SALE VALUE OF CARBON CREDIT IS CAPITAL RECEIPT- a point of view supported by judicial rulings.

[C.A. DEV KUMAR KOTHARI]

Relevant links and references:

The Constitution of India List I - Union List  entry 82. Taxes on income other than agricultural income.

Section 2(24), 28, 41, 45, 55, and 56 of Income-tax Act, 1961.

Commissioner Of Income-Tax, Uttar Pradesh Versus Maheshwari Devi Jute Mills Limited 1965 (4) TMI 10 (SC) 

Sri Krishna Dairy And Agricultural Farm Versus Commissioner Of Income-Tax 1987 (4) TMI 39 (HC) 

DEPUTY COMMISSIONER OF INCOME-TAX Versus SMT SUNITI SINGH 2008 (1) TMI 61 (HC)  

Japan Chamber Of Commerce And Industry In India. Versus Director Of Income-tax (Exemptions), New Delhi.  2008 (4) TMI 350 (Tri) 

Carbon credit (CC):

A CC is defined as the unit related to reduction of one tones of CO2 (carbon dioxide) emission from the baseline of the project activity. Under International Emissions Trading (IET), countries can trade in the international CC market to cover their shortfall in allowances. Those countries which have surplus can sell the countries who have capped emission commitments under the Kyoto Protocol.

 This enables a developed country to buy CCs off the shelf through the instrumentally of a ‘climate exchange’ .IET is an administrative approach to control pollution by providing fiscal incentives to reduce emissions.

Carbon Emission Right (CER) is a type of financial derivative product that gets its value from reduction in emission of greenhouse gas. The trade in CERs can be on the spot or on forward basis. CCs create a market for reducing emissions by giving a monetary value to the cost of polluting the air.

CER can be acquired through self generation or through trading.

Developing countries like India can set up carbon reducing projects approved by UNFCCC. When such projects go on stream, these generate CERs, These CERs can be sold through the climate exchange.

Self generated CC will have different tax treatment in comparison to trading in CC. This will depend on tax laws of country from where CC is sold and can also be affected by tax laws of country in which CC is purchased.

Carbon credit – general perceptions:

Carbon credit may be allowed for saving of power and fuel and reduction of emission of carbon, heat  and other harmful gases in the environment. Carbon credit may be allowed for use of natural power sources through wind mills, solar power equipment etc. and also for other equipments which reduces consumption of conventional fuels for generation of power in form of electricity or some other form provided the process or equipment deployed for generation of power has effect of reduction of emission of carbon, other harmful gases, and heat in environment to reduce global warming.

Carbon credit is not an item which is produced in course of business of manufacturing of goods or even during generation of electricity or other form of power.  Carbon credit is available to user of advanced equipments or a person who saves energy consumption not because of its business but because of GLOBAL ENVIORNMENTAL CONCERNS RELATED TO ALL OVER WORLD. Thus the source of receipt is those global environmental concerns. This is rather a new concept. This is a general overall perception about carbon credit in minds of public.

The scope of carbon credit may increase in future, even household may be entitled to get carbon credit for saving power.

Contributions of individuals to environment:

Everyone can contribute to environment by reducing power consumption in different manner. A reduced car driving, reduced travel by any means like road, rail, air or water transport system, reduced wastage of anything will reduce power consumption and reduce carbon emission in environment. For example one can avoid ironing on some cloths say morning walk outfit and save about 36 kg of coal p.a., reduce consumption of water (by avoiding wastage) every day say 10 ltr. And reduce power consumption equal to about 15kg of coal P.A. Every glass of water which reaches our lips require power and other things for cleaning and purification of water, pumping of water from ground tank to overhead tank, and then cleaning of water, cooling of water, so by taking water as required and avoiding wastage of water we can contribute to environment. This is simplest example, similarly in manufacture or production of most of items which we use, some power in form of coal, gas, electricity etc. is required for heating, processing, cooling etc. So by avoiding wastage of everything, we can reduce consumption of power and reduce environmental pollution not only be reduced carbon, heat and gas emissions but also by reduction of things thrown which cause damages to environment.   

