The Green Tax Conflict: A Critical Study of Section 115BBG and the Evolving Carbon Credit Trading Scheme in India

The authors are Kshtiz Rohilla and Sumit Saini, Third Year Students from Dr. BR Ambedkar National Law University, Sonipat.

Abstract:

At present, the Indian transition to a mandatory emissions trading system is being hindered by a “green tax trap” owing to the incongruence between climate commitments and taxation regimes. While the government has launched the Carbon Credit Trading Scheme (CCTS) [1] to fulfil its commitment to achieve Net-Zero by 2070, the Income Tax Act of 1961 remains entrenched in the “Kyoto Protocol era.” Under Section 115BBG,[2] carbon credits are liable to a 10% flat tax on gross receipts with an absolute bar on deductions, treating market-based compliance tools as “incidental gifts.” The most problematic aspect is the “30% tax cliff” created by the narrow definition of carbon credits under Section 115BBG. The credits must be validated by the United Nations Framework Convention on Climate Change to qualify for the 10% tax treatment. Consequently, the domestic credits (CCCs) issued by the Bureau of Energy Efficiency (BEE) may be liable to the standard 30% corporate tax rate, causing a substantial economic distortion.

Moreover, the “gross taxation” treatment also includes the “technology penalty” because there is no provision for deduction in capital-intensive sectors such as Green Hydrogen and Carbon Capture. This goes against the accounting matching principle. Moreover, the GST treatment uncertainties, when taken together, may result in a total tax rate of 28%, thus hindering the mitigation of climate change in India. To resolve this issue, this piece recommends a change in the statutory definition, a move to net taxation, and tax-neutral issuance to unlock the green economy.

I. Introduction: The Convergence of Climate Mandates and Fiscal Frameworks

The world’s appeal to address climate change has moved from being a visionary international agreement to a specific domestic legal framework. India, with the third-highest greenhouse gas emissions globally, has been at the vanguard of this shift with its commitment to the Paris Agreement and then the “Panchamrit” commitment at COP26.[3] The heart of this is the reduction of the emissions intensity of the Gross Domestic Product (GDP) by 45% by 2030 and the achievement of a Net-Zero target by 2070. [4] This calls for not only a technological transformation in the industrial sector but also a complex legal and fiscal framework that can account for carbon costs and encourage their reduction.

Historically, the Indian model of energy efficiency has been spearheaded by the Perform, Achieve, and Trade (PAT) scheme, a mandatory energy efficiency scheme that identified particular industrial sectors through the allocation of Energy Saving Certificates (ESCs).[5] Although the PAT scheme enabled substantial energy savings, the scheme aimed at energy efficiency and not GHG emissions. However, realising the weakness in the existing system, the government has launched a paradigm shift towards the Carbon Credit Trading Scheme (CCTS). Sectioned under the Energy Conservation (Amendment) Act, 2022, the CCTS gives the Central Government the authority to establish a national carbon market, which is an expression of climate change visions in a system of binding compliance obligations for hundreds of identified industrial units.[6]

However, a fundamental conceptual and legal paradox has arisen at the intersection of environmental policies and taxation laws. While the Ministry of Power and the Bureau of Energy Efficiency (BEE) are working towards a visionary and market-based compliance system, the Income Tax Act, 1961, is stuck in a pre-CCTS era. Section 115BBG of the Income Tax Act, sectioned under the Finance Act, 2017, levies a flat rate of 10% on the gross receipts of the transfer of carbon credits, thereby explicitly disallowing any deduction for expenses or allowances.[7] This was conceptualised during the period of the Clean Development Mechanism (CDM) era of the Kyoto Protocol, where carbon credits were viewed primarily as "incidental" entitlements or "regulatory gifts" that were recognised by international organisations such as the United Nations Framework Convention on Climate Change (UNFCCC).[8]

This article is divided into five sections. Section II discusses the jurisprudential development of the concept of carbon credits from "regulatory gifts" to "taxable assets." Section III of the article discusses the technical architecture of the proposed CCTS system.[9] Section IV of the article presents the critical analysis of the "Green Tax Trap" under Section 115BBG. Section V of the article presents the comparative analysis of the "mature carbon markets." Section VI of the article presents the tripartite reform of the Indian fiscal and statutory framework in consonance with the Net Zero 2070 goals.[10]

II. The Jurisprudential Evolution: From "Gift" to "Asset"

This section will explore the transformation of carbon credits, initially as tax-exempt incentives for the environment and ultimately as heavily regulated fiscal tools under Section 115BBG. The transformation will also be assessed in terms of the shift from the judicial 'purpose test' to the legislative quest for administrative finality.

