By TIOL News Service

HYDERABAD, JUNE 17, 2014: THE issues before the Bench are - Whether receipts on sale of carbon credits are capital in nature and Whether sale of carbon credits are liable to tax. And the verdict goes against the Revenue.

Facts of the case

The assessee is engaged in the business activity of generation of biomass based power. During the year, the assessee had received Carbon Emission Reduction Certificates, also known as 'carbon credits' for its project activity of switching off fossil fuel from naphtha and diesel to biomass. The assessee sold most of these carbon credits to a foreign company, M/s. Noble Carbon Credits Ltd. of Ireland. The assessee accounted for these receipts as capital in nature and having shown losses, these receipts were not offered for taxation. According to the assessee, these carbon credits were issued to every industry which saved emission of carbon and were not limited to power projects.

The AO observed that the receipts were directly attributable to the business of production of power. Therefore, being attributable to the assessee's business activity, the AO held that these receipts, on account of a tradeable commodity quoted on a stock exchange, were revenue in nature. Thus, after giving effect to the set off of brought forward losses, the total income was determined and tax demand was raised against the assessee.

In appeal, the CIT(A) confirmed the AO's order holding that the amount realised by transferring carbon credits represented income from transfer of goods and that the entire amount realised on sale of such goods represented the income of the assessee. The CIT(A) thus gave a finding that the amount which was considered as the income of the assessee could not be considered as income from business and was not entitled for deduction under section 80IA. The CIT(A) thus confirmed the addition made by the AO.

In appeal before the Tribunal, the assessee submitted that the receipt had no relationship with the process of production nor was it connected with the sale of power or with the raw material consumed. It was not even the sale proceed of any bye product. These receipts were not related to the assessee’s business activity and did not represent a revenue receipt and did not fall within any of the clauses of section 2(24).

The Tribunal allowed the assessee’s appeal. The Tribunal concluded that carbon credits were not generated or created due to carrying on business but it accrued due to "world concern". The consideration received on account of carbon credits could not be considered as income, as carbon credit is not an offshoot of business but an offshoot of environmental concerns. No asset was generated in the course of business but it was generated due to environmental concerns. Credit for reducing carbon emission or greenhouse effect could be transferred to another party in need of reduction of carbon emission. It did not increase profit in any manner and did not need any expenses. It was a nature of entitlement to reduce carbon emission but there was no cost of acquisition or cost of production to get this entitlement. Carbon credit was not in the nature of profit or in the nature of income and it could not be subjected to tax in any manner under any head of income. It was not liable for tax in terms of sections 2(24), 28, 45 and 56 of the Income-tax Act, 1961. Hence, carbon credit was held to be an entitlement or accretion of capital and hence income earned on sale of these credits was capital receipt.

Relying on the decision of the Supreme Court in the case of Maheshwari Devi Jute Mills, the Tribunal held that the receipt of such consideration could not be considered as business income and it was a capital receipt.

In appeal before the High court, the Revenue submitted that the generation of carbon credits was intricately linked to the machinery and processes employed in the production process by the assessee. Therefore, the consideration received on account of sale of carbon credits should be treated to be business income as the sale was made in connection with the assessee’s business.

Having heard the parties, the High Court Held:

++ we are unable to accept the same, as the Tribunal has factually found that “Carbon Credit is not an offshoot of business but an offshoot of environmental concerns. No asset is generated in the course of business but it is generated due to environmental concerns.” We agree with this factual analysis as the assessee is carrying on the business of power generation. The Carbon Credit is not even directly linked with power generation. On the sale of excess Carbon Credits the income was received and hence as correctly held by the Tribunal, it is capital receipt and it cannot be business receipt or income. In the circumstances, we do not find any element of law in this appeal.

(See 2014-TIOL-978-HC-AP-IT)