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 years 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
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to the 1980s 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 SEBs 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 3032% 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
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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 systems evolutionary nature and its competitiveness, needs special attention. This govt. in its vision statement last year has recognised
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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 regasification 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
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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 VATable. 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. Giving infrastructure status to import terminals and pipelines would mean lowering of the financing cost for the development of these assets. Investors will enjoy tax-free income from their contribution in the creation of these businesses. Other infrastructures including power sector do enjoy this holiday. Mr. S.L. Rao added that any tax suggestion must also take a look at what the impact will be on the tax revenues and the alternatives for revenues to be made up. To this Mr. Gokul Chaudhary responded that the import of natural gas, whether by pipelines or by tankers of LNG, will be an addition to the existing volumes. Therefore govt. will not be a net looser. Mr. O.N. Marwah added that the impact on increased production by lowering taxes must be borne in mind.
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Ms. Sujatha Srikumar said that taxation is a critical area in the power sector and there is need for rationalization, logic and a rational approach. Mr. S.L. Rao concluded that we need a national fuel policy, a taxation structure that reflects the countrys priorities between fuels and these priorities would obviously also include the environmental impact of different fuels. Mr. O.N. Marwah Power suggested that just as some state govts. have exempted certain industries from payment of sales tax of 15% so that the states are able to grow, why not the power sector be exempted for a certain period say 5 years from all taxes? Revenue loss can be compensated with the increase in production and industrial activity. Ms. Sandra Shroff said that China charges industries pays Rs. 2.50/unit for their electricity while in Gujarat the rate is upto Rs. 5. and at this rate, availability and quality, industry will relocate. Mr. S.L. Rao said that manufacturing in the contribution to GDP has been static in India at around 15%, while in China it is around 24%. At the same time the Chinese pricing is a very opaque system and from all the reports on China manufacturing there is a differential cost of power itself. Mr. Shyam Wadhera said that there are major cost elements which are impacted by taxes and duties and are related to capital cost i.e. the return on equity. The taxes and duties which impact the capital cost are customs duty, excise duty, sales tax and withholding tax. On customs duty, the power plant equipment is subjected to 28.1% which includes 5% basic duty and 60% countervailing duty. In terms of the installed cost, the custom duty impact is Rs. 5.4 crore/MW, which translates into per unit impact on price of 16 paisa. Then we have the sales tax, with different states charging sales tax on machinery and equipment procured for the power sector. Haryana State Electricity Board has extended concessional sales tax of 1%. These facilities are not available with the other states. This can be considered by the other states also. Next is withholding tax, the impact of exemption on withholding tax, income tax on interest payments on external commercial borrowings is also a significant element. The withholding tax rate is 20% and 8% interest rate for loan which grossed up becomes 10%. Then we have the taxes on fuel, LNG, attracts the basic custom duty of 5%. On coal we have a duty of Rs. 3.5/MT which translates to Rs. 0.23 p/kwh. On Naphtha we have a duty of 16% which translates to Rs. 0.40 p/kwh. Initially, an exemption was given to seven power
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stations after which NTPC approach the govt. and extension was given to NTPCs gas based power station (Naphtha). We have been able to convince the govt. to withdrawn excise duty on Naphtha for the LNG fired stations of NTPC. On sales tax, different states are charging different sales tax rates on fuels used in power sector. For coal it is 2% (Rs. 1.15 /Kwh) in UP, in MP it is 4% (Rs. 2.30/Kwh), for gas, the sales tax charged in Rajasthan is 4% (Rs. 3.12/Kwh) and in Gujarat it is significantly high 22% (Rs. 17.80/Kwh). For Naphtha, it is 4% (Rs. 8.38 / Kwh) in Rajasthan and 17.6% (Rs. 36.7/Kwh) in Gujarat. In addition to sales tax the states also levy royalty on the coal mines within the state and supplied to power stations. The rates vary for each state and are also different for each grade. Also royalty is charged for gas supplied to power plants. On coal, rates for royalty vary from Rs. 50-95/MT which translates into Rs. 6.38/Kwh