IN Accrit b DITI ninas RI No aDITIep Tax Policies on

Bisnis & Birokrasi, Jurnal Ilmu Administrasi dan OrganisasiInternational Journal of Administrative Science & Organization, September 2011 Volume 18, Number 3

ISSN 0854 - 3844, Accredited by DIKTI Kemendiknas RI No : 64a/DIKTI/Kep/2010

INTRODUCTION

Climate change has become an urgent global issue, a threat to the enviroment with long-term negative effects. Anthropogenic climate change results from human lifestyles, consumptions of objects, and choices that pollute and exploit non-renewable natural sources. Climate change is also harmful to agriculture and fishery, and may even alter the ecosystem (Pandve et al., 2011).

Climate change is caused by changes in climate vari-ables, especially air temperature and rainfall, which occur gradually in a period of 50 to 10 years (intercentenial) (www.climatechange.menlh.go.id). In 1988, the United Nations, through the United Nations Environment Pro-gramme (UNEP) and World Meteorological Organiza-tion (WMO), established the Intergovernmental Panel on Climate Change (IPCC). The panel designed policies in accordance with global issues and literatures on the sci-entific, technical, and socio-economic aspects in climate change. In their fourth report, Climate Change 2007: Syn-thesis Report, IPCC states that during the past 100 years (1906-2005) the temperature of the earth’s surface has risen 0.74°C on average, and land temperature rises more quickly than sea temperature. The global warming rate in the past 50 years is twice the rate in the past 100 years (World Bank, 2010).

Global warming occurs at such a high speed due to the concentration of gasses known as greenhouse gasses or GHGs, whose amount within the earth’s atmosphere con-tinues to increase. Anthropogenic greenhouse gas emis-sion in general is caused by the burning of fossil fuels such as coal, oil, and natural gas, which releases billions of tons of carbon (CO2/Carbon Dioxide) to the atmosphere

every year (DNPI, 2012). Furthermore, non-CO2 green-house gasses such as CH4 (methane), N2O (nitrous oxide), HFCs (hexaflourocarbons), PFCs (perflourocarbons), and SF6 (sodium hexafluoride) are pollutants generated by ob-jects in daily human activities, such as air conditioners and refrigerators, as well as activities such as agriculture, waste disposal, and the use of fertilizer (KLH, 2012).

Greenhouse gasses are, in fact, a natural part of human life. Without the greenhouse effect, the temperature on the earth’s surface would have fallen to 18˚C. The problem is that currently the concentration of greenhouse gasses is increasing and going past the normal rate. Radiation from the sun and the earth’s surface is trapped within greenhouse gasses, thus the radiation, instead of being released into space, returns to the earth’s surface. This leads to rising temperature in the air and on earth, which in turn leads to global warming.

Various scientific discoveries on climate change have proven that global and long-term efforts are crucial in managing climate change. An international endeavor began with the Kyoto Protocol in 1997, which results in a legally binding convention called the United Nations Framework Convention on Climate Change (UNFCCC). It strictly regulates the efforts to reduce greenhouse gas emission in developed countries. Signing the Kyoto Protocol means a country approves of the target to reduce greenhouse gas emission by 5% since 1990 until the 2008-2012 period. Industrial countries reduce greenhouse gas emission through joint implementation, emission trading, and the clean development mechanism (Resanond et al., 2011). The Kyoto Protocol obligates all Annex I countries (those with a long history of emission and that are categorized as developed countries based on their

Tax Policies on Certified Emission Reduction Transactions

TITI M. PUTRANTIDepartment of Administrative Sciences, Faculty of Political and Social Sciences Universitas Indonesia, Indonesia

[email protected]

Abstract. The purpose of Clean Development Mechanism (CDM) is to reduce the emission of greenhouse gas through carbon credit. The mechanism allows projects or business enterprises related to the reduction of carbon emission in developing countries to receive the Certified Emission Reduction (CER). The current research uses the qualitative approach and analyzes policies on Value-Added Taxes (PPN) and the Income Tax (PPh) to determine the ones appropriate for CER transactions in Indonesia. India’s policies of PPN and PPh on CER transactions are used as a benchmark to analyze tax policies on CER transactions in Indonesia. The current research shows that, in regard to PPN-taxable objects, CER is the equivalent of a marketable security or collateral. Article 4 Clause (2) Point d in UU PPN Indonesia states that marketable securities are categorized as non-taxable goods; therefore, in accordance with UU PPN, a CER transaction is exempt from PPN. PPh laws and regulations state that the income from CER sales in Indonesia is subject to the income tax. To support the policy on carbon emission reduction, the government can issue a policy in which PPN is not levied on imported machines or equipments used in technology transfer activities, and thus facilitate the growth of CDM projects.

Keywords: certified emission reduction (CER), clean development mechanism (CDM), income tax, value-ddded taxes


gross national product/GDP) to reduce their greenhouse gas emission by 5.2% on average in 1990. Greenhouse gas emission reduction is not obligatory for non-Annex I countries; however, they must implement a participation mechanism for emission reduction called the common but differentiated responsibility (Hertel, 2011).

The international community’s commitment to manage climate change and the Kyoto Protocol have encouraged many countries to issue relevant policies. Research by Balme (2011) on the Chinese government’s policies in managing climate change reviews the implementation of the policies and assesses China’s capacity in low carbon transition. The problems faced by the People’s Republic of China (PRC) in formulating climate policies include not only general rejection of climate change as a fact, but also a reluctance in introducing new policies and rules, as well as conflict with economic interests. An interesting paradox in this situation is related to the centrality of China’s growth model in global economy; the regulations have a wide implication for China’s domestic economy and may also affect global economy.

