MAY 24, 2019

By Akash Deep Singh, Principal Associate and Rohit Arora, Associate, DSK Legal

A. THE necessity of reducing carbon emissions was first recognized at the Kyoto Protocol of the United Nations Framework on Climate Change signed in 1997 wherein the member countries, including India, committed to limit and reduce the greenhouse gas emissions.

B. The Kyoto Protocol also provides for trading of Carbon Credits i.e. emission reduction units through Clean Development Mechanism (CDM). Under CDM, specified parties engaged in project activities resulting in Certified Emission Reductions (CERs) may trade in such CERs. The purchasers of CERs may use such CERs to comply with part of their quantified emission limitation and reduction commitments.

C. Technically, one Carbon Credit tantamount to reduction of one metric tons of carbon dioxide emissions or emissions of its equivalent gases. Carbon Credits play a beneficial role in terms of supporting the environment as well as ensuring the financial health of the companies engaged in carbon trading. In India, we already have a sophisticated market for such trading. However, trading of Carbon Credits has always been a contentious issue under the indirect taxation laws. In this article, we have examined the taxability of carbon credits under the newly enacted GST law.

D. Going by the legislative scheme of the GST laws, GST is applicable either on goods or services or both. Thus, anything which is neither "goods" nor "services" can never be subject to levy of GST. Being so, for levying GST,s the CER/Carbon Credit should be either goods or services. Section 2(52) of the Central Goods and Services Tax Act, 2017 ("CGST Act") defines the term "goods" as "goods means every kind of movable property other than money and securities but includes actionable claims, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply."

E. Further the term "services" has been defined as "services means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged."

F. From a perusal of the above definitions, it is clear that money and securities have been kept out of the scope of goods as well as services. Thus, if CERs qualify as "money" or "securities", the supply of the same will not be taxable as being out of the scope of GST laws. A reading of definition of the term "money" under Section 2 (75) of the Central Goods and Services Tax Act, 2017 ("CGST Act") makes it apparent that CERs are not money nor they are classifiable under specifically mentioned instruments therein. Moreover, use of such certificates as consideration to settle an obligation has not been recognised by Reserve Bank of India.

G. With regard to taxability of CER, two school of thoughts are prevailing in the trade, one treats CERs as "goods" and thus taxable under GST, while the, the other treats CERs as "securities" hence of the view that no GST is payable on CERs.

H. In order to be classifiable as "goods", the following criteria must be satisfied:

(a) It must be movable,

(b) It must be marketable

(c) It must not be money or securities

The above criteria were extensively discussed by the Hon'ble Supreme Court in various cases. Some of the relevant cases are as follows:

- In Vikas Sales Corporation vs Commissioner of Commercial Taxes = 2002-TIOL-608-SC-CT-LB the Supreme Court dealt with the issue of taxability of "replenishment licenses or R.E.P. licences" issued under the EXIM policy to provide to the registered exporters the facility of importing the essential inputs required for the manufacture of the products exported. It was held that the license is not only a beneficial interest in respect of a movable property not in possession of the person but is itself a valuable right which is freely transferable. The import license, therefore, must be treated as merchandise and clearly falls within the definition of "goods".

- Tata Consultancy Services vs. State of Andhra Pradesh = 2004-TIOL-87-SC-CT-LB. The Hon'ble Supreme held that, ""goods" may be tangible property or an intangible one. It would become goods provided it has the attributes thereof having regard to (a) its utility; (b) capable of being bought and sold and (c) capable of being transmitted, transferred, delivered, stored and possessed."

- Yasha Overseas vs. Commissioner of Sales Tax and Ors. = 2008-TIOL-97-SC-CT, the Apex Court held that DEPB is identical to REP licenses and qualify as goods on the basis that it is freely marketable and have an intrinsic value.

- In Union of India and Ors. v. Sonic Electrochem (P) Ltd. and Anr. = 2002-TIOL-212-SC-CX, the Supreme Court dealt with the question of determination of "marketability" of articles. It stated that, "It is difficult to lay down a precise test to determine marketability of articles. Marketability of goods has certain attributes. The essence of marketability is neither in the form nor in the shape or condition in which the manufactured articles are to be found, it is the commercial identity of the articles known to the market for being bought and sold. The fact that the product in question is generally not being bought and sold or has no demand in the market would be irrelevant."

From the above discussion, it can be said that CERs qualify as "goods" as they have intrinsic value and are movable and freely transferable. Moreover, CER's always have had a market of their own.

I. The issue pertaining to determine the nature of Carbon Credit/CERs as goods, was deliberated under the Notification No. 256/CDVAT/2009/43 dated 13.01.2010 issued by the Commissioner, Trade and Taxes, Delhi VAT under section 85 of the Delhi VAT 2004. The Commissioner analyzed the definition of "goods", "dealer" and "sale" under the DVAT Act, 2004 in relation to CERs and the cases being Yasha Overseas (supra), Vikas Sales Corporation (supra) and Tata Consultancy Services (supra) were discussed by the Commissioner in regard to the taxability of CERs as "goods". Thereafter, vide the said Notification, CERs were declared as goods under the DVAT law. Relevant part of the said Notification is as follows:

"A careful examination of the product called Certified Emission Reductions (CERs) commonly known as carbon credits shows that it is a certificate having market value. There are people/entities who are willing to sell and others who are willing to purchase such certificates. The intrinsic nature and value of carbon credits coupled with their free transferability makes the said product a marketable commodity. The said product is therefore covered under the definition of the term "goods" as it figures in sub-section (1) of Section 2 of DVAT Act, 2004.

