A carbon credit certificate is a permit that allows an industry, that holds it, to emit a certain amount of carbon dioxide or other greenhouse gases with equal mass as that of carbon credits. One carbon credit permits the emission of a mass equal to one ton of carbon dioxide or equivalent amounts of another greenhouse gas. Carbon credit trading has seen a surge in recent years as climate change continues to be one of the biggest international agendas. The McKinsey report suggests that the value of global carbon markets grew by 20% in 2020.
There is, however, an ambiguous position as to whether to tax these commodities as a Revenue Receipt or not at all considering its similar character as that of a Capital Receipt. Revenue Receipts are taxable under the Income Tax Act, 1961 (hereinafter ‘the Act’) while the Capital Receipts are not since the Revenue Receipts are in the income statement of a company and are directly taxable under the Act, however, the Capital Receipts are generated on account of transfer of a capital asset of a company.
The Income-tax Department has been treating such income, as received from the sale of carbon credits, as Business Income under the Act which is subject to a tax rate of 30%. Divergent decisions, however, have been given by several courts on the issue of whether to consider income received or receivable on the transfer of carbon credits as Revenue Receipt or Capital Receipt. To bring clarity to this question, Section 115BBG has been included in the Act, however, the outcome was not as intended, leading to more ambiguity.
This question has been recently highlighted in the case of The Principal Commissioner of Income Tax v. M/S. Lanco Tanjore Power Co. Ltd, which is yet to be decided. However, the authors have evaluated in this article the previous and the current position of the sale of carbon credits in lieu of taxability concerning the nature of receipt, by comparing the characteristics of such a sale with Revenue Receipt and Capital Receipt respectively.
CONSTRUING CARBON CREDITS AS BUSINESS INCOME U/S 28(iv)
The sale of Carbon Credits is contested by the Revenue Department to be covered under the head of profits and gains of business under Section 28(iv) of the Act, since Carbon Credits qualify as a benefit, as has been stated under Section 28(iv ), and further have a clear nexus with business and they arise in the course of business only. Section 28(iv) of the Act defines profits and gains arising out of business activity as the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession. Subsequently, the sale of carbon credits also possesses the same characteristics since they are benefits that arise out of business only when the holding company may have employed such sustainable means as are requisitioned by the United Nations Framework Convention on Climate Change (hereinafter ‘UNFCCC’) or upgraded their business model to be made eligible for acquiring such credits. These contentions were asserted in the case of Apollo tires Ltd. v. ACIT and were upheld by the Cochin bench of the Income Tax Appellate Tribunal (hereinafter ‘ITAT’). They may also be considered as a benefit to be arising out of business based on the similar characteristics that they hold with Import Entitlements which were decided by the Kerala High Court as Revenue Receipts in the case of DK Industries & Others v Commr. of Income tax. This is how Carbon Credits hold similar character as that of a Revenue Receipt and must be taxed in the same way.
CONSTRUING CARBON CREDITS AS CAPITAL GAINS U/S 45
On the other hand, the contentions raised above have always been opposed by the assessee arguing that such a sale possesses the characteristics of capital gains as defined under Section 45 of the Act because carbon credits are not a circulating asset of a company as having been established in many cases such as by the Hyderabad bench of the ITAT in CIT v. My Home Power Pvt. Ltd. and therefore is a capital asset whose sale would produce a capital gain. This gain, however, is barred from being taxed under that the sale of carbon credits holds the characteristics of Capital Gains under Section 45 of the Income Tax Act, 1961. However, since they have not been included in Section 55 of the Act despite being self-generated, they cannot be taxed as Capital Gains.
Also, since, Carbon Credits are entitlements provided to a company for emitting fewer Greenhouse Gases into the atmosphere, the sale is an offshoot of environmental concern, which makes it exempt from taxation. The same view is supported by the catena of judicial precedent including the landmark judgment of My Home Power Pvt. Ltd. v. DCIT.
Therefore, carbon credits must be, as contested by the assessees, treated as a Capital Receipt and must not be taxed.
THE QUESTION OF INTENTION OF LEGISLATURE BY INTRODUCTION OF SECTION 115BBG
The introduction of Section 115BBG has made the confusing position of the carbon credits even more confusing by putting them under the chapter head of Determination of Tax under Certain Special Cases. Therefore, questions are being raised from both the sides of the Revenue Department as well as the Assessee as to how these receipts must be treated in cases prior to the introduction of Section 115BBG. However, Revenue has been contending on the point that even though, the carbon credits hold the dual nature of both environmental concerns and profits and gains of business, with the introduction of the section 115BBG, the intention of the legislature has been cleared that the said transaction must always be taxed as a revenue receipt by still charging a certain percentage of tax. This contention is argued to be flawed since, if the Legislature was to consider such a sale as Revenue Receipt, they would have cleared it by means of including such a transaction under the above-mentioned section as has been argued by the Revenue Department and would not have included a new section that is Section 115BBG in the first place.
SETTING THE DEBATE
Carbon Credits no doubt hold the dual character as a) they are generated as a result of the Clean Development Mechanism employed by the UNFCCC and b) they are also arising out of business concerns in lieu of their trade in the commodity exchange, generating revenue for a company and incentivising these companies to adopt such means and would produce extra income for them.
The real question however lies with the intention of the legislature as to whether to consider the sale of Carbon Credits as a Revenue Receipt or a Capital Receipt and the answer to this would somewhere lie among the two points discussed further.
firstit must be noted and has been established in many cases by many courts including the Hon’ble Supreme Court in the case of Padmaraje R. Kadambande v. CIT that all the Revenue Receipts which are not expressly excluded must be taxable while all the capital receipts unless expressly debarred must be ineligible to be taxed. Therefore, to tax a capital receipt, it must either be included under the definition of income under Section 2(24) or must be expressly included under capital gains defined under Section 45 of the Act. Hence, since in this case, either of them didn’t take place, therefore, the intention of the legislature must have been to consider such receipts as revenue receipts.
Secondly, the apex court in the recent case of VVF (India) Limited v. State of Maharashtra, while discussing the strict interpretation of taxation statutes, reaffirmed Justice Bhagwati’s stand in the case of AV Fernandez v. The State of Kerala, that in a taxation statute nothing is to be construed, what’s written must be followed strictly and literally and therefore, it cannot be construed, based on what is written, that these receipts were intended by the legislature to be treated as revenue receipt. Further, to prove that a particular receipt is of a revenue nature, the burden of proof lies on the Revenue Department, which in this case they have failed to provide for so far, therefore, the receipt generated from the sale of carbon credits can be treated as capital receipts not liable to tax.
Judgments by different courts, including the Hon’ble Supreme Court, have so far failed the determination of the type of receipt that the transaction at hand would be encompassed. Although, a concessional rate of 10% has been provided to tax such scenarios, however, such criteria may be evaluated based on the fact that the substantial question of law, that what might have been the intention of the legislature, was being ignored. However, in the present case, this question has been raised and would be material in the determination of the long-awaited rhetorical. Therefore, to stop such a situation from arising in the future, the debate must be settled by the courts of law as soon as possible because if this debate remains unsettled, it will continue to contribute to an erred system of taxation.
Keywords: Taxation, Carbon Credits, Direct Taxation, Finance Act.
(Govind Gupta and Roshi Surele are 4th-year law students from the Institute of Law, Nirma University. The author(s) may be contacted via mail at [email protected]).
Cite as: Govind Gupta and Roshi Surele, ‘Conundrums Involving Taxability of Carbon Credits Under Section 115bbg’ (The Rmlnlu Law Review Blog15 September 2022)