Tax Consequences Of Carbon Credits In India And Abroad

Introduction : Carbon credits are essentially certificates that represent one tonne of greenhouse gas emissions either avoided or removed. They're bought and sold on carbon markets — some government-run, like the EU ETS, others voluntary — and they work a bit like shares in a company: instead of a right to profits, you're trading a right to emit (or a right to claim you've offset emissions).

And just as trading stocks can trigger tax liabilities, trading carbon credits should too, at least in principle. In practice, though, applying standard tax rules to these credits is messier than it sounds. Part of the problem is that carbon credits come in two flavors: compliance credits, used by regulated companies to hit legal emissions targets, and voluntary credits, which companies buy on their own to meet CSR goals or net-zero pledges.

India's position in this space has shifted dramatically. It used to be mainly a seller of CERs under the Kyoto Protocol; now it's building its own domestic carbon market, with the Carbon Credit Trading Scheme (CCTS) folded into the Energy Conservation (Amendment) Act, 2022 — part of a broader effort to align with both its international climate commitments and Article 6 of the Paris Agreement. Meanwhile, Article 6.2 and 6.4 mechanisms for trading Internationally Transferred Mitigation Outcomes are also taking shape globally.

This piece looks at how carbon credit transactions should be classified and taxed — and at what rate — both in India and in comparison with the US, UK, and EU.

Business Income, Certified Emission Reductions (CERs), Cross-Border Taxation, Transfer Pricing.

Legal Provisions

Indian Direct Tax Framework: Income Tax Act, 1961

• Section 115BBG: This new Section, substituted in place of an earlier similar provision for transactions in specific securities, was brought in via the Finance Act 2017 for the AY 2018-19. Under this Section, income of such person which is derived from the transfer of a ‘carbon credit’ is taxed at a flat 10% rate (plus applicable surcharge and cess) on the ‘gross amount received by him’, and specifically states under sub-Section (2) that no deduction is allowed for any expense or any allowance in this case.

• Statutory Definition under Explanation to Section 115BBG: Section 115BBG refers to a ‘carbon credit’ in its Explanation as a credit for reduction of carbon dioxide (or another GHGs equivalent) certified by the UNFCCC or an agency specified for this purpose by the UNFCCC. This extremely narrow definition seems to imply that credits under schemes other than the Kyoto Protocol are not included, leading to considerable confusion over the applicability of the 10% special rate in a large number of real-time trading transactions where it's derived under private standards (such as Verra or Gold Standard), or from domestic regimes like the recently introduced carbon credit trading regime.

• General Provisions (Section 28(i) and Section 45): If transactions involving carbon credits are not covered by the beneficial regime under Section 115BBG (for any of the reasons explained above), then such transactions fall under Section 28(i) for business income tax, or under Section 45 for the purpose of capital gains tax. Each of these has different implications for both the rate of taxation, the taxable amount and deductibility of expenses.

Indian Indirect Tax Framework: Central Goods and Services Tax Act, 2017 (CGST Act)

• Section 2(52) and Section 2(102) CGST Act: The classification of carbon credit under Indian GST law whether as ‘goods’ or ‘services’ will primarily depend on the underlying legal definition for both terms provided in the GST legislation. Section 2(52) of CGST Act provides for the ‘goods’ definition: “'goods' means every kind of movable property other than money and securities but includes the actionable claims and growing crops, grass and things attached to or forming part of the land which are to be severed before consumption or under a contract of sale”. Similarly, Section 2(102) of CGST Act: "'service' means anything other than goods"; thereby acting as a residuary category that covers any provision and non-provision of anything that isn’t goods, money or securities.

• Classification and Rate Structure: India's tax policy has, in a press note and related Circular No. 34/8/2018-GST, accepted that other similar certificates, e.g. RECs and PSLCs, can be viewed as "duty credit scrips/goods" under GST; hence likely to be taxed like goods. Following this analogy, carbon credits can be seen to fit the broad definition of goods – especially within the definition of actionable claims in the Explanation to Sec. 2(52), representing perhaps, a future saleable right – and given they are in tangible nature (as certificates representing such claims) also qualify. They are likely to fall under Harmonised System of Nomenclature (HSN) Code 4907 / 9973 and would generally attract an 18% GST rate. The real controversy could, however lie in their classification under the definition of securities which has been broadly expanded under the SCRA to even include instruments, which by themselves or as an aggregate form part of ‘tradable securities’ with market value but aren’t covered under current list.

