Purchase and Sale of Carbon Credits is undertaken globally as a part of the Clean Development Mechanism (CDM), which is targeted towards reduction of Green Houses Gases in the atmosphere. Under this mechanism, Carbon Credits are purchased and sold for a consideration. The taxability of the gains arising from such sale have been a matter of litigation. The esteemed authors have analysed the conflicting decision and discussed the intricate points related to the taxability under the Income-tax Act, 1961 of the consideration received on the sales of these credits.
Issue
To limit concentration of Green House Gases (GHGs), in the atmosphere, for addressing the problem of global warming, the United Nations Framework Convention on Climate Change (UNFCCC) was adopted in 1992. Subsequently, to supplement the convention, the Kyoto Protocol came into force in February 2005, which sets limits on the maximum amount of emission of GHGs by countries. The Kyoto Protocol commits certain developed countries to reduce their GHG emissions. In order to enable the developed countries to meet their emission reduction targets, the Kyoto Protocol provides three market-based mechanisms, one of which is the Clean Development Mechanism (CDM).
Under the CDM, a developed country can take up a GHG reduction project activity in a developing/least developed country where the cost of GHG reduction is usually much lower, and in consideration for undertaking the activity the developed country would be given carbon credits for meeting its emission reduction targets. Alternatively, entities in developing/least developed countries can set up a GHG reduction project, in their respective countries, get it approved by UNFCCC and earn carbon credits. Such carbon credits generated, by the entities in the developing/least developed country, can be bought, for a consideration, by the entities of the developed countries responsible for emission reduction targets. Under the CDM, carbon credits are measured in terms of Certified Emission Reduction (CER) where one CER is equal to 1 metric tonne of carbon dioxide equivalent, and for which a certificate is issued, which certificate is saleable.
The question has arisen, under the Indian tax laws, as to whether the consideration received by an entity for sale of carbon credits generated by it is of a capital nature or a revenue nature, and whether such amount is taxable or not. Incidental questions are whether such income is eligible for deduction under chapter VIA and whether it is liable for MAT. While the Hyderabad, Jaipur and the Chennai benches of the tribunal have taken the view that sale proceeds of carbon credits are not taxable, being capital receipts arising out of environmental concerns and not out of the business, the Cochin bench of the tribunal has taken the view that the sale proceeds of such carbon credits are taxable as a benefit arising out of business.
My Home Power’s case
The issue first arose for consideration before the Hyderabad bench of the tribunal in the case of My Home Power Ltd vs. Dy. CIT 21 ITR (Trib) 186.
In this case, the company was engaged in the business of power generation through biomass power generation unit. During the relevant year, it received 1,74,037 Carbon Emission Reduction Certificates (CERs) or carbon credits for the project activity of switching off fossil fuel from naphtha and diesel to biomass. It sold 1,70,556 CERs to a foreign company and received Rs. 12.87 crore. It accounted this receipt as capital in nature and did not offer it for taxation.
The assessing officer treated the sale proceeds of the CERs to be a revenue receipt, since they were a tradable commodity, and even quoted on stock exchanges. He accordingly added a net receipt of Rs. 11.75 crore to the returned income. The Commissioner(Appeals) confirmed the order of the assessing officer and further held that it was not income from business and was therefore not entitled for deduction u/s. 80-IA.
Before the Tribunal, it was argued on behalf of the assessee that the main business activity of the assessee was generation of biomass-based power. The receipt had no relationship with the process of production, nor was it connected with the sale of power or with the raw material consumed. It was also not the sale proceeds of any by-product. It was further argued that CERs were issued to every industry, which saved emission of carbon, and was not limited to power projects. Further, the certificates were issued keeping in view the production relating to periods prior to the previous year. It was claimed that the amount was not compensation for loss suffered in the process of production or for expenditure incurred in acquisition of capital assets.
It was further argued that the certificates issued by the UNFCCC under the Kyoto protocol only recognised the achievement made by the assessee in emitting lesser quantity of gases than the assigned quantity, and had no relation to either revenue or capital expenditure incurred by the assessee. The certificate itself did not have any value unless there were other industries which were in need of such certificate, and was not dependent on production. In a hypothetical situation where all the industries in the world were able to limit emissions of gases to the assigned level, it was argued that there would be no value for such certificates issued by UNFCCC.