A. The Pre-2017 Paradigm: The Purpose Test and Capital Receipts

The judicial stance on income earned from carbon credits before 2017 was characterised by a conflict between the Revenue’s endeavour to treat such income as business income and the judicial application of the ‘Purpose Test’. The Purpose Test, as held by the Supreme Court in the case of Sahney Steel & Press Works Ltd. v. Commissioner of Income Tax (1997), “whether a receipt is to be treated as capital or revenue, is dependent upon the legislative intent and the purpose of the incentive.”[11] Incentives or subsidies that are granted to encourage the development of an industry or the acquisition of capital assets are to be treated as capital receipts, while incentives that are granted to encourage business activity or profitability are to be treated as revenue.

The Purpose Test was further clarified in the case of Ponni Sugars & Chemicals Limited (2008), where the Court held that “the source, form, and timing of income are of secondary importance to its predominant purpose.”[12] Under the CDM framework, Certified Emission Reductions (CERs) were regarded as incidental benefits accruable as a consequence of clean-up activities in the environment, and not as a consequence of the main manufacturing or trading activity. Since these credits were incidental to the introduction of clean technology and did not have any "cost of acquisition" as such, the first judicial decisions uniformly favoured the assessee, and carbon credit income was held to be non-taxable capital income.[13]

B. CIT v. My Home Power Ltd.: The Doctrine of Regulatory Entitlement

The landmark decision of the Andhra Pradesh High Court in CIT v. My Home Power Ltd. (2014) reinforced the capital status of carbon credits.[14] The High Court affirmed the decision of the Hyderabad ITAT, which held that carbon credits were "not an offshoot of business but an offshoot of environmental concerns". The High Court drew an important analogy from the Supreme Court decision in CIT v. Maheshwari Devi Jute Mills Ltd. (1965), which involved "loom-hour quotas" or production entitlements allocated through industrial licenses.[15] The Supreme Court had held that income from the sale of such quotas was capital income, since it represented the realisation of a rights-based entitlement conferred by the State.

The justification in My Home Power Ltd. was that CERs were state-created (or internationally created) rights whose transfer did not amount to business income or revenue receipt.  The ITAT also held that these credits were a “sort of gift” provided by the UNFCCC for environmental distinction, which fell beyond the ambit of “income” under Section 2(24) or “profits and gains” under Section 28 of the Act.[16] This judicial interpretation granted tax immunity to carbon credit transactions during the CDM period, but it also solidified the notion that these credits were passive rights rather than active market-based instruments.

C. Legislative Intervention: The Architecture of Section 115BBG

In light of the judicial setbacks and the increasing number of litigation cases, the legislature finally brought Section 115BBG into force through the Finance Act, 2017.[17] This section came into effect from April 1, 2018, and aimed to provide administrative finality through a specific low-tax treatment regime for carbon credit transactions. This section is a deeming section that applies “notwithstanding anything contained in any other provision” of the Act, effectively nullifying the Purpose Test and judicial precedents.[18]

The mechanics of Section 115BBG are determined by two major pillars, firstly and secondly:

1. Firstly: A flat rate of 10% (surcharge and cess as applicable) on income earned from the transfer of carbon credits.[19]

2. Secondly: An absolute bar on any deduction in respect of any expenditure or allowance.[20]

Notably, the "Explanation" to the section has defined the term "carbon credit" as "a reduction of CO2 emissions validated by the United Nations Framework Convention on Climate Change".[21] Although this definition was helpful in the context of CDM-era CERs, it has resulted in a rigid statutory anchor that has not been able to foresee the transition to domestic carbon markets and validation systems.