• Export and Zero-Rating (Section 16 IGST Act): The supply of carbon credits by an Indian entity to a foreign buyer could be treated as an "export of service" or "export of goods" if the conditions laid down under the Section 2(6) of the IGST Act [namely (i) exporter is located in India, (ii) recipient is located outside India, (iii) supply takes place from India and (iv) is payable in convertible foreign exchange) – if any- or a designated foreign currency– is satisfied. In such an instance, this supply would be zero-rated and subject to Section 16 IGST Act allowing exporter to claim refund of input tax credit under Section 16(3).

International Statutory and Regulatory Frameworks

• United States (Internal Revenue Code - IRC): Under the tax regime of the US, the IRS treats carbon credits as property, following the 2008-91 Notice and 2011-28 Revenue Ruling. Offset credits and carbon allowances are ordinarily seen as Section 1231 assets or capital assets, based on whether they are used in trade or business, or held for investment, creating either ordinary business income or capital gains. Development expenses for these assets may be deductible under section 37(a)(1).

• European Union (EU ETS & VAT Directive 2006/112/EC): Within the EU ETS framework, the sale of emission allowances is viewed as the provision of a service and thus falls under the EU VAT directive; the supply of which is usually zero-rated on export but effectively levied on purchase through a reverse charge mechanism to prevent missing trader fraud as envisaged under Art.135. On the direct tax front (company income tax) however, member states mostly treat EU Allowances as part of either inventory or an intangible asset on their balance sheet.

• United Kingdom (HMRC Capital Gains and VAT Manuals): His Majesty's Revenue and Customs (HMRC) regards corporate carbon credits as intangible assets which fall under UK corporation tax and are treated as ordinary business income or capital gain based on nature and holding period(s); theVAT is charged typically at standard rate (i.e.20%) unless some specific carve-outs like terminal market provisions apply to commodity related trading.

Legal Analysis

Characterization Dilemma in India: Capital Receipt vs. Business Income

Before Section 115BBG (2017), the core dispute was whether carbon credit receipts were capital receipts (tax-exempt) or business income under Section 28(i). The Revenue Department argued credits arose from regular business operations and enhanced profits, making them taxable. Taxpayers successfully countered that credits were a byproduct of capital investment in green technology, not the business's primary trading activity, and thus constituted non-taxable capital receipts absent a specific charging provision. Judicial consensus favoured this capital receipt view.

Section 115BBG

Section 115BBG taxes carbon credit transfers at a flat 10%, but the way it's written leaves several gaps.

• Who counts as an "authorized agency"? The section only recognizes certificates issued by the UNFCCC or its authorized bodies. That leaves out voluntary-market standards like Verra, Gold Standard, and the American Carbon Registry entirely. So if a company earns income from voluntary credits, it's genuinely unclear whether that gets the concessional 10% rate, or gets taxed at regular corporate rates of up to 30%.

• Where does CCTS fit in? The 2022 amendment to the Energy Conservation Act set up the Carbon Credit Trading Scheme under the Ministry of Power, with the Bureau of Energy Efficiency (BEE) and the National Steering Committee (NSCICM) issuing domestic Carbon Credit Certificates. Problem is, BEE and NSCICM are domestic bodies, not UNFCCC-authorized ones, so as things stand, income from trading these domestic certificates doesn't qualify for the 10% rate either. It would take a specific amendment to fix this.

• No deductions allowed. Section 115BBG(2) blocks any deduction for expenses tied to generating or transferring carbon credits. That's a real problem for project developers, who often sink significant money into validation fees, monitoring, registry charges, and verification audits. Tax the gross receipts at 10% without letting them deduct costs, and in expensive projects the effective tax rate, measured against actual profit, can blow past 50%.

GST:

The indirect tax picture is arguably more tangled

• Are carbon credits goods, services, or securities? Carbon credits are intangible, which makes classification tricky. Treated as "goods," they'd attract GST. But under Section 2(h) of the SCRA, 1956, instruments traded on recognized exchanges can count as "securities" — and securities are explicitly excluded from GST under Sections 2(52) and 2(102) of the CGST Act. So, if CCTS-traded domestic credits end up classified as securities, they could escape GST altogether. Until CBIC puts out a clarifying circular, businesses are stuck guessing — and exposed to the risk of getting it wrong.

• Cross-border sales and export benefits. When an Indian developer sells voluntary carbon credits to an overseas buyer, Section 13 of the IGST Act decides where the "place of supply" is. Since carbon credits are intangible and typically treated as a service, the place of supply is wherever the buyer is located — outside India. That means the transaction can qualify as a zero-rated export (subject to meeting the conditions in Section 2(6) of the IGST Act), letting developers claim refunds on input tax credit built up from things like consultancy, verification, and engineering services.

