2016-VIL-981-ITAT-AHM

Income Tax Appellate Tribunal AHMEDABAD

I.T.A. No.: 538/Ahd/2013

Date: 18.03.2016

DY COMMISSIONER OF INCOME TAX CENTRAL CIRCLE 2 (2) , AHMEDABAD

Vs

KALPATARU POWER TRANSMISSION LTD

For The Appellant : Vibha Bhalla
For The Respondent : Milin Mehta

BENCH

Pramod Kumar AM and S S Godara JM

JUDGMENT

Per Pramod Kumar AM:

1. This appeal, filed by the Assessing Officer, is directed against the order dated 10th December 2012 passed by the Commissioner (Appeals), in the matter of assessment under section 143(3) of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’), for the assessment year 2009-10.

2. There are only two issues requiring our adjudication in this appeal i.e.whether or not the CIT(A) was justified, to use the words employed in the grounds of appeal before us, in deleting (a) “the addition of Rs. 5,78,28,058, made on account of sale of carbon credits”; and (b) “the addition of Rs. 68,45,142 made on account of disallowance under section 14A”. We will take up these issues one by one, and in the same order.

Issue I: Taxability of carbon credit

3. To adjudicate on this issue, a few material facts and some developments, leading to this litigation before us, will have to be taken note of. The assessee before us is mainly engaged in the business of manufacturing of transmission line towers and steel structures, commissioning of transmission line tower and supply of transmission and distribution line material. During the course of the scrutiny assessment proceedings, the Assessing Officer noticed that while the assessee has shown, in its profit and loss account, income from carbon credits (also referred to as CERs i.e. certified emission reductions) amounting to Rs. 5,78,28,058, it has not offered the same to tax on the ground of carbon credits being in the nature of capital receipts. It was also noted that these credits have been earned by the assessee from its bio-mass power plants situated at Tonk (Rs 4,73,00,773) and Padampur (Rs 1,05,27,285). The details with regard to the sale of the carbon credits, as furnished by the assessee during these proceedings, were examined by the Assessing Officer. It was in this backdrop that the Assessing Officer required the assessee to show cause as to why the income on sale of carbon credits, being revenue receipt in nature, not be brought to tax in the hands of the assessee. The defence of the assessee was two fold- first, that the carbon credits are not taxable, as the carbon credit receipts are in the capital field; and – second, that in any event, even if carbon credit receipts are taxable in nature, the assessee is entitled to corresponding deduction under section 80IA as these receipts are derived from the undertaking entitled to deduction under that section. The elaborate written submissions submitted by the assessee were reproduced in the assessment order. The contentions so advanced were summarized as follows:

3.5 The contentions of the assessee have been examined. For clarity and convenience same are summarized here:

A. The assessee has contended that the CERs are Non-taxable capital receipts as:

- It is an effort to protect global environment in the global benefit.

-It is in nature of grant and subsidy.

- It has been earned because of contracts entered into by the company with the countries which have binding commitment under Kyoto Protocol to reduce Green House gases (GHGs).

B. The assessee has further contended that CERs is not realization of sales.

C. The CERs have not accrued to the assessee-company as:

- The assessee-company got UNFCC approval for Padampur Plant on 20.06.2011 and for Tonk Plant through AtmosfairgGmbh on 14.01.2011 and through Carbon One on 19.10.2009.

- The assessee company has also contended that the Padampur unit was registered on 25.03.2005 and Tonk Plant on 07.10.2008.

- The CER sale receipts were received in FY 2009-10 and 2010-11.

- The CERs have not accrued under the Income-tax Act, 1961. D. The CERs are not liable to tax under the head of 'Capital Gains',

E. The assessee has taken an alternate contention that if the receipt on sale of CERs is considered to be business income then deduction under section 80IA is allowable

4. The Assessing Officer, however, did not yield to these submissions. He was of the view that it is wrong for the assessee to compare the carbon credits with the Government subsidies, inasmuch as the receipts are not from the Government or any regulatory body. What the assessee has received is the sale consideration of the carbon credits from another business entity, in need of these credits, and not from an independent body to promote the public good. He was of the view that “the contention that since the underlying purpose is advancing public interest and has a benevolent objective, the receipt is not chargeable to tax, is without any (legally sustainable) basis in taxation”. He also pointed out that all the precedents cited by the assessee with respect to subsidies etc were the cases in which monies were received from the public bodies. It was also noted that while there was no specific provision for taxation of carbon credits but connotations of ‘income’, under section 2(24) of the Act, were wide enough to cover the same. He was of the view that “it is settled that the word ‘income’ will take in its fold any monetary returns coming in unless specifically exempt”. As regards the question whether carbon credits accrued during the relevant previous year or not, the findings of the Assessing Officer were as follows:

5.1 The contention of the assessee is that the CERs have not accrued as per the Income tax Act as the Padampur and Tonk Plants got UNFCC certificates and the registration for the said plants with regard to the CER credits in the years following the relevant previous year. Despite the fact that the treatment in accounts is not decisive it is noted that in totality of the facts and circumstances the aforesaid receipt is liable to tax in the relevant assessment year. The facts and circumstances are discussed hereunder:

- As per the details provided by the assessee company the Date of the registration for the Padampur Plant is 23.05.2005 and that of Tonk Plant is 07.05.2008.

