Buy, Sell, Confuse: The Carbon Credit Game Show across borders

In the fight against climate change, carbon credits have emerged as a vital market-based tool to control greenhouse gas (GHG) emissions. A carbon credit represents the right to emit one metric ton of carbon dioxide (or its equivalent in other GHGs). The principle is simple: entities that reduce their emissions below assigned limits can sell their unused credits to entities that exceed their caps, thereby creating a financial incentive to reduce worldwide emissions. The carbon credit market in India has gained significant momentum with the introduction of voluntary trading mechanisms and upcoming compliance frameworks, positioning the country as a key player in the global carbon trading ecosystem.

The provisions relating to issuance of carbon credits emanate from the Energy Conservation (Amendment) Act, 2022 and the Carbon Credit Trading Scheme, 2023. The Central Government is authorised to issue or allow other agencies to issue Carbon Credit Certificates (CCCs) to eligible projects. The Bureau of Energy Efficiency (BEE), under the Ministry of Power, manages the carbon market.

With the government’s approval, BEE sets emission reduction targets for various sectors, approves agencies to verify carbon savings and awards certificates to organisations that meet or exceed their savings targets. For example, a cement factory that upgrades its machines to reduce emissions far below its industry’s limit set for its industry can have its results verified by an approved inspection agency. The BEE then rewards the factory with carbon credit certificates for the extra emissions it avoided. The factory can then sell these credits to a steel plant that could not meet its own target, allowing the steel plant to stay compliant, the cement factory to earn extra revenue, and both to contribute to reducing the country’s overall emissions.

Carbon credit trading transforms environmental responsibility into a quantifiable and tradable economic unit. By enabling credits to be traded, the market creates a financial incentive for companies to adopt low emission practices and gives them flexibility in meeting their environmental goals. Projects in that verifiably reduce emissions can earn ‘Certified Emission Reductions’, which may then be purchased by other entities to fulfil legal obligations.

The carbon credit trading programs have spurred major investments in solar farms and windmills, and projects that help industries cut electricity use. Factories have also upgraded their machines to use less electricity, lowering costs and curbing pollution. By doing this, India has earned millions of tradable carbon credits for sale in global markets and is now setting up its own homegrown carbon trading market so these benefits can accrue even faster.

The classification, nature of supply and rate of Goods and Services Tax (GST) applicable on certain certificates such as CCCs have long been a subject matter of debate. Following the GST Council’s deliberations on 9th, 10th and 13th January, 2018, Circular No. 34/8/2018-GST, dated March 1, 2018 was issued to clarify that Priority Sector Lending Certificates (PSLCs) are taxable as goods at the rate of 18% under the residuary entry (S. No. 453 of Schedule III) of Notification No. 1/2017-Central Tax (Rate) dated 28 June 2017, as amended (Rate Notification).

Subsequently, vide Circular No. 46/20/2018-GST, dated June 6, 2018, it was clarified that Renewable Energy Certificates, PSLCs and other similar documents are classifiable under Chapter Heading 4907 of the Customs Tariff Act, 1975 and attract 12% GST. Later, Notification No. 8/2021-Central Tax (Rate) dated September 30, 2021 was issued to increase GST rate on CCCs to 18% with effect from October 1, 2021.

Notably, the Customs Authority for Advance Rulings, Mumbai in Re: United Breweries Ltd. [2024 (390) E.L.T. 475 (A.A.R. - Cus. - Mum.)], inter alia, ruled that International Renewable Energy Certificates downloaded in the electronic form will qualify as ‘intangible goods’. However, in the absence of specific machinery provisions, such electronic instruments cannot be classifiable as goods under the Customs Tariff Act, 1975 and consequently cannot be subjected to levy of duties of customs duty. As a corollary, purchase of CCCs in electronic form from overseas suppliers would neither attract customs duty nor GST under reverse charge on account of import of services.

The export of CCCs qualifies as zero-rated, provided the exporter files a shipping bill. Under Rule 96 of the Central Goods and Services Tax Rules, 2017, refund of integrated tax paid on exported goods is processed by the Customs ICEGATE system, based on the details in the shipping bill (treated as the refund application) and the export general manifest. Even when the exports are made under LUT/Bond (without payment of integrated tax), the shipping bill data is essential as it links export invoices reported in Form GSTR-1 with the refund application filed in Form GST RFD-01. Accordingly, if no shipping bill is filed—such as in the case of electronic transfers of CCCs—the exporter risks losing the zero-rated benefit.

