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Clarity On Taxation Of Carbon Credits

Published on Wed, Mar 19,2014 | 18:06, Updated at Wed, Mar 19 at 18:06Source : 

By: N.C. Hegde, Partner, Deloitte Haskins & Sells

There has been an increased awareness and concern lately, for pollution and global warming. In order to address these issues, member countries of the UNO have committed to the Kyoto Protocol to limit and reduce greenhouse gas emissions.

Countries which control emissions are allotted carbon credits which is a tradable certificate representing the right to emit one tonne of carbon dioxide. A reduction in emissions entitles the entity to a credit in the form of a Certified Emissions Reduction certificate (CER). The CER is granted by a Board sponsored by the UNO to projects in developing countries. The CER is tradable and its holder can transfer it to an entity which needs Carbon Credits to overcome an unfavorable position on carbon emissions. India being relatively less industrialized is one of the largest beneficiaries of the Kyoto Protocol.

The tax treatment of credits is an issue that has been a subject matter of considerable debate..Tax issues may arise at the time of entitlement of the credit, since the same could be viewed as a benefit arising from the carrying on of a business specifically taxable under section 28(iv) of the Income-tax Act (‘Act’), or on its sale, where questions may arise whether the receipt is on a capital or revenue account and in the case of the former whether there could be any taxable capital gains.

In that background, the recent decision of the Tax Appellate Tribunal in M/s. Shree Cement Ltd. (ITA No. 504/JP/12) (ITAT Jp) does provide some guidance on the issue.

The company had undertaken an approved project for reducing on-site and off-site emissions at its thermal power plants. This had resulted in generation of carbon credits of Rs.16 crores which was claimed as capital receipt and not taxable.

The Tax Officer assessed the same as business income which was confirmed by the Commissioner of Income-tax (Appeals). Before the Tribunal, the appellant relied upon other Tribunal rulings. In the aforesaid rulings the Tribunal had held that the credits are not an offshoot of business but arise out of commercial concerns. According to the Tribunal the source of credit was world concern and environment and did not arise from the sale of a product, by-product or rendering of any services. Carbon credit had no element of profit or gain and it cannot be subjected to tax in any manner under any head of income.

The Tribunal further relied on the observations of the Apex Court in Vodafone International Holdings v CIT (341 ITR 1) that the provisions of the Direct tax Code provided a contemporary exposition of the taxability of the receipt. They observed that the fact that these credits are made specifically taxable as business receipts under the proposed Direct Tax Code whereas similar provisions are absent under the Act, lead to an inference that the same are not intended to be taxed.

The Tribunal also relied upon the Hyderabad Tribunal ruling of My Home Power Ltd. –vs.- DCIT (2013) 151 TTJ 616 (Hyd) which has in turn relied on the Supreme Court decision of Maheshwari Devi Jute Mills Limited (57 ITR 36). In the Supreme Court decision the assessee, a manufacturer of jute goods, was a member of the Jute Mills Association. To protect against loss resulting from over-production, the members of the association entered into an agreement restricting hours of work. The hours for which the members were entitled to work their factories were called ‘loom-hours’. Allotment of ‘loom-hours’ depended upon the number of looms installed by each member. The assessee was unable to work its loom for the allotted hours and it sold its unutilized ‘loom-hours’ and received certain amounts as consideration for the same. The Court held that the payment received on sale of loom hours was on account of exploitation of a capital asset and therefore, of a capital nature. The Tribunal, in the present case, held that similar reasoning could be applied in relation to carbon credits.

The Tribunal ultimately held that the amounts would be classified as a capital receipt and would not be taxable in the hands of the appellant. Though it is not clear in the ruling whether the tax incidence was the entitlement or the transfer of credits, this issue by itself may not alter the view that even on transfer of the CER’s, the gains are not taxable. This is because an assessee, relying upon the principles laid down by the Supreme Court in CIT v B.C. SrinivasaSetty (128 ITR 294) and other rulings, can always contend that in the absence of a cost of acquisition or improvement, the capital gains itself are incapable of determination and hence the taxation charge itself fails.  

The recent rulings of the Tribunal seem to have ‘cleared the air’ temporarily on tax treatment of carbon credits. Till such time a High Court does not decide on the issues raised, there will always be some uncertainty regarding tax. In terms of section 28(va) of the Act, compensation received from the multilateral fund of the Montreal Protocol on Substances that deplete the Ozone layer under the United Nations Environment Programme, is not taxable as business income. A suitable amendment excluding amounts in respect of carbon credits under the Kyoto Protocol would also be welcome.


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