- There has been emission reduction during the relevant previous year and the same has been computed by the assessee with certainty and as per the prescribed procedure.

- The assessee-company has entered into contracts with the Sponsors during the relevant period as is clear from the dates of registration.

- The assessee has itself recognized the receipts on account of CERs in books of accounts and credited the same to the profit and loss account. Moreover, the assessee is following mercantile system of accounting wherein income and expenditures that have accrued are only credited or debited to the books of accounts. It is pertinent here to refer to point No. 34 of the Notes to accounts of the assessee-company wherein it has been clearly noted that:

- There is reasonable certainty about its ultimate realization.

- There is a reasonable assurance that the Company complies with the conditions in relating thereto.

5.2 In view of the above, the receipt of the CERs was reasonably certain as the assessee-company has already completed the formalities for getting the UNFCC certification, as itself stated by it in its submission. Only residual - formalities were required to be completed. Thus, the contention of the assessee on this count is rejected.

5. As regards the alternative contention of the assessee, i.e. availability of deduction under section 80IA of the Act, the Assessing Officer accepted the same with respect to Padampur plant (i.e. Rs. 1,05,27,285) as the assessee had claimed deduction under section 80IA, for the relevant previous year, in respect of this unit only.

6. It was in this backdrop that the Assessing Officer concluded that “in view of the above, the net receipts of Rs. 5,72,38,569 on sale of CERs (i.e. certified emission reductions or carbon credits) are added to the business income of the assessee being taxable revenue receipts”.

7. Aggrieved by the stand so taken by the Assessing Officer, assessee carried the matter in appeal before the CIT(A). Learned CIT(A) upheld the grievance of the assessee and deleted the addition of Rs. 5,72,38,569 by holding it to be capital receipt. His line of reasoning was as follows:

5. Facts of the case and arguments of the appellant have been carefully considered. At the outset it will be worthwhile to understand the nature of receipt in the case of appellant. The main business activity of appellant company is generation of power. Appellant has two Biomass based Power Generation Plant using agricultural waste as fuel at Padampur and Tonk in Rajasthan State. The CER (Carbon Emission Reduction) certificates are issued to the appellant for saving emission of carbon. The CERs are issued to every industry which saves emission of carbon and not.only limited to power projects. The receipt has no relationship with the process of production nor it is connected with sale of power. This amount is neither a compensation for loss suffered in the process of production nor any expenditure incurred in acquisition of capital asset. This amount also does not represent any subsidy for either establishing the industry or for purchase of capital or raw material. Moreover, CBDT in Circular No.142 dated 1/8/1974 (95 ITR 131) observed that subsidy received for helping the growth of industries which is not meant for supplementing the profit is not considered as taxable. So, even if the amount is treated in the nature of subsidy, the same is not taxable.

5.1 It is settled law that any subsidy which compensates revenue expenditure is revenue in nature and which compensates capital expenditure is capital in nature. The amount received in the case of appellant is for public good and not to compensate either any capital expenditure or revenue expenditure. The same cannot be therefore treated as revenue income of appellant.

5.2 The reliance placed by AO on the decision of Hon'ble Supreme Court in the case of Tata Consultancy Services vs. State of Andhra Pradesh [2004] 271 ITR 401 is of no help because in that case the company was engaged in the business of sale of computer software. It was held by Hon'ble Court that the items treated by company are in the nature of goods or stock-in-trade. However, in the case of the appellant company, the CERs are not in the nature of stock-in-trade. They are not even a bye product in this case. Thus facts of the case of the appellant are different.

5.3 Identical issue has been considered by Hon’ble ITAT B Bench in the case of M/s. My Home Power Ltd. vs. DCIT in ITA No. 1114/Hyd/2009. In this case the Hon'ble ITAT held as follows :

"We have heard both the parties and perused the material on record. 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". It has been made available assuming character of transferable right or entitlement only due to world concern. The source of carbon credit is world concern and environment. Due to that the assessee gets a privilege in the nature of transfer of carbon credits. Thus, the amount received for carbon credits has no element of profit or gain and it cannot be subjected to tax in any manner under any head of income. It is not liable for tax for the assessment year under consideration in terms of sections 2(24), 28, 45 and 56 of the Income tax Act, 1961. Carbon credits are made available to the assessee on account of saving of energy consumption and not because of its business. Further, in our opinion, carbon credits cannot be considered as a bi-product. It is a credit given to the assessee under the Kyoto Protocol and because of international understanding. Thus, the assessee who have surplus carbon credits can sell them to other assesses to have capped emission commitment under the Kyoto Protocol. 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 our opinion, carbon credit is entitlement or accretion of capital and hence income earned on sale of these credits is capital receipt. For this proposition, we place reliance on the' judgement of the Supreme Court in the case of CIT vs. Maheshwari Devi Jute Mills Ltd. (57 ITR 36) wherein 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 is similar to consideration received by transferring of loom hours. The Supreme Court considered this fact and observed that taxability of payment received for sale of loom hours by the assessee is on account of exploitation of capital asset and it is capital receipt and not an income. Similarly, in the present case the assessee transferred the carbon credits like loom hours to some other concerns for certain consideration. Therefore, the receipt of such consideration cannot be considered as business income and it is a capital receipt. Accordingly, we are of the opinion that the consideration received on account of carbon credits cannot be considered as income as taxable in the assessment year under consideration. 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. It is a nature of entitlement to reduce carbon emission, however, there is no cost of acquisition or cost of production to get this entitlement. Carbon credit is not in the nature of profit or in the nature of income.

