In this article we will discuss the concept of carbon credits, what it means and what is its impact from the economic perspective.
Overview
The Carbon Credit market operates on a fundamental principle – mitigating carbon emissions through a certification process. This process categorises Carbon Credits (CC) into two distinct types, each serving a unique purpose in the world of environmental sustainability.
Certified Emissions Reductions (CERs)
The first category, known as Certified Emissions Reductions (CERs), is certified under the United Nations Framework Convention on Climate Change’s (UNFCCC) Clean Development Mechanism (CDM). These carbon credits play a crucial role in helping nations adhere to state-imposed restrictions outlined in the Kyoto Protocol. However, obtaining validation from UNFCCC is a meticulous and time-consuming process, necessitating prior approval from the national CDM authority.
Voluntary Carbon Credits
In contrast, various self-regulated certification agencies certify the second category of carbon credits, which is part of the voluntary CC market. Entities acquire these credits on a purely voluntary basis, driven by their pursuit of fulfilling self-imposed net-zero emissions targets. Unlike CERs, which are mandatory under international protocols, voluntary CC offer organisations the flexibility to engage in sustainability initiatives tailored to their unique environmental goals.
Market Dynamics
The Carbon Credit market, influenced by these two certification categories, reflects the global commitment to combat climate change. The demand for CERs is often driven by governmental adherence to international protocols, while voluntary carbon credits are sought after by businesses and organisations striving to align with environmental sustainability practices.
“The ultimate test of man’s conscience is our willingness to sacrifice something today for future generations whose words of thanks will not be heard.”
– Gayford Nelson
Sale Of Carbon Credit In India – Business Income Or Not?
Until some time ago, it was disputed whether the sale of carbon credits, being a business practice, would fall under the head of ‘Profits and Gains from Business and Profession’. The argument in support of it was based on the reasoning that it is a profit realised in the books of the company and should be subject to tax at the rate of 30 per cent. However, it was perceived that this rate of taxation was rather high and dissuaded companies with excess credits to part with them.
Concessional Tax Rate On Carbon Credit Income Tax Since April, 2018
After a recent amendment, a new section has been inserted in the Income Tax Act that now taxes carbon credits at the rate of 10 percent, instead of subjecting it to the regular tax of 30 percent. The new section 115BBG applicable from the assessment year 2018-19 about CC specifies that where the individual’s income includes any income from transfer of carbon credits, the same would be subject to taxation of 10 percent, with no deduction being allowable as expenditures made for the same.
This section does not restrict itself to just businesses and hence individuals who have CC may take advantage of this section. Another perspective suggests that this section, now offering a twenty percent reduction in tax payable on such income, may lead to the establishment of more environmentally conscious companies. These companies would now be interested in earning profits from the sale of carbon credits while paying 10 per cent tax on the income, as opposed to the regular 30 percent tax plus applicable surcharges.
Taxability of CC Under Indian Direct Tax Laws (Income Tax)
The taxability of income from the sale of carbon credits has been a subject of legal intricacies and amendments under Indian Direct Tax Laws. An amendment in the Income-tax Act, effective from April 1, 2018, introduced Section 115BBG, bringing explicit provisions for the taxation of income derived from the transfer of UNFCCC-validated cc.
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Taxation of UNFCCC Validated CC
Section 115BBG unequivocally mandates that income from the transfer of UNFCCC-validated carbon credits is taxable at a flat rate of ten percent (10%). Notably, this provision disallows any deduction in respect of expenditures or allowances related to such income.
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Pre-Amendment Scenario and Ongoing Litigation
Before the April 2018 amendment, ambiguity clouded the tax treatment of income from carbon credits, leading to legal disputes between the revenue authorities and taxpayers. In a notable case, the Madras High Court held that earnings from the sale of carbon credits should be treated as capital receipts, thereby exempting them from income tax. However, this decision remains under appeal before the Supreme Court, leaving the final verdict pending.
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Uncertainty in Taxation of Non-Validated CC
Despite the 2018 amendment, clarity remains elusive regarding the taxability of income from the sale of carbon credits not validated by UNFCCC. A notable gap arises from the amendment’s failure to expressly categorise such income as a revenue receipt. The ultimate legal position will only crystallise upon the Supreme Court’s pronouncement in the ongoing appeal.
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Navigating Tax Obligations
Given the prevailing uncertainty, taxpayers dealing with the sale of non-validated carbon credits find themselves in a complex situation. Section 115BBG, while providing a framework for taxing validated credits, does not explicitly address the taxation status of non-validated credits.