III. The CCTS Framework: A Paradigm Shift in Carbon Compliance

In this section, the technical transition from the 'energy efficiency benchmarking' system of the PAT scheme to the 'baseline and credit' system of the CCTS is presented. This framework will form the basis of the technical background for the fiscal conflicts analysed in Section IV.

A. Transitioning to Mandatory Emissions Trading

The notification of the Carbon Credit Trading Scheme (CCTS) in June 2023, under Section 14(w) of the Energy Conservation (Amendment) Act, 2022, signals India's transition to a results-based emissions trading system.[22] Although the energy efficiency benchmarking of the PAT scheme targets energy savings, the CCTS is a mandatory "baseline-and-credit" trading scheme that aims to directly price carbon emissions. The GHG reduction achievements are measured in terms of Carbon Credit Certificates (CCCs), where each certificate represents one metric tonne of CO2 equivalent (tCO2e) reduced below the assigned target.[23]

This transition turns carbon credits from voluntary "entitlements" to mandatory tools of compliance. Under CCTS, industrial sectors are no longer voluntary pursuers of global reputation but are now "obligated entities" bound by legal obligations to emission intensity targets.[24] Non-compliance with these targets is penalised with extremely harsh economic penalties in the form of Environmental Compensation, calculated at twice the average market price of a CCC.[25]

B. Phased Implementation and Sectoral Coverage

The implementation of the regulatory framework is being carried out through the Greenhouse Gas Emission Intensity Target Rules, 2025, which specify the sectors and entities that are required to comply with the framework.[26] The first target of the framework is the most energy-intensive sectors, which will then be extended to the entire industrial structure of the economy.

Sectoral Category	Priority Sectors Included (Phase 1 & 2)	Aggregate Obligated Entities
Energy-Intensive Heavy Industry	Iron & Steel, Cement, Aluminium	~282 (Initial Phase)
Chemical & Processing	Chlor-Alkali, Fertilizers, Petrochemicals	~208 (Secondary Phase)
Infrastructure & Manufacturing	Petroleum Refineries, Pulp & Paper, Textiles	Combined Total: 490

The targets are measured in terms of tonnes of CO2e per unit of product, with a 2023-24 baseline. The MoEFCC has set up ranges of reduction of about 2.8% to 15%, depending on the sector's reduction potential. Notably, the compliance requirement is "back-loaded," where 40% of the reduction requirement needs to be met in FY 2025-26 and the remaining 60% in FY 2026-27.[27] This is a time-bound requirement that requires immediate investment in low-carbon technologies, making the tax treatment of the credits generated a material investment consideration, and not just a detail.

C. Market Infrastructure and Regulated Trading

The CCTS market infrastructure is highly developed and ensures transparency and liquidity. CCCs are issued by the BEE, recorded in a blockchain-based National Registry administered by the Grid Controller of India (GCI), and traded on electricity exchanges such as the IEX and PXIL.[28] The market is administered by the Central Electricity Regulatory Commission (CERC), which ensures regulatory support in terms of price determination and settlement.[29]

The market infrastructure also supports a "Voluntary Offset Mechanism," whereby non-obligated parties (such as agricultural or forestry projects) can produce and sell credits to obligated parties. This two-market system (compliance + offset) mirrors the structure of mature Emissions Trading Systems (ETS), such as the EU ETS, but at the same time reveals an astonishing regulatory gap: whereas the CCTS considers CCCs a regulated financial asset, the Income Tax Act considers them UNFCCC-validated international gifts.[30]

IV. Critical Analysis: The "Green" Tax Trap

The inquiry has identified three major fiscal barriers, namely, the ‘Definition Gap’ resulting in a 30% tax cliff, the ‘Technology Penalty’ of gross taxation, and the cumulative effect of GST classification ambiguity.

A. The Definition Gap: The 30% Tax Cliff Risk

The heart of the legal issue is found in the Explanation to Section 115BBG, which states that a carbon credit must be "validated by the UNFCCC" in order to qualify for the 10% tax rate. The Indian domestic carbon credits, CCCs, which are issued by the BEE on the sovereign authority of the Republic of India, fail to meet this criterion. This is not a definition gap but a risk of financial loss, as held in the ITAT Amritsar decision in Satia Industries Ltd. v. NFAC (2022).