maximum. On gas the royalty is Rs. 212.70/1000 SCM which translates into Rs. 4.41/Kwh. Other taxes and duties impacting the power utilities are dividend tax and duty on electricity. The dividend tax outflows on account of tax on dividend paid to govt. impacts the internal resource generation of companies like NTPC which plough back their profits for capacity additions and debt servicing. State Electricity Duty (SED), is another component affecting the cost of power to the consumer. There is no uniformity in SED levied by the State govts. The govt. of AP & MP are levying excise duty on the sale of electricity outside the states. In 1992 NTPC had filed a case with the High Court against the levy on sales outside the states. The High Court decided that inter state sale of electricity should not be taxed by the state govt. where the power station is located. Ultimately a constitutional issue was taken to the Supreme Court and the Supreme Court has upheld the decision of the Andhra High Court saying that states cannot levy duty on electricity generated within the state but sold outside the state. The impact of electricity duty has considerably reduced after Supreme Courts decision, which is limited to AP & MP only as far as NTPC is concerned. It was 3 paisa in MP. Water Cess: There are different levels of water cess in different states. We have noted an interesting tendency of the state govts. with central power stations. When NTPC is establishing a power station, we get lot of support and concessional rate from the states govts. but once the power station is established then rates at which the water is given to us are substantially hiked. In MP, it was
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hiked to almost 100 times the rate we got when we started the project. We need a uniform policy which allows reasonable rates to be charged by the state govts. Recommendations of Mr Wadhera, NTPC Imposition of various duties and taxes by the states needs to be reviewed, considering the multiplier effect on the power tariff and economy. The benefit of customs duty exemption for mega power projects should be extended to all power projects for a limited period, may be 5/10 years till we are looking at major capacity additions in the country. Deemed export benefit to domestic suppliers available to for mega power projects should be extended to all power projects it is important to state govts. need to be persuaded to exempt fuel (specially liquid fuel) for power plants from levy of sales tax, cess and royalties which are adding to the cost of generation. State Governments need to be persuaded to exempt fuel for power plants from levy of sales tax, cess and royalties which are adding to the cost of generation. All LNG terminals should be given a status of infrastructure project and thereby allow customs duty to be levied at the concessional rates Liquefied Natural gas may be included in declared goods so that local sales tax is subjected to a ceiling of 4%. Tax exemption on earnings of financial institutions from interest income from power projects could result in reduction in interest rates. The power generating companies may be exempted from Income Tax. Alternatively, exemption under Section 195A of the Act may be considered to avoid tax on tax. Deemed export benefit is available to the Indian manufacturer only in a limited sense when they are importing raw material when the project is funded by World Bank or ADB. These benefits should be extended even if the project is not funded by World Bank and even if there is no actual export. Mr. P.S. Bami added that mega power projects are exempted from customs duty. LNG terminals have no customs duty but if you want to put up a merchanting LNG station which will supply LNG to various consumers, customs duty has to be paid. For independent LNG it is 25% and LNG terminal for captive power is 5%. The excise duty is 16%. An independent LNG station which is not captive to a particular fertiliser or any power company, ultimately pays duty of 21.8%. Income tax is a pass through as it is recoverable from the consumer but is treated as an income and again taxed. The actual income tax comes to 8 paisa /KWH and the tax on tax is 5 paisa/kwh, so that the total impact is 13 paisa / KWH. Important fuels should be

declared as Declared Goods so that nobody can charge more than 4%. Gas has unjustified wide variations in sales tax from one state to another. In Gujarat it is 17.6% (Rs. 36.07/KWH) and in Rajasthan it is 4% (Rs. 8.38/KWH). When the same gas goes to fertilizer industry we want to subsidize it and reduce the prices. Gas as a fuel should be treated at the same level for power industry as well . The prices of Naptha in NTPCs case alone vary from 2.5% to 17.6%. The impact is 20 paisa. Naphtha is free of customs duty when used for fertilizer industry but for power 10% is charged. On HSD excise duty of 14% is charged and additional excise duty of Rs. 1000 per Ltr. is charged. It should also be free for power. West Bengal charges rural education cess of 20% of the coal value and primary education cess of 5%. The coal that reaches power plants is of lesser grade than what is declared. Even if power pay as per the actual category of coal received, the royalty is charged as per the declared quality of the mine. The difference