If carbon credit be allowed for such savings to individuals also there will be considerable improvement in environment.

Observation about carbon credit by Tribunal:

We find that incidentally,  before Tribunal  issue about carbon credit  was discussed for consideration in context of registration of a charitable institution which was engaged inter alia in environmental matters also. This was in CASE OF Japan Chamber of Commerce and Industry in India *v. Director of Income-tax(Exemptions), New Delhi   2008 (4) TMI 350 (Tri) BEFORE THE ITAT DELHI BENCH ‘B’  DELHI IN PARAGRAPH 5 TRIBUNAL OBSERVED AND NOTED ABOUT CARBON CREDIT AS FOLLOWS:

              The issue of carbon  credits  is an offshoot of environmental preservation. This is a global issue and is directly related to main objects of the assessee-society.

From this finding of the Tribunal we find that carbon credit is an offshoot of environmental preservation which is a global issue. This is what is general perception about carbon credit which many of people conversant with it has as transpires during discussions with about 50 people.

So far we do not have benefit of judicial rulings directly on issue of carbon credit. However, there are some judgments of the Supreme Court and High Courts which are on applicable principals.

Carbon credit is not an off shoot of business:

Carbon credit cannot be called an offshoot of business. The businessman want to save costs and for that purpose make efforts to save power and fuel. In that course, emission of carbon, harmful gases and heat are reduced. Had there been no concern of world environment no one would speak about carbon credit. The discussion of carbon credit is only because of world concern about environment.

Steel plants, sugar mills and other factories saving power:

Many assesses are carrying business of manufacturing and selling various products like steel, sugar , textile, aluminum in manufacture of which considerable power is required. In some plants there is scope of co-generation and recycling of material and element of power. For example in case of sugar mills  sugar is main product,  molasses and, bagasse are by product and scrap respectively. Some sugar mills are able to sell surplus electrical power as they have co-generation plant and by installing better equipment have been able to generate more electricity with the same quantity of baggase.Power is generated in co-generation unit and  used for captive use and excess power is sold. Bagasse is scrap generated on extracting juice from sugar cane. Baggase is used to generate steam and electricity. This saves power and reduces carbon emission. Therefore, some sugar mills are entitled to get carbon credit.

Carbon credit is not a by-product of sugar mills:

To save power and to reduce carbon emission, sugar mills have  installed better equipments, to reduce consumption of power and to reduce carbon emission and heat emission. The reduction of cost of power is a result of technical up gradation etc. and that gain is included in profit by reduction of cost.  Reduction of carbon emission has benefitted sugar mills us by having better environment in their area. These are benefits which they  have availed and which are connected with their  business. The benefit of these by way of reduced cost, improved revenue, have been incorporated in  accounts in form of reduced  consumption of power and fuels, revenue from selling electricity and better environment resulting into better working and health conditions of people around their  plant including their  workmen, officers and associates. There would not be any additional gain by these measures, in the  course of their  business if there was no global concern of environmental preservation.

Therefore, the sale value of carbon credit is as a result of global environmental concerns.

  Therefore, transferable carbon credit is not   a result or incident of their  business. Carbon credit is due to environment concerns of the society at large on world scale. This is new development arising from world environment concerns and not a result of business activities of assessee.

Not profit or gain: 

Amount received for transfer of “Certified Emission Reductions (CERs)” popularly called carbon credit (CC) is not in nature of profit or gain or income of any type under the income-tax Act or even in broader sense of tax on income. The Income-tax Act,  1961 is “An Act to consolidate and amend the law relating to income-tax and super –tax”. Looking at historical background as well as income-tax Act in its present form and even otherwise we find that consideration for transfer of carbon credit is not in nature of ‘income’ of any type.   

