Can tax deductions enable sustainable citizen-driven green finance?

India is the world’s third largest emitter of greenhouses gas, at 3.9 billion tonnes of carbon dioxide-equivalent (CO₂ eq) per year. However, the nation’s emissions per capita is only 2.8 CO₂ eq, 2.5 times less than the global average and about one-sixth of that of the US.¹

India’s strategy for climate resilience, created under the Paris Agreement, is intended to manage and mitigate carbon emissions as India pursues an ambitious growth plan. This includes reducing emissions intensity by 45% compared to 2005 and increasing the 50% cumulative electric power installed capacity from non-fossil fuel based energy resources by 2030. However, the funding required for these changes is falling short owing to the lack of access to a sustainable finance flow.²

India needs a reliable, established route to increasing green finance

At the beginning of 2023, India introduced its first sovereign green bond, a debit security issued by a government to raise funds for projects that have positive environmental impact,³ to overcome this shortage. This initiative has the potential to evolve into a successful model, but its immediate benefit is limited for several reasons: the lack of a comprehensive regulatory framework and guidelines for its operation, or clear definitions of what qualifies as a ‘green’ project means investors remain hesitant; investors also have limited knowledge and awareness of green bonds, and the market is in its infancy so has low liquidity; and uncertainty around the political and economic conditions are also lowering investor confidence.

Therefore, in the short-to-medium term, India needs a reliable, established route to increasing green finance. Reforms to India’s well-established Income Tax Act, 1961, could be a novel instrument of citizen-driven green finance in India.

Taxation toolkit

India already has some existing tax incentives that support net zero goals. For example, research institutions are granted tax exemption on parts of their income subject to certain conditions. This is intended to foster and enable scientific research, but it is for ‘scientific research and development’ in general and thus does not necessarily contribute directly to net zero initiatives, and it only benefits established research associations and not associations of all scales.

Funds can be transferred from citizens directly to the green initiatives they wish to support

A specific net zero incentive was introduced in the Finance Act, 2017, which gives a tax relief on any income from the transfer of carbon credit. This section has resulted in some controversy as to whether the amount received on transfer of carbon credits is ‘income’ as understood under the provisions of the Indian income tax law and hence is liable to tax. This lack of clarity has not helped the incentive advance the object of promoting carbon credits substantially.

A more direct contribution on increasing green finance is a deduction in respect of purchase of electric vehicles. However, the high price of electric vehicles, the intermittent availability of electricity in rural areas and the deduction available for investment and maintenance costs  of the vehicle, has meant this is not as impactful as it could be.

These positive movements in the direction of reducing carbon emissions are not providing enough impact. The challenge that India faces is how to encourage and foster an environment where multiple green initiatives are identified, nourished and propagated across the country.

Deductible donations

One commonly used income tax deduction is the exemption for donations to charities. If a similar mechanism was devised for green initiatives that advanced R&D and execution to reduce emissions – such as in renewable energy, carbon capture, afforestation, and green mobility – it would give the entities undertaking these initiatives the opportunity to receive funding directly from tax payers.

There are already several GOs and NGOs that advance environmental issues. However, the addition of a deduction specifically aimed at advancing Net Zero initiatives would have several benefits. It offers tax payers the benefit of an additional deduction, and it ensures that funds are directed specifically at advancing green initiatives, incentivising contributions to such entities. This would mean that instead of green finance trickling down from the top, funds can directly be transferred from citizens and other tax payers to the green initiatives they wish to support.

This approach will enable entities of all scales to receive funding from any tax payer

The Income Tax Act’s existing mechanism for the eligibility, application, operation, and cancellation of an establishment as a charitable institution could be expanded or given the additional charge of handling these aspects of a ‘green initiative’ certification. The same Income Tax exemptions wing has powers of cancellation, penalties and prosecutions to deal with misuses.

The amount donated can be monitored, it is decentralised and will save the time and effort of the government in identifying green initiatives to contribute to in a roundabout manner.

As an example, imagine a group of individuals in a community organising themselves to plant trees as part of a small-scale reafforestation programme. If they are granted a certificate as a green initiative, they could crowd-fund from the communities where those trees are being planted so that those benefiting from the work can donate to it and receive a tax deduction on their contribution as a further incentive. This has the potential to help students, small companies or even hobbyists develop ideas for sustainable fuels, carbon capture or green transport to and to receive the funding they require from their community.

This approach will enable entities of all scales to receive funding from any tax payer opening an entirely new stream of funds, aside from grants, loans and private investment. with charitable institutions to implement the same for entities undertaking green initiatives, the amount of money that these entities will have direct access to will be considerable and convenient. As a comparison, the revenue impact of deductions for charitable donations for the 2016–17 tax year were INR14,343 million (£131 million) and the projected revenue impact for the year 2017–18 is INR15,935.

Norman Vincent Peele, the American author, famously said ‘Every problem has in it the seeds of its own solution. If you don’t have any problems, you don’t get any seeds.’ By enabling the public to support local Net Zero initiatives that they directly see and feel a part of, while receiving the benefit of a deduction, will ensure that the local seeds of solutions receive the local nourishment that they require.