25. Further, as per guidance note on accounting for Self-generated Certified Emission Reductions (CERs) issued by the Institute of Chartered Accountants of India (ICAI) in June, 2009 states that CERs should be recognized 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 recognized as inventories, the generating assessee should apply AS-9 to recognize revenue in respect of sale of CERs,

26. Thus, sale of carbon credits is to be considered as capital receipt. This ground is allowed."

5.3. In view of above mentioned facts and decision of Hon'ble ITAT Hyderabad as mentioned above, I hold that amount received by appellant on sale of carbon credits are in the nature of capital receipts. AO is therefore not justified in making addition of Rs. 5,78,28,058/-. The addition is directed to be deleted. This ground of appeal is thus allowed

8. The Assessing Officer is aggrieved of the relief so granted by the CIT(A) and is in appeal before us.

9. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.

10. We are alive to learned counsel’s core contention that the issue about taxability of carbon credits is no longer res integra inasmuch as there are several decisions of this Tribunal, and one of which has been approved by Hon’ble Andhra Pradesh High Court, which have held that the carbon credit receipts are not taxable. However, for the reasons we will set out in a short while, we consider it appropriate to deal with the matter in a little detail and set out our understanding about certain basic aspects of this case, rather than disposing of appeal, without examining the facts of case, summarily as a covered matter.

11. A carbon credit is a financial instrument that represents a ton of CO2 (carbon dioxide) or CO2e (carbon dioxide equivalent gases) removed or reduced from the atmosphere from an emission reduction project. It has been used interchangeably with the CERs (i.e. Certified Emission Reductions) and that is the approach we will have here as well. The relevance of carbon credit, so far as our purpose is concerned, is under the Kyoto protocol. Kyoto Protocol, signed in Japan in 1997 in Kyoto, is an international agreement, between various developed countries, linked to the United Nations Framework Convention on Climate Change (UNFCCC), which commits its signatories by setting internationally binding emission reduction targets. This agreement is signed in the backdrop of recognition that developed countries are principally responsible for the current high levels of harmful gas emissions in the atmosphere, as a result of more than one and a half century of industrial activity. What it seeks to achieve, in measurable terms and as set out in Article 3, is to “ensure that their aggregate anthropogenic carbon dioxide equivalent emissions of greenhouse gases listed Annexure 1 (to the protocol) do not exceed their assigned amounts….…..with a view to reducing their overall emissions of such gases by at least 5% below 1990 levels in the commitments period 2008-2012” to their quantified emission limitation and reduction commitments inscribed in the Annexure. Article 2 of Kyoto protocol commits each signatory country to “achieving its quantified emission limitations and reduction commitments” and sets out the various modes of doing so. Article 6 of this agreement, i.e. Kyoto Protocol, provides that for achieving these reduction norms, the parties may “acquire from, any other such party emission reduction units resulting from projects aimed at reducing anthropogenic emissions by sources or enhancing anthropogenic removals by sinks of greenhouse gases in any sector of the economy” provided, inter alia, “any such project has the approval of the parties involved” and “any such project provides a reduction in emissions by sources, or an enhancement of removals by sinks, that is additional to any that would otherwise occur”. The emission reduction units, which is what carbon credits or CERs (certified emission reductions) imply, can thus be acquired by the parties as well, as long as the project, in which these reductions are achieved, are approved by the parties to the protocol. Of course, this method of reduction of harmful gases is only supplemental method inasmuch as these countries cannot rely solely, or mainly, on so acquiring CERs from harmful emission reductions, but that is not really material in the present context because what we are dealing with is only acquiring the CERs from Indian entities. In effect, even if the emission for harmful gas is reduced in a developing country like India, as long as the project in which this reduction is achieved is approved by parties to the protocol and these emission reduction units are transferred by the Indian entity so reducing the emissions to the entities in the parties to the Kyoto protocol, such emission reductions can be taken into account in their committed reductions. The respective parties to the Kyoto protocol have in turn put the emission obligations on the business entities in their countries, and, to fulfil the emission obligations, these entities have obtained the emission reduction credits from entities in other parts of the world. There are entities which trade in and facilitate transfer of these credits from one entity to another. There are sponsorship arrangements, under the Clean Development Mechanism, will allow the CERs generated by Indian entities to transfer the CERs to the foreign entities. It is this peculiar feature of mechanism of fulfilling the commitments that lead to a unique business model in terms of the carbon credits. Of course, the carbon credits through work in developing countries can either be through buying the credits straight away, through joint implementations or by sponsoring a project in the developing world where cost of reducing the harmful gas emission is much lower. These three modes are termed as IET (International Emission Trading), JI (Joint Implementation) and CDM (Clean Development Mechanism) respectively. Whatever be the mode, the common thread is that for all this emission reduction work in the developing countries, developed countries get the credits and virtually a legitimacy to their higher emission to harmful gas emissions. The following diagram could perhaps throw some light on how carbon credits get converted into cash, or, to put it bluntly, how business entities in the developed countries wash their guilt for generating harmful gases by doling out monies to those who save emission of harmful gases:

(http://www.dailytimesgazette.com/carbon-credit-scheme-blamed-for-the-increased-emission-of-greenhousegases- 2/24240/)

12. The question that we are really required to adjudicate upon is whether the monies received by a person, on transfer of carbon credits, is taxable under the Indian Income Tax Act,1961.