A careful examination of various aspects about “called Certified Emission Reductions (CERs)”/ Carbon Credits shows that it is a credit for reducing carbon emission or reduced green house effect. Carbon Credit holder can transfer it to other party who need Carbon Credit to overcome his negative or unfavorable position about carbon emissions.

Amount received against Carbon Credit (CC) is not received for producing and/or selling any product, by-product or scrap like sugar, molasses, bagasse, press-mud, fly ash or for rendering any service while carrying business.

 Carbon credit is also not allowed to meet any expenses or to increase profit of business. In fact carbon credit has no business consideration but only consideration is to reduce carbon emission and have a positive CC position.

In fact carbon credit is allowed for reduced carbon emission. It is allowed for a general public purpose not for India but on world scale basis. It is allowed to improve world environment, atmospheres, ecological balance, reducing worldwide warming, to sustain and prolong existence of living being. This important aspect is clearly considered by the Tribunal in case of Japan Chamber, (supra.) as discussed earlier.

Carbon credit is an altogether  new aspect which is beyond perception of existing tax laws. Carbon credit is not allowed to produce anything in fact it is allowed  not to produce some things or for reduced production of such things   that is smoke, gases and heat which harm environment.

Manufacturing units are not trader of carbon credit:

Manufacturers of steel, sugar or electricity companies who get carbon credit are not a trader of carbon credit. They are not engaged in buying and selling carbon credit as a trader in carbon credit would do. Therefore selling carbon credit by such assesses who get carbon credit for saving power etc. are not traders of carbon credit.

 Entitlement:

Carbon credit is in nature of ‘an entitlement’  received to improve world atmosphere and environment by reducing carbon, heat and gas emissions. The entitlement earned for carbon credit can at best, in context of our income tax law be regarded as a a capital accretion and on sale one receive is capital receipt and not even consideration for transfer of a business asset. Any asset is not generated or created due to carrying business but is accrued due to ‘world concerns’. It has been made available and assumed character of transferable right or entitlement only due to ‘world concerns’.

In such cases carbon credit is not acquired by assessee by purchase, there is no previous owner; it was not created due to any efforts made and costs incurred by assessee. The business is not the source of creation of carbon credit. The source of carbon credit is world concern of atmosphere and environment.  

It can be said that carbon credit is not a physical product,  is  not a result of power generation, it is not a result of  production or manufacture of any item say sugar , steel or generation of power.     

Carbon credit is in fact a result of changed world environmental concerns and due to that assessee gets a privilege in nature of transferable carbon credit. 

In such cases assessee does not incur any costs of acquisition or cost of production to get entitlement of carbon credit. Thus, amount received for carbon credit has no element of profit or gain; it cannot be subject to tax by way of tax on income in any manner under any head of income. It is capital receipt, hence under the provisions of Indian Constitution also it cannot be brought under tax by way of tax on income. Carbon credit is no where specified in section 2 (24), 28, 41,45,55 or 56 of the Income-tax Act. 

Therefore, carbon credit receipt is not in nature of taxable income in any sense under the Income-tax Act.

Carbon credit compared with loom hours:

Carbon credit is not off shoot of business. That adds to argument more in favor of assessee. Even if it be considered as related to business we can compare Carbon credit with LOOM HOURS in case of Jute Industry, as was considered by the Supreme Court in the following case:

CIT, Uttar Pradesh Vs. Maheshwari Devi Jute Mills Limited 1965 (4) TMI 10 (SC)

In this case due to certain special circumstances right to work jute mills were restricted and each mill was granted right to work certain number of LOOM HOURS. However, a mill was also allowed to transfer his entitlement in favour of other jute mills. The assessee transferred certain loom hours in favour of some other jute mill and got certain consideration. The revenue was of view that loom hours were directly related with business of assessee and therefore sale price was business income. The Supreme Court affirmed judgment of the High Court and held that the sale value was not revenue but a capital receipt. The editorial head notes of the case are as follows: 

