Taxing Carbon Emissions Across Borders - Evaluating the Relevance of CBAM in the Indian Tax Landscape

The authors are Shivam Agrawal & Priyanshu Pandey, third year students at Hidayatullah National Law University, Raipur

Abstract:

Countries across the globe have intensified their protection against climate change. The European Union's Carbon Border Adjustment Mechanism presents a pioneering step in integrating environmental goals with taxation and policy tools. It is designed to impose tariffs based on emissions. This article examines the feasibility and implications of introducing a similar mechanism within India's complex legal and economic landscape.

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Introduction

The European Union came to the understanding that some industries or companies are exploiting the market while disregarding the problems of the environment. To counter this problem, the EU introduced the "Carbon Border Adjustment Mechanism" (CBAM) in 2023, for the improvement of environmental health among other key objectives of setting a levelled playing ground for industries that are not heavily reliant on carbon combustion.

This mechanism is meant to put a carbon price tag on imported products equal to the price of carbon faced by domestic producers of cement, steel, aluminium, and fertilizers to level the playing field for EU firms. It is to be compatible with the EU’s Emissions Trading System (ETS), whereby companies buy and sell carbon permits. The CBAM, by determining the price at the border, allows the imported goods to bear the same carbon costs as the domestically produced goods policy.

An Overview of the CBAM in the EU

The European Union's CBAM is a first-of-a-kind policy tool designed to address carbon leakage and support its climate goals. It works by adding a carbon cost, comparable to a levy, to imported products from countries that lack similar measures of carbon charging.

The CBAM has been initially applied to only a select group of six sectors, which have been historically highly carbon intensive. This initial coverage will ensure that the risk of the highest carbon leakage is targeted first and the mechanism is tested adequately before being applied to other less carbon-intensive sectors, taking into account the goal of the EU on attaining climate neutrality by 2050.

It operates on the basis of "CBAM certificates" which are permits that are required to be purchased by importers. They are based on the carbon emissions which are considered or proven to be embedded in the imported goods. The importers have to declare the embedded emissions on an annual basis and submit the required number of certificates according to the same. 

A transitional model has been adopted, applicable from 2023 to 2026, to ease the adoption of the new system by corporations. During this period, the focus is not on actually deriving the payment of certificates, but on ensuring that embedded emissions are duly monitored and reported. Therefore, the final operationalisation of the mechanism will be based on sound practices and experience.

Integrating Carbon Taxation in India's Taxation Framework

Existing Mechanism in India:

India is not completely unaware of the mechanism of implementation of tax for the purpose of environment and climate protection. It has a number of tax measures aimed at promoting sustainability.

One of the most important measures is the "coal cess" which was introduced in "the Clean Energy Cess" framework in 2010. Towards the beginning, the cess was fixed at Rs. 50 (per ton of coal) while it now stands at Rs. 400. The revenue is put into the National Clean Energy Fund (NCEF), which provides funding for clean energy projects.

India has also launched the "Perform, Achieve and Trade" scheme which is aimed at increasing energy efficiency in the energy-efficient industries. It was launched in 2012 and it sets consumption reduction targets for a specified number of sectors. Industries which exceed their targets can trade their "Energy Saving Certificates" with other industries that fail to exceed their determined targets. 

In 2023, the "Carbon Credit Trading Scheme" was introduced in India. It is a market-based system aiming to reduce emissions by pricing them through a carbon credit certificate trading mechanism. It incorporates a 'compliance mechanism' through which the concerned entities will comply to the GHG emission targets as notified by the government and an 'accreditation procedure' which sets out the minimum eligibility requirements for registering as an "Accredited Carbon Verification Agency".

Adopting a National Carbon Tax System - A rationale:

Change in climate conditions, as a global problem, has already attracted the interest of the legal and tax authorities while the necessity of implementing carbon taxation is being experienced globally. In this context, the application of national technology carbon tax in terms of India may be effective in improving its economic performance and at the same time controlling its carbon emissions.

A national carbon tax would provide direct discouragement for corporations on emission of carbon since the latter would be priced. The mainly affected sectors in India for carbon emission are sectors such as coal, cement, power etc are the main focuses of the tax. Consequently, one might assert, that the argument in favour of adopting a carbon tax is broadly based on a number of factors. It earns money; solves the problem of carbon dioxide and adheres to the conditions of worldwide climate agreements. Therefore, the rationale for adopting a carbon tax is multifaceted.

