India’s market mechanisms for raising climate finance

By Gautam Chabra and Meyyappan Nagappan, Trilegal
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The 2015 Paris Agreement represents the strongest global intentions yet for industrial, economic and social transformation to combat climate change. India, as part of its nationally determined contribution (NDC) under the agreement, has pledged to reduce the carbon intensity of its GDP to 45% below 2005 levels by 2030 and achieve net zero by 2070.

It is estimated that India needs up to USD10 trillion to achieve its net-zero ambitions. To further its decarbonisation efforts, the government has, for now, chosen to establish market mechanisms rather than impose carbon taxes. It hopes to attract sufficient climate finance to help bring down the cost of adopting decarbonisation technologies.

Gautam Chabra
Gautam Chabra
Partner
Trilegal

India already has in place a number of carbon initiatives. The renewable energy certificate (REC) mechanism deals with trading environmental attributes from the generation of electricity from renewable energy projects. The perform, achieve and trade scheme for the trading of energy-saving certificates (ESCerts) incentivises entities that beat their mandatory energy efficiency targets. Recently, the government has introduced the carbon credits trading scheme (CCTS) to develop an Indian carbon market (ICM) on a cap-and-trade basis. Obligated entities that achieve their mandatory emissions reduction targets will earn credits to trade on the ICM with obligated and voluntary buyers. The voluntary green credits programme (GCP) and the framework for a voluntary carbon market in agriculture are being set up to encourage environmentally positive activities such as afforestation, waste management and sustainable agriculture.

India also has dealings with voluntary carbon markets, with projects in various sectors registered with the likes of Verra and Gold Standard.

While interest around emissions trading is encouraging, some areas should be clarified. Inconsistent court rulings have been made on whether income from the transfer of RECs, ESCerts and emissions reduction certificates (ERC) is capital or revenue. Under the Income Tax Act, 1961, capital is not subject to tax unless specifically made so, whereas all revenue is taxable. While the government has confirmed the taxability of ERCs under the Clean Development Mechanism by imposing tax at the rate of 10% on income from their transfer, the taxability of RECs, ESCerts, and other ERCs including under CCTS, GCP and other voluntary mechanisms is uncertain. Clarity is also needed on the goods and services tax treatment of ERCs.

Meyyappan Nagappan
Meyyappan Nagappan
Partner
Trilegal

Where ERCs are generated through underlying activities in one country, such as afforestation in India, but owned by residents of another, there may be doubt regarding which country has jurisdiction over them. This will affect their taxability.

Companies using funds to meet their expenditure requirement for corporate social responsibility (CSR) provisions under the Companies Act, 2013, such as for afforestation, may also become eligible to receive ERCs under the GCP or other voluntary mechanisms. There may be a good case to be made that as long as revenue received from the sale of ERCs is reused to fund further CSR activities, such overlap may be allowed. However, clarification would be helpful.

While India may prioritise ensuring that market mechanisms are meeting its NDCs by not exporting ERCs, a mechanism for the participation of foreign buyers may be attractive because it attracts international climate finance. Entities in developed countries that are heavily invested in hard-to-abate sectors such as petrochemicals, iron and steel, shipping and aviation or are under stakeholder pressure from climate-sensitive investors, especially sovereign wealth funds, pension funds and financial institutions, are likely to seek developing markets such as India for opportunities to offset their carbon emissions.

Rules for the fungibility of various types of ERCs, where each certificate may represent different units, and a common ICM may give impetus to the carbon market. The government may consider framing rules for intermediary traders to participate in these markets.

While the government still needs to establish these carbon markets and design them so that the carbon price discovered through them is sufficient to strongly incentivise decarbonisation, resolving grey areas may result in a faster adoption of the market mechanism by stakeholders.

Gautam Chabra and Meyyappan Nagappan are partners at Trilegal

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