It was claimed that the process of business commenced from purchase of raw material and ended with the sale of finished products, and that the gain was not earned in any of the in-between processes, nor did it represent receipt to compensate the loss suffered in the process. Therefore, the amount did not represent any income in the process or during the course of business. It was also claimed that the amount did not represent subsidy for establishing the industry or for purchase of raw material or a capital asset. UNFCCC did not reimburse either revenue or capital expenditure, and in fact did not provide any funds, but merely certified that the industry emitted a particular quantity of gases as against the permissible quantity. It was therefore not a subsidy granted to reimburse losses. In fact, no payment was made by UNFCCC, but only a certificate was issued without any consideration of profit or loss or the cost of acquisition of capital assets.
It was also argued that the amount could not be considered to be a perquisite, as it was not received from any person having a business connection with the company, and was not received in the process of carrying on the business. It was claimed that unless there existed a business connection, no benefit or perquisite could be derived.
It was also claimed that the amount did not fall within the definition of income u/s. 2(24). It did not represent an incentive granted in the process of business activity, as the amount was not received under any scheme framed by the government or anybody to benefit the industry or to reimburse either the cost of the raw material or the cost of capital asset. The amount was not an award for the revenue loss suffered by the company, as it was granted without relevance to the financial gains or losses. The payment was made without any relevance to the financial transactions of the assessee and there was no consideration for paying this amount. The amount was paid in the interest of the international community and not in the interest of industry as such, or in the interest of the assessee as a compensation for the loss or expenditure during the course of business, and was therefore a sort of gift given by UNFCCC for the distinction achieved by the assessee in achieving emission of lesser amount of gases than the assigned amount. It was therefore not an income within the meaning of section 2(24) or section 28.
Reliance was placed on the decision of the Supreme Court in the case of CIT vs. Sterling Foods 237 ITR 579, for the proposition that just as certificates issued by the government for export of goods which were capable of sale, was held as not arising from the industrial undertaking, but from the export promotion scheme of the government, so also such CER certificates were attributable to the climatic protection scheme of the UNFCCC, which had no relevance to the business activities of the assessee.
It was further pointed out that under the draft Direct Taxes Code (DTC), such items were regarded as income, yet no amendment had been made to the Income-tax Act to bring such items to tax as income. Therefore, the intention of Parliament was not to tax such CERs till such time as DTC came into force.
It was pointed out that in the case of subsidies, subsidies received on revenue account alone would be taxed as income, while subsidies received on capital account were not to be taxed, but would be reduced from the cost of the capital asset for the purposes of claiming depreciation. Further, subsidy received for the public good was held as not taxable. In the case of the assessee, the amount did not represent composition for loss on revenue account, nor a gain during business activities, nor a reimbursement of any capital expenditure. It was claimed that the amount received was for public good and was therefore not taxable.
Besides claiming that it was a capital receipt, it was alternatively claimed that the income was not assessable for the relevant assessment year, since it related to reduction of carbon emissions during earlier years, that the amount was eligible for deduction u/s. 80-IA since the assessing officer was of the view that it was connected to the production of power and that, if it all it was to be taxed, the expenditure relatable to earning certificates had to be arrived at by taking into consideration the assets used and the materials consumed in the earlier years and such amount had to be reduced from the gross receipts to arrive at the taxable amount.
On behalf of the revenue, it was argued that the underlying intention behind the technological implementation by a company in the developing world is not only to reduce the pollution of atmosphere, but also to earn some profit from out of excess units that can be generated by implementation of the CDM project. It was claimed that the CER credits can be considered as goods, as they had all the attributes of goods, viz. utility, capability of being bought and sold, and capability of being transmitted, transferred, delivered, stored and possessed. According to the revenue, the purchase agreement between the assessee and the foreign company indicated that the sale transaction of CERs was nothing but a transaction in goods.
It was further argued on behalf of the revenue that by implementing the CDM project, the assessee got the benefit of efficiency in respect of reduction of pollution. Had there been no other benefits attached to it, under normal circumstances, the assessee would not have bothered to obtain CERs. It was because of the expenditure incurred for implementation of the project as a pollution reduction measure that the assessee got the benefit of the certificates. The expenditure incurred was claimed in its profit and loss account. Since it was known that the UNFCCC certificates had intrinsic value and had a ready market for redemption or trading, the assessee obviously pursued obtaining of these certificates. Further, these certificates were traded and were therefore akin to shares or stocks transacted in the stock exchange, and were therefore revenue receipts rightly brought to tax by the assessing officer.
