Wednesday, November 7, 2012

Income from Sale of 'Carbon Credits' is Capital Receipt

[2012] 27 27 (Hyderabad - Trib.)


My Home Power Ltd. v. Deputy Commissioner of Income-tax, Central Circle - 7

Carbon credit is accretion of capital and hence income earned on sale of these credits is capital receipt and not revenue receipt liable to tax


• The assessee-company was generating power through biomass power generation unit. For the relevant year, it had received 1,74,037 CERs (carbon credits) for the project activity of switching off fossil fuel from naphtha and diesel to biomass and sold 1,70,556 CERs to a foreign company for Rs. 12.87 crores.

• The AO held sale proceeds of the CERs to be a revenue receipt since the CERs are a tradable commodity and even quoted in stock exchange; and accordingly a tax demand of Rs. 3,60,80,529 was raised.

• The CIT (A) besides confirming the order of the AO, also gave a finding that the amount which was considered as income of the assessee could not be considered as income from business and as such the same was not entitled for deduction under section 80-IA.

• Against this the assessee went in appeal.

Case of the assessee

• It was argued that since the company's main business activity is generation of biomass based power, the receipt in question had no relationship with production nor it was connected with the sale of power or with the raw material consumed. It was not even the sale proceed of any bye product. The CERCs are issued to every industry which saves emission of carbon and not limited to power projects.

• It was submitted that the certificate issued by the United Nations Framework Convention on Climate Change (UNFCCC), Kyoto Protocol only indicates the achievement made by the assessee company in emitting lesser quantity of gases than the assigned quantity. It does not mention about either revenue or capital expenditure incurred by the assessee.

• The assessee further submitted that the UNFCCC does not reimburse either revenue or capital expenditure. In fact the UNFCCC does not provide any funds to the industry. It only certifies that the industry emitted a particular quantity of gases as against the permissible quantity. It is not, therefore, a subsidy granted to reimburse the losses. The amount cannot be considered to be a perquisite as this is not received from any person having a business connection with the company and is not received in the process of carrying on the business. It was also submitted that the amount could not be considered as income within any of the clauses of section 2(24) or section 28.

Case of the Revenue

• The AO while considering the receipt to be revenue in nature had relied on the decision of the Supreme Court in TATA Consultancy Services v. State of Andhra Pradesh where on the issue of levy of sales tax on computer software, it was held that a 'goods' may be tangible property or intangible property. It would become 'goods' provided it has the attributes thereof with regard to (a) its utility (b) capability of being bought and sold (c) capability of being transmitted, transferred, delivered, stored and possess. The CER credits could be considered as 'goods' as they had all the attributes of goods. The different clauses in the purchase agreement between the assessee-company and the purchaser foreign company clearly indicates that the sale transaction of CER was nothing but a transaction in 'goods'.

• According to the revenue, the assessee submitted that the certificates are in recognition of the achievement for reducing the pollution. However, had there been no other benefit attached to it, in the normal situation, the assessee company would not have bothered for obtaining the CERs. In fact, there is something more because it is known that the certificates issued by UNFCCC have intrinsic value and has a worldwide ready market for its redemption/ trading; therefore, the assessee obviously pursued to obtain the said certificates.

• The revenue considered CERs akin to shares or stock which are transacted in the stock exchange. Hence, it was argued that the sale proceeds arising out of sale of the CERs by the assessee was a revenue receipt and rightly brought to tax by the AO.

• The revenue further submitted that since the income from sale of CERs is independent of the main business of power generation it could not be said that the receipt from sale of CERs would automatically be entitled for deduction under section 80-IA by virtue of the fact that the power generation business of the assessee was entitled for deduction under section 80-IA.

Deciding the issue of taxability of 'carbon credit' in favour of assessee the Tribunal held as under:

• Carbon credit is in the nature of "an entitlement" received to improve world atmosphere and environment reducing carbon, heat and gas emissions. The entitlement earned for carbon credits can, at best, be regarded as a capital receipt and cannot be taxed as a revenue receipt. It is not generated or created due to carrying on business but it is accrued due to "world concern" and "environment".