According to Kumaresan, et al. (2011), climate change in Southeast Asia affects both national and regional frameworks, which necessitates climate change management. The consequences of climate change may become disastrous for public health and safety, economy, politics, and resources. Therefore it is imperative that Southeast Asia countries take steps on both the national and regional levels to mitigate climate change and develop a comprehensive plan in managing climate change and health risks.

Indonesia, through Law No. 17/2004, becomes the 124th country to participate in the ratification of the Kyoto Protocol. This indicates that Indonesia plays a strong role in the global effort to limit climate changes in the future. Indonesia is committed to provide significant contribution in limiting greenhouse gas emission, and the target is to reduce emission by 26% in 2020 and by 41% in 2050 with international support (Ministry of Finance, 2009). Being a non-Annex I country, Indonesia is not bound to emission reduction’s targets and obligations.

The Indonesian government plans long-term policies and fiscal strategies in a Green Paper titled Economic and Fiscal Policy Strategies for Climate Change Mitigation in Indonesia. The Green Paper describes long-term strategies or policies to mitigate climate change, namely through the reduction of carbon emission which is expected to transform high-emission economic and industrial activities into low-emission activities (Ministry of Finance, 2009).

Figure 1 illustrates the government’s long-term effort in implementing policies that support the reduction of

greenhouse gas emission through carbon pricing. An economic review in Stern Review, “The Economics of Climate Change,” defines three methods of carbon pricing in order to reduce carbon emission: first, by levying carbon tax; second, through a carbon trading mechanism based on a trade to capture and later sell and purchase carbon properly (the cap and trade system); and third, implicit pricing on technology-preventive carbon through special laws, regulations, and standards. These methods are useful in an imperfect market of irreplaceable technology.

In its development, global policies on the reduction of greenhouse gas emission through carbon pricing are divided into two methods: the levying of carbon tax and the cap and trade system (Droege, 2011). The levying of carbon tax is considered significant in minimizing the increase of climate change caused by greenhouse gasses. However, despite advantages in handling negative effects from carbon emission, carbon tax may also cause a dead weight loss in actual calculation (Stern, 2007). Furthermore, there has been no comprehensive government review on the cost and benefit of levying carbon tax in Indonesia. Consequently, the government has not considered levying tax on carbon emission as part of climate change mitigation (www.koran-jakarta.com).

Another method of implementing carbon pricing is the cap and trade system. It is a market-based mechanism established in the Kyoto Protocol that enables developed countries to meet their obligatory target in reducing greenhouse gas emission (Metcalf and Weisbach, 2009). In most greenhouse gas emission trade schemes, one ton of carbon dioxide unit is sold, and non-CO2 gas is converted into an equivalent CO2-unit for trading purposes.

For developing countries like Indonesia, which is not bound to the emission reduction target (a non-Annex I country), the Clean Development Mechanism (CDM) is the sole program to be applied in its effort to

Figure 1. Sequence of the introduction of carbon pricing

Source: Ministry of Finance’s Green Paper, 2009

PUTRANTI, TAX POLICIES ON CERTIFIED EMISSION REDUCTION 200

reduce greenhouse gas emission through carbon credit (Resanond, et al., 2011). Currently CDM is the major offset program in the world to facilitate the interests of businesses or developed industrial countries using carbon trading. The mechanism allows projects or business enterprises related to the reduction of carbon emission in developing countries to obtain the Certified Emission Reduction (CER), where one credit equals one ton of CO2. The CER can then be sold or used by businesses or developed industrial countries to meet their target in carbon emission reduction, which is bound by the Kyoto Protocol.

CER is a unit of greenhouse gas emission reduction equivalent to one ton metric of CO2 (CO2 equivalent) (Labre and Atkinson, 2010). CER is issued in accordance with current international CDM rules and procedures by the CDM executive board. Legally, international CDM rules only define the international procedure for CDM projects. Anything related to CER trade or transaction (carbon trading), especially the levying of tax on CER, is nor further regulated in the rules. Therefore, regulations regarding the levying of tax on CER fall entirely within a country’s national legal domain.

CER transaction in emission trading has great potential in increasing state income. Higher potential income from CER transaction is followed by higher potential tax on CER transaction. The levying of tax in CER transaction within a country’s jurisdiction may vary from one country to another, and the appropriate tax on CER trasanction becomes crucial issue.

The current research analyzes policies on Value-Added Taxes (PPN) and the Income Tax (PPh) to determine the ones appropriate for CER transactions in Indonesia. As a direct tax, the income tax system applies the ability-to-pay principle. The concept for income proposed by Schanz, Haig, and Simon, known as the SHS concept, has greatly influenced tax policies in many countries since it is considered as the fairest and most applicable concept (Mansury, 2003). Essentially, Schanz, Haig, and Simon posit that the accretion theory of income is the only theory that brings about an income concept in which it is possible to apply the ability-to-pay approach (Mansury, 2003).

On the other hand, consumption-based tax can be levied as an indirect tax, which includes sales tax and VAT. The VAT system is nothing new; it is basically a sales tax levied in a different form. The VAT system has quickly emerged on a global scale and become a reliable income system with a distinct implementation. In the current research, tax (PPN and PPh) policies regarding CER transaction in India become the benchmark in analyzing feasible tax policies in Indonesia. Indonesia must also take into consideration the trend in the development of

CER taxation, as Indonesia urgently requires investment and the trend may also help reduce carbon emission.

