ACCOUNTING AND AUDITING

Accounting and Taxation Aspects of

Carbon Trading
The emergence of the opportunity of revenue generation by taking up structured
Clean Development Mechanism (CDM) projects has given a new dimension to Ac-
counting and Taxation. As the concept of Carbon Trading is totally new, even at the
international level, there are some issues to be settled before arriving at a common
opinion. This article takes an in-depth view of the concept.

T
he Kyoto Protocol, which came into Kyoto Protocol. Studies by Crisil and CII estimate
force and became legally binding on 15th the value of the Indian CDM market at more
February 2005 when Russia ratified the than a billion dollars per annum.
treaty, demands a 5.2% cut in greenhouse gas Trading of Carbon Credits: Trading of
emissions from the industrialised world as a carbon credits happens in the form of CERs or
whole by 2012. India, along with China and Brazil, Certified Emissions Reductions. CERs are in the
has emerged as one of its largest beneficiaries form of certificates, just like a stock. A CER is
in terms of new source of revenue. This is due given by the CDM Executive Board to projects
to Clean Development Mechanism (CDM), in developing countries to certify that they
which is perhaps most exciting feature of the have reduced greenhouse gas emissions by one
total scheme which allows 'Annex 1 countries' tonne of carbon dioxide per year. For example,
(A total of 36 countries are listed in Annex 1) to if a project generates energy using wind power
meet their emission reduction targets by paying instead of burning coal, and in the process saves
for greenhouse gas emission reduction in non- (say) 25 tonnes of carbon dioxide per year, it can
Annex 1 (developing) countries. claim 25 CERs (One CER is equivalent to one
Most Annex 1 countries have legally tonne of carbon dioxide reduced).
binding greenhouse gas emission reduction CDM Executive Board: A board comprising
requirements under the Kyoto Protocol. These 10 members supervises the operation of CDM.
countries, instead of reducing emissions of their The Board has the final say on whether a project
own companies, can ‘buy’ emission reductions is approved or not, and lays out procedures and
in non-Annex 1 countries. Article 12 of the guidelines for CDM.
Kyoto Protocol states: “The purpose of the Clean
Development Mechanism shall be to assist Verification: A CDM project is monitored or
Parties not included in Annex 1 in achieving ‘verified’ after the project has been approved
sustainable development and in contributing to or registered by the CDM Executive Board.
the ultimate objective of the convention, and to After the project is registered by the Executive
assist Parties included in Annex 1 in achieving Board, the Designated Operational Entity (DOE)
compliance with their quantified emission periodically checks (usually once a year) whether
limitation and reduction commitments.” emission reduction has actually taken place or
not. It is only after verification by the DOE that
India, being a non-Annex 1 country, is CERs are delivered. There are presently 11 DOEs
naturally one of largest beneficiaries of the globally, out of which five are represented in
– CA. Sanjay K. Agrawal India.
(The author is a member of the Institute Emergence of CER Credits: In March 2006,
working as Head-Taxation, Indo Gulf
Fertilisers. He can be reached at san- the United Nations Framework Convention
[email protected]) on Climate Change (UNFCCC) CDM Registry

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CDM is a Journey, not a Destination:

Developing a CDM project should not be
viewed as a commercial transaction. It is not a
huge business but simply a profitable way of
making business environmentally conscious.
A CDM project cannot be undertaken only
on the basis of generation of expected CERs
points and its market value. To be sustainable,
the project must be financially sound by itself.
There are several benefits of undertaking CDM
projects, starting from reduced energy bills by
using energy-efficient equipment, additional
Administrator, for the first time, forwarded depreciation on capital equipments installed
CERs to the holding account of a project for CDM projects, reduced regulatory oversight,
participant representing a milestone in the image of a responsible corporate citizen,
implementation of the Kyoto Protocol’s CDM. advance preparation for such time when India
The forwarding of CERs to the holding accounts will be given targets to reduce greenhouse gas
of project participants provides them with the emissions on its own account, and so on.
end product of their efforts to reduce emissions
The availability of a mechanism of recognition
of greenhouse gases in developing countries.
of carbon credits and its marketability provides
These CERs have a ready market, where
additional revenues, and makes businesses
transactions happen on arm’s-length basis and
more competitive in the global market. As of
price quoted fluctuate as per the situation of
now, there are no separate Indian accounting
demand and supply, and also according to the
standards to measure income and expenditure
negotiation skills of the two parties.
from carbon reducing projects. The existing
Financial Accounting Issues of CDM standards can well account for new capital
Credits in India investments, its depreciation, recurring costs
and sale proceeds of CERs. Some experts feel
India is one of the major players in the global that CDM projects should be accounted for
market on the supply side of CERs. Indian as a separate segment under AS-17 (segment
companies have started getting credit of CERs reporting). This line of thought does not
and some of them have also entered into sale appear practical if the concept of ‘journey, not
arrangement with buyers in the international destination’ is properly followed. A CDM project
market. As this is a new concept, it has given rise cannot be a profit centre or cost centre in itself.
to interesting financial accounting dimensions. In a multi-segment industry, any CDM project
Issues involved are (i) how to account for can be identified with its parent segment.
expenditure on CDM projects, (ii) whether or
not to account for self-generated CERs held with CERs are Goods: CER credits are considered
registry, (iii) if credits are to be accounted, at goods, as they have all the attributes thereof.
what point of time these should be recognised As held by the apex court in TATA Consultancy
in books of accounts and at what value, and Services v. State of Andhra Pradesh [2004] 141
(iv) how to account for sale consideration of Taxman 132/ 271 ITR 401, while dealing with
CERs and its disclosure in accounts and notes. issue of levy of sales tax on computer software,
Answers to these questions are found within “a ‘goods’ may be a tangible property or an
existing pronouncements of ICAI as well as intangible one. It would become goods provided
Schedule VI requirements. Taxation issues will it has the attributes thereof having regard to (a)
naturally follow. its utility; (b) capability of being bought and