The Tribunal observed that carbon credits were in the nature of an entitlement received to improve world atmosphere and environment, reducing carbon, heat and gas emissions. According to the Tribunal, the entitlement earned for carbon credits could at best be regarded as a capital receipt and could not be taxed as a revenue receipt. It was not generated or created due to carrying on of business, but it accrued due to world concern. Its availability and assumption of the character of transferable right or entitlement was only due to the world concern.Therefore, the source of carbon credits was world concern and environment, to which the assessee got a privilege in the nature of transfer of carbon credits. Therefore, the amount received for carbon credits had no element of profit or gain and could not be subject to tax in any manner under any head of income.
According to the Tribunal, carbon credits were made available to the assessee on account of saving of energy consumption and not because of its business. Transferable carbon credits was not a result or incidence of one’s business but was a credit for reduction of emissions. In its view, carbon credits could not be considered to be a by-product. It was a credit given to the assessee under the Kyoto Protocol and because of international understanding. According to the Tribunal, the amount received was not received for producing and selling any product, by-product or of rendering any service in the course of carrying on of the business, but was an entitlement or accretion of capital, and hence income earned on sale of these credits was a capital receipt.
The Tribunal relied on the decision of the Supreme Court in the case of CIT vs. Maheshwari Devi Jute Mills Ltd. 57 ITR 36, where it was held that consideration for transfer of surplus loom hours by one mill to another mill under an agreement for control of production was a capital receipt and not an income. It was held that such sale proceeds was on account of exploitation of a capital asset, and it was a capital receipt and not an income. According to the Tribunal, the consideration received by the assessee for carbon credits was similar to the consideration received by transfer of loom hours.
Accordingly, the Tribunal held that carbon credits was not an offshoot of business, but an offshoot of environmental concerns, and that carbon credits did not increase profits in any manner and did not need any expenses. It was a nature of entitlement to reduce carbon emissions, with no cost of acquisition or cost of production to get such entitlement. Therefore, carbon credits was not in the nature of profit or in the nature of income, but a capital receipt.
The view taken by the Hyderabad bench of the Tribunal in this decision was followed by the Chennai bench of the tribunal in the cases of Ambika Cotton Mills Ltd vs. Dy CIT 27 ITR (Trib) 44 and Sri Velayudhaswamy Spinning Mills (P) Ltd vs. Dy CIT 27 ITR (Trib) 106 and recently, the Jaipur bench in the case of Shree Cements Ltd. vs. ACIT, 31 ITR(Trib) 513 has followed the decisions of the Chennai bench.
Apollo Tyres’ case
The issue again came up before the Cochin bench of the Tribunal in the case of Apollo Tyres Ltd. vs. ACIT 149 ITD 756, 31 ITR(Trib) 477.
In this case, the assessee received Rs. 3.12 crore from sale of CERs or carbon credits generated in the gas turbine unit. The assessee claimed that the income earned on sale of carbon credits was directly and inextricably linked to generation of power and that the assessee would therefore be entitled to deduction u/s. 80-IA. However, the assessing officer and the DRP held that the income was not derived from eligible business and was therefore not eligible for deduction u/s. 80-IA.
Before the Tribunal, the assessee raised an additional ground that the income received on sale of carbon credits was in the nature of capital receipt, and therefore not liable for taxation.
On behalf of the assessee, it was argued before the tribunal that the entitlement to carbon credits arose from the undertaking of the developed countries to reduce global warming and climate change mitigation across the world. It was claimed that carbon credits was an incentive provided to a project which employed a methodology to effect demonstrable and measurable reduction of emission of carbon dioxide in the atmosphere. The mechanism provided for trading CERs provided an opportunity to the holder of such certificate to dispose of the same to an actual user to acquire such credit to be counted toward fulfilment of its committed target reduction. Therefore, the mechanism provided by the United Nations provided an incentive for employment of new technology which helped in emission reduction, and therefore contributed to the desired object to protect the world environment. The purpose of Kyoto protocol was to protect the global environment and incorporate green initiative by adopting new technologies. The underlying object of CERs by the UNFCCC was focused on climate change mitigation by reducing the harmful effect of GHG emission and not to ensure that the recipient of such CER could run his business in a more profitable or cost effective manner.
It was argued on behalf of the assessee that all capital receipts were not income, but only capital gains chargeable u/s. 45 by virtue of the specific definition contained in section 2(24) (vi). Reliance was placed on the decision of the Hyderabad bench of the Tribunal in the case of My Home Power Ltd. (supra) for the proposition that the amount received on transfer of carbon credits was a capital receipt, and therefore not liable for taxation. It was alternatively argued that in case the tribunal found that the income on sale of carbon credits was a revenue receipt, then the assessee was entitled to deduction u/s. 80-IA, because it was inextricably linked to the business of the assessee.