can be between Rs. 50-95 per ton. Producers price of gas at Dadri is Rs. 2016 per 1000 SCM. Consumer price is Rs. 2850 per 1000 SCM. Transportation charge by the time it comes to Dadri is Rs. 1350, almost 50% of the producers cost. There is 10% royalty, tax of Gujarat Government on gas as produced, additional tax of 10% on the sales tax, entry tax, local sales tax, turnover tax, surcharge on the turnover tax and again sales tax varying from 5 22%. The total impact of all these taxes (92 paisa variable charge) is approximately 15-20 paisa which is the constituent of taxation alone. Mr. R. Krishanmurthy considered the vagaries in the Indian Income Tax Act and its effect on the cost of borrowings and the impact on power sector. Withholding Tax (WT) which was available on foreign borrowings was withdrawn by GOI last year. We are hence not able for example, to take advantage of the historically low cost of Japanese Yen which is prevailing today. There is always a grossing up of 20-25%. If we are able to get an all-inclusive cost of 5%, the grossing up of 22-25% increases the cost. Only where we have ECA credit facility or double taxation avoidance agreements, the incidence of taxes can be lower. External Commercial Borrowings have been a good instrument for financing of a project. ECB made prior to June 2006 will continue to enjoy the benefit of WT exemption u/s 10-15-4F. PFC took up this issue with GOI and expanded the scope of definition of interest by way of explanation u/s 10-15-4 explanation 2, which provided that the expression of interest includes hedging transaction
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charges under currency fluctuation. With the removal of this section if we do hedging transaction with the foreign bank that does not have a place of business in India we have to pay to WT. It eliminates the scope of our getting finer rates. This anomaly has to be corrected. Power companies are enjoying tax holiday u/s 80-IA. There is a provision of 10 year tax holiday under income earned by power companies from a new project. But this provision does not give benefit to the investors investing in the equity and taking risks. The company gets the benefit. On the contrary the investor has to pay dividend tax, if he is getting dividend in the first year. To improve investments and to achieve our target of an additional 100,000 MW this provision must be extended to individual investors. The govt. has already removed the provision of tax free bonds which are available from 1984-92. In 1992 the allocation of tax free bonds was restricted to railways, telecom and housing sectors which was later gradually withdrawn. Except 54 EC of the REC and other institutions u/s 80-IA, no other institution or infrastructure is getting the benefit of tax free bonds. Since the introduction of section 10-23G, PFC has been analysing projects and giving benefit directly. After the subsequent amendment it is made compulsory that the project authorities have to get approval from the CBDT. Normally the approval is given for three assessment years. The exemption should be given for at least as many years as in gestation period or upto 2006 as per the Act. Getting approval delays the benefit further. PFC is the only financial institution which is giving 1% tax in interest rebate for projects covered u/s 10-23G. We get the benefit of 0.70% in tax computation which we are passing by 1% reduction to projects covered u/s 10-23G. MOP must decide which project should come u/s 10-23 G instead of keeping the power with CBDT, since MOP is a nodal ministry having all the technical expertise. Even though it is mentioned in section 80-IA read with 10-23G, that all T&D companies are eligible for getting the benefit, no T&D project has been approved u/s 10-23G. Power sector must be seen in totality. Generation cannot stand alone without T&D. So the spirit of the act should be extended to all, be it generation, transmission or distribution. For this, procedures have to be stream lined. This will have a great impact on the final tariff. New instruments like tax paid bonds should be introduced. Just like dividend is paid on the tax at the time of declaration of dividend, at the time interest is released to the investor, the tax can be recovered at an agreed percentage, say
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20%. If this is introduced the hassles of an individual investor of going and filing returns is reduced and he gets a tax free income where the company paying the interest pays the tax and GOI gets the entire amount at one time. Vidyut Vikas Patras should be introduced. In next 10 years Rs. 900,000 crores need to be invested to achieve the target of 100,000 MW as per the Udesh Kohli Committee. Just like Indira Vikas Patras which helped to reduce the total deficit of GOI, if Vidyut Vikas Patras are introduced, it will bring in investment and hence improve the economy. The power companies should be allowed to invest in bonds u/s 80-IA, 54-EAC. Just like power companies, the financial institutions that are financing power projects can also be given tax holiday u/s 80-IA. Ultimately it will help to reduce the cost of power and the financial institutions will also be able to give lower rate of interest. Similar benefits should also be extended to the lenders. In