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sold; and (c) capability of being transmitted, price or all significant risks and rewards of
transferred, delivered, stored and possessed.” ownership have been transferred to the
This approach was reiterated by the apex court buyer and the seller retains no effective
in BSNL v. UOI [2006] 152 Taxman 135/ 282 ITR control of the goods transferred to a degree
273/ 145 STC 1. usually associated with ownership; and
CER Sale is Other Income, Not Turnover: (ii) no significant uncertainty exists regarding
We can safely conclude from the discussion the amount of the consideration that will be
above that sale proceeds of CER credits cannot derived from the sale of the goods.”
be included in Turnover. Section 43A(11) of the Self-generated CERs Held with Registry:
Companies Act, 1956, defines ‘Turnover’ as “the Self-generated CERs held with registry cannot be
aggregate value of the realisation made from included in Inventories as defined in Accounting
the sale, supply or distribution of goods or on Standard-2, as they are not held for sale in the
account of services rendered, or both”. Part II of ordinary course of business. On the other hand,
Schedule VI to the Companies Act, 1956, requires such credits meet all the criteria of ‘Intangible
a separate disclosure of “profits or losses in respect Asset’ as defined in Accounting Standard-26
of transactions of a kind, not usually undertaken i.e. (i) identifiability, (ii) control over a resource,
by the company or undertaken in circumstances and (iii) expectation of future economic benefits
of an exceptional or non-recurring nature, if flowing to the enterprise.
material in amount”.
Para 19 to 23 of Accounting Standard-26 deal
Though CERs are goods, their sale is with recognition and initial measurement of an
undertaken, if not in exceptional circumstances, intangible asset. Para 20, which is the operating
certainly on non-recurring basis. We have portion of this section, provides that an intangible
already seen that a CDM project cannot be a asset should be recognised if, and only if:
profit/cost centre in itself, and, therefore, it is
neither possible nor desirable to attempt to work (a) it is probable that future economic benefits
out separate profit or loss of any CDM project, attributable to the asset will flow to the
enterprise; and
with an accuracy expected from accountants. A
combined reading of Section 43A and Schedule (b) the cost of asset can be measured reliably.
VI of the Companies Act clearly establishes that Since we have already demonstrated that
sale proceeds of CERs should be disclosed as a availability of CER credits is only an additional
line item in schedule of other income, if amount benefit of a CDM project, it would be impossible
is material. to measure the cost of self-generated CER asset
Revenue Recognition on Sale of CER reliably. Thus it can be concluded that though
Credits: As we have already concluded that self-generated CERs held with registry are
CER credits are goods, their sales proceeds have Assets (Intangible), they cannot be recognised
to be recognised in financial accounts as per in Accounts due to specific requirements of
para.11 of the Accounting Standard 9 (‘revenue Accounting Standard-26.
recognition’). The conditions of para.11 are self- Accounting Carbon Credits as per AS-
explanatory, and are reproduced below: 12: Some experts, having admitted that there
“11. In a transaction involving the sale of are presently no guidelines/standards for
goods, performance should be regarded as accounting of Carbon Credits, have suggested
being achieved when the following conditions that they be accounted as Government Grant.
have been fulfilled: There logic is based on the definition of the term
‘Government’ prescribed in para 3.1 of AS-12,
(i) the seller of goods has transferred to the which reads: “Government refers to government,
buyer the property in the goods for a government agencies and similar bodies,

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whether local, national or international.” The logic forwarded

appears to be misplaced, as in case of financial transactions
arising out of carbon credit, monetary consideration will
not flow from any government or government agency. In
total gambit, UNFCC CDM registry acts as a Demat banker
recognising CER credits and keeping an account of it. There
is no grant at all from any agency. Further, as soon as Carbon
Credits are accounted as Government Grants, Accounting
Standard-9 ‘revenue recognition’ will cease to operate, leading
to other accounting and taxation complications.

Tax Planning
CER credits are indeed intangible assets, held with registry.
CER credits acquired from other parties for the purposes of
trading are recognised in the books at the cost of acquisition,
whereas self-generated CER credits are not reflected in financial
accounts. As issues for accounting of CER credits will appear for
the first time in Financial Year 2006-07, it’s important to disclose
the accounting policy adopted for this purpose. It would be
appropriate to disclose units of CER held with registry in notes
bi-furcating between purchased and self-generated.
As CERs are capital assets, tax liability should be admitted
under the head Capital Gain, and claim for concessional rate of
taxation should also be made if credit is held for more than 36
months immediately preceding the date of transfer. This gives
an opportunity to take a decision about timings of sale of such
credits, keeping a balance between cash flow needs, interest
factor and difference in rate of tax between long-term and
short-term holdings. As there would be no cost of acquisition
for self-generated CER credits, section 55(2) of the Income Tax
Act will come into operation, and total sale consideration will
be liable for Capital Gains Tax (long term/short term) according
to the period of holding.
In Indian circumstances, if sale of CER credits happen to
overseas buyers, of the property held overseas, such sale,
though sale of ‘goods’, will not attract any sales tax.

Conclusion
As the issues for accounting of CER credits will appear for
the first time in FY 2006-07, it will generate a fair amount of
debate among accountancy professionals. ICAI may come
up with some guidelines in due course. The views of taxation
authorities would be another interesting dimension. This
write-up may serve as a starting point for such discussions and
debates. r

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