IMPACT OF TAXATION ON THE INDIAN POWER SECTOR
18TH JULY, 2002 at Hotel Oberoi, New Delhi
EDITED BY PROF S L RAO
INTRODUCTION
Prof S L Rao opened the discussion by commenting that the subject was being discussed for the first time in the power sector and follows the discussions on viability of the sector at the last conference. This conference expects to make a beginning in considering taxation in the power sector by analysing the total impact of taxation in the power tariffs, the impact of taxation, tax incentives and disincentives and how can investors, promoters and managers of projects minimize their tax liabilities. In discussing incentives for example, we will look at issues like accelerated depreciation that has a positive impact on cash flows and profitability but frontloads the tariffs on customers. We found in the CERC that income tax is a pass through item in power tariffs. It is estimated, and on a quarterly basis. As a result, the generators make profit on tax because they get the money in advance, and because it is estimated and not based on actuals. CERC ordered that it should be done on the basis of actuals and the actuals should be that of last year for the present year and the present year’s actuals would be charged next year, with adjustments to be made each year for over or under charging. As far as projects are concerned, only so-called mega projects get customs duty relief on imported equipment. There are excise duties on local equipment, countervailing duties, sales taxes and taxes on works contracts. On fuels there are royalties on coal, gas, etc; hydro generation has a 13% free supply to the originating state; there are varying rates of cess on captive generation and on wheeling; customs duty on gas is ad valorem and with highly volatile gas prices, has frequent additional increases due to the duties; there is central sales tax on interstate movement of fuels; local sales taxes like the penal 22% on gas in Gujarat which has almost all the LNG terminals being established there, giving Gujarat a chance to tax other consuming states; and of course there are octroi and entry taxes. There is an indirect tax because of the transport delays due to these sales and local taxes. There are also direct taxes to be considered. On direct taxes, the issues of Section 10-23G of the Income Tax Act on infrastructure benefits on gross income on interest, dividends, etc have to be considered. The applicability of MAT to power sector is an additional burden. Dividend tax, and the estimation of income tax as a pass through item are other issues that must be considered. We do not expect to cover all issues in depth, nor to come to conclusions in this first conference, but we do hope to develop a plan for future work.
Mr. P. Abraham, on the role of governments, said that traditionally power tariffs were low primarily because of state policies. But despite all their inefficiencies, up to the 1980’s many SEBs earned at least 3% on assets or even more. MSEB was earning around 4-5%. In contrast, government has given NTPC a share capital of Rs. 8000 crores on which interest is not charged. The dividend does not match the cost of that capital. The Regulatory Commissions (RC) where established are in some cases bringing in commercial attitudes. All utilities have to improve their commercial and efficiency norms. But the Governemnt of India (GOI) will have to share in a substantial manner, at least in the initial stages of reform, in the losses of SEB’s due to social programmes. Governments are diverting social expenditures to power subsidies. States are doing a great deal to mobilize resources. But the Centre cannot put the full burden of the costs of industrialization on the state governments alone. For example, the entire agricultural sector is subsidized by them. Power has to be made affordable for the agricultural sector. It is the duty of the GOI to ensure that the power sector is taken care of and not treated as a sector to be supported only by the states. Support need not be only in the form of cash subsidies but could be in the form of incentives. But despite subsidies and incentives, tariffs are bound to increase in the future. Mr S L Rao concluded that while the governments at the centre and the state levels have many responsibilities, power being a concurrent subject, the centre cannot distance itself from the responsibilities of sharing the costs. Government needs revenues and there are limits to taxation. The central govt has to share some of the burden with the states.
Fuels: Mr. O N Marwah said that taxation is used as a revenue tool by various govts and state govts are using fuel as the cash cow to give more and more milk, because they find that this is an area that they can tax heavily, with rising revenues as prices of fuels keep rising. Power sector finds petro-fuels expensive because they cannot recover the costs in the final tariff. The impact of taxation on naptha, levied by the central and state govts comes to a maximum level of 30-32% of the fuel cost and for furnace oil (FO) it is 30-35% of the fuel cost. The price for FO is based on the concept of cost to product import parity in the country. We refine 30% of oil from crude oil and the remaining 70% is imported. The crude oil attracts customs duty of 10% + excise duty of 16% which is levied on the refining process in the country. In addition there is sales tax levied by state govts. The total impact comes to around Rs5480 in case of naptha and Rs5600 in case of FO. The price is related to import parity of the fuel oil. The CIF value of naptha is $ 219/ton and FO is $ 154/ton (appx.). Based on these prices at which the fuels are imported, the indigenous price is fixed by the oil companies. The CIF value is Rs. 10,900 for naptha and Rs. 7700 for FO. On this, 10% import duty, marketing margins and profit of approximately 5% (Rs. 680 for naptha and Rs. 500 for FO) are added. The differential freight from inland refineries comes to Rs. 575/ton and Rs. 325/ton. Excise duty comes to Rs. 1840 for naptha and Rs.1600 for FO. Then comes Sales Tax levied by the state govts varying from 11-20%. The final price of naptha comes to Rs. 18100 and FO Rs. 14000. Till now, ten power plants have been exempted from paying excise duty, after the fulfillment of certain conditions. If others get this benefit the impact will be 24-25%. If the sales tax which is as high as 20% is brought down to 10 or 15%, the cost of taxation on fuels will be around 15%. On exempting sales tax completely, the impact of taxation will be 8-9%. This will significantly impact the earning capacity of power plants and the viability of the projects will greatly improve. The appetite of the state govts is not limited to sales tax. There is entry tax levied in the states on fuels. VAT can be introduced in their place.