the hydropower sector in the initial years the tariff is high and it tapers down over a period of time. Such projects should get long term funding. PFC and Power Grid have made a dent in the market by providing an average period of 10-12 years, a fifteen year paper repayable from 7 th year onwards and average period of maturity of 10 years is coming. For the first time PFC has done a transaction with a bullet of 15 years of about Rs. 200 crores. Another suggestion is that if the depreciation is less than the loan repayment due in the initial year, the tax provision can be modified so that the depreciation is higher. This will facilitate cash flows in the initial years of the project commissioning and reduce the tax liability which is a pass through cost. For mega projects imports are allowed without duty payment. This customs duty exemption should be extended to all projects. Another experiment is to allow deferred duty on import by power companies. The same can be payable after the project successfully runs 5 years. This can reduce the funding requirement and interest cost in the initial period. The import duty for gas based projects is 20%, while spares attract duty of 5052%. For renovating old projects this unnecessarily increases the cost. Spares should be charged with lesser import duty than the project import. Full exemption from customs duty for next 10 years sales tax, excise tax, works contract abolition for specific projects, can be thought of. The loss of revenue can be made up by higher industrial output with lower tariffs. A back end levy after 10 years can be considered. The time limit of exemption of WT u/s 80-IA should be increased to 2012.
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Ms. Saroj Punhani said that to reduce the cost of power ways of reducing the cost of inputs must be examined. The various issues taxation can have incidence on our capital equipment required for power project, supplies coming from abroad or in house, financing and income accrued by the power companies. Even if it is a pass through it has an effect on the tariff which is ultimately borne by the consumer. From the developers point of view, duty free import should be extended to all the items related to a project, EPC contracors/sub-contractors, which will have an ultimate impact on tariff. There should not any WT on the financial borrowings. Exemption of stamp duty by state govts. can also bring down tariff significantly. For example, in Hirma project the stamp duty alone was Rs. 400 crores. There are a lot of grey areas in the provision of income tax. If a contractor has a branch office in India and is importing form outside, the entire income on that account attracts lot of taxes. If it is a lumpsum turn key project, all the supplies and engineering designs are not defined separately, it again attracts taxes. It is desirable from the developers point of view that the income derived from the contractor on CIF value of supply of goods from outside India should be tax exempt. If the R&D cess can be waived or addressed in a treaty with a particular country this, this will bring down the cost. Mr. R. Krishnamurthy offered to study the incidence of tax on tariff and to undertake case studies of two/three projects which are under the process of commissioning, have been commissioned or are just starting, to see the implications of various tax clauses. PFC can finance and outsource a good agency, putting the recommendations before the govt. and regulatory authorities. Hedging cost has been a bone of contention between power producers and regulators. Now CERC has agreed to allow part of the hedging cost to be inbuilt in the tariff. Mr. Seth Vedantham said that if there is reduction of customs duty, domestic manufacturing will suffer. It is not the tariff that matters to the govt. but the preference of domestic fuels over imported fuel. Why should there be less tax on mega power projects? For big projects, Govt. has given 10 years tax holiday and with depreciation for 4 years, 14 years is enough time to structure the tariff. For India, main fuel is coal. The customs duty on LNG is 5-10% but the basic cost is high. India cannot afford costly fuels. Tariff has to be low. There is no need for national fuel policy because it is the competitiveness for a better tariff that will determine the cost of power. Prof S.L. Rao said that the logic for having a national fuel policy is that taxation can be used by govt. to promote or dissuade the Indian industry from going for
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one fuel or another. But the govt. today has neither a national fuel policy nor has a taxation policy which is coordinated between the fuels. Therefore, it is essential to have both. There are fuels we might like to encourage, and in an open market prices cannot be influenced except by taxation. So taxation as a part of national fuel policy is essential. Mr. V.S. Ailawadi said that the average consumer tariff in 1992-93 was 128 paisa/KWH which has now increased to 303 p/KWH. The interse cost amongst consumer categories is increasing. The power purchase cost in 1992-93 was 76 p/KWH, 1999-2000 166 p/KWH and in 2001 it is 184 p/KWH. One of the important factors for higher power purchase costs is higher fuel costs. The fuel element which constituted