In the current COVID-19 lock-down scenario, when all talk has been shifted to “Oxygen”, we need to also understand the importance of talking about its sister element, Carbon, and the concept of Carbon credit.
What is Carbon Credit?
A Carbon Credit is an intangible commodity equal to one ton of CO2, that allows companies to compensate for their emissions of Greenhouse Gases. A carbon credit is a tradable certificate or permit that reduces the emission of CO2 by the industries into the environment.
The buying and selling of Carbon Credits is regulated by a legal contract called Emission Reduction Purchase Agreement (ERPA).
To understand carbon credit, let’s take an example of Company X and Y. Co. X has a cap on production to only produce 1,000 units of emissions, but without any energy efficient technology it produces around 1,500 units. Co. X knows that it will face a tax or penalty for going over the production cap. This is where Co. Y comes in. Suppose Company Y has the same production cap but has energy efficient methods of production that lead to only 500 units of emissions, a credit of 500 units is created.
The 500 units can be traded with Co. X for cold, hard cash. Essentially, Co. X pays Co. Y to allow itself to emit more while Co. Y emits less. In reality, however, many complexities exist such as:
· Fact-checking whether emission levels are bona-fide and consistent
· Tracking the sale, purchase and holding of carbon credits
· Exploring energy efficient methods of technology that allow for receipt of credit
· Doing a cost benefit analysis of the penalty in the case of exceeding the cap versus the cost of external carbon credit
Where does India come into the picture? We are usually Co. Y as more developed countries plan their manufacturing in developing countries to reduce their costs and emissions. So, such Indian companies have a primary revenue stream from income of transfer of carbon credits.
Let us proceed to understand the accounting and tax implications of carbon credit.
Accounting for Carbon Credit
As the Kyoto Protocol Norms Company’s books are of primary importance. To break this down even better, let us look at the usage and trading of Carbon Credits, knowing exactly how to account for them in two types of carbon credit:
· Voluntary Emissions Reduction: These are exchanged over the counter for credits
· Certified Emissions Reduction: These credits are created due to an existence of regulatory framework.
For either of these to be an asset, they must be controlled by the generating entity. As a non-monetary asset which is intangible and held by the generating entity for sale they will be accounted for as inventories in accordance with Ind AS 2 and valued at lower of cost or net realizable value. The income from transfer of carbon credits will be accounted for as revenue under Ind AS 115.
Taxability of Income from Transfer of Carbon Credit:
Section 115BBG of the Income Tax Act, 1961 elucidates on taxation of income from transfer of Carbon Credits. In layman terms, the section merely states that income from transfer of carbon credit will be taxed at the 10% and the remaining income will be taxed as per the assessee’s existing tax status. Also, no deduction is allowed against the said income from transfer. An important point to note is that income from transfer of carbon credit does not fall under the purview of Business Income. In any case the expenses incurred in the course of manufacturing is claimed as expenditure
GST on trading of Carbon Credit
GST for trading in Priority Sector Lending Certificates is at 12%. PSLC is very similar to the concept of trading carbon credit and hence even though they are not directly linked, carbon credit trading is also taxable at the same rate. In any case the problems as is existing in PSLC related GST issues exist in carbon credits as well.
What is the impact of carbon credit?
· On Revenue: In the case of introduction of a formal carbon tax, the Indian Government would face a significant loss of revenue. However, as many developed nations plan manufacturing in India, this would lead to increased income from transfer of carbon credits.
· On Innovation: Carbon tax and credit forces Indian companies to look at innovative sustainable ways of production and manufacturing to reduce emissions.
· On Investment: FDI inflow in renewable energy markets has been the new trend wave in India and as energy efficient technology is extremely capital intensive, Indian Companies would be dependent on increased government and external investment.
· On Healthcare Infrastructure: Expanding sustainable healthcare facilities has increased benefits especially at a time like this where the healthcare infrastructure’s fractured system has come to light.
· On Pollution: India racks up losses amounting to approximately USD 150bn p.a. owing to pollution and a formal carbon tax would ensure companies found consistent methods to reduce the same.
The Carbon Credit Pricing:
The carbon credit pricing get done as follows;
· Carbon tax: It is a direct tax with a fixed price for CO2 emissions, but it doesn’t promise emission reduction.
· Emission trading system: It allows the polluters to achieve the fixed emission target at their pace with low costs. It promises the reduction of emission but not the price.
· Crediting mechanism: The reduction that occurs as a part of a project by Organizations or Government who are assigned credits which can be bought or sold later. It needs third-party verification.
· Result based climate finance (RBFC): Entities receive funds when they meet climate-related goals such as CO2 emissions, which demands third-party verification.
· Internal carbon pricing: Entities through internal pricing for carbon credits encourage the investment in low-carbon technologies. It is of two types, Shadow price, and Internal carbon pricing.
The future of finance is to legitimize and regulate the trading of carbon credit and to enforce uniform carbon taxes to ensure that climate change can be slowed as we move toward a more sustainable tomorrow.
Carbon Crediting: Climate Change Currency
We have taken all necessary measures to verify that all the information put forward here has been used from authentic and reliable resources to maintain our accuracy. This publication in no way intends to provide professional advice of any sort. We recommend expert advice from legal, tax, accounting, etc, sought before any action.