RESEARCH METHODS

The current research uses the qualitative approach (Marshall and Rossman, 1989; Creswell, 2003; Denzin and Lincoln, 2009) in order to provide an overview of the appropriate tax policy for CER transactions in Indonesia. As an object of research, the appropriate tax policy for CER transactions in Indonesia is a new one. Although several corporations are already involved in CER transaction, Indonesia is yet to implement an appropriate tax policy for CER trade.

Literature study as the initial data collection method also serves as a strong theoretical and conceptual basis for the research. The data gathered in the research constitutes of qualitative data and quantitative data. Interviews and focus group discussions (FGD) complement the data during the research.

A tax structure policy based on the income tax system and consumption tax will encourage the growth of tax potentials. Therefore a review on Value-Added Taxes (PPN) and Income Tax (PPh) policies on CER transactions may assist the growth of tax potentials in Indonesia. The analysis results may serve as an alternative suggestion in regard to feasible taxation policies that are applicable in Indonesia, while taking adjustments of current tax policies into account.

RESULT AND DISCUSSION

To understand the legal nature of CER, first we must be familiar with the nature of CER, including its definition according to Indonesian law. The legal status of CER transactions in Indonesia is not yet defined in many jurisdictions, also in tax laws. Specific regulations for CER transactions in Indonesia do not exist as yet.

CER’s accurate and clear definition and legal nature are important. CER’s characteristics and nature may vary from one country to another and each country is fully authorized to issue regulations for CER. The correct tax treatment for CER transaction very much depends on the country’s law definition of CER’s characteristics and nature; PPN taxation on CER transactions under a national law must begin with those definitions.

CER transactions themselves seldom involve clear definitions on CER’s characteristics and nature, which is a significant disadvantage. To determine whether PPN should be levied on CER transactions, first we must decide whether CER is classified as a taxable good or service.

Essentially CER is a real, measured, and proven


emission reduction, generated by companies that participate in CDM projects in Indonesia. CER is accrued through a series of stages in accordance with the international rules and procedures set by the CDM executive board. The reduction of greenhouse gasses by companies that participate in CDM projects is in line with the companies’ regular business activities, with an added value: the requirement that emission reduction must be included in all activities even when there are no activities pertaining to the CDM project.

As a product, CER from developing countries that are produced by companies participating in CDM projects can be offered to the international carbon market for trade. The transaction is commonly known as carbon trading. Through this transaction, developed countries that are also categorized as Annex I countries can meet their target for CDM emission reduction in accordance with the Kyoto Protocol.

Next, we must analyze whether the product is classified as a taxable good or service. In order for it to be taxed with PPN, a good or service must be treated as part of the supplier’s economic activity, and payment (or something regarded as payment) must be delivered by someone to several other people (Williams, 1996). In practice, the difference between goods and services is defined based on the product’s characteristics and nature. Accordingly, the taxable supply used as the basis for levying the PPN must be clearly defined.

International CDM rules describe CER characteristics as follows: (a) Its status or type of tradable Kyoto Protocol unit, i.e. whether it is a CER, an Emission Reduction Unit (ERU) from a Joint Implementation project, or another unit, for example an Assigned Amount Unit (AAU); (b) The Kyoto Protocol Commitment Period for which the CER was issued (the first period extends from 2008 to 2012, inclusive); (c) The Host Country of the project from which the CER is issued; and (d) The CDM project activity itself (Baker and McKenzie, 2009).

Each CER issued by the CDM executive board is a unique electronic serial number. It can be used to identify the status, unit, and type of the Kyoto Protocol being traded; when the CER is issued; the country that issues it; and information on the CDM project’s activities. From here we can deduce whether CER is a good or service taxable by PPN, as it is part of the CDM project participants’ economic activities. In addition, CER is paid for by CDM project implementers.

Substance-wise, CER is a commodity for open trade, has market value, and is sold in a market with ready buyers (Annex I countries) and sellers (non-Annex I countries). CER is unique in that the product has no physical form, but it has sales value and its own market (carbon market).

Based on these characteristics, CER from the greenhouse gas emission reduction (CDM) can be categorized as goods.

Basically PPN is an objective tax levied on an event, activity, or transaction, taking into consideration the persons or institution involved in the event, activity, or transaction (Lang, et al., 2009). This definition underlines the fact that PPN must be paid for by taxpayers. According to Smith, PPN is levied on a company’s increasing value which is brought about by products resulting from its business activities. Using this definition, we can determine whether the CER from a CDM project is classified as an added value generated by a company. The abovementioned product is defined as a group or anything that can be offered to a market, there to garner attention or be sold, used, or comsumed in order to satisfy the customers’ wants or needs (Kotler, 1996).

Basically taxable supplies refer to a delivery or transaction on which tax is levied (Datt and Keating, 2011). In Indonesia, taxable supplies are known as the supplying of taxable goods (BKP) or taxable services (JKP) that are payable by PPN by taxable entrepreneurs (PKP).

When classifying objects taxable by PPN, we must bear in mind the basic principles of taxable supplies. The goods supplied as taxable goods (BKP) are divided into tangible property, intangible property, movable property, and immovable property (Williams, 1996; Feldman, 2011).