higher fuel cost was 33 paisa in 1992-93 which has gone upto 50.59 paisa in 2001. For this one of the reasons is taxation. Another factor is higher depreciation rate which was 9% in 1992-93 and now is 19.8%. Interest payment is also one of the factors. It was 22% in 1992-93 and is now 38.98%. The power purchase cost has increased from 27.9% in 1992-93 to 48.5% per unit. The cost of fuel in coal based thermal plant per KWH has increased from 53 paisa to Re. 1.Fuel prices and duty structure are a key to controlling power prices. We should try to achieve a suitable framework to promote and increase the percentage share of hydro power. This can bring down the cost of power. We should also ask for a review of taxation structures. Duties and taxes have cascading effect and reflect in the cost of power. Commercial orientation of SEBs is very crucial. Unless SEBs become efficient, no measure or concessions can help. Distributed generation can also help in cost reduction. Mr. P. Bhullar said that taxation structures play a key role in investments by affecting returns. Tax on dividend and distribution is a matter of concern. Debt equity structure plays a major role in IPP funding. Funding of IPP projects is on a non-recouse basis and entire cash flows come from the project cash flows. We need long term debt that goes upto 14-15 years. Any investor would want to make his investment secured and be levied with minimum taxes. Section 10-23G is one of the initiatives undertaken by the ministry. Under this section investments from infrastructure capital fund or company / cooperative bank made either in the form of shares or long term planning in enterprises / undertakings which qualify as under section 80-IA (4) or 80-IAB, for computation of taxes the dividend interest in terms of long term capital gains earned out of these investments is not included in the total income. Key issue is that from April 1, 2003 the income by way of dividends u/s 115(O)would also be included in the total income. The provision that stands as on date does not exempt Section 115(O).

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Mr. P.N. Krishnan focused on Section 10-23G. He argued that Section 14-A should be amended so that the benefit goes to the deserving party. By the action of financial institutions the whole purpose of Section 10-23G was failed. If the financial institutions want to avail the benefit, they should affect necessary reduction in the interest rates to the IPPs. Although today the prevailing rate is 10-11%, many IPPs are still paying at 20%. On one hand IPPs have to face a continuous cry from Electricity Boards to lower the tariffs, and on the other hand Section The Finance Ministry should to get back Section 10-23G and make it operative as it was originally intended to be. Effectively it should make the cost of borrowings lower for generating companies by allowing a 100% tax break on tax exemption earned by the lender, provided the benefits are passed on to the borrower. There is no point in advancing money at 16% and getting tax exemption on such a revenue. It should be made mandatory for the lender that the benefit of tax exemption should be passed on to the generating company, either in form of lower interest rate or rebate. Only PFC is diligently following the practice of passing back the benefit. PFC clearly states that if there is Section 10-23G benefit involved, they will give 1% rebate. If it is not so the interest rate is 1% higher. The same logic holds good for MAT. Under the two part tariff mechanism for the computation of income tax, it is grossed up for determining the passing up of liability of the Electricity Board to the generating company to ensure that the return on equity is on net on tax basis i.e. 16%. The applicable rate for MAT is 8.25%. It gets grossed up and the impact comes to 12% in the form of tariff to the Electricity Boards. This is again passed on to the customer or the government in the form of subsidies which the Electricity Boards collect from the govt. 85% of the money collected by the center is passed back to the states. So the state pays the net MAT at a very high premium to collect that 85%. Recommendations by Prof S.L. RAO Although we have an exhaustive list of innumerable taxes, we do not know the impact of all these taxes in different parts of India on different types of power generated. Various companies present at the conference have offered their support to establish a working group to discuss and analyze the impact of taxation on the Power sector. Fuel is an important component in the energy chain. In India taxation on fuels is very heavy and should be brought down. Our govt. needs to rework the fiscal framework. Sales tax is the bug-bear for LNG and the entire gas business. Tax costs are loaded into the tariff. The consumers cannot take the benefit even though it is being paid for in the energy chain. India is not ready for VAT. VAT needs to rationalise the impact of sales tax. A group of public finance specialists have studied VAT and found out that many states are not ready for it. If they introduce VAT many states will suffer tax losses. Concern was expressed about the urgent need for a National Fuel Policy and reforms in taxation structure to look at the differential between various states and attempt for