      “Respondent assessee, who was a member of Jute Mills Association entered into agreement with Association restricting hours of work and was allotted loom-hours - Respondent being unable to work looms allotted transferred same for consideration - ITO included in total income of respondent amount received by sale of ‘loom-hours’ as revenue receipts liable to tax - Whether ‘loom-hours’ were asset of respondent but temporary user of ‘loom-hours’ could not be granted and, therefore, transaction involving transfer of ‘loom-hours’ was sale - Held, yes - Whether receipts from sale of ‘loom-hours’ were in nature of capital receipts and were not taxable - Held, yes

The same principal applies in case in relation to carbon credit. Carbon credit entitlements are accretion of capital and on sale of the same assessee receive capital and not revenue. Thus, sale proceeds are capital receipt and not revenue receipt.

Carbon Credit as a capital asset:

Even if we assume that carbon credit entitlements can be considered a transferable ‘capital asset’, we find that there is no cost of acquisition and no cost of improvement of carbon credit. Therefore, it is not a capital asset in context of S. 45 read with S.48. Accordingly the sale value of carbon credits cannot be called profit or gain in context of S.45 and 48.

Carbon credit compared with calves in a dairy:

Carbon Credit which is acquired for reduced carbon emission in cases of industries can be compare with calves in a dairy farm. In dairy farm milk giving cattles like cow, is a capital assets which are acquired for business purposes and milk produced is main product, cow-dung is a by-product.

However, calves (Bachara or Bachari) is not a product or by-product of dairy farm. Calves are accretions of capital of dairy farm. In case of sale of calf, capital is realized. The sale value is not even  taxable under the head ‘capital gains’ because there is no cost of acquisition and no ascertainable cost of improvement of calf we cannot make alteration to calf, the improvement will be natural and without cost of additions.

 In case of Sri Krishna Dairy And Agricultural Farm Versus Commissioner Of Income-Tax 1987 (4) TMI 39 (HC)   [1988] 169 ITR 291 (AP), 65 CTR 44, 35 TAXMANN 151 it was decided that the sale value of calves is not taxable  as  capital gains because there is no cost of acquisition. The High Court applied law and principals laid down in the case of B.C.Sriniwas Setty 128 ITR  294 (SC). This judgment  has been followed and applied in some other cases also for example in case of . DEPUTY COMMISSIONER OF INCOME-TAX Versus SMT SUNITI SINGH 2008 (1) TMI 61 (HC)  Other Citation: [2008] 299 ITR 183 (MP). There seems  no contrary judgment.

The revenue has not challenged the judgment of  AP High Court in case of Shree  Krishna (supra.).  This is fortified when we find that Sri Krisha Dairy case was decided on 02.04.1987, author   checked case status on website of the Supreme Court  from  1987 to  2000, there is no case filed by revenue to challenge judgment in case of Shree Krishna Dairy.

In  case  of industries getting  carbon credit entitlement, it can be said that such entitlement are  just like calves in case of dairy business. Rather it can be said that  the accretion of carbon credit is not out of business carried but it is due to totally related to world concern of environment as opposed to direct business connection.

Thus, capital accretion is not due to business carried but world concerns of society, there is no cost of acquisition and cost of improvement, therefore the sale value of carbon credit is capital receipt and not even taxable as ‘capital gains’.

Direct Tax Code:

When we find that capital accretion closely related and having connection with business is not regarded as revenue, there is no reason to consider sale value of carbon credit as revenue as is contemplated in the Direct Tax Codes. Mere inclusion of a capital receipt in definition of income will not make it an item of income within the meaning of ‘income’ under the Constitution of India therefore, in considered view of author many items of capital value which have been included in definition of income are not consistent with the concept of income and if properly challenged such entries in meaning of income will be found ultra virse the Constitution of India.