On behalf of the revenue, it was argued that income or amount received by termination or sterilisation of a capital asset would fall in the capital field, but if the amount was received in the course of regular business activity due to sale of a product or entitlement incentive received due to a scheme of the government or the international community, then it would fall in the revenue field. According to the revenue, in the case before the tribunal, there was no sterilisation of any capital asset. The assessee generated power by using a gas turbine. What was given to the assessee was an incentive in the course of its regular business and therefore the amount received on sale of carbon credits had to be treated as a revenue receipt.
It was further submitted that the income on sale of carbon credits was not derived from the industrial undertaking. Though there might be a nexus between the business of the assessee and the receipt of income on sale of carbon credits, the income had to be necessarily derived from the industrial undertaking. In the case before the Tribunal, the income was derived on account of the scheme of the UNFCCC and not from the industrial undertaking. It was therefore argued that the assessee was not entitled to deduction u/s. 80-IA.
The Tribunal analysed the concept of carbon credits. According to it, carbon credits was nothing but an incentive given to an industrial undertaking for reduction of the emission of GHGs, including carbon dioxide. It noted that there were several ways for reduction of emission of GHGs, such as by switching over to wind and solar energy, forest regeneration, installation of energy-efficient machinery, landfill methane capture, etc. According to the Tribunal, it was obvious that carbon credits was nothing but a measurement given to the amount of GHG emission rates in the atmosphere in the process of industrialisation, manufacturing activity, etc. Therefore, carbon credits was a privilege/entitlement given to industries for reducing the emission of GHGs in the course of their industrial activity.
While considering whether the receipt was a capital receipt or a revenue receipt, the Tribunal analysed the decision of the Hyderabad bench of the tribunal in the case of My Home Power Ltd. (supra). It noted that the Tribunal in that case had placed reliance on the judgement of the Supreme Court in Maheshwari Devi Jute Mills Ltd. (supra), and that it had held that the amount received on sale of carbon credits was on sale of entitlement conferred on the assessee by UNFCCC under Kyoto Protocol. It also noted that sale of carbon credits did not result in sterilisation of any capital asset.
Analysing the decision of the Supreme Court in the case of Maheshwari Devi Jute Mills Ltd. (supra), the Cochin bench of the Tribunal noted that in the case before the Supreme Court, it was accepted by the revenue at the lower levels that the loom hours were assets belonging to each member and that it was only at the Supreme Court level, that the revenue contended that the loom hour was a privilege, and not an asset. The Supreme Court did not consider the aspect of whether the loom hours was a capital asset, since it had been accepted to be a capital asset, right up to the proceedings before the High Court, and a change in stand was not permitted by the Supreme Court. It was based on these facts that the Supreme Court held that the receipt on sale of loom hours must be regarded as capital receipt and not as income. The Tribunal according held that the said decision did not really help the case of the assesee as it was delivered on the facts of the case and therefore found that the Hyderabad bench was unduly influenced by the said decision of the Supreme Court in concluding that the carbon credits were capital assets.
The Cochin bench of the Tribunal noted that in the case before it, right from the assessment proceedings before the assessing officer till before the Tribunal, the assessee had not made any claim that the carbon credit was a capital asset as defined in section 2(14). Further, the assessee had claimed deduction u/s. 80-IA in respect of sale of carbon credits. Therefore, the assessee had effectively conceded that carbon credits were not capital assets. According to the Tribunal, had the assessee claimed that the carbon credits were capital assets, it would not have claimed deduction u/s. 80-IA on the income derived from sale of the carbon credits. The Tribunal observed that the assessee itself treated the carbon credits as an entitlement or privilege generated in the course of business activity.
The Tribunal noted that the assessee was engaged in the business of manufacture of tyres and for the purpose of captive consumption, the assessee generated electric power by using a gas turbine. In the process of power generation, the assessee reduced emission of carbon dioxide and therefore received carbon credits. According to the Tribunal, it was obvious that carbon credits were obtained by the assessee in the course of its business activity. The Tribunal was of the view that when the carbon credits was an entitlement or privilege accruing to the assessee in the course of carrying on of manufacturing activity, it could not be said that such carbon credits was an accretion of a capital asset. It noted that carbon credits was not a fixed asset or tool of the assessee to carry on its business. According to it, the sale of carbon credits was a trading or revenue receipt.