According to Williams (1996), the supply of goods referred to above is the transfer of rights for tangible property, intangible property, movable property, and immovable property. In a CER transaction, host countries of CDM, including Indonesia, can reduce domestic greenhouse gas emission and attract investment through CDM projects that have officially obtained a Letter of Approval (LoA). A LoA is a letter issued by the designed national authority (DNA) in a CDM host country that confirms that the proposed CDM project will help achieve sustainable development in the country. DNA affirms that the country has the right over all emission reduction generated by CDM projects. Thus, the LoA states that project participants are authorized to: (a) become the private owner of rights, title, and interests in the greenhouse gas emission reduction accomplished by CDM projects, and (b) sell the rights, title, and interests.

A transaction where CER is sold and purchased involves a transfer of the private ownership of rights, title, and interests. In an international carbon credit transaction, the transfer of the ownership of objects (taxable goods or intangible taxable goods) refers to the private ownership of rights, title, and interests in regard


to emission reduction, and their transfer from developing countries like Indonesia as sellers to developed countries as buyers.

After a transfer of CER-related rights, Indonesia no longer has authority over any emission reduction generated by CDM projects, or the right to claim CER as part of the emission reduction implemented by Indonesia. This is a transfer of rights, paid with an amount of money by an Annex I country as buyer, which entails the transfer of CER sales-related rights previously owned by companies participating in CDM projects.

Figure 2 shows the CER transaction scheme between non-Annex I country (Indonesia) and Annex I country (France), where the CER ownership of 10 tons of CO2-equivalent is transferred. Following the transfer, Indonesia no longer has the right to claim the emission reduction certified by UNFCCC (with an emission reduction value stated in the CER) as the emission reduction from CDM projects in Indonesia. The purpose is to avoid double accounting on the emission reduction from CDM projects in a country.

Although there is no physical transfer of the CER, the transfer is classified as a supply of goods, since the CER transaction involves a transfer of rights from the seller (the country implementing emission reduction or non-Annex I country) to the buyer who buys the emission reduction certificate (Annex I country) (Maydybura and Andrew, 2011). Therefore, the transfer of CER is a supply of goods and can be categorized as a tax payable by PPN, as the CER ownership rights have been fully transferred from seller to buyer.

Although CER trade and transaction may be categorized

as a supply of goods, we need to further explore CER’s characteristics to determine whether it falls under the (PPN-taxable) tangible goods or intangible goods category. Tangible property refers to goods that can be owned or physically touched, usually objects or products in commercial law. Intangible property refers to goods that cannot be physically touched, such as legal rights. There is also a difference between personal property (tangible assets that can be owned by individuals, such as goods) and real property (which only includes legal ownership rights on land and anything pertaining to or inseparable from the land) (Williams, 1996).

Essentially, the CER issued by the CDM executive board for CDM projects (carried out by private institutions or government organizations, in developing countries that have ratified the Kyoto Protocol) is an object that cannot be physically touched. In substance, CER is no more than a unique electronic serial number. Each CER can be used to identify the status or unit of the Kyoto Protocol being traded; when the CER is issued; the country that issues it; the CDM project’s activities; and the legal rights attached to the CER ownership. Based on these characteristics of CER, we can say that it is categorized as intangible goods.

Another reason that supports the claim that CER can be categorized as intangible goods is that CER does not have a physical form. It cannot be seen, touched, tasted, held, and cannot receive any other physical treatment. Other distinct CER characteristics include having a sales value and its own market (carbon market). However, in reality, the tax regulation to be applied on CER in the international carbon market is ambiguous (Shaw, 2011). The reason is that CER simply refers to an announcement made by the CDM executive board which shows that a company has succeeded in reducing its emission by x tons of CO2 equivalent. The announcement of CER’s amount can be accessed in a transparent and open manner at all times through the CDM executive board’s and UNFCCC’s accounts.

As international CDM rules do not explicitly define CER’s legal status, the tax regulation to be applied on CER in each country is settled according to national law. To date, there are no laws and regulations in Indonesia, especially tax regulations, that define CER’s legal status. Thus this research analyzes CER’s legal status based on CER trade facts or practices that are common among entrepreneurs participating in CDM projects in Indonesia.

The undefined tax treatment for CER transactions in Indonesia, caused by the lack of tax regulations for CER trade, leads to legal uncertainty in CER trade which affects companies that have sold CER. A letter has been submitted in 2009 to the Directorate General of Taxes, requesting a clear and appropriate tax treatment for CER

Figure 2. Transfer of CER ownership rightsSource: Institute for Global Environtmental Strategies

(IGES), reprocessed by researcher


transactions. Thus far no reply has been received.In practice, companies treat CER as a marketable

security based on its definitions. CER is a certificate of acknowledgment issued by the UN that the company to which the certificate belongs has reduced the CO2 emission (greenhouse gas) by the number stated in the certificate (e.g. 4,000 tons of CO2). UN rules that the certificate can only be traded in developed countries - more specifically, in markets for emission reduction (such as the European Climate Exchange or the Chicago Climate Exchange). The certificate is priced according to current market prices. A certificate buyer may trade it once more and use it to fulfill the obligation to reduce emission, as obligated by the relevant government and in accordance with the Kyoto Protocol. Thus, in regard to PPN, CER is the equivalent of a marketable security.

