The United Nations Framework Convention on Climate Change (UNFCCC), an international treaty on environment, was drawn up to reduce carbon emissions. The Kyoto Protocol, 1998 was adopted by parties to the UNFCCC to achieve quantified emission limitations through specific policies and measures, to minimise the adverse effects of climate change.

India, along with other developing nations, is at an advantage as it can implement approved projects for trading Certified Emission Reduction, or CERs. Furthermore, in December 2011, at UNFCCC Durban, the Kyoto mandate was extended until end of 2017, ending speculations that Kyoto may be replaced by another treaty.

Transfer of carbon credits

Carbon credits are part of a tradable permit scheme. They incentivise reduction of greenhouse gas emissions by giving a monetary value. One credit gives the owner the right to emit one tonne of carbon dioxide. Such credits have to be authentic, scientifically based, and comply with a regulatory body. The taxability of income arising from sale of credits has been a matter of debate, as there was no clarity under the Income-tax Act, 1961. However, the Direct Taxes Code Bill, 2010 explicitly provides that money received or receivable from transfer of carbon credits will be treated as business income. The Direct Taxes Code is proposed to come into effect from April 1, 2013.

Recently, the Hyderabad Income Tax Appellate Tribunal, in the case of My Home Power Ltd, held that carbon credit is not generated from carrying on business, but due to concern about the environment. Those with surplus credits benefit by selling to someone who needs them under the Kyoto Protocol. The amount is not received for producing and/ or selling a product, by-product, or for rendering a service.

Guidelines for taxing carbon credits

Carbon credit is entitlement or accretion of capital and, hence, income from their sale is capital receipt. The Supreme Court had decided in the case of Maheshwari Devi Jute Mills Ltd that transfer of surplus loom hours to another mill out of those allotted to a taxpayer under an agreement for control of production was capital receipt and not income. Similarly, in the present case, the taxpayer transferred the carbon credits, like the loom hours, to some other concern for a certain consideration. There is no cost or expense involved in carbon credit generation. Therefore, the receipt of such consideration cannot be regarded as business income, and was considered capital receipt. Furthermore, the Tribunal held that the amount received for transfer of carbon credits had no element of profit or gain, and cannot be subjected to tax under the Income Tax Act.

Various provisions from the Direct Taxes Code, such as GAAR, transfer of indirect assets, and software taxability as royalty have been introduced under the Act. However, the Government has chosen not to amend the Income Tax Act with respect to receipts for transfer of carbon credits. Therefore, this is a welcome ruling and will certainly provide clarity for taxpayers.

(Punit Shah is Partner, KPMG in India, and Mrugen Trivedi is Technical Director, KPMG in India)

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