13. Let us take a pause here and understand the true nature of this receipt, in the hands of the person transferring the carbon credits from India.

14. The proximate reason for receipt of money on transfer of carbon credit is that someone in the developed countries is generating more harmful gas emission that he was permitted to generate, under the Kyoto protocol, and instead of reducing the harmful gas emission on his own or to supplement his efforts in reduction of these harmful emissions, he is buying credits for the reduction in harmful gases achieved by someone else in this developing country.

15. What does a person get by buying these carbon credits or CERs. For each carbon credit that a person in the developed world buys, he gets right to emit one more ton of CO2 (carbon dioxide) or CO2e (carbon dioxide equivalent gases). Nobody would normally buy these credits as a token of appreciation of the work done in the developing world. The purchase of these credits is driven by the business compulsions. The business compulsion is to meet the emission norms. These emission norms are met by reduction in emission on its own and also paying money to someone in the developing world to buy credit for what environmental friendly work has been done by that entity. All this is in no way reducing the emissions but merely redistributing the right to emit greenhouse gases. That is an act too unkind to the global concerns, and it ends up supporting the global warming rather than controlling it. There is no point in glorifying these transactions of carbon credits as an act of benevolence or by putting those buying and selling these carbon credits on a higher moral pedestal. As Prof Adam Smith said three centuries ago, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest”. Nothing exemplifies it better than the situation before us.

16. Undoubtedly, generation of carbon credit does certainly mean that the entity getting the carbon credits has achieved reduction in harmful gas emissions, and that is an environmental friendly achievement. It is a testimonial of the good work done by the entity. The carbon credits are not, however, for being showcased. Doing good for the environment is one thing, getting it certified and practically monetizing it is quite another. It is not a standalone activity to lower the harmful emissions. What is practically being done is use of environment friendly measures in the course of normal business activity. The emission reduction is an integral party of the core activity carried out by the business. It is not some philanthropic act which gets the assessee before us these carbon credits, it is the manner in which the business activities are carried out, when found to be environment friendly and resulting in lesser emission of harmful gases, result in these carbon credits. All that one gains from these carbon credits in India is the right to transfer it. These credits have no other value. When these rights are transferred to someone in the developed world, it does not do any good to any noble cause- much less to the environmental concerns of this planet. If at all it does good to anything, it is to seller’s cash register and to buyer’s insensitivity to the environment. The activist criticism that carbon credit sale consideration is something which has given legitimacy to the developed world’s continuing apathy to the environmental concerns, may perhaps be too exaggerated but not wholly unjustified.

17. It is in this light of factual scenario that we need to address ourselves to the taxability of sale consideration for carbon credits. 18. As we deal with this aspect of the matter, we may acknowledge the fact that there is a series of decisions of this Tribunal, starting with the decision in the case of My Home Power Ltd Vs DCIT [(2013) 63 SOT 227 (Hyd)], on this issue and all but one of these decisions are in favour of the assessee. The reasoning, which prevailed upon the bench to decide the matter in favour of the assessee, has been set out in the case of My Home Power Ltd (supra) as follows:

…. 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". It has been made available assuming character of transferable right or entitlement only due to world concern. The source of carbon credit is world concern and environment. Due to that the assessee gets a privilege in the nature of transfer of carbon credits. Thus, the amount received for carbon credits has no element of profit or gain and it cannot be subjected to tax in any manner under any head of income. It is not liable for tax for the assessment year under consideration in terms of sections 2(24), 28, 45 and 56 of the Income-tax Act, 1961. Carbon credits are made available to the assessee on account of saving of energy consumption and not because of its business. Further, in our opinion, carbon credits cannot be considered as a biproduct. It is a credit given to the assessee 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 under the Kyoto Protocol. 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 our opinion, carbon credit is entitlement or accretion of capital and hence income earned on sale of these credits is capital receipt. For this proposition, we place reliance on the judgment of the Supreme Court in the case of CIT v. Maheshwari Devi Jute Mills Ltd. [1965] 57 ITR 36 wherein 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 is similar to consideration received by transferring of loom hours. The Supreme Court considered this fact and observed that taxability of payment received for sale of loom hours by the assessee is on account of exploitation of capital asset and it is capital receipt and not an income. Similarly, in the present case the assessee transferred the carbon credits like loom hours to some other concerns for certain consideration. Therefore, the receipt of such consideration cannot be considered as business income and it is a capital receipt. Accordingly, we are of the opinion that the consideration received on account of carbon credits cannot be considered as income as taxable in the assessment year under consideration. 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. It is a nature of entitlement to reduce carbon emission, however, there is no cost of acquisition or cost of production to get this entitlement. Carbon credit is not in the nature of profit or in the nature of income.

