases
which is validated by the United Nations Framework on Climate Change and which
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4. can be traded in market at its prevailing market price.”
Further, the memorandum to the Finance Bill clarifies that the said amendment is
introduced with a view to encourage measures to protect the environment.
Accordingly, the proposed amendment intends to tax receipts from transfer of
CERs, which are included in total income of the taxpayer at a concessional tax
rate of 10% as against corporate tax rate of 30% plus being levied by tax
authorities considering the receipts as business income.
To summarize, the proposed section provides that, where total income of a
taxpayer includes any income by way of transfer of carbon credits, gross receipts
from transfer of carbon credits (without deduction of any expenditure or
allowance) will be subject to tax at the rate of 10% (plus applicable surcharge and
cess).
The phrase ‘total income’ has been defined under Section 2(45) of the Act as total
amount of ‘income’ referred to in Section 5 (Scope of total income), computed in
the manner laid down in the Act. Accordingly, receipt from transfer of carbon
credit can be subject to tax as per Section 115BBG only if it falls within the
definition of ‘income’ as per Section 2(24) of the Act.
However, it may be noted that no consequential amendment has been carried out
in Section 2(24) to treat receipts from sale of CERs as ‘income’ liable to tax under
the Act. It is a well settled principle that when a receipt, not ordinarily in the
nature of income, is to be considered as income, it is required to be specifically
included in the definition of income under Section 2(24) of the Act.
Following decisions, for instance, were held based on similar principle. The Apex
Court in the case of Guffic Chem (P.) Ltd. [2011] 332 ITR 602 (SC), wherein,
payment received as non-competition fee under a negative covenant, prior to April
1, 2003 (prior to introduction of provisions of Sec. 2(24)(xii) r.w.s. 28(va)) was
considered as a capital receipt not taxable as income.
Similarly, in the case of Lachit Films Vs. CIT [195 ITR 402] (Gauhati), grant in aid
received by assesse was considered as financial aid or subsidy, not includible in
the total income as grant in aid had not been included in Section 2(24).
Various provisions have thus been included in the definition of ‘income’ under
Section 2(24) in relation to export incentives, receipts from keyman insurance
policies, non-compete fees, gifts, capital gains, benefits and perquisites, etc. to
bring the same to tax net.
Accordingly, in absence of any consequential amendment to Section 2(24) of the
Act, the dispute with respect to taxation of carbon credits continues. Should the
controversy in relation to nature of receipts from sale of carbon credits is settled,
holding the receipt as capital receipt, it should be possible to argue that the
same will not fall within the definition of income and hence should not be taxed
under Section 115BBG proposed to be introduced.
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