The Tribunal also considered the aspect of whether import entitlement was at par with carbon credits. It noted that both import entitlements and carbon credits came from a scheme, one of the government and one of the UNFCCC under the Kyoto protocol. It was therefore of the view that both were on par. Following the decision of the Kerala High Court in the case of OK Industries vs. CIT 42 CTR 82, which had held that import entitlement was generated in the course of business activity and could not be treated as an asset within the meaning of section 2(14), the Tribunal held that carbon credits also could not be treated as capital assets.
The Cochin bench of the Tribunal observed that the provisions of section 28(iv) read with section 2(24)(vd), which brought to tax the value of any benefit or privilege arising from business, were not brought to the notice of the Hyderabad bench of the Tribunal in the case of My Home Power Ltd. (supra), and that therefore that decision was not applicable to the case before it.
The Tribunal therefore held that the sale of carbon credits constituted revenue receipts and profits and gains of the business u/s. 28(iv) read with section 2(24)(vd).
Observations
Sale proceeds of carbon credits have not been specifically included in section 28, or in the definition of income u/s. 2(24). The legislature when desired, has amended the Income-tax Act to include certain specific receipts as income, even though the character of such receipts may not necessarily be in the nature of income. For instance, profits on sale of import entitlements and certain other specified receipts are specifically included as an income u/s. 28(iiia) to (iiie) read with section 2(24)(va) to (ve). Similarly, amounts received under an agreement for not carrying out any activity in relation to business is specifically taxable u/s. 28(va) read with section 2(24)(xii). The Cochin bench of the Tribunal does not seem to have considered this important fact of the omission, to expressly provide for the taxation of the carbon credits, which fact convey the intent of the legislature to not expose such receipts to taxation, which intent is further strengthened by clause(ii) to the proviso to section 28(va).
There is a specific exclusion, from taxation, under the clause(ii) to the proviso to section 28(va) for compensation received from the multilateral fund of the Montreal Protocol on Substances that Deplete the Ozone Layer under the United Nations Environment Programme. Such compensation is similar in character to carbon credits, in the sense that both are received under a multilateral convention for protection of the environment for doing or not doing a particular activity, which results in environment improvement. The intention therefore appears to be not to tax such amounts, since these are rewards for benefiting the world and public in general.
The Cochin bench of the Tribunal seems to have been largely influenced by the fact that the assessee, in the initial stages before the tax authorities, had taken the stand that the amount was taxable and was relatable to its power generation business. It therefore proceeded on the footing that the assessee itself had considered the carbon credits as the receipts arising from its power generation business.
The fact that carbon credits are transferable or that they are traded on stock exchanges is irrelevant for deciding the fact as to whether they are capital receipts or revenue receipts. Similarly, it is not necessary that all benefits arising from business activity are of a revenue nature. For instance, by carrying on business, goodwill or a brand may be generated, which is of a capital nature. In fact the various receipts, now specifically made taxable under different clauses of section 28 aforesaid, are the cases of business receipts in the nature of capital, that are made taxable under specific legislation.
The real issue is whether the carbon credits, even where regarded as benefits or perquisites, arise from the business? The Hyderabad bench of the Tribunal, relied on the Supreme Court’s decision in the case of Sterling Foods (supra) to take a view that the export entitlements did not arise from the business of the industrial undertaking, but from the scheme of the Government. The view of the Cochin bench of the Tribunal, however meritorious, that the carbon credits arose on account of the manner in which the business was carried on, and was not totally divorced from the business activity, is at the most debatable. Considering the importance of the environment protection and the need to promote the measures to protect it, the Government should specifically amend the law if it believes that the carbon credits are taxable as income. In fact, the intention seems to have been to tax it once the DTC came into force, as the draft DTC had provisions for taxing such amount. If the intention is to tax it now, the Income-tax Act needs to be amended on the lines of Clauses (va) to (ve) of section 2(24) and Clauses (iiia) to (iiie) of section 28 for that purpose.
However, for the time being, the issue seems to have been concluded in favour of the assessee, by the Andhra Pradesh High Court, which approved the decision of the Hyderabad bench of the Tribunal in the case of CIT vs. My Home Power Ltd., 365 ITR 82. The Andhra Pradesh High Court agreed with the findings of the Tribunal that carbon credit is not an offshoot of business, but an offshoot of environmental concerns, and that no asset is generated in the course of business, but is generated due to environmental concerns. According to the High Court, the carbon credit was not even directly linked with power generation. The High Court held that the amount received on sale of excess carbon credits, was a capital receipt, and not a business receipt or income.