• The amount received for carbon credits has no element of profit; thus it cannot be subjected to tax and hence not liable for tax in terms of sections 2(24), 28, 45 and 56.

• Carbon credits are made available on account of saving of energy consumption and not because of assessee's business. Further, carbon credits cannot be considered as a bi-product. It is a credit given under the Kyoto Protocol and because of international understanding. Thus, the assessees who have surplus carbon credits can sell them to other assessees to have capped emission commitment. Transferable carbon credit is not a result or incidence of one's business and it is a credit for reducing emissions.

• The persons having carbon credits get benefit by selling the same to a person who needs carbon credits to overcome one's negative point carbon credit. The amount received is not received for producing and/or selling any product, bi-product or for rendering any service for carrying on the business. In fact, carbon credit is entitlement or accretion of capital and hence income earned on sale of these credits is capital receipt.

• In the case of CIT v. Maheshwari Devi Jute Mills Ltd. (57 ITR 36) the Supreme Court held that transfer of surplus loom hours to other mill out of those allotted to the assessee under an agreement for control of production was capital receipt and not income. Being so, the consideration received by the assessee in respect of carbon credit is similar to consideration received by transferring of loom hours.

• 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. Credit for reducing carbon emission or greenhouse effect can be transferred to another party in need of reduction of carbon emission. It does not increase profit in any manner and does not need any expenses.

• Thus, sale of carbon credits is to be considered as capital receipt.

• However, at the end of Judgment, the Tribunal had taken view in accordance with guidance note issued by ICAI which states that CERs should be recognised in books when those are created by UNFCCC and/or unconditionally available to the generating entity. CERs are inventories of the generating entities as they are generated and held for the purpose of sale in ordinary course. Even though CERs are intangible assets those should be accounted as per AS-2 (Valuation of inventories) at a cost or market price, whichever is lower. Since CERs are recognised as inventories, the generating assessee should apply AS-9 to recognise revenue in respect of sale of CERs.

Thursday, November 1, 2012

No TDS obligation for general credit entry & so no s. 40(a)(i) disallowance

No TDS obligation for general credit entry & so no s. 40(a)(i) disallowance.

Even if TDS applicable, no s. 201 TDS liability if s. 40(a)(i) disallowance made

Pfizer Ltd vs. ITO (ITAT Mumbai)

The assessee made a provision for Rs. 10 crores in respect of payment due to various parties but did not deduct TDS thereon. The provision was made without making specific entries into the accounts of the parties. The assessee disallowed the expenditure in respect of the said provision u/s 40(a)(i) & 40(a)(ia). Next year the entire provision of expenses was written back and the actual amounts paid to the respective parties were credited to their respective accounts after deducting TDS. The AO held that despite such disallowance, the assessee was liable u/s 201 as an assessee-in-default for failure to deduct TDS. On appeal by the assessee, HELD by the Tribunal:

(i) As the provision was made without making specific entries into the accounts of the parties and the payee was not identifiable, the TDS provisions are not applicable. The whole scheme of TDS proceeds on the assumption that the person whose liability is to pay an income knows the identity of the beneficiary or the recipient of the income. The TDS mechanism cannot be put into practice until identity of the person in whose hands it is includible as income can be ascertained (IDBI vs. ITO 107 ITD 45(Mum) followed);

(ii) Once the amount has been disallowed u/s 40(a)(i) for non-deduction of tax, it cannot be subject to TDS provisions again so as to make the assessee liable to pay the tax u/s 201 & interest u/s 201(1A). If the AO’s view was accepted that the assessee was liable to pay the TDS not deducted, then a disallowance u/s 40(a)(i) and 40(a)(ia) cannot be made and those provisions may become otiose.



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