In the above case, the Tribunal held that the taxation treatment of Renewable Energy Certificates (RECs), which are domestic credits issued under the Electricity Act of 2003, did not qualify for the tax rate of 10% since they were not validated by the UNFCCC.1 Since the RECs did not meet the specific definition of Section 115BBG, the income earned from the sale of RECs was liable to be taxed at the standard corporate tax rate of 30%.

Applying the same logic to the CCTS, the tax rate applicable to the obligated parties is 30%. This "tax cliff" is a profound economic distortion of the incentive structure in the carbon market. In the case of the steel industry, for example, 1 million surplus CCCs may be worth ₹50 crore in market value. The difference between a 10% and 30% tax rate is a ₹10 crore loss of capital that is, capital that would otherwise be invested in abatement technology.

B. Gross vs. Net Taxation: The "Technology Penalty" on Abatement CAPEX

The second economic distortion in the CCTS is the "gross taxation" system imposed by Section 115BBG(2) of the Act, which clearly prohibits any deduction for expenses incurred in earning carbon credits. This system imposes an economic absurdity by treating the investment in green technology as if it were a windfall gain.1 In general tax principles (Section 37 of the Act), a taxpayer is entitled to deduct expenses incurred for earning income. However, Section 115BBG imposes a "technology penalty" by denying cost recovery for:

• Green Hydrogen Infrastructure: Multi-thousand crore investments in electrolysers and storage.

• Carbon Capture, Utilisation, and Storage (CCUS): High-CAPEX installations such as Tata Steel’s Jamshedpur plant.

• Monitoring and Verification: Ongoing costs paid to recognised carbon verification bodies.

This gross-taxation structure may potentially lead to a situation where a company achieving zero economic profit (where technology costs equal credit revenue) is still required to pay a 10% tax on gross receipts. This violates the "matching principle" of accounting and taxation, offering a perverse incentive to companies to play against over-compliance and technology adoption.

C. GST Classification Ambiguity and Cascading Burdens

The third issue is the lack of institutional coordination between the direct tax department and the indirect tax department regarding the classification of CCCs. The CERC and the Ministry of Power have classified CCCs as "actionable claims" or "securities" to facilitate trading on stock exchanges. In light of Schedule III of the GST Act, 2017[31], securities are exempt from GST.

However, if the revenue authorities treat CCCs as "services" (as in some previous interpretations of CERs), then CCCs will be liable to a 18% GST. This will result in a "cascading tax burden":

• Income Tax (115BBG): 10% on gross receipts.

• GST: 18% on transaction value.

• Total Effective Tax: ~28%.

Moreover, if the GST paid on abatement equipment, such as CCUS technology, cannot be offset fully against the GST on credit sales because of disagreements on classification, then this will result in Input Tax Credit (ITC) blockage, thus increasing the cost of decarbonization. This lack of transparency will further decrease market liquidity and force market participants to engage in untransparent over-the-counter transactions in order to escape the notice of the regulatory authorities.

V. International Comparative Jurisprudence:

To unlock the "green tax trap" in the Indian scenario, it is pertinent to examine the carbon markets in more advanced nations where the tax treatment system systemically functions as a catalyst and not as a brake.

A. The EU-ETS: The Art of Institutional Harmony through Tax Neutrality

The EU-ETS is an example of institutional harmony that offers an insight into the fragmented nature of the Indian tax regime. The revised Markets in Financial Instruments Directive (MiFID II)[32] treats emission rights as 'financial instruments,' ensuring the carbon market is governed by the same rules as the financial markets.

About taxation, the EU adopts the principle of 'Tax Neutrality' in the allocation of allowances. The majority of the EU states do not tax the allocation of allowances as a 'gift' or 'income,' whereas the Indian tax code treats the allocation of allowances under Section 115BBG(2) as 'incidental entitlements.' The EU adopts the system of 'Realised Gain,' whereby income is taxed only when excess allowances are realised and sold, and the system of 'Net Taxation,' whereby deductions are made for abatement technology, ensuring that there is no conflict with the 'Polluter Pays Principle.' This is a solution to the Indian 'tax cliff' because tax is levied only when economic gain is realised.

