Aravind Ganapathy is a 5th year student of National University of Advanced Legal Studies, Kochi and Shreya Arun is a Fifth year of Maharashtra National Law University, Mumbai
Introduction
In the global effort to combat climate change, carbon credits serve as a key mechanism to promote sustainability and reduce harmful emissions. A carbon credit authorises the holder to emit a specific quantity of carbon dioxide or other greenhouse gases, typically equivalent to one metric ton of CO2. These credits can be freely traded, sold, or retired, providing an avenue for businesses and individuals to offset their environmental impact by purchasing credits from organisations that have successfully reduced emissions through projects.Carbon markets are the platforms that facilitate the buying and selling of these credits, employing a market-based approach to controlling greenhouse gas emissions. Compliance and voluntary markets are the two distinct types of carbon markets. Compliance markets are regulated by governments, where entities are required to hold carbon credits proportional to their emissions. In contrast, voluntary markets allow participants, whether businesses or individuals, to voluntarily buy credits on their own initiative, often to help fulfil sustainability commitments.
In India, the government is actively working towards developing a robust carbon market framework. The Ministry of Power and the Ministry of Environment, Forests, and Climate Change are collaborating to establish the Indian Carbon Market (ICM). This initiative aims to create a national framework for pricing greenhouse gas emissions through the trading of carbon credit certificates. The ICM is envisioned as a vehicle to mobilise investments for the transition to low-carbon pathways, incentivizing businesses and individuals to adopt sustainable practices and contribute to India’s goal of reducing the emissions intensity of its GDP by 45% by 2030, compared to 2005 levels, and net zero emissions by 2070. As the world embraces digitization, the tokenization of carbon credits has gained traction, leveraging blockchain technology to enhance transparency, liquidity, and accessibility. However, this intersection of environmental finance and digital assets has given rise to a regulatory conundrum – the taxation of tokenized carbon credits.
The Crux of the Matter: Carbon Credit or Virtual Digital Asset?
India’s Income Tax Act has defined Virtual Digital Assets (VDAs) under Section 2(47A) as a broad category encompassing any information, code, or token generated through cryptographic means, representing value and capable of being transferred, stored, or traded electronically. This definition encompasses cryptocurrencies, non-fungible tokens (NFTs), and other digital assets notified by the Central Government. Concurrently, Section 115BBG of the Income Tax Act explicitly addresses the taxation of income derived from the transfer of UNFCCC-validated carbon credits, subjecting it to a flat rate of 10%. Herein lies the conundrum: a tokenized carbon credit, by virtue of its digital representation, could potentially be classified as both a carbon credit and a Virtual Digital Asset (VDA). This dual classification raises questions about the appropriate tax treatment, as the taxation of VDAs under Section 115BBH attracts a significantly higher rate of 30%.
The Assessee’s Perspective: Favouring the Lower Tax Rate
The case of Goldman Sachs (India) Finance Private Limited vs. Deputy Commissioner of Income Tax is highly relevant in understanding the taxation of tokenized carbon credits. In this case, the core issue revolved around the computation of book profits under Section 115JB of the Income Tax Act, 1961, particularly concerning the reversal of provisions for bad and doubtful debts. The Assessing Officer (A.O.) initially denied the deduction claimed by the taxpayer for reversing a significant provision of Rs. 31,30,20,000, which had been accumulated over multiple assessment years. The A.O. argued that since these provisions were not added back to calculate book profits in previous years, they couldn’t be deducted upon reversal in the assessment year 2013-14. During the proceedings at the Income Tax Appellate Tribunal (ITAT) in Mumbai, the case was examined through the lens of Section 115JB and The Tribunal acknowledged the A.O.’s obligation to adhere strictly to the law but emphasised the need to consider the law’s purpose and spirit. They noted that if adding back these amounts to book profits in earlier years wouldn’t have resulted in additional tax liability due to already paying higher taxes on normal profits, insisting on such additions for compliance would be meaningless. Ultimately, the Tribunal found merit in the assessee’s argument that strict compliance in this case would not serve the broader objective of the law, which is to ensure that only the actual profits of a company are subjected to tax. Therefore, the Tribunal set aside the order of the Commissioner of Income Tax (Appeals) and decided in favour of the assessee, emphasising that when the tax implications are neutral, the law should be interpreted in a manner that avoids unnecessary compliance burdens for the assessee and aligns with the practical business realities and judicial precedents.
Applying this case in the context of taxing tokenized carbon credits, the aforementioned principle can be invoked to argue for the lower 10% tax rate under Section 115BBG to take precedence over the higher 30% rate under Section 115BBH for VDAs. The ITAT’s decision provides a solid legal basis for resolving the ambiguity surrounding the taxation of tokenized carbon credits in favour of the assessee, by applying the more beneficial tax treatment under Section 115BBG.
Legislative Intent: Promoting Environmental Sustainability
The Indian government’s approach to regulating and taxing carbon credits and VDAs has been shaped by distinct priorities and considerations. While the higher taxation of VDAs was intended to discourage speculative trading and generate revenue from the rapidly growing crypto market, the treatment of carbon credits reflects a recognition of their vital role in achieving environmental sustainability goals. India’s goal of reducing the emissions intensity of its GDP by 45% in 2030, compared to 2005 levels, and net-zero emissions by 2070, are ambitious targets that require concerted efforts and the adoption of innovative solutions. Carbon credits, particularly those validated by the UNFCCC, provide a mechanism for incentivizing businesses and individuals to reduce their carbon footprints and contribute to this national objective. By subjecting UNFCCC-validated carbon credits to a lower tax rate of 10%, the government will be signalling its commitment to promoting the use of these instruments as tools for environmental sustainability. This favourable tax treatment will encourage the adoption and trading of carbon credits, fostering a vibrant market that aligns with India’s climate goals.
The Way Forward: Bridging the Regulatory Gap
While the ITAT’s ruling in the Goldman Sachs case provides a favourable interpretation for taxpayers, the lack of explicit legislative guidance on the taxation of tokenized carbon credits leaves room for ambiguity and potential disputes. As the tokenization of assets gains rapid momentum globally, it becomes imperative for the Indian government to address this regulatory lacuna proactively. One potential solution could be the introduction of a specific provision within the Income Tax Act, explicitly clarifying the tax treatment of tokenized carbon credits. This provision could either affirm the applicability of the lower tax rate under Section 115 BBG or introduce a separate, tailored tax regime that acknowledges the unique nature of these digital assets while promoting their adoption as a tool for environmental sustainability. Alternatively, the government could choose to exclude UNFCCC-validated tokenized carbon credits from the definition of VDAs under Section 2(47A), thereby eliminating the potential for dual classification and ensuring their taxation solely as carbon credits under Section 115BBG.