Can tax deductions enable sustainable, citizen-driven green finance?

India is the world’s third largest emitter of greenhouse gases, with 3.9 billion tonnes of carbon dioxide equivalent (CO₂eq) per year. However, the country’s emissions per capita are only 2.8 CO₂eq, 2.5 times less than the global average and about one-sixth that of the US.¹

India’s Climate Resilience Strategy, created under the Paris Agreement, aims to control and reduce carbon emissions as India pursues an ambitious growth plan. This includes reducing emissions intensity by 45% compared to 2005 and increasing cumulative installed electrical energy capacity by 50% from non-fossil fuel energy sources by 2030. However, the financing needed for these changes is insufficient due to the lack of access to a sustainable financing stream.²

India needs a reliable, proven route to more green financing

In early 2023, India introduced its first green government bond, a debit note issued by a government to raise money for projects that have a positive impact on the environment.³ to overcome this deficiency. This initiative has the potential to become 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, leaves investors hesitant; investors also have limited knowledge and awareness of green bonds, and the market is still in its infancy and thus has low liquidity; and uncertainty surrounding political and economic conditions also lower investor confidence.

Therefore, India needs a reliable, proven route to more green financing in the short to medium term. Reforms to the well-established Indian Income Tax Act of 1961 could provide a new vehicle for citizen-driven green finance in India.

Tax toolkit

India already has a number of existing fiscal incentives that support net-zero targets. For example, research institutions receive tax exemption on part of their income under certain conditions. This is intended to promote and enable scientific research, but it is for ‘scientific research and development’ generally and so does not necessarily contribute directly to net zero initiatives, and it only benefits established research associations and not to associations of any size.

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

The 2017 Finance Act introduced a specific net zero incentive, which provides a tax credit on all revenues from the transfer of carbon credits. This section has caused some controversy on whether the amount received on transfer of carbon credits is ‘income’ within the meaning of the provisions of the Indian Income Tax Act and is therefore liable to tax^{. This lack of clarity has not helped to substantially advance the goal of advancing carbon credits.}

A more direct contribution to increasing green financing is a deduction for the purchase of electric vehicles. However, the high price of electric vehicles, the periodic availability of electricity in rural areas and the deductions available for investment and maintenance costs of the vehicle, has ensured that this does not have the impact it could have.

These positive moves toward reducing carbon emissions are not having enough impact. The challenge India faces is how to encourage and foster an environment where multiple green initiatives are identified, nurtured and propagated across the country.

Deductible donations

A commonly used deduction for income tax is the exemption for donations to charities. If a similar mechanism were devised for green initiatives that promote R&D and implementation to reduce emissions – such as in the areas of renewable energy, carbon capture, afforestation and green mobility – this would give the entities undertaking these initiatives the opportunity to receive direct funding to receive from taxpayers. .

There are already several GOs and NGOs promoting environmental issues. However, the addition of a deduction specifically aimed at promoting Net Zero initiatives would have several benefits. It offers taxpayers the benefit of an additional deduction and ensures that the funds are specifically used to promote green initiatives, thereby encouraging contributions to such entities. This would mean that instead of green financing trickling down from the top, funds could be transferred directly from citizens and other taxpayers to the green initiatives they want to support.

This approach will enable entities of all sizes to receive funding from any taxpayer

The Income Tax Act’s existing mechanism for the eligibility, application, operation and cancellation of an establishment as a charity could be expanded or incur the additional cost of dealing with these aspects of a ‘green initiative’ certification. The same income tax exemption wing has powers of withdrawal, sanctions and prosecution to tackle abuse.

The amount donated can be monitored, it is decentralized and will save the government time and effort in identifying green initiatives to which they can contribute in a cumbersome manner.

For example, imagine a group of individuals in a community organizing themselves to plant trees as part of a small-scale reforestation program. If they get certified as a green initiative, they can crowdfund from the communities where those trees are planted, so that those who benefit from the work can donate to them and receive a tax deduction on their contribution as an added incentive. This has the potential to help students, small businesses or even hobbyists develop ideas for sustainable fuels, carbon capture or green transportation and receive the funding they need from their communities.

This approach will allow entities of all sizes to receive financing from any taxpayer, creating an entirely new flow of money in addition to grants, loans and private investments. With charities implementing the same for entities undertaking green initiatives, the amount of money these entities will have direct access to will be significant and convenient. By comparison, the revenue impact of deductions for charitable donations for the 2016-2017 tax year was INR 14,343 million (£131 million) and the expected revenue impact for the year 2017-2018 is INR 15,935.

Norman Vincent Peele, the American writer, famously said: ‘Every problem carries within it the germ of its own solution. If you don’t have any problems, you won’t get any seeds.’ Enabling the public to support local Net Zero initiatives that they can directly see and feel they are a part of, while receiving the benefit of a deduction, ensures that the local seeds of solutions get the local nourishment that they need.