Investment and other subsidies
Foreign Direct Investment (‘FDI’)
The growth of the clean energy sector in India has been impressive. India permits FDI up to 100 percent in the sector under the automatic route in Renewable Energy Generation and Distribution projects that are subject to the provisions of the Electricity Act of 2003. Under the Act, no prior approval of regulatory authorities is required.
Tax holiday under the domestic income tax law
Undertakings engaged in the generation and/or distribution of power has been offered a 10-year tax holiday for renewable energy plants if power generation begins before 31 March 2014. However, the plants have to pay a minimum alternative tax at the rate of approximately 20 to 21 percent (based on the income), which can be offset in future years (10 years).
It is likely that a new Direct Taxes Code will be made effective as of 1 April 2014. The draft provisions of the Direct Taxes Code provide for alternative mechanisms for providing tax incentives to power companies. As regards this incentive, almost all revenue and capital expenditures will be allowed as a tax deduction upfront instead of claiming amortization/depreciation on the capital expenditure. In addition, there would be no tax holiday.
The Indian Renewable Energy Development Agency has been established under the Ministry for Non-Conventional Energy Sources as a specialized financing agency to promote and finance renewable energy projects.
Generation Based Incentives (GBI)
To attract foreign investors, the government has taken several initiatives such as introducing GBI schemes to promote projects under Independent Power Producers (IPP) mode for wind and solar power.
Under the domestic income-tax law, companies involved in renewable energy such as solar and wind was provided with accelerated depreciation at 80 percent. However, the government has restricted the accelerated depreciation of 80 percent to windmills installed on or before 31 March 2012. Windmills installed after 31 March 2012 will be eligible for depreciation of 15 percent instead of 80 percent on the written-down value method.
It may be noted that 80 percent depreciation is still available for solar power projects.
Further, power companies have been provided with an option to claim depreciation under straight line method. However, a company can claim either accelerated depreciation or GBI (but not both).
Renewable Purchase Obligation (RPO)
The current contribution of renewable energy is 12.5 percent of India’s total generation installed capacity. The Ministry of New and Renewable Energy estimates that this contribution will increase to around 16 percent or 17 percent by the end of the 12th Five Year Plan in 2017.
RPO is one of the tools for implementing this ambitious goal. Under RPO rules, distribution companies, open access consumers and captive consumers are obligated to buy a certain percentage of their power from renewable sources of energy. We believe that going forward; the enforcement of RPO will create the volumes needed for the Renewable Energy Certificate market.
Jawaharlal Nehru National Solar Mission (JNNSM)
The JNNSM is a transformational initiative for solar energy development in India. Its primary focus is to establish an enabling environment for solar technology, both at a centralized and decentralized level, with 20,000 MW of grid-connected solar power capacity by 2022.
Related to this initiative, the government has launched the Payment Security Mechanism for Grid Connected Solar Power Projects and a Renewable Energy Certificate Mechanism. The government has also created the Amendment in National Tariff Policy for enabling a solar-specific Renewable Portfolio Obligation.
The JNNSM program has been designed as a three-stage process with targets set under each phase. Phase 1 (up to 2013) will focus on capturing available options in solar thermal; promoting off-grid systems to serve populations without access to commercial energy, and making a modest increase in capacity to grid-based systems. Under Phase 2 (2013-2017), 10,000 MW grid-connected solar plants will be implemented, including rooftop and other small-scale applications. For off-grid solar applications, the cumulative target for Phase 2 is 1,000 MW. Besides the national program, solar programs at the state level also exist.
The policy framework has generated tremendous interest in this space, and the response JNNSM program has received from the market is overwhelming.
Carbon Credits and Clean Development Mechanisms (CDMs)
The Clean Development Mechanism (CDM) is an arrangement under the Kyoto Protocol. The mechanism allows developed (Annex 1) countries with a green house gas (GHG) reduction commitment to invest in projects that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries. The developed country gets carbon credits, while the developing country gets capital and clean technology.
India is the second largest seller of carbon credits. The country is also a leading destination among non-Annex 1 countries with regards to CDM implementation. It has the highest rating of any CDM host country, with 32 percent of the world total of 1,081 projects registered with CDM EB.
Tax and fiscal incentives
Tax cost forms a substantial part of Engineering Procurement and Construction (EPC) project costs, which can range from 10 percent to 20 percent of the total renewable energy project cost. Considering the special focus on renewable energy, the Central Government has given various incentives on setting up the renewable energy power project which includes exemption from customs and excise duties on specific goods required for setting up the renewable energy projects.
However, these exemptions are subject to the fulfilment of prescribed conditions and compliances to be undertaken by the EPC contractor or IPP.
Furthermore, some of the state governments have provided the incentives in the form of a VAT at a reduced rate (5 percent) whereas the other states levy a VAT of 15 percent. Given the vast variety of tax and fiscal incentives available, one needs to quantify the tax cost and explore the structuring options before investing in the solar sector.
For investors based overseas, an entry strategy for India is highly important. To achieve tax efficiency with regard to taxability of gains on sale of shares, many companies opt to route the investments through an intermediate entity in a tax-friendly jurisdiction.
Typically, renewable energy companies in India procure equipment and services from overseas. In this scenario, contract structuring from a tax perspective helps renewable energy companies to achieve major tax efficiency upfront. In the case of multiple parties coming together and bidding as a consortium, contract structuring is critical to avoid the risk of the consortium being taxed as an Association of Persons.
In India, based on the nature of operation, different forms of entity can be established. Operating through a limited liability company by forming a joint venture/wholly owned subsidiary could be one of the possible options where the foreign company is looking at a long-term presence in India. However, one needs to rule out other relationships and entities before proceeding with these options.
In addition, the renewable energy sector is capital intensive, so investing companies need to carefully explore the options available for funding their projects and repatriating profits in a tax-efficient manner.
The taxation of EPC contracts offers various challenges and opportunities. The EPC contract can be structured as a single contract or as divisible contracts. The selection of either option can cause a huge impact on the tax costs and working capital of the project.
The selection of schemes for the payment of indirect tax liabilities on renewable energy power plant construction offers various tax planning avenues for renewable energy power projects. Furthermore, any scheme can involve difficulties in compliance, such as a restriction on procurement of goods outside the state.
The procurement of goods and supply chain structuring play a vital role in the solar power project costs, since the tax rates are different for procurement of goods from outside India, from other states or from the same state.
Generally, the EPC contractor also undertakes the operation and maintenance of the power plant. The taxability of an Operation and Management (O&M) contract has been the subject of disputes in various decisions.
The exemption provided under the Customs and Excise Act is subject to various conditions and compliances. Hence, it is very important to ensure the compliance of the respective conditions as otherwise the benefits envisaged may not be available.
The proposed introduction of the Goods and Services Tax will also play a major role in the costing of a renewable energy power project.
Given the vast variety of tax and fiscal incentives available, one needs to quantify the tax cost and explore the structuring options, before planning the capex, at the tender/bid stage and also at the time of awarding contracts, so that tax costs are optimized.