19. In all other decisions on the same lines, as cited before us, there is a reference to the aforesaid observations of the Tribunal and there is hardly any independent analysis of the factual situation. The same reasoning has been adopted by the coordinate benches.

20. With greatest respect to the coordinate benches, we have our serious reservations on this factual finding by the coordinate benches. As a matter of fact, the findings are given in only one decision, i.e. My Home Power (supra), and other decisions simply, and somewhat mechanically, follow the same. The factual findings in this case are not the same, as arrived by the coordinate bench in the case of My Home Power (supra), and we are, therefore, not inclined to be guided by this decision. However, for the reasons we will set out in a short while, it is not necessary to refer the matter to a special bench at this stage. Let us first set out our reasons of expressing this voice of dissent:

i. As it was evident from the response to the questions posed by us during the course of hearing, the grant of CERs are inextricably linked to the actual functioning of the unit inasmuch as it was reduction of emission of harmful gases, as a result of the change in the manner in which unit functioned e.g. lesser or no use of fossil fuel, which entitles the assessee to the CER. Take, for example, a situation in which the unit is closed and does not function at all. Learned counsel fairly accepts that there cannot be any CERs in such a situation. In such a situation, we donot subscribe to the view that the CER “is not generated or created due to carrying on business but it is accrued due to ‘world concern’”. We are of the view that the CER is generated due to carrying on business in a manner friendly to the cause of reduction of harmful gases and thus protect the environment.

ii. As regards the finding that “Carbon credits are made available to the assessee on account of saving of energy consumption and not because of its business”, we are of the considered view that the CERs are made available to the assessee because of its carrying on the business in an environment friendly manner, and, as we have emphasized before, if there is no carrying on of the business, there are no carbon credits. The question of savings in energy consumption arises only in the course of the business. The CERs, in our opinion, are an offshoot of business being carried in environmentally responsible manner. Take, for example, lowering or eliminating the use of fossil fuel. When a business does so, and uses other fuels, e.g. renewable energy or solar energy, in the place of fossil fuels, e.g. oil, coal or natural gas, it is the activity of carrying on business in this manner which earns the business CERs. The activity of business and activity of earning carbon credits cannot, therefore, be divorced from each other. The core activity is business and being environmentally responsible is the manner in which this core activity is carried out. It is thus incorrect to say that carbon credits are made available to the assessee not because of its business.

iii. The activity of obtaining CERs is a systematic activity which requires careful planning and a series of actions before the CERs are obtained. For example, a project is to be first approved by the appropriate authorities which grant the CERs. The functioning of the business and the reductions in emissions are to be monitored by the appropriate authorities. The carbon credits are not a windfall which appear out of the blue. A series of conscious decisions are thus required to be taken by the assessee in order to get the CERs and the considerations of CERs essentially therefore have a role to play on the manner in which business is carried out. For example, when renewal energy is substituted for the fossil fuels, the expected gains of carbon credits are also factored. It is an integral part of the business activity, and an important consideration about the choice of courses available in carrying on the business, which results in CERs. The generation of CERs is thus on account of business activity. We, therefore, find ourselves in disagreement with the views of the coordinate bench to the effect 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.”

iv. This gain is not in terms of money, but it is a gain nevertheless. It is clearly a benefit in the sense it entitles the assessee to transfer a right to produce more emission- which is a valuable entitlement, and it arises from carrying on of business. This factual finding is important in the context of Section 28(iv) which provides for taxability of “the value of any benefit or perquisite, whether convertible into money or not, arising from business or exercise of profession” as a business income. Accordingly, we are unable to subscribe to the finding of the coordinate bench that “It is not liable for tax for the assessment year under consideration in terms of sections 2(24), 28, 45 and 56 of the Income-tax Act, 1961”

v. As India does not have any commitments for reduction of emission of CO2 and CO2e, under the Kyoto Protocol, the concept of ‘surplus CERs” for a resident assessee is devoid of legally sustainable basis. Every CER that a resident assessee gets is available for transfer, as long as there is a willing buyer, who will have economic advantage or at least philanthropic satisfaction- assuming that he will buy it only to cancel it, for the same. The assessee does get any advantage in the capital field from the same. It is wholly unlike a case of someone with a surplus production capacity or entitlement which he transfers for a consideration. A capacity entitlement is in the field of capital inasmuch as it governs the production an assessee can have over a period. That is not the case here. It is in this background that we are unable to concur with the observations of the coordinate bench which state that “carbon credit is entitlement or accretion of capital and hence income earned on sale of these credits is capital receipt. For this proposition, we place reliance on the judgment of the Supreme Court in the case of CIT v. Maheshwari Devi Jute Mills Ltd. [1965] 57 ITR 36 wherein 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 is similar to consideration received by transferring of loom hours. The Supreme Court considered this fact and observed that taxability of payment received for sale of loom hours by the assessee is on account of exploitation of capital asset and it is capital receipt and not an income”. These views do not appeal to us. Based on the material before us, we are unable to subscribe to the view that the CER receipts are capital receipts in nature.

vi. As regards the judicial precedents in respect of taxability of subsidies received by the assessee, we are of the considered view that these judicial precedents are not relevant in the present context. The assessee has not received any monies, as a subsidy, from any government or public or multilateral forum. What he has received is an advantage incidental to carrying on business in an environmentally responsible manner. It is an offshoot of business.