The appropriate tax treatment for CER in Indonesia is fully within the jurisdiction of the government as the maker of public policies. UU PPN does not explicitly state the definition of marketable securities and the types of marketable securities. The definition can refer to the paper’s general nature or the general laws pertaining to it (lex generalis), which are defined in the commercial code law (KUHD). According to KUHD, marketable securities include the following: bills of exchange, charter parties, orders, checks, bills of lading, bonds, and certificates, especially bills of exchange and checks used as payment.

Securities, a common term in the financial world, are the proof that the owner has certain and specific rights due to the ownership. A security is valuable because of its economic value and because it can be traded on a certain level, and the owner receives profit from the trade. The specific rights in security ownership includes the right to a supply of certain goods, company-related rights, or the right to present a bill for an amount of money. Thus, a security has two functions: as an instrument of trade and as evidence of current debts (Simanjuntak, 1997).

If we classify CER as a security, we must confirm that CER fulfills the criteria by referring to definition of a security. A marketable security is a legally acknowledged valuable security or valuable recognition which can be negotiated or sold for future profit and for real assets. Marketable securities include various instruments of temporary investment, such as treasury bills, certificates of deposit, and commercial papers. The instruments are closely tied to cash assets and can be converted into cash assets or liquidated within minutes or hours.

Each instrument is very much eligible for trade and exchange. Stocks, short bonds, certificates of deposit, and commercial papers are all marketable securities because there is a public demand for the instruments and because they are easily convertible into cash.

Securities are usually classified as money market instruments or stock market instruments. Money market instruments have a faster maturity date (one year or less), low default risk, and high values. On the other hand, the market for securities with longer maturity dates (more than one year) such as stocks, bonds, and mortgage bonds, is called a stock market.

The CER issued by the CDM executive board is basi-cally an announcement that the companies participating in the CDM project have reduced their emission by x tons of CO2 equivalent. Consequently, CER is the evidence that the owner of the valuable recognition from the CDM executive board has certain rights which are inherent in the ownership. The owner is entitled to the profit from CER sales, as CER has economic value and can be sold and purchased (as instruments of trade) on a certain level and at certain prices.

A CER transaction in the international carbon market means transferring CER from the seller’s account to the buyer’s account. Thus, a CER transaction is essentially not the physical sale of the CER; rather, it is the sale of the CER content. In the delivery of CER to the rightful buyer, all the content within the CER (x tons of CO2 equivalent) is transferred to the buyer, a developed country.

After the CER content is delivered through the transfer from the seller’s (non-Annex I country) account to the buyer’s (Annex I country) account, the seller is entitled to an amount of money from the buyer. In the meantime, Annex I countries benefit from the CER, which represents certified emission reduction from CDM projects in developing countries, as the reduction contributes to the emission reduction target in Annex I countries. This is the reason CER is called an instrument with economic value, closely tied to cash assets, and can be converted into cash assets or liquidated within minutes or hours.

CER trade occurs following requests from Annex I countries to help meet their domestic emission reduction targets. Public demand for CER as tradeable instruments results in the international carbon market. There are at least three important carbon markets: (a) The European market based on the emission trading scheme or EU ETS (European Union Emissions Trading Scheme) (b) Mar-kets based on projects to achieve the Kyoto Protocol tar-gets; the biggest targets are traded through CER, and (c) Voluntary markets to reduce emissions or VER (Volun-tary Emission Reductions) (Maguire, 2011; Maydybura and Andrew, 2011). From these descriptions, we can de-duce that CER as instruments of trade have constantly available markets that fulfill the criteria for markets, as sellers and buyers are also always available.

Based on the above analysis, CER in the international carbon trade can be called the equivalent of marketable


securities for three reasons. First, CER is a valuable recognition issued by the CDM Executive Board, stating that companies participating in CDM projects have reduced emission by x tons of CO2 equivalent or the number stated in the CER (e.g. 1,000 tons of CO2). CER is the evidence that the owner of the valuable recognition issued by the CDM Executive Board has certain rights inherent in the ownership. Second, CER are instruments with economic value as they are closely tied to cash assets and can be converted into cash assets or liquidated within minutes or hours. CER owners benefit from CER sales by receiving all the content stated in the CER, namely x tons of CO2 equivalent, and the price per x ton of CO2

equivalent is determined by current market prices. Third, CER is an instrument that can be sold and purchased (as instruments of trade) on a certain level and at certain prices; CER can only be traded in a carbon market, where buyers and sellers are always available as in money markets or stock markets.

In short, CER is an emission reduction unit generated by a CDM project, has economic value, and is widely traded in carbon markets. In regard to PPN in Indonesia, this definition implies that CER is the equivalent of a marketable security.

As an object taxable by PPN (taxable supply), CER as a marketable security is then categorized as non-taxable goods. UU PPN, Article 4A Clause (2) Point d, rules that marketable securities are exempt from PPN (non-taxable goods). Taxable supply in the case of a CER transaction (sold by seller, Indonesia, to buyer, a developed country) does not count as a supply of goods according to UU PPN. Thus, a CER transaction as a transaction is not subject to PPN (non-taxable supply).

The payment received from a CER transaction is considered as revenue for the companies participating in CDM projects. The revenue is regarded as economic benefits in the acquirement of goods and services in order to fulfill company needs. PPh regulations in Indonesia stipulate that the revenue from CER transactions is subject to income tax; CER sales are considered revenue for taxpayers because the sales meet the five main criteria for income as stated in Article 4 Clause 1, the legal basis for the levying of income tax in Indonesia. Revenue from CER is not included in the negative list in the current UU PPh in Indonesia, UU PPh No. 36/2008, Article 4 Clause 3.

