Carbon Credits is an incentive given to an industrial undertaking with the motive to reduce emission of GHGs (Green House Gases), including carbon dioxide.
The need for carbon trading was felt when it was realized that the industries have been the biggest polluter of greenhouse gases which has resulted in global warming. The Kyoto Protocol is an International Treaty which extends the 1992 United Nations Framework Convention on Climate change (UNFCC) that commits state parties to reduce greenhouse gas emissions, based on the scientific consensus that global warming is occurring and it is likely that carbon dioxide emissions have caused it. The Kyoto Protocol was adopted in Kyoto, Japan on 11 December 1997 and entered into force on 16 February 2005. There are currently 192 parties to the protocol.
The KYOTO PROTOCOLS commit certain developed countries to reduce emission of Green house gas and for these they will be given Carbon Credits.
• Need of Carbon Credits
As economy today is developing and industrialization is gaining pace, pollution levels and global warming have increased significantly. Considering its environmental consequences and impact on living beings, continuous efforts have been made to create awareness about harmful impact of Global Warmingand ways to reduce it through use of non-polluting sources of energy. But only creating awareness was not enough as emissions of GHG was still increasing, so it was necessary to attach some financial incentive to it, so that it’s harmful impact could be curbed. Consequently the concept of “CARBON TRADING” was introduced.
• What does CARBON TRADING involve ?
Every Industrialized nation has been given certain quota of units; The quantity of the initial assigned amount is denominated in Assigned amount units(AAUs), which are individual units, which is equivalent to emission of 1 Ton of CO2 or equivalent emissions of other greenhouse gases like Methane, Nitrogen oxides etc. and these are entered into the country’s national registry.
If any country doesn’t use up its entire allowance of credits, it can either save it or exchange it for money or give it to some country which has exceeded its limit. If a country uses up its entire limit, it has to buy credits from another country that has not used up its entire allowance.
Similarly, Operators that have not used up their quotas can sell their unused allowances as carbon credits, while businesses that are about to exceed their quotas can buy the extra allowances as credits, privately or on the open market.
• All these transactions are expressed in Carbon credits and their trading in the market is called “Carbon Trading / Emission Trading.
• The Kyoto Protocol also provides for trading of carbon credits through Clean Development Mechanism (CDM).
• Trading of Carbon Credits
If an entity reduces emission of harmful gases, it will be entitled to a certificate called “Certified Emission Reduction”(CER).The CER is tradable and holder can transfer it to an entity which has exceeded its carbon emission limits.
Carbon credit in India is traded on NCDEX (National Commodity and derivative Exchange) only as a future contract. Futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality at a specified future date at a price agreed today (the futures price). The contracts are traded on a future exchange. These types of contracts are only applicable to goods which are in the form of movable property other than actionable claims, money and securities. . Forward contracts in India are governed by the Indian Contract Act, 1872.
• Taxability of Carbon Credits:
(A) Taxability under Direct Tax Laws :
Income Tax Department has been treating income derived on transfer of carbon credits as Business Income taxable @30%. However, divergent decisions have been given by the courts on the issue as to whether the income received or receivable on transfer of carbon credit is a revenue receipt or capital receipt.
In order to bring clarity on the issue of taxation of income from transfer of carbon credits, new section 115BBG was amended w.e.f. 01 April 2018.
Section 115BBG states that:
115BBG. (1) Where the total income of an assessee includes any income by way of transfer of carbon credits,the income-tax payable shall be the aggregate of—
(a) the amount of income-tax calculated on the income by way of transfer of carbon credits, at the rate of ten per cent; and
(b) the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by the amount of income referred to in clause (a).
(2) Notwithstanding anything contained in this Act, no deduction in respect of any expenditure or allowance shall be allowed to the assessee under any provision of this Act in computing his income referred to in clause (a)of sub- section (1)
(B) Taxability under Indirect Tax Laws :
With regards to Taxability of CER, there are two different school of thoughts being practiced currently. One treats CER as“Goods” and Other treats it as “Services” under Goods and Services Tax regime.
If we consider CER as GOODS:
As per Goods and Service Tax Act, 2017; anything to be classified as “goods” should satisfy following criteria –
I] It must be movable
II] It must be marketable
III] It must not be any money or securities.