vii. As we have noted earlier in our order, sale of carbon credit does not do any good to the protection of environment or address global concerns about environment. Ironically, while these credits are generated by conducting business in an environmentally responsible manner, sale of these credits only result in higher emission of harmful gases in the countries signatory to the Kyoto Protocol. In a way, therefore, it is compensation for giving someone right to generate more harmful emissions than he is permitted to otherwise emit. It is inappropriate to glorify this income as offshoot of “environmental concerns”.

viii. The question of binding judicial precedents arises only in the context of what is actually decided and on the legal questions. The factual aspects which have not been considered or decided in the judicial precedents cannot be treated as covered by these precedents. It is our bounden duty to examine the factual aspects in sufficient detail so as to come to a definite conclusion. As a final fact finding authority, we cannot wish away, or decline to deal with, the hard facts staring at our face, just because the coordinate benches had no occasions to take note of these facts or because these facts have not been brought to the notice of the bench.

ix. Since these crucial facts were not brought to the notice of the coordinate bench, the coordinate bench could not deal with the peculiarities of different types of carbon credits, identify the kind of carbon credit that is examined with respect to the taxability issues and was thus lead to proceed on certain assumptions which seem to be incorrect.

21. On our perusal of the material on record, it appears to us that the case before us is not even a case of sale of carbon credits under the international emission trading (IET). It appears to be a case for generation of carbon credit mechanism through the clean development mechanism (CDM) wherein the project generating the carbon credits is sponsored by an entity in the jurisdiction which has emission reduction commitments under the Kyoto protocol. Learned Commissioner (Appeals) has, while referring to the decision of the coordinate bench in the case of My Home Power Ltd (supra), has not examined the nature of these carbon credits and whether these carbon credits, if found to be under the CDM, will be at par with the carbon credits under the IET as was apparently the case in that judicial precedent. In any case, there is no categorical finding about the nature of CERs in the case of My Home Power (supra) though it has proceeded that generation of CERs was not the offshoot of business which cannot be the case when the project itself is set up, under CDM, under the sponsorship of a foreign entity, specifically for the purpose of generating the CERs. When the very raison d'être for the project being set up is generation of CERs, it cannot be said that CERs are not offshoot of business.

22. Clearly, therefore, the My Home Power decision will not hold good in the case of CERs under the CDM.

23. One of the glaring peculiarity of the carbon credits under the CDM is the sponsorship arrangement by the foreign entity and the fact that very setting up of the project is predominantly for the purpose of transferring resultant CERs to the foreign entity. The impact of this peculiarity on the nature of receipt is not at all examined. The coordinate benches have also proceeded on the basis that all carbon credits are to be given uniform treatment by treating them capital receipts which are not incidental to carrying on the business. This assumption cannot, in any case, hold good for carbon credits under the CDM since in these cases the unit generating these credits are set up for the predominant purpose of generating emission reductions through making modifications in the working mechanism. 24. As a co-ordinate bench of equal strength, and it is not open for us to disregard the views of the coordinate benches. While it is well settled in law that coordinate benches cannot disregard the view of another coordinate bench, it is, however, equally true that it is vital to the administration of justice that those exercising judicial power must have the necessary freedom to doubt the correctness of an earlier decision if and when subsequent proceedings bring to light what is perceived by them as an erroneous decision in the earlier case. In the case of Union of India Vs Paras Laminates Pvt Ltd [(1990) 186 ITR 722 (SC)], Hon’ble Supreme Court has, inter alia, observed as follows:

It is true that a Bench of two members must not lightly disregard the decision of another bench of the same Tribunal on an identical question. …………..The rationale of this rule is the need for continuity, certainty and predictability in the administration of justice. Persons affected by decisions of Tribunals or Courts have a right to expect that those exercising judicial functions will follow the reason or ground of the judicial decision in the earlier case on identical matters.……….It is, however, equally true that it is vital to the administration of justice that those exercising judicial power must have the necessary freedom to doubt the correctness of an earlier decision if and when subsequent proceedings bring to light what is perceived by them as an erroneous decision in the earlier case…………

25. While we are alive to the fact that the remedy to a such a situation normally lies, as is well settled in law, referring the matter to a larger bench, we do not think, for the reasons we will set out in a short while- in addition to the reason that the My Home Power decision (supra) may not apply in the carbon credits under the CDM at all, that it is a fit case for doing so at this stage.

26. We have noted that the activity which has triggered the taxability of carbon credits is assessee’s entitlement to the CERs and not the actual sale of the CERs. This aspect of the matter is clear from the observations made by the Assessing Officer in paragraph 5.1 and 5.2 of the assessment order which have been reproduced below paragraph 4 at page 4 and 5 of this order. The foundation of taxability on the accrual basis thus rests on the factors, as set out by the Assessing officer above, that the related plants were functional in the relevant period, that these was an emission reduction in the related period which was duly certified, that the assessee had entered into the contracts with sponsors, that the assessee itself had recognized the income, that the assessee was following mercantile system of accounting, that there was a reasonable certainty about its ultimate realization. The Assessing Officer was of the view that since “the receipt of the CERs was reasonably certain as the assessee-company has already completed the formalities for getting the UNFCC certification, as itself stated by it in its submission” and since “only residual -formalities were required to be completed”, the CER income, as shown in the profit and loss account, should be brought to tax. Learned CIT(A) has not dealt with this aspect of the matter as the addition was deleted on merits.