The economic benefits obtained by taxpayers can be grouped into four categories: (a) employment income or income from work in a work relationship and freelance jobs (b) capital income or income from the sales of capital (c) business income or income received from business activities, and (d) other income, or income from sources

other than the above (Nightingale, 2002). According to these categories, income from CER sales transaction is included in other income.

CER income as other income is the concept adopted and implemented in their accounting by companies in Indonesia that are involved in CER sales transaction. Conceptually, the reason an income is categorized as other income is that the criteria for the income do not match the criteria for the other three types of income: income from jobs, income from capital, and income from business.

The income received from CER transactions cannot be categorized as income from jobs or employment income. According to the current concept, employment income consists of two types of income, labour income and professional income (Nightingale, 2002). Labour income is the income received by employees or labors, such as wages or salary. Professional income is the income received by professionals such as doctors, consultants, and legal experts, such as honoraria and fees. These definitions show that the categorization is individual-based, instead of institution- or company-based. Thus the income from CER sales transaction is not employment income, as it is received by a company, therefore an institution, participating in CDM projects in Indonesia.

Neither can the income from CER transaction be categorized as capital income. The reason is that capital refers to the fixed or current property owned by an individual or institution and not for sale, in the form of movable or immovable property such as interest, dividends, royalty, rent, profit from the sales of property, or rights not used in business. These characteristics do not match those of CER, as one of the objectives of CDM projects, other than participation in climate change management, is to generate CER for trading purposes and help CDM achieve sustainable development.

As with the previous category, income from CER sales transaction cannot be categorized as business income, which is defined as income from business activities. If the perspective taken is that of the treatment commonly applied on transaction, the income can be categorized as business income and can be said to be received through individual or institutional effort. However, the activities to generate CER are not the main activities of or enterprise from the companies participating in CDM projects.

A simple illustration: one of the companies involved in CER trade in Indonesia also owns an enterprise for generating electricity, which uses alternative fuels such as natural gas, biodiesel, and others, with no fossil fuel used. The company’s main activity or enterprise is to supply green energy electricity to buyers. However, not using fossil fuel as a component in generating electricity does not mean the generation is emission-free, as the burning


of natural gas generates greenhouse gas. On the other hand, sites that generate electricity within the company’s operational area also utilize exhausted gas and do not release it into the atmosphere. The gas is reprocessed in a project to be later used by the electricity buyers; it replaces the freon used in air conditioners as freon is not enviromentally friendly. The utilization of the exhausted gas is included in CDM projects, to serve as proof for emission reduction activities which will be certified by the UNFCCC executive board. Next, the company offers the reduction for trade to Annex I countries.

The above illustration shows that the income from CER received by the company is not its main income, as the company’s main business is generating electricity using alternative fuel, and the income is recorded as business income. The income received from CER transactions is irregular in nature. There are two methods to determine whether an income is a business income or other income (Mansury, 1992). One method uses the number of transaction test: an income is considered income from an enterprise or business when it is generated from transactions during a certain time period with a certain frequency, for instance, transactions with a high frequency within one year.

In practice, the PPh levied on the income from CER transactions is categorized as PPh for other income. The amount of PPh is compliant with UU PPN No. 36/2008, Article 17. The implication here is that the costs paid for by the company reduce the income.

In regard to tax, a number of countries such as Hong Kong view the carbon credit from CER as a service (Zhao, 2011). Tax treatment for CER transactions is entirely determined by a country’s domestic law, including in India. From a physical perspective, CER in India may fall within the intangible asset category. In Section 26 in Accounting Standards in India, intangible asset is defined as “an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes” (Accounting Standards Board, the Institute of Chartered Accountants of India, 2009).

When we refer to the above section, one CER criterion matches one general criterion for intangible asset, namely non-monetary assets without physical substance. Nevertheless, CER is not entirely and indisputably categorized as an intangible asset, as it is not supplied to be used in the production of goods of services, for rental to others, or for administrative purposes, as defined in Section 26.

Although the section states that intangible assets in general are not for sale, another definition in the same section also states that an asset can be called an intangible

asset even when it is for sale. Intangible assets that are supplied for sale in a regular business enterprise must be recorded according to accounting standards in Section 2 and categorized as inventories. The definitions for inventories are as follows: (a) Held for sale in the ordinary course of business; (b) In the process of production for such sale; (c) In the form of materials or supplies to be consumed in the production process or in the rendering of services (Accounting Standards Boards, the Institute of Chartered Accountants of India, 2009).

In India, inventories are defined as assets that are owned and will be sold in a regular business enterprise, in the production process for the sale, or as consumed material or equipment in a production process or service provision. These descriptions show that CER is an intangible asset and must be recorded under inventories, as required in Section 2. This is in accordance with CER’s general nature as an intangible asset which is supplied for sale in a regular business enterprise. From this analysis we can see that, in a CER transaction in India, the sales transaction is considered as the sale of the supply of the goods for sale in a regular business enterprise. In reference to the five classifications for taxable income, the income from CER sales in India is an income from business or an enterprise.

In addition, the Direct Tax Code 2010 also classifies the income from CER transactions as income from business or an enterprise. It is explained in the code that the incomes categorized under Income from Business are profits from a business, where the amount of business expenditure is deducted from gross earnings from the business. This is in accordance with Section 32, Sub-Section 3: “The profits from any business not referred to in sub-section (2) shall be the gross earnings from the business as reduced by the amount of business expenditure incurred by the assessee” (www.incometaxindia.gov.in).