Further, any person/company/entity undertaking the activity of sale and purchase of carbon credits (CERs) is a dealer in terms of the definition of the dealer as contained in sub-section (1) of Section 2 of DVAT Act, 2004. The transaction of sale of carbon credits (CERs) by a person/entity to another person/entity constitutes "sale" in terms of the definition of term as contained in Section 2(1)(zc) of DVAT Act, 2004.

12. It is also pertinent to refer to Entry No. 3 of IIIrd Schedule appended to the DVAT Act, 2004 which reads as follows :-

Entry No. 3 of IIIrd Schedule

"01-04-2005

All intangible goods like copyright, patent, rep license, goodwill etc."

The nature, substance and manner/modalities of the trading of CERs (carbon credits) makes the product known as Certified Emission Reductions (CERs) similar to the products mentioned in the said entry. Thus, the item CER is covered by the aforesaid entry."

The Commissioner vide the aforementioned Notification declared Carbon Credits /CERs as goods as they have certain intrinsic value, are capable of being brought, sold, transferred and possessed and are no different from ordinary commodity bought and sold in the market. Hence, its sale is liable to value added tax in the State.

J. Further, Carbon Credits were declared as goods under the Securities Contracts (Regulation) Act, 1956. The National Commodity & Derivative Exchange Limited (NCDEX) vide the Circular No. NCDEX/ TRADING-035/2008/080 dated April 7, 2008, notified the launch of future/forwards contract pertaining to CER/Carbon Credit. Further pursuant to the repeal of the Forward Contracts (Regulation) Act, 1952 (FCRA) and amendment to the Securities Contracts (Regulation) Act, 1956 (SCRA), the Central Government vide Notification No. S.O.3068(E) dated September 27, 2016 notified carbon credits as goods for the purposes of clause (bc) of section 2 of SCRA. i.e. to be treated as commodity derivative which is not a security.

K. CERs are alike Priority Sector Lending Certificates (PSLCs) and Renewable Energy Certificates (RECs). PSLCs are tradable certificates issued against priority sector loans of banks so as to enable banks to achieve their specified target and sub-targets for priority sector lending through purchase of these instruments in the event of a shortfall and at the same time incentivizing the surplus banks to lend more to these sectors. REC also known as green energy certificates or tradable renewable certificates certifying that the bearer owns one megawatt-hour (MWh) of electricity generated from a renewable energy resource. Once the power provider has fed the energy into the grid, the REC they receive can then be sold in the open market as a commodity. Therefore, it is evident that CERs, RECs and PSLCs are the certificates having intrinsic value traded in the market.

L. Further, the Central Government issued the Circular No. 34/8/2018-GST dated 01.03.2018 and Circular No. 46/20/2018-GST dated 06.06.2018, whereby the applicability of GST on PSLCs and RECs has been clarified. The government vide the latter clarified that RECs, PSLCs etc. are classified under heading 4907 and will accordingly attract GST @ 12 % instead of 18% under the residual head, which was earlier clarified by the Circular No. 34/8/2018-GST dated 01.03.2018. An extract of Schedule II to Notification Number 1/2017-Central Tax (Rate), dated 28.06.2017 which provides for the rate of tax on Chapter 4907 goods is reproduced below:

M. Now we will discuss the other view prevailing in the business that CERs can classify as securities. "Securities" under GST are the same as defined in clause (h) of section 2 of the Securities Contract (Regulation) Act, 1956 ("SCRA") i.e. "Securities include- (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.;

(ia) derivative;

(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;

(ic) security receipt as defined in clause (zg) of section 2 of ten Securities and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;

(id) units or any other such instrument issued to the investors under any mutual fund scheme;

(ii) Government Securities;

(iia) such other instruments as may be declared by the Central Government to be securities; and

(iii) rights and interest in securities"

Carbon Credits/CERs may be treated as "Securities" as they appear to fall under the wide term, "other marketable securities of a like nature in or of any incorporated company or other body corporate". If it comes out that CERs are classifiable as securities, same will be out of the scope of term goods and thus not taxable under GST. Recently, a writ petition has been filed before the Hon'ble Bombay High Court, wherein the petitioner has challenged the Circulars no. 34/8/2018 dated 01.03.2018 and 46/20/2018 dated 06.06.2018 on the ground that REC scrips qualify as securities under GST. Further, the petitioner has stated that REC scrips are alike duty credit scrips prevalent in the customs law, which are exempt under GST and the same treatment should be provided to REC Scrips.

N. Considering the earlier judicial pronouncement and treatment under VAT regime, the balance seems to be tilting in the favour of CERs being goods and thus subject to GST, however, GST being new law, any interpretation differing from the earlier view cannot be ruled out absolutely. Whatever may be the ultimate outcome of the litigation in this regard, the ambiguity in treatment of REC/Carbon Credits is going to subsist in the trade for a while, considering the fact that it involves probable loss of revenue to the central government. Authors don't think that in case of RECs being declared as securities, revenue department will stop and accept the judgment of the High court as final. An appeal against such judgment is inevitable.

O. Considering the objective, of introducing CERs and RECs, which is reduction of emissions of greenhouse gases and encouragement of use of renewable energy in industry, taxing the supply of CERs and RECs doesn't seem appropriate as increased cost will put extra burden on buyers resulting in to less demand of CERs and RECs. Less demand would inevitably deter the companies to make extra efforts in acquiring carbon credit by cutting on their carbon emission and acquiring means of generating energy though renewable sources. Legislature should take appropriate steps to clarify the ambiguity and sooner would be better.

(The views expressed are strictly personal.)