27. In our considered view, however, that is not the correct approach.

28. The event triggering the taxation in respect of carbon credits is the sale of carbon credits. It is only when the carbon credits are transferred, and transferred for a valuable consideration, that an income accrues. The grant of carbon credits is not the event triggering the taxation of income. These carbon credits are of no practical use, in Indian perspective, unless these are transferred by the assessee. The principles of conservatism, which is one of the most fundamental principle in determining of commercial profits, does not permit an anticipated income being accounted for, even though all anticipated losses, as soon as these can be quantified on a reasonable basis, are invariably taken into account in this process. Till the point of time these carbon credits are actually sold, the income embedded in these carbon credits, even when any, does not crystallize and continues to remain, at best, an anticipated income. Whether the CERs are generated under the CDM or for the IEM or even under JI, the taxability of the income from CERs will be taxable only when the right to receive consideration for transfer of these CERs is quantified and crystallized. We may add here that, while the ground of appeal raised by the Assessing Officer refers to “addition of Rs. 5,78,28,058 made on account of sale of carbon credits”, it is not even the case of the Assessing Officer that the sale was made in the relevant previous year. This aspect of the matter is clear from the observations made by the Assessing Officer, which have been reproduced earlier in this order after our paragraph 4, and this is what has been emphatically stated at the bar, in the course of hearing before us, by the learned counsel. Once both the parties are unanimous on the factual aspect that the sale is not effected in the relevant previous year, there cannot be any good reasons to bring the CER value to tax in this assessment year.

29. In view of the above discussions, in our considered view, the gains on sale of CERs, though taxable in nature, could only have been taxed at the point of time when these CERs were actually transferred to the foreign entity. Accordingly, the value of CERs, even though quantifiable, cannot be brought to tax by the reason of accrual simplictor. That is precisely what has been done in this case. It is for this reason that we confirm the relief granted by the CIT(A) and decline to interfere in the matter.

30. During the course of hearing, learned Departmental Representative has submitted that in the event of our holding that the income from CERs is taxable only in the year of sale, we should also give specific directions to facilitate reopening of the matters for the assessment years in which the CERs are actually sold. That would, according to the learned Departmental Representative, meet the ends of justice. We are, however, not persuaded by this plea. We do not think any such directions are at all needed. In addition to other course open to the Assessing Officer, Explanation 2 to Section 153(3) reasonably safeguard the legitimate interests of the revenue. We need not supplement the same.

31. It is in this backdrop and being aware of the fact that our views on whether or not the carbon credits, particularly under the CDM, are taxable will have limited and somewhat academic significance at this stage since the question of taxability will need to be finally adjudicated by us only in the year in which sale proceeds of the carbon credit are received by the assessee, we have not referred the matter for constitution of a special bench at this stage. That occasion will arise only in the year and in the case in which sale proceeds are received by the assessee. We are sure that as a final fact finding body, in an appropriate case, all these aspects of the nature and taxability of carbon credits, as have been briefly touched upon in this order, will be examined in a befitting manner by a special bench of this Tribunal in due course. In any case, the case before us, as we have noted above, is with respect to carbon credits under CDM mechanism, which has its own peculiarities and on which there are no judicial precedents as yet. The call on whether or not this is a case to be referred to special bench will have to be taken by the bench which is in seisin of the matter regarding taxability in the year of receipt.

32. For the detailed reasons set out above, and subject to observations as above, we approve the conclusions arrived at by the learned CIT(A) and decline to interfere in the matter so far as outcome of the appeal before the CIT(A) is concerned.

33. Ground no. 1 is thus dismissed.

Issue II: Disallowance under section 14A

34. So far as this disallowance of Rs. 68,15,142 is concerned, which stands deleted by the CIT(A), only a few material facts need to be taken note of. During the course of the assessment proceedings, the Assessing Officer noticed that the assessee has earned a dividend income of Rs. 3,32,19,012. It was also noted that the assessee has offered a disallowance of Rs. 30,000 under section 14A, but the assessee has not furnished any details in support of this amount. It was in this backdrop that the assessee was required to show cause as to why disallowance not be made under section 14A read with rule 8D. The assessee explained that the investments have been made out of interest free funds, the nexus of these investments with the interest free funds was demonstrated, It was also explained that similar disallowances have been accepted in the past as well. The Assessing Officer accepted the assessee’s explanation that no interest bearing funds are used in these investments, but proceeded with making a disallowance in respect of 0.5% of the average investments, which worked out to Rs. 68,45,112, under rule 8D r.w.s. 14A. Aggrieved, assessee carried the matter in appeal before the CIT(A) who reversed the action of the Assessing Officer by observing as follows:

6.2 It was intimated by appellant during the course of assessment proceedings that investments were made in earlier years in shares of subsidy companies and other companies. None of these shares were liquidated in the past 3 years. In such a situation, AO is not justified to conclude that the directors of the appellant company were involved in investment decisions and part of their remuneration needs to be disallowed. Before invoking the provisions of Rule 8D, AO has to give a finding that claim made by the appellant in the return of income is not correct. In this case AO has not given any such finding. It is only presumption of AO that directors of the company might have been involved in decision making relating to liquidation of old investments and investment in new areas. No facts have been brought on record by AO which indicate that there were lot of movements in the investment activity requiring involvement of senior management personnel. I therefore, hold that there is no justification for disallowance of Rs. 68,15,142/- and the same is directed to be deleted. Ground No.2 of the appeal is allowed.

