June  2009
volume I  issue 4
TURNING CARBON INTO CASH …
And related taxation issues

Today there is an emerging opportunity of revenue generation by taking up structured Clean Development Mechanism (CDM) projects. Popularly known as Carbon Trading, this concept of revenue generation is still catching on. Credible studies estimate the market for Carbon Trading (CDM) in India to be around one billion dollars per annum, if entrepreneurs consider the environmental impact while structuring their businesses.

This article looks at the taxability of revenue arising from sale of carbon credits or Certified Emissions Reductions (CERs) when considered under the following heads:

1. Profits and Gains from Business or Profession (‘PGBP’) When an assessee purchases CERs and sells them to third parties on a regular basis, it can be regarded that the assessee is engaged in trade of carbon credits. The profits arising there from would then be taxed as business income.

So what is carbon trading?

Over the last century the greenhouse gas emissions from the developed world have reached alarming proportions. The legally binding Kyoto protocol ratified by nearly all countries (except US and Australia who remain the highest polluters) has set targets to reduce the greenhouse gases.

The protocol provides a mechanism, whereby those pursuing CDM projects can trade their ‘emission reductions’ and benefit by being more responsible. Say if one sets up a project, which will use wind power and therefore saves 100 tonnes of carbon dioxide being emitted per year had it come from a coal burning thermal power plant. Such a project today can
potentially ‘earn’ 100 CER, where one CER is equal to one tonne of carbon dioxide reduced per year. As such, a country like the UK , which is required to reduce 1 million tonnes of carbon dioxide each year, can purchase these CERs from this company and thereby reduce its target by 100.

These CERs or carbon credits are issued by the CDM Executive Board to projects in developing countries and they are like ‘stock in trade’ / ‘certificates’. This CDM Board also approves all such projects. Such projects are monitored by Designated Operational Entity (DOE) to see whether emissions are actually reducing each year as envisaged. Based on such verification the CERs are issued. These CERs have a market and get bought and sold like any other market based on the market situation.
 

However a question arises as to whether gain arising rom sale of self‐generated CERs can be considered as usiness income. It appears that since CER credits have all the attributes of goods; such as‐ utility, capability of being bought and sold, transferred, stored/possessed; they can be treated as part of the income.

This view has been held by the apex court in the TATA Consultancy Services v. State of Andhra Pradesh (2004) 271 ITR 401, while dealing with the issue of levy of sales tax on computer software. And later reiterated by the apex court in BSNL v UOI (2006) 282 ITR 273.

2. Capital Gains: However, one may also explore the possibility of treating CER credits as ‘ Capital Asset ’ within the meaning of Section 2(14) of the Income Tax Act. Section 45 of the Act provides that the profits or gains arising from transfer of a capital asset shall be chargeable to tax as capital gains. Capital asset is defined to mean property of any kind, whether fixed or circular, movable or immovable, tangible or intangible and whether or not used for the purpose of the business of the assessee.

As per the above, carbon credits can be considered as capital assets. It may, hence, be contended that the gain arising from transfer of carbon credits shall be chargeable to tax as capital gains. Section 48 provides for the mode of computation of capital gains. The full value of sale consideration is reduced by the expenses incurred on transfer and the cost / indexed cost of acquisition and improvement to arrive at the capital gains.

In case of carbon credits, the sale consideration and expenses relating to transfer will be available. However, determining the cost of acquisition of self‐generated carbon credits will be an issue to be considered. The Act provides that in case of 10 specified assets (such as Goodwill, Loom Hours, etc.), the cost of acquisition shall be deemed to be NIL unless they are acquired from a third party. Carbon credits are not specifically mentioned in those 10 specified assets. There is no mechanism under the Act to compute the cost of acquisition of self‐generated carbon credits. Hence, it can be argued that even though the sale of carbon credits falls within the ambit of the charging section for capital gains, there are no machinery provisions to compute the amount of capital gains. Relying on the Supreme Courtdecision in the case of B.C.Srinivasa Setty, it can be argued that gain on transfer of carbon credits cannot be taxed as capital gains.

However, as stated earlier ‐ this is an unchartered territory that has not yet tested the wisdom of Indian Jurisprudence. Hence one will have to be very cautious before adopting any view.
INSIDE THIS ISSUE
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