Comparative International Jurisprudence

• United States: The IRS framework under the Internal Revenue Code emphasizes economic substance. Unlike India's flat-rate gross tax under Section 115BBG, the US allows full deduction of creation and transaction costs. Gain on the sale of credits held for more than one year by non-dealers qualifies for long-term capital gains treatment (maximum 20%), whereas credits traded by dealers yield ordinary income.

• European Union: Under the EU ETS framework, the primary focus is VAT harmonization. By treating EUAs as services and applying the reverse-charge mechanism across member states, the EU has effectively eliminated cross-border missing-trader fraud. Direct taxation across member states (e.g., Germany, France, Netherlands) treats allowances as operational assets, permitting tax depreciation and expense deductibility.

• Article 6 mechanism of the Paris Agreement: Under Article 6.2 and 6.4, the transfer of ITMOs requires 'Corresponding Adjustments' by host countries to prevent double counting. From a tax perspective, host countries (including India) must reconcile national carbon accounting with international tax treaties (Double Taxation Avoidance Agreements - DTAAs). The transfer of ITMOs raises complex permanent establishment (PE) and royalty/business profit allocation issues under Article 7 and Article 12 of OECD/UN Model Tax Conventions.

Relevant Case Laws

Indian Precedents

• Commissioner of Income Tax v. My Home Power Ltd., (2014) 365 ITR 82 (AP HC) The high court of Andhra Pradesh ruled that earnings from selling CERs is a capital receipt, not taxable as business income. Carben credits arise from environmental conservation efforts and constitute an intangible capital asset created through capital investment. Carbon credit receipts were capital in nature prior to Section 115BBG.

• Principal Commissioner of Income Tax v. L.H. Sugar Factories Ltd., (2016) 388 ITR 401 (All HC)

  The Allahabad High Court held that carbon credits earned by a sugar manufacturer through bagasse-based cogeneration plants were capital receipts. It ruled these credits weren't generated in the ordinary course of the sugar business, but were a byproduct of environmental protection assets. The judgment reaffirmed that capital receipts cannot be taxed as income without an express statutory provision.

• Subhash Kabini Power Corporation Ltd. v. Commissioner of Income Tax, (2016) 385 ITR 592 (Karnataka HC) The ruling was in favor of the taxpayer, holding that carbon credits earned by a power generation project were capital in nature. The court concluded that the receipt was not linked to the sale of power or regular trading operations, rejecting the Revenue’s contention that carbon credits had business revenue.

• Ambika Cotton Mills Ltd. v. Assistant Commissioner of Income Tax, (2014) 148 ITD 428 (ITAT, Chennai) The ITAT stated that carbon credits are an offshoot of capital expenditure incurred on clean progression technologies. It was emphasized that carbon credits are not included in textile manufacturers’ stock in trade, validating their categorization as non-taxable capital receipts pre- 2017.

Foreign and International Precedents

Armstrong v. Commissioner, 139 T.C. 468 (2012) (United States Tax Court) : The court examined the tax treatment of government-issued environmental credits and offset rights. It affirmed that environmental credits granted by statutory authorities constitute property under section 1001 if the IRC. This established that tax basis of generated credits is determined by capital costs directly allocable to their curation, allowing taxpayers to offset against gross receipts upon transfer.

HM Revenue & Customs v. Vital Nut Co Ltd., [2017] UKUT 0124 (TCC) (United Kingdom Upper Tribunal) : The UK Upper Tribunal analyzed the classification of tradable environmental compliance units for Corporation Tax and VAT purposes. The Tribunal held that trading in emission allowances forms part of taxable commercial transactions, and where credits are held as part of trading stock, realization yields ordinary trading profit rather than capital gain.

Practical Implications

Implications for Indian Renewable Energy and Carbon Project Developers: The current tax framework creates structural friction for renewable energy, forestry, and industrial decarbonization developers in India. The restriction under Section 115BBG (2) denying expense deductions disincentivizes capital-intensive carbon sequestration projects. Developers must meticulously structure project contracts to distinguish between project development consultancy (taxable under normal business income rules with full expense deduction) and actual credit transfers (taxable under Section 115BBG).

Transfer pricing exposure and Cross border transactions: Global organizations transferring carbon credits between Indian subsidiaries and international group firms face harsh TP scrutiny as per the IT act. Deciphering the ALP (Arm’s Length Price) for carbon credits is very complicated owing to price volatility across voluntary registries and compliance markets. Cross border transfers require alignment with Article 6.2 to avoid double taxation triggered by export levies.