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Recommendation for Tax Compliance
In the absence of a definitive legal stance on non-validated carbon credits, a cautious approach for taxpayers is to consider the relatively safer position offered by Section 115BBG. This involves paying income tax on the proceeds from the sale of non-validated cc, while simultaneously availing applicable deductions for related expenditures.
Taxability of Carbon Credits Under Indian Indirect Tax Laws (GST)
Section 2(52) of the Central Goods and Services Tax Act, 2017 (CGST Act) defines ‘goods’ as every kind of movable property other than money and securities. Notably, securities are explicitly excluded from the definition, and a careful examination reveals that carbon credits do not fall under this category.
Government Notifications and Clarifications
The legislative landscape gained clarity with the Central Government’s notification (S.O.3068(E) dated September 27, 2016), designating carbon credits as goods (commodity derivatives) under the Securities Contract (Regulation) Act. This classification aligns carbon credits with renewable energy certificates (RECs), as affirmed in Circular No. 34/8/2018-GST.
GST Rate Determination
Effective from October 1, 2021, (as per Notification No. 8/2021-Central Tax (Rate)), the GST rate for RECs and PSLCs (priority sector lending certificates), initially classified under Heading 4907 at 12%, has been revised to 18%. This adjustment is crucial for transactions involving carbon credits, placing them under the 18% GST bracket post-October 2021.
GST on Export of Carbon Credits
Export of carbon credits enjoys a special status under GST, being categorised as a zero-rated supply. This implies that transactions involving the export of carbon credits are exempt from GST, providing a favourable landscape for international trade in these environmental commodities.
Who Decides The Price Of Carbon Credits?
A natural question that arises is whether companies are free to charge their cc at a price they fix if there are guidelines on fixation of prices of this tradable certificate. While the United Nations Framework on Climate Change is one of the validating bodies responsible for oversight, it does not formulate pricing guidelines. Businesses and individuals are increasingly promoting carbon credits as a market commodity that they can buy and sell in the open market privately, and make them available for exchange on the commodities market. This practice has already begun at NASDAQ and the European Climate Exchange. Believers think that businesses and individuals can come together and reduce prescribed national emissions through this reinforced effort.
Well, any business or entity should focus on reducing emissions but there are national and international levels of the same. If an entity needs to go beyond these specified carbon emission limits, then it can do so by paying for the carbon credits owned by another company. However, it is harmful to do so as it will ruin the sustainable efforts to keep the environment safe.
Conclusion
Recently, the concept of ‘green economics’ has devised the usage of economic and social instruments to control environmental damage and secure the planet for future generations. Incentivising people economically to watch their carbon footprint has been able to make considerable headway in terms of reducing the emissions of carbon dioxide and other poisonous by-products in the manufacturing process. Companies are undertaking innovations in the form of clean energy at their own cost to create a healthier dynamic with the community within which they operate. For more legal information, visit Vakilsearch.
FAQs
What is the carbon emissions tax credit?
A carbon credit is a permit that allows the holding company to release a certain amount of carbon dioxide or other greenhouse gases. One load requires a mass equal to one ton of carbon dioxide to be released. The carbon allowance is one half of a 'cap-and-trade' scheme.
How Are Carbon Credits Taxable in India?
Taxability of carbon credits under Indian Direct Tax Laws (Income Tax) With effect from 1st April 2018, Section 115BBG of the Income-tax Act has been inserted. The provision explicitly provides that the income from the transfer of UNFCCC validated carbon credits is taxable at the rate of ten (10) per cent.
Is there a GST Charged on carbon credits?
With effect from 23 November 2022, the issuance, transfer or sale of carbon credits (or any digital representation of the carbon credit) is treated as an excluded transaction (not subject to goods and services tax (GST)).
What are the two types of carbon credit?
For the carbon credit connoisseur, it's more important to know the two different carbon markets that credits are traded on! There is the compliance and voluntary market — and your location and industry determine whether you must participate in the compliance market.
What is the difference between a carbon tax and a carbon credit?
Carbon emissions trading sets an upper limit on total carbon emissions, allowing entities to trade credits according to their usage. Carbon taxes are a price tag put on fossil fuel emissions to disincentive their use and promote a switch to green energy. Both are types of carbon pricing.
What is the cost of carbon credit in India?
In India, DTE-CSE investigation shows that the price would range from $2 to $10 (R165-R824) per credit that has been retired till now. Assuming that the global average price is $4 per credit, India's carbon market is valued at $1.2 billion (R9,894 crore)—or possibly more given the current market rates.