B. The Australian Model: Mitigating Liquidity Risks via the Rolling Balance

The Australian system of taxing Australian Carbon Credit Units ("ACCUs") under Division 420 of the Income Tax Assessment Act 1997 (Cth)[33] is an extremely sophisticated system that serves as an alternative to the punitive gross taxation system applicable in India.

Under the Australian system, also known as the "Rolling Balance Mechanism," the value of the carbon units must be accounted for at the end of the year, with increases being taxable but reductions being fully deductible. Unlike the system applicable in India under Section 115BBG, which does not permit the deduction of any expense, under the Australian system, the full deduction of the cost incurred in becoming the holder of the unit, including the cost incurred in the development of the projects and the cost incurred in the verification of the projects, is available. Moreover, the tax treatment of the funds under the Australian system, which treats the funds as "primary production income" for certain sectors, serves to illustrate the tax incentive that can be provided under the tax system for market participation through tax averaging.

C. The United States: Promoting Abatement through Technology Neutrality

The US Federal Tax Code is a strong proponent of the 'carrot' method, using Section 45Q of the Internal Revenue Code,[34] which is in stark contrast to the 'stick' method adopted in the Indian context.

Under Section 45Q, large tax credits are available for carbon capture and storage projects, and these are also transferable, enabling the 'developer' to benefit financially, including 'direct pay' options, from the success of the project. However, Section 115BBG is technology agnostic in a penal sense, imposing a tax on the revenue generated by a ₹180 crore CCUS project at the same gross rate as a low-cost administrative system, without considering the huge cost and technological differentials between the two approaches, one of which is a 'deep decarbonization' solution.

VI. Conclusion & Proposals for Reform

For India to make use of the CCTS as a “survival strategy” against the impending EU Carbon Border Adjustment Mechanism (CBAM) and achieve its 2070 Net-Zero goal, the Income Tax Act must be amended to “speak the language of the carbon market.” The “Green” Tax Conflict is more than a legal irritant; it is an economic oddity that is poised to soon bring India’s climate progress to a grinding halt.

Proposals for Reform:

1.      Firstly, the legislature must improve the Statutory Definition provided in the Explanation to Section 115BBG by waiving the restrictive requirement of “UNFCCC validation.” The definition must also be expanded to include the following: “Carbon Credit Certificates (CCCs) issued under the Energy Conservation Act, 2022,”[35] and “Renewable Energy Certificates (RECs) issued under the Electricity Act, 2003.” This is essential to eliminate the existing tax cliff of 30% and reinstate the concessional spirit of 10% that the Finance Act, 2017, had introduced.

2.      Secondly, the legislature must introduce the paradigm of From Gross to Net Taxation by striking down the absolute ban on deductions under Section 115BBG(2) applicable to obligated entities. To eliminate the technology penalty applicable to high levels of decarbonization, the tax system must provide for the deduction of the “Cost of Acquisition” and “Monitoring, Reporting, and Verification (MRV) Expenses” at regular intervals. This will ensure that only the real economic gains, rather than the huge capital expenses incurred for new-age technologies such as Green Hydrogen or CCUS, are taxed, bringing the country in line with the best practices worldwide.

3.      Thirdly, it is suggested that the Central Board of Direct Taxes ("CBDT") should issue a Clarification on "Tax Neutral" Issuance, which should state that there is no taxable "accession to wealth" or income upon receipt of the initial issuance of CCCs by the BEE. By allowing taxation only upon "transfer" or "sale," it is possible for the government to provide market liquidity and thereby prevent cash flow crises for the "obligated entities."

4.     Finally, it is suggested that a GST Council Recommendation is necessary for the classification of CCCs as "securities" under Schedule III of the Central Goods and Services Tax Act, 2017.[36] The classification of CCCs as exempt securities will prevent cascading taxation and thereby provide for the harmonious integration of direct and indirect taxation, which is necessary for the transparent and exchange-based trading system envisioned by the CERC.