35. The Assessing Officer is aggrieved and is in appeal before us.

36. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.

37. The basic thrust of learned counsel’s submission is that unless the assessee points out any specific expenditure for earning of tax exempt income, disallowance under rule 8D for 0.5% of average investments cannot be made. He also submits that the Assessing Officer has himself accepted that no direct expenses are incurred in earning the dividend income. It is also contended that the provisions of Section 14A(2) and 14A(3) are not satisfied on the facts of the present case, and, as such, rule 8D cannot be invoked.

38. Learned counsel’s submissions, as also the basis on which the learned CIT(A) has granted the relief, are factually incorrect. We have noted that the Assessing Officer has specifically rejected the assessee’s offer of disallowance of Rs. 30,000 by observing as follows:

12.6 The contentions of the assessee have been perused. The only contention raised by the assessee is that it has surplus funds and the investments have been made out of dividend income accrued to the company and funds made available to the company on maturity of mutual funds in which the surplus funds raised from the Qualified Institutional Placements (QIPs) were invested. The assessee has demonstrated one to one nexus between the maturity of the mutual funds and the investments made during the relevant period.

12.7 However, the assessee has failed to provide the basis on which disallowance under section 14A of the Act has been worked out. As already discussed above that the assessee has huge investment portfolio, holding investments of more than 120 crores, has earned substantial exempt income of Rs. 3.32 crores. Moreover, there has been significant activity in the investment portfolio where old investments are liquidated and new investments are made. Making, managing and disposing off the investments require decision making, its accounting, tracking of the changes etc. Moreover, as per the Annual report of the company the directors of the company are being paid salary, commission on profits and other perquisites aggregating to Rs. 750 lacs (aprox.). As the decisions with regard to investments made by the company are important decisions the same are taken by the directors of the company and a part of their remuneration is relatable to these investments and the income derived therefrom.

12.8 In view of the discussion held above it is clear certain administrative, salary and other general expenses have been incurred in relation to the investments that result in income that does not form part of total income. Moreover, the assessee has not made disallowance under section 14A on any rational, logical or actual basis, but, the same has been disallowed on adhoc basis.

39. We have noted that Section 14A(2) categorically provides that “The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.[Emphasis supplied by us]”. Here is a case in which the Assessing Officer has taken note of the huge expenditure, a part of which is also attributable to the tax exempt income, and finds that the small disallowance of Rs. 30,000 made by the assessee is not on any rational, logical or actual basis, and, it is for this reason that the Assessing Officer has invoked disallowance under rule 8D. We see no infirmity in the stand so taken by the Assessing Officer. The conditions of Section 14A (2) are clearly fulfilled. The CIT(A) has granted the impugned relief on the basis that the AO has not given any finding about incorrectness of the disallowance offered by the assessee, but this is, as we can see from the extracts from the assessment order, factually incorrect. As regards learned counsel’s reliance on Priya Exhibitors Pvt Ltd vs DCIT [(2012) 54 SOT 356 (Del)], we find that the coordinate bench had specifically stated that “….. Their Lordships has held that the Assessing Officer must in the first instance determine whether the claim of the assessee is correct and determination must be made having regard to the accounts of the assessee. The legislature directs him to follow rule 8D only where the Assessing Officer is not satisfied with the claim of assessee. In the present case, the Assessing Officer has not fulfilled his onus of recording his findings”. The facts in the present case are diametrically opposed to the said factual position. It is a case, as evident from the reproductions set our earlier in this order, in which the Assessing Officer has recorded specific dissatisfaction with the claim of the assessee. As a matter of fact, this precedent supports the case of the revenue. We may now refer to the observations of the CIT(A) to the effect that “It is only presumption of AO that directors of the company might have been involved in decision making relating to liquidation of old investments and investment in new areas. No facts have been brought on record by AO which indicate that there were lot of movements in the investment activity requiring involvement of senior management personnel”. We find that its not even in dispute that a part of expenses attributable to the work in connection with the investment are to be disallowed, as the assessee has on its own offered Rs. 30,000 for disallowance in this regard. The dispute is confined to the quantum of disallowance and the basis on which it is to be quantified. In the absence of any reasonable basis of disallowance offered by the assessee, and in the absence of the assessee even disclosing the basis on which disallowance is made, the Assessing Officer had invoked the rule 8D. We see no infirmity in this action. In view of these discussions, as also bearing in mind entirety of the case, we vacate the relief granted by the CIT(A) and restore the disallowance of Rs. 68,45,142 made by the Assessing Officer.

40. Ground no. 2 is thus allowed.

41. In the result, the appeal is partly allowed in the terms indicated above.

Pronounced in the open court today on 18th day of March, 2016.

 

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