Carbon credits offers a partial solution and an extra dimension in the strategy for mitigating anthropogenic greenhouse gases emissions causing climate changes. ‘Economic Survey 2023-24’ has two chapters titled ‘Climate Change And Energy Transition: Dealing With Trade Offs’ and ‘Climate Change and India: A Look Through Our Lens’ respectively offering valuable information. The following is a broad-based macro view of the topic of carbon credits.
IFRS S2 Sustainability Disclosure Standard ‘Climate Related Disclosures’, Appendix A defines Carbon Credit as ‘an emissions unit that is issued by a carbon crediting programme and represents an emission reduction or removal of greenhouse gases’. Carbon credits are typically generated by an entity that undertakes an activity of mitigating by preventing, reducing or removing the emissions either internally in their own processes or in external activities such as afforestation programmes. There are also entities without any obligations for emissions who generate carbon credits for marketing them.
These credits can be used either to nullify the entity’s obligations for own emissions, or for a consideration be transferred to other entities who are unable to nullify their emissions through their own efforts. The latter practice is called “carbon offset’. Carbon credits are measured in terms of one credit being equivalent to one tonne of emission of carbon dioxide (tCO2e).
The Kyoto Protocol, 2006
The carbon credit programme we now have is a voluntary one under the aegis of the United Nations Framework Convention on Climate Change (UNFCCC) known as the ‘Kyoto Protocol’.
The Kyoto Protocol introduced an obligation on the part of the developed nations (referred to as Annex 1 countries) to mitigate their emissions of greenhouse gases. Developing nations were however, exempted from these obligations. The scheme that is relevant to India is the ‘Clean Development Mechanism (CDM)’.
Under this scheme, developed nations, in lieu of their obligations are permitted to initiate projects in developing countries for mitigating emissions or buy credits from parties who voluntarily generate these credits. The credits which are granted at the rate of one credit for one tonne of emission mitigated are called ‘Certified Emission Reductions (CER)’.
Cap and Trade Framework
Outside India, the ‘Cap and Trade’ framework for carbon tax and credits has now become common in different forms. The scheme operates in the following manner:
(i) An entity operating in a particular industry with a quota of emissions permitted, if it generates lower than the emissions permitted, the emissions ‘saved’ generate credits which can be sold to another entity which has exceeded its permitted quota of emissions.
(ii) An entity which has exceeded its quote of emissions permitted will be levied tax per tonne of emissions which the entity can either pay or make up by buying credits from another entity in a scheme of offset.
(iii) Over time, the amount of emission allowances will be reduced and those who are unable to reduce their emissions will have to incur expenditure by way of carbon taxes or acquire carbon credits. Eventually, even payment of more taxes may cease to be an option since the technologies in use may be banned.
Accounting guidance
While the treatment prescribed by the Institute of Chartered Accountants of India (ICAI), per the guidance note of 2012 titled ‘Guidance Note on Accounting for Self-generated Certified Emission Reductions (CERs)’ is that the CERs should be treated as inventory.
As regards Income-tax, the first High Court decision came from the High Court of Andhra Pradesh in ‘Commissioner of Income-tax – IV v. My Home Power Ltd. [2014] 46 taxmann.com 314’ in which the High Court held that the CER receipt is a capital receipt not liable to tax.
The Supreme Court had subsequently declined a Special Leave Petition to the Revenue for lodging an appeal. This has, however, become irrelevant since the Finance Act, 2017 inserted Section 115BBG levying Income-tax on CER at 10 per cent.
The future
In the Paris Accord of 2015 (COP21) held under the aegis of UNFCCC, commitments were made by 196 nations to keep the global temperature-rise below 2°C. The action proposed by the individual nations is known as the ‘Nationally Determined Contributions (NDCs)’ i.e. a series of steps required for mitigation by each of the countries.
The NDCs in order to implement would require support systems such as a carbon tax framework, clear guidelines on generation of carbon credits with a green taxonomy, establishing a regulatory mechanism for trading in carbon credits and other infrastructure.
New rules
First, the Carbon Credit Trading Scheme, 2023 was notified on June 28, 2023 by the Ministry of Power. Subsequently, in July 2024, ‘Detailed Procedure for Compliance Mechanism under CCTS’ and ‘Accreditation Procedure and Eligibility Criteria for Accredited Carbon Verification Agency’, were issued. The carbon tax and carbon credit framework is now beginning to take shape.
Second, the ‘Green Credit Rules, 2023’ notified on October 12, 2023 is a novel project.
Launched by the Ministry of Environment, Forest and Climate Change, it is designed to encourage even individuals to generate carbon credits.
The scheme has the potential to combine with CSR with participation by village-level self-help groups.
Green Taxonomy
Green taxonomy establishes the list of green activities which will give an investor the assurance required before making the investments and as announced by the Finance Minister will soon be unveiled.
The present voluntary market will soon transform into a statute-driven market as a result of the obligations to be fulfilled under India’s ‘Nationally Determined Contributions’.
With a large and growing economy, as a large emitter of greenhouse gases, and in view of the obligations undertaken, India will become a huge domestic-led demand market for carbon credits. As the ecosystem is now beginning to fall in place, soon, there will be a huge flurry of activity.
The writer is a Chartered Accountant