A tax on carbon credit trade: ARE WE PREPARED?

By M H Ahssan

The Income Tax department is reportedly mulling a tax on carbon credit trade and the revenue potential of the proposed impost is said to be about Rs 1,000 crore a year. What are the implications of the move for the industry?

Carbon credits (CCs) are meant to provide a way to reduce greenhouse emissions on industrial scales by the capping of total annual emissions. The market assigns a money value to shortfalls, if any, through trading. The credits can be exchanged between businesses or bought and sold internationally at the rates prevailing at the time the deal is made. They can also be used to finance carbon reduction schemes between trading partners in a country or around the world.

A CC is defined as the unit related to reduction of one tonne 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 these to 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. Emissions become an internal cost of doing business and are visible on the balance sheets .

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. The companies can also buy and then sell CERs at profit. Carbon accounting implies that the country concerned has first to measure the amount of CO2 released by various industries, determine the limit of allowable emissions and then work out the system of generating CERs. Presently, these are no accounting standards/or guidance notes for accounting CERs which ICAI will have to work out.

As for the income-tax treatment, CERs are to be treated as ‘intangible assets’ held with the registry of such rights. CERs acquired from others will have to be accounted for on cost basis. The profit and loss on these will have to be worked out with reference to sale price. Self generated CERs will not appear in the balance sheets. Their existence will have to be disclosed in the accounting policy in the published accounts.

As CERs are capital assets, the profit or loss arising on disposal of acquired CERs will have to be disclosed on that basis. If these are held for more than 36 months, these will have to be treated as ‘long term capital assets’ and taxed on that basis. If self generated, CERs are sold, there will be no liability for tax as these will have no cost.