The gross earnings come from an aggregate of four sources, described in Section 33, Sub-Section 1: “The gross earnings referred to in sub-section (3) of section 32 shall be the aggregate of the following, namely: (i) the amount of any accrual or receipt from, or in connection with, the business; (ii) the value of any benefit or perquisite, whether convertible into money or not, accrued or received from, or in connection with, the business; (iii) the value of the inventory of the business, as on the close of the financial year; and (iv) any amount received from a business after its discontinuance.”

According to the above sub-section, the gross earnings refer to the definition in Section 32 Sub-Section 3. The business profit not specified in Section 32 Sub-Section 2 is the gross earnings from the business as reduced by the amount of business expenditure incurred by the assesee. Section 32 Sub-Section 2 regulates the levying of the final


income tax in India, where the tax calculation does not take expenditure into account. In Section 33 Sub-Section 1, the gross earnings refer to the amount of any accrual or receipt from, or in connection with, the business, the value of any benefit or perquisite, whether convertible into money or not, accrued or received from, or in connection with, the business, the value of the inventory of the business, as on the close of the financial year, and any amount received from a business after its discontinuance.

Furthermore, DTC 2010 stipulates that the income accrued from the sales of carbon credit or CER is included in the gross earnings categorized as increasing or accrued business income from a business enterprise. Section 33 Sub-Section 2 (xi) states that: “The accruals or receipts referred to in sub-section (1) shall, without prejudice to the generality of the provisions of that sub-section, include the following, namely:— (xi) any consideration accrued or received on transfer of carbon credits.” From this classification for the income from the sales of carbon credit or CER, we can see a more definite tax treatment for the income accrued from the sales of carbon credit or CER: it falls within the category of business income. The profit, which is taxable, is obtained after the expenditure required is deducted from it. Next, the income tax is levied on the gross earnings, in accordance with the income tax regulation for institutions in India.

The income tax for institutions is regulated in DTC 2010, in First Schedule, Paragraph E. According to the section, the company profit generated by CER income is combined with income from other businesses operated by the CDM project developer and reduced by predetermined expenditure. A basic 30% income tax for institutions, plus extra fees (10% of the income) charged at institutional taxpayers with a taxable income of more than one million rupees, is then levied on the income.

In addition, the Regional Government for National Capital in Delhi has issued a rule on the law for CER’s taxability, as CER is, in substance, a trade commodity. CER has market value and a ready market with available buyers and sellers, and is freely transferred as a trade commodity. Therefore carbon credit in India is considered as goods in accordance with rules on sales tax or VAT/PPN.

The definition for goods is further elaborated on in Section 2 Sub-Section 1 Point jk in the DVAT Law (Delhi VAT Act, 2004): “‘Goods’ means every kind of movable property (other than newspaper actionable claims, stocks, shares and marketable securities and includes (i) Livestock, all material, commodities, grass or things attached to or forming part of the earth which are agreed to be served before sale or under a contract of sale; and (ii) Property in goods (whether as goods or in some other

form) involved in the execution of a works contract, lease or hire purchase or those to be used in the fitting out, improvement or repair of movable property” (www.delhi.gov.in).

The section specifies goods as all movable property including securities, stocks, and other objects listed in the section. CER is a certificate for emission reduction that can be sold and purchased; therefore, in accordance with the section, CER in a CER transaction can be classified as goods for income tax purposes. A CER transaction or transfer can be considered a supply of goods and is taxable.

The Delhi VAT Act 2004 further regulates that CER is categorized as intangible goods, in Entry No. 3, the Third Schedule (BMR Advisors, 2010): “All intangible goods like copyright, patent, rep license, goodwill etc.” From this definition, we can conclude that CER have similar characteristics with the intangible goods listed above; thus, a transfer of CER is a transfer of ownership, from India to a developed country as buyer. After the ownership transfer, India no longer has any claim on the emission reduction certified by UNFCCC or CER as part of the country’s successful emission reduction. For tax purposes, CER is classified as intangible goods, as it has similar characteristics with a copyright or patent.

A jurisprudence from the Supreme Court supports the above regulation. In the case of the Tata Consultancy Service vs the state of Andhra Pradesh (regarding the sales tax on computer software), the Supreme Court decides: “A ‘goods’ may be a tangible property or an intangible one. It would become goods provided it has the attributes thereof having regard to (a) its utility; (b) its capability of being bought and sold and (c) its capability of being transmitted, transferred, delivered, stored and possessed. If a software whether customized or non-customized satisfies these attributes, the same would be goods” (BMR Advisors, 2010). CER conforms to these definitions and fulfills the criteria for goods.

Therefore, in a CER transaction in India, CER is treated as a commodity of goods being sold and purchased. The buyer, a developed country, will receive CER at the end of the verification, certification, and delivery processes. The CER ownership rights are then fully transferred from seller to buyer. Once again, a CER transaction is a VAT-taxable supply of intangible goods that complies with the Delhi VAT Act.

If CER receives the same treatment as electricity under the Delhi VAT Act, it is legally defined as goods that are exempt from VAT. As CER is categorized under goods on which VAT is not levied, it is also exempt from the 4% tax. The purpose of the regulation is to encourage the growth of CDM projects and CER trade in India.