Supply Chain Decarbonization and Scope 3 Accounting: Unless the transaction meets Section 37(1)'s requirements for required business expenditure, businesses purchasing carbon credits to offset Scope 1, 2, or 3 emissions are not eligible to claim tax credits for these offsets. For appropriate financial planning, buyers need to know if these purchases are considered non-deductible capital expenditures or “deductible operating costs.

Harmonizing CCTS Regulations with Tax Laws: The Energy Conservation Act of 2022, the Income Tax Act of 1961, and the CGST Act of 2017 must immediately converge statutorily in order for the Indian Carbon Market to be launched under CCTS. Domestic carbon trading would be hampered by protracted litigation in the absence of clear legislative changes that extend Section 115BBG to Carbon Credit Certificates (CCCs) and provide GST classification instructions.

Conclusion

India's carbon credit tariff is still developing, striking a balance between environmental policy and income targets. Although Section 115BBG established a 10% concessional tax rate, market players face significant challenges due to its restrictive language and prohibition on expenditure deductions.

Carbon credits were formerly non-taxable capital receipts, according to rulings from courts such as the Andhra Pradesh, Allahabad, and Karnataka High Courts. India's tax system has to be updated in light of the complicated market of today (voluntary credits, local CCTS certifications, and international ITMO transfers under Article 6).

There are three suggested reforms: First, change Section 115BBG to specifically include domestic carbon credit certificates and accepted voluntary standards such as the Gold Standard and Verra. Second, under Section 115BBG(2), permit the deduction of registry, verification, and validation costs.

Aligning these rules with OECD transfer pricing guidelines and Paris Agreement Article 6 will help Indian exporters stay globally competitive while supporting climate goals.

Author: Yashvi Chaturvedi in case of any queries please contact/write back to us via email to content@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.

References

1. Income Tax Act, 1961, § 115BBG, No. 43, Acts of Parliament, 1961 (India).

2. Income Tax Act, 1961, § 28(i), No. 43, Acts of Parliament, 1961 (India).

3. Income Tax Act, 1961, § 45, No. 43, Acts of Parliament, 1961 (India).

4. Central Goods and Services Tax Act, 2017, § 2(52), No. 12, Acts of Parliament, 2017 (India).

5. Central Goods and Services Tax Act, 2017, § 2(102), No. 12, Acts of Parliament, 2017 (India).

6. Integrated Goods and Services Tax Act, 2017, § 16, No. 13, Acts of Parliament, 2017 (India).

7. Energy Conservation (Amendment) Act, 2022, No. 19, Acts of Parliament, 2022 (India).

8. Paris Agreement to the United Nations Framework Convention on Climate Change, Dec. 12, 2015, T.I.A.S. No. 16-1104, art. 6.2 & 6.4.

9. European Parliament and Council Directive 2003/87/EC (EU ETS Directive), 2003 O.J. (L 275) 32.

10. Council Directive 2006/112/EC (EU VAT Directive), 2006 O.J. (L 347) 1, art. 9 & 198.

11. United States Internal Revenue Code, 26 U.S.C. §§ 1001, 1221, 1231 (2018).

12. United States Internal Revenue Service, Rev. Rul. 2011-28, 2011-49 I.R.B. 830.

13. HM Revenue & Customs, Business Income Manual BIM35835: Carbon Trading (United Kingdom, 2021).

14. Commissioner of Income Tax v. My Home Power Ltd., (2014) 365 ITR 82 (AP HC) (India).

15. Principal Commissioner of Income Tax v. L.H. Sugar Factories Ltd., (2016) 388 ITR 401 (All HC) (India).

16. Subhash Kabini Power Corp. Ltd. v. Commissioner of Income Tax, (2016) 385 ITR 592 (Kar HC) (India).

17. Ambika Cotton Mills Ltd. v. Assistant Commissioner of Income Tax, (2014) 148 ITD 428 (Chennai ITAT) (India).

18. Armstrong v. Commissioner, 139 T.C. 468 (2012) (United States).

19. HM Revenue & Customs v. Vital Nut Co Ltd., [2017] UKUT 0124 (TCC) (United Kingdom).

20. Central Board of Indirect Taxes and Customs (CBIC), Circular No. 34/8/2018-GST (Ministry of Finance, India, 2018).

21. Securities Contracts (Regulation) Act, 1956, § 2(h), No. 42, Acts of Parliament, 1956 (India).

22. OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Publishing, Paris, 2022).