From the afore mentioned conditions, it can be said that CERs qualify as “goods” as they have intrinsic value and are movable and freely transferable. Further, CER’s always have had their own market. Some important notifications and clarifications in this regard are mentioned below in brief :
(a) Notification No. 256/CDVAT/2009/43 dated 13.01.2010 issued by the Commissioner, Trade and Taxes, Delhi VAT under section 85 of the Delhi VAT 2004. The Commissioner vide the aforementioned Notification declared Carbon Credits /CERs as good as they have certain intrinsic value, are capable of being brought, sold, transferred and possessed and are not different from ordinary commodity sold and bought in the market.
(b) Carbon Credits were declared as goods under the Securities Contracts (Regulation) Act, 1956. The National Commodity & Derivative Exchange Limited (NCDEX) vide the Circular No. NCDEX/ TRADING-035/2008/080 dated April 7, 2008
(c) CERs are alike Priority Sector Lending Certificates (PSLCs) and Renewable Energy Certificates (RECs). Therefore, it is evident thatCERs, RECs and PSLCs are the certificates having intrinsic value traded in the market.
(d) Thus as per Circular No. 34/8/2018-GST dated 01.03.2018 and Circular No. 46/20/2018-GST dated 06.06.2018, whereby the applicability of GST on PSLCs and RECs has been clarified. The government vide the latter clarified that RECs, PSLCs etc. are classified under heading 4907 and will accordingly attract GST @ 12 % instead of 18% under the residual head, which was earlier clarified by the Circular No. 34/8/2018-GST dated 01.03.2018.
If we consider CER as SERVICES:
“Securities” under GST are the same as defined inclause (h) of section 2 of the Securities Contract (Regulation) Act, 1956 (“SCRA”) i.e. “Securities include- (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate
Carbon Credits/CERs may be treated as “Securities” as they appear to fall under the wide term, “other marketable securities of a like nature in or of any incorporated company or other body corporate“. If it comes out that CERs are classifiable as securities, same will be out of the scope of term goods and thus not taxable under GST.
Recently, a writ petition has been filed before the Bombay High Court, wherein the petitioner has challenged the Circulars no. 34/8/2018 dated 01.03.2018and 46/20/2018 dated 06.06.2018 on the ground that REC scrips qualify as securities under GST. However still there is ambiguity and soon legislature should clear it.
• Accounting aspect of Carbon Credits :
Why not AS-26 “ Intangible Assets”?
According to AS-26, an Intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production and supply of goods and services, for rentals to others, or for administrative purposes.
But CER are not used in production or supply or administrative purposes or for rentals.
Therefore we cannot classify it as Intangible Asset.
Treatment Under AS-2 :
CER is generated by the generating entity and held for sale. Accounting for Self-Generated CER in the ordinary course of business are excluded from the scope of AS 26. Therefore, they are to be accounted for in accordance withAS2 – Inventory Valuation. Inventories are assets when they are held for sale in the ordinary course of business, and used in production for such sale or in the form of materials or supplies to be consumed in the production process or in the rendering of services. Thus the CER should be accounted as per requirements of AS 2. Therefore CER is to be valued at the lower of cost or net realizable value. Cost of inventories should comprise of all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location or condition.
Income from the sale of CRE is to be recognized in accordance with the Accounting Standard (AS) 9 REVENUE RECOGNITION as the CER is now an inventory.
Treatment of Tangible and Intangible assets used to reduce emission and generate CER :
Tangible assets like incinerators etc. to be accounted in accordance with AS 10 (Property, Plant and equipment)
Intangibles like Research and development to be accounted in accordance withAS-26 (Intangible assets).
• Disclosures required in respect of Carbon Credits :
An entity should disclose the following information in financial statements:
(a) Number of CRE held as inventory and basis of valuation.
(b) Number of CRE under certification.
(c) Depreciation and operating maintenance costs of Emission Reduction Equipment expensed during the year.
• Conclusion :
It is expected that India will gain at least $5 billion to $10 billion from carbon trading (Rs 22,500 crore to Rs 45,000 crore) over a period of time. Also India is one of the largest beneficiaries of the total world carbon trade through the Clean Development Mechanism claiming about 31 per cent (CDM).
Though India is beneficiary in Carbon Trading and gaining through it, but Carbon trading requires more regulations and a proper legislation to govern it. Further ambiguities regarding taxability of it should be cleared.
This all will help to get the best through Carbon Trading and will also help to achieve its main objective of reducing carbon emissions as it would prove as encouragement for industries and they will try their best to maintain emissions low.
- Anjali P. Shah