Taking the regulations on CER issued by the Indian government as an example, we suggest that the growth of CDM projects and CER in Indonesia may be facilitated through tax policies, especially through PPN. Article 16B in UU PPN may act as an incentive for companies participating in the development of CDM projects, in response to incentives related to climate change initiatives. In addition, appropriate income tax-related policies are required for encouraging the growth of CDM projects in Indonesia. The non-final income tax, implemented in accordance with the PPh regulation for institutions, Article 17, is already considered appropriate for Indonesia, as taxpayers are treated in a fair manner. Conceptually, equity is one of the principles to be considered in a policy option in order to build a taxation system (Ceriani, at al., 2011) that is fair for all.

Mansury (2003) emphasizes that the income tax needs to conform to the equity principle and adhere to the two above definitions of justice. The requirement for horizontal justice is equal treatment for the equals: taxpayers with equal economic benefits must pay the same amount of taxes, regardless of the type, form, name, and source of income. The basis for the tax levied is the net income, or the gross income after it is reduced by the costs for obtaining, charging, and maintaining the income. The requirement for vertical justice is unequal treatment for the unequals: the difference in the amount of tax is determined by the difference in the amount of the gross economic benefits. Taxpayers with a higher amount of gross economic benefits pay higher taxes in comparison to taxpayers with a lower amount of the gross economic benefits.

Therefore, the most appropriate income tax to be levied on the income from a CER transaction is the non-final income tax based on the progressive tariff in Article 17. Another reason for adhering to Article 17 is that currently the government provides no actual contribution, in the form of facilities or financing, to the development of CDM projects. At the moment, financing is the issue with the largest influence on the growth of CDM projects in Indonesia. A great number of companies have attempted to participate in CDM projects, but the government does not provide actual support for them, and there are only a few private financing institutions available.

Government intervention in and support for the growth of CDM projects through financing from a financing institution do not exist in Indonesia as yet. Meanwhile, the companies working to develop CDM projects urgently need this type of contribution. It is difficult for companies to start CDM projects when they have to finance the projects themselves. In many other countries, the governments issue orders to private financing institutions

to finance a budding CDM project.In Indonesia, there is no government regulation that

states that a CDM project deserves a loan. Moreover, almost all private financing institutions have unfavorable preconceived notions of CDM projects: the projects are complicated and the risk of failure is high. Although the CER from CDM projects benefit the project developers and the environment, these risks and obstacles hinder private financing institutions from participating in CDM projects.

A CDM project, besides reducing the carbon emission in developing countries, also contributes to economic improvement and sustainable development in Indonesia. A CDM project benefits a developing country through its CER contribution to project investments; it is estimated that CER contribution ranges from 7% to 40%, depending on the type of project and the sector (Institute of Global Environmental Strategies, 2005). It is therefore clear that CDM-related projects merit government support in the form of incentives or facilities, in order to encourage the growth of CDM projects and the amount of CER acquired in Indonesia. If feasible, PPN should be exempt for company activities related to CDM projects, such as when companies import machines or equipments for technology transfer purposes, to reduce greenhouse gas emission, and for environmentally friendly purposes. The exemption from PPN should apply to activities from companies that develop CDM projects, rather than to the sales of CER by companies.

CONCLUSION

Certified Emission Reduction (CER) is a unit of emission reduction generated by CDM projects. CER, which is widely traded in international carbon markets, is categorized as goods acording to PPN regulations in Indonesia. In determining PPN-taxable objects (taxable supply), CER may be equated with a marketable security or collateral. According to UU PPN Article 4 Clause (2) Point d, a marketable security is categorized as non-taxable goods, and a CER transaction is exempt from PPN (non-taxable supply).

The income from CER sales transaction conforms to definition of income in the SHS concept. In the current research, the income received by taxpayers engaged in CER transactions in Indonesia is not a company’s main income; it is not business income from the company’s daily activities. Therefore, in the company’s account books, the income is recorded under other income. In accordance with PPh laws and regulations, the income from CER sales in Indonesia is subject to the income tax, and the taxpayer is the company that receives the


income from the transaction of the CER generated by the company’s CDM project.

This is also the case in India, where CER is categorized as goods. In determining VAT-taxable objects (taxable supply), CER is categorized as intangible goods and subject to a VAT of 4%. The Delhi VAT Act also provides CER transactions with facilities in the form of VAT exemption. The income from CER sales transactions in India is categorized as business income, as legally defined in the Direct Tax Code 2010, Section 33 Sub-Section 2 (xi). In the income tax calculation, CER is grouped with other business income and subject to the 30% tariff for institutional income tax or corporate tax rate. Institutional taxpayers in India must also pay an extra fee of 10% when their taxable income exceeds one million rupees.

Exemption from PPN may encourage the growth of CDM projects and the increase of CER income in Indonesia. The exemption may apply to company activities related to CDM projects, such as when companies import machines or equipments for technology transfer purposes, to reduce greenhouse gas emission, and for environmentally friendly purposes. When the import of taxable goods, namely in a technology transfer for reducing greenhouse gas emission, is exempt from PPN, CDM activities in Indonesia are expected to obtain a higher rate of success. The most appropriate income tax to be levied on the income from a CER transaction in Indonesia is the income tax based on the tariff defined in Article 17. The reason is that the income tax based on Article 17 is considered to be fairest and in accordance with the ability-to-pay concept or the taxpayer’s ability to pay. The taxable income is calculated based on the gross amount of economic benefits, while taking into account the costs related to CER sales.

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