Prof S L Rao concluded that we need to estimate the impact on power cost of the taxation on the two fuels, naptha and FO. What is the proportion of power tariff which is accounted for by taxes? The suggestion that reducing or removing these taxes will substantially reduce the tariffs and hence increase the viability of power projects may bot be feasible. Instead we need to look at tax structure reforms and the relative taxes. There is little scope for overall reduction as the govt needs these revenues. But it should at the same time try to make it easier for the consumers. Entry tax is a nuisance as it causes huge inefficiencies. The problem of differential sales tax should be dealt with as it results in business moving away from one state to another.
Mr. Gokul Chaudhary recognized that the energy gap is increasing and will continue to increase for the next 25 years unless no singular measure is adopted to make power affordable and reliable. Fuels are an important component in the energy chain and can bring significant efficiency and competitiveness in the final cost of power. So far there has been no comprehensive study as to how all the inputs finally translate into the cost of power and that his organization is willing to commit time and resources for such a study which will be useful to industry for lobbying with the states and central govts. In Hydrocarbon Vision 2225, there is a mention about the widening energy gap and the need for diversified and competitive fuel supply to ensure continuous development of the economy. The regulatory and policy framework for the fuel sector has to be such that it welcomes and attracts investment, both foreign and domestic. It should provide a stable and progressive fiscal regime that sustains the well being of all the stakeholders, the investors, the consumers, the govt. and the economy at large.
Gas, given this system’s evolutionary nature and its competitiveness, needs special attention. This govt. in its vision statement last year has recognised natural gas as the preferred fuel of the future. It recognises the need for natural gas transported via both pipelines and LNG tankers. We need to analyse whether the present legislative and regulatory framework delivers the desired results i.e. delivery of natural gas as the competitive fuel for the power sector in India. The vision statement does talk about medium and long term measures which are indeed noble in intent but need to be translated into reality by implementation. These measures include the seriousness about allowing a level playing field for various gas suppliers and the rationalisation of duties and tariffs.
At the time of import, customs duty is loaded in the CIF value of the fuel. CIF value is typically FOB, insurance and freight. Since purchases are on FOB, there is a mechanism to add the rest to evaluate CIF value on which the custom duty is levied. It ranges from 10-30%. This is compounded for the energy gas business with significant sales tax, as in Gujarat where most of the LNG terminals are being placed. At the beginning of the chain there is the development and production of fuel in the resource country. This culminates for LNG in the development of liquefaction facilities at the export terminals at the resource end itself. LNG as a commodity requires cryogenic tankers for shipment, followed by LNG unloading and storage facility at the market location, followed by re-gasification and pipeline grid to the burner tip. Whichever the fuel, energy component in the fuel chain requires significant capital outlay and its development requires coexistence of all other components simultaneously combined with the customers’ facilities.
Indian fiscal and regulatory framework directly impacts the chain right from shipping, all the way to the customer and beyond. This includes custom duty at the time of importation. Excise duty is added as a countervailing duty. There is Sales tax on the subsequent sale in the country and finally there is corporate income tax on the operating entities in India. The entire chain is inter-dependent. Indian fiscal and regulatory framework has a tremendous bearing on the entire chain and its sustenance. While different ministries and departments of govt of India continue to evaluate and legislate different laws specific to their business which falls under their administrative control, there needs to be an overall understanding of the impact of every component in this chain. Hence, an isolated approach whether by power ministry, shipping or petroleum could yield detrimental impact on the business. It is important that there is an integrated policy, which addresses all these segments including the fiscal measures that need to be implemented. Specific to the power sector, govt. has historically provided some incentives. These include corporate tax holiday, somewhat mitigated by MAT, infrastructure status which provides for certain financing incentives and customs duty reliefs on capital goods. However, taxes continue to constitute a significant part of the fuel price. High taxes have a cascading and adverse impact on the growth potential of the economy, as it affects affordability. Therefore govt. needs to rework the fiscal framework to ensure the price of potentially significant natural gas. It is not to be loaded with taxes. Govt. should seek benefit from greater tax collection generated due to correspondingly greater economic activity which comes from affordable, rational fuel prices.
In Gujarat the sales tax is 22%. This means tax cost of US$ 0.7 – 1/MMBTU assuming that the regasified LNG is ranging from US$ 3-4/MMBTU. Such a high tax cost is prohibitive, specially as the natural gas anchors around the power sector which is already struggling with low affordability issues, merit order dispatch coupled with the fact that sales tax cost, while it is added into the tariff is not really passed through as in the tax regime, to enable the consumer to take credit for it. The change over to VAT is not expected to bring any relief because States have indicated lack of a credit mechanism for natural gas since electricity is not VAT’able. The VAT on natural gas, which will be imposed on the final cost, will move into the tariff and not be a pass through change available to the consumer of the electricity. Government of India should recognize that fuels are of national importance and significance and classify them as “Declared Goods”, so that state govts. Cannot levy sales tax exceeding 4%
In addition, once VAT is implemented, electricity should be given the status of zero VATed good so that all taxes paid till that day can be clawed back.
Import terminals and pipelines are integral to the development of the energy sector. These are enabling infrastructure. They require equal fiscal treatment as any other infrastructure. Recognition as infrastructure would mean lower customs duty at the import of capital goods for the creation of these facilities. Currently, the effective rate of customs duty on the import of capital goods is 15%. Effectively, reducing the rate of customs duty to a more rational level would mean that the cost of regasified LNG or pipeline tariff will come down.