To conclude, tax laws must be a “catalyst” that provides the stability and predictability necessary for long-term climate capital.  If the Income Tax Act continues to be a “hurdle,” India’s ambitious transition to a Net-Zero economy will be unnecessarily costly and doctrinally compromised. For India to trade its way to a sustainable future, its tax laws must first learn the grammar of the green economy.

References

[1] Ministry of Power, Government of India, Carbon Credit Trading Scheme 2023, Notification SO 2823(E) (28 June 2023), issued under the Energy Conservation Act 2001.

[2] Income-tax Act 1961, s 115BBG.

[3] Ministry of External Affairs, ‘National Statement by Prime Minister Shri Narendra Modi at COP26 Summit in Glasgow’ (1 November 2021).

[4] Ministry of Environment, Forest and Climate Change, ‘India’s Updated First Nationally Determined Contribution Under Paris Agreement (2021-2030)’ (August 2022).

[5] Energy Conservation Act 2001; Bureau of Energy Efficiency, ‘Perform, Achieve and Trade (PAT) Scheme’ https://beeindia.gov.in/ accessed 31 January 2026.

[6] Energy Conservation (Amendment) Act 2022, s 14(w); Ministry of Power, ‘Carbon Credit Trading Scheme, 2023’ (Notification No SO 2825(E), 28 June 2023).

[7] Finance Act 2017; Income Tax Act 1961, s 115BBG.

[8] UNFCCC, ‘Clean Development Mechanism (CDM)’ https://cdm.unfccc.int/ accessed 31 January 2026.

[9] Ministry of Power, ‘Carbon Credit Trading Scheme, 2023’ (n 10) cl 4

[10] Ministry of Environment, Forest and Climate Change, ‘Greenhouse Gas Emission Intensity Target Rules, 2025’ (Notification No SO [TBD], 2025).

[11] Sahney Steel & Press Works Ltd v Commissioner of Income Tax (1997) 228 ITR 253 (SC).

[12] Commissioner of Income Tax v Ponni Sugars & Chemicals Ltd (2008) 306 ITR 392 (SC).

[13] Ambika Cotton Mills Ltd v DCIT (2013) 27 ITR (Trib) 44 (Chennai).

[14] Commissioner of Income Tax v My Home Power Ltd (2014) 365 ITR 82 (AP).

[15] Commissioner of Income Tax v Maheshwari Devi Jute Mills Ltd (1965) 57 ITR 36 (SC).

[16] Income Tax Act 1961, ss 2(24), 28; My Home Power Ltd v DCIT [2013] 21 ITR (Trib) 165 (Hyd).

[17] Finance Act 2017, s 44.

[18] Income Tax Act 1961, s 115BBG(1).

[19] Income Tax Act 1961, s 115BBG(1).

[20] Income Tax Act 1961, s 115BBG(2)(b).

[21] Income Tax Act 1961, s 115BBG, Explanation.

[22] Energy Conservation (Amendment) Act 2022, s 14(w).

[23] Ministry of Power, ‘Carbon Credit Trading Scheme, 2023’ (n 10) cl 2(f).

[24] ibid cl 6.

[25] Energy Conservation Act 2001, s 26; Ministry of Power (n 10) cl 10.

[26] Ministry of Environment, Forest and Climate Change (n 14).

[27] ibid r 4.

[28] Ministry of Power (n 10) cl 5.

[29] Central Electricity Regulatory Commission, ‘CERC (Terms and Conditions for Carbon Credit Trading) Regulations, 2023’.

[30] Income Tax Act 1961, s 115BBG.

[31] “SCHEDULE III” <https://taxinformation.cbic.gov.in/content/html/tax_repository/gst/acts/2017_CGST_act/active/chapter21/scheduleiii_v1.00.html>

[32] Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (MiFID II) [2014] OJ L173/349.

[33] Income Tax Assessment Act 1997 (Cth) div 420.

[34] Internal Revenue Code, 26 USC s 45Q.

[35] Energy Conservation Act 2001, as amended by the Energy Conservation (Amendment) Act 2022.

[36] Central Goods and Services Tax Act 2017, sch III.