Carbon credits are classified as ‘goods’ under GST law, and taxed at 18% in India, while their export is treated as zero-rated, subject to specified conditions.

Interestingly, Singapore has adopted a hybrid approach. Since November 23, 2022, most transactions involving the issuance, transfer or sale of CCCs are neither treated as a supply of goods nor as a supply of services and are hence excluded from levy of GST. Prior to that date, such transactions attracted GST as supply of services.

Australia follows a more favourable route by zero-rating carbon credits for GST purposes. Canada employs a self-assessment model, requiring buyers to account for GST / harmonised sales tax (HST) themselves. China, meanwhile, treats CCCs as intangible assets, subject to a 6% value added tax (VAT).

The United Kingdom (UK) has recently revised its tax position by bringing voluntary carbon credits into the VAT net. While previously falling outside the scope of VAT, CCCs are now classified as taxable supplies of services, thereby aligning its treatment in their tax regime.

At the European Union level, there have been no significant regulatory changes beyond member-state adjustments. However, Brazil has exempted carbon credit sales from both state and federal consumption taxes post tax reform. Germany implemented stricter measures to address VAT fraud by extending the domestic reverse charge mechanism on carbon credit transactions until 2026, shifting VAT liability from seller to buyer.

The global carbon credit landscape is riddled with inconsistencies in both regulatory structure and taxation treatment. Divergent practices in classifying the CCCs add another layer of complexity. India treats CCCs as goods, China as intangible assets, the UK as tradable instruments, Canada as intangible goods and Singapore as neither goods nor services. Taxation practices vary as well. China and the UK impose VAT / GST, Singapore does not tax, Australia zero-rates and in India, the legal position on taxability of carbon credits remains partially unsettled, creating uncertainty in cross-border transactions.

Cross-border transactions involving carbon credit sales are subject to significant legal and indirect tax challenges arising from divergent classification and taxation treatment across jurisdictions. While one jurisdiction treats CCCs as a tangible commodity, the other categorises them as intangible rights. Inconsistencies in VAT / GST regime can frequently emerge. Such mismatches may lead to instances of double taxation, where both jurisdictions seek to levy tax or non-taxation where neither asserts taxing rights. For instance, where an Indian project developer sells CCCs in electronic form to a UK buyer without filing the requisite shipping bills, the transaction may attract GST in India and VAT in the UK, resulting in taxation in both jurisdictions. Conversely, a Singapore-based broker procuring CCCs from a Canadian supplier and reselling them to a purchaser in India may not incur tax liability in any of the jurisdictions involved.

This lack of harmonisation creates uncertainty, necessitating enhanced due diligence and jurisdiction specific tax structuring. This increases compliance and administrative costs and discourages broader market participation, particularly from smaller players.

In light of the dynamic and evolving regulatory landscape—including for example the UK’s recent VAT reform or Brazil’s tax exemption—market participants face significant regulatory and fiscal risk. While the tax authorities across the jurisdictions are making concerted efforts to standardise or clarify tax treatment of carbon credits, varying economic priorities and legal frameworks make global harmonisation unlikely in the near term. Any material change in classification or applicable tax rate in an emerging market like India can significantly alter credit prices, investment patterns and the viability of certain emissions reduction projects that rely on predictable revenue streams from the sale of CCCs.

While carbon credits constitute a critical instrument in advancing global decarbonisation objectives, their regulatory and taxation frameworks are highly fragmented across jurisdictions. Variations in legal classification—whether as goods, intangible assets, tradable rights, or services—when coupled with divergent VAT / GST treatments, have resulted in a lack of harmonisation. For companies, particularly those engaged in cross-border trade, this lack of uniformity necessitates careful due diligence, a robust compliance framework and strategic tax planning. With global climate goals gaining urgency, the call for unified regulations is bound to strengthen—but for now, successfully navigating this intricate and fragmented landscape remains an essential skill for companies.

About the authors: Brijesh Kothary is a Partner and Saundarya Sinha is an Associate at Khaitan & Co.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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