Legal and Economic Challenges

The first legal issue is going to lie in integrating a CBAM-like system with the Indian constitution and laws. The subject matter of taxation does not singularly rest in the domain of any particular government but is divided between various levels of Union and state governments. A national carbon tax may likely come under the ambit of the Union but states might well raise a claim to that right. In this approach, it is felt that a new detailed legislation which clearly delineates the scope of a carbon tax and ensures its compliance across states, can be enacted. Establishing the benchmark for emissions and verifying the emissions of various industries, especially those with complex supply chains, could lead to various challenges relating to the accuracy and fairness of such calculations. Therefore, the methodology to be adopted must be sound in law and not be vague or overbroad.

Legal issues might also be generated in the international scene, especially in the area of international business. By design, CBAM-like measures are capped in net effect and may also be viewed as preservationist.  In order to implement a carbon tax, India will also need to ensure that the mechanism is WTO-compatible so that trade disagreements do not arise in future. As per Articles 1 and 3 of the GATT, differential restrictions for different countries and arbitrary treatment of imported goods vis-a-vis domestic goods are prohibited. The CBAM itself has been subject to intense criticism for its alleged protectionist nature. India can potentially invoke  Article XX of the General Agreement on Tariffs and Trade, by demonstrating that the tax ultimately and genuinely addresses environmental concerns and is not a disguised restriction on trade.

On the economic side, a carbon tax will severely disrupt industries which are reliant on fossil fuels. As a result of high costs, competition could decline in both local and global market contexts. This burden might even be passed on to the consumers causing inflation as stated in the following section. This will mean that the government will have to assist those industries through subsidies or tax exemptions so they do not experience layoffs or close down. It will also involve heavy capital investment in the systems and structures needed to monitor and report emissions.

Proposed Framework and Recommendations

Proposed framework for implementation:

The carbon tax for India could be designed on the basis of tons of CO2 emitted per unit or per product. This can be implemented among sectors among the target sectors such as the coal and steel sector. This will be done in line with the PAT scheme and the CBAM. It will also clear all the taxation issues of businesses and will also ensure that businesses have a clue as to how they are expected to pay their taxes.

The tax rate could be implemented on a cumulative and an industry basis. It has to be understood that each industry and sector may not be on the same ballpark and to tax them the same may not be justified. The tax rate could be progressively raised from one year to the next. But to start off, a low price has to be adopted, which can be worked up progressively. Even before the adoption of the tax, compliance measures of the corporations may be worked upon and improved.

Additionally, in order to shed light on the interplay between the carbon tax framework and the PAT scheme, it is essential to address how compliance shortfalls are managed. For instance, if a company fails to meet its energy efficiency target and resorts to purchasing the cerrtificates, it should be specified whether the carbon tax would apply exclusively to this non-compliant entity or if a distinct cap would be established solely for taxation. It must be kept in mind that utilizing the cap determined under the PAT scheme for tax purposes might lead to operational and administrative conflicts between the two systems. Therefore, the framework must adopt detailed guidelines to align both mechanisms and prevent overlap.

The following recommendations may be considered while introducing a carbon tax in India, on the lines of the CBAM:

(i) Phased implementation: Taking a cue from CBAM, carbon tax must first be introduced only for high-emission sectors. Furthermore, it should be imposed at a low rate first to allow enough time to switch to cleaner technologies and decrease the carbon footprint, without provoking significant market disturbances.

(ii) Introducing tax credit for exports: Where countries have taxes in place such as the EU which already has a carbon tax in place, tax credit or rebates may be provided to ensure that the competitiveness is not disadvantageously affected. This will require significant bilateral/multilateral engagement to establish a structure based on consensus.

(iii) Setting sector-specific carbon intensity benchmarks: Benchmarks for deciding tax rates for various sectors cannot be uniform and standard across the sectors. This is to ensure that carbon tax rates reflect the Company’s strategic realities as applied to an industry.

(iv) Abolishing the compensation cess: As and when the government introduces the carbon tax, it should do away with the current compensation cess since the revenue generated from it is not earmarked for an environmental cause and introduce the carbon tax in a manner similar to a cess, being reserved only for the specified purposes.

Conclusion

The Government of India has refused to implement the mechanism on the Indian land. The refusal is largely based on the contention that such a mechanism will hamper the growth of a fast-developing country like India. It is also said that the mechanism is detrimental to the domestic market cost, from the Indian government’s point of view. Moreover, several nations, including India, Russia, and Brazil have jointly condemned the mechanism due to its unfair and discriminatory nature.

It is clear from the current dispenstion's point of view that the mechanism is not ready to be applicable on Indian soil. However, given the change in the climate conditions and the deterring environment, India will have to adopt a robust carbon taxation mechanism. At the same time, the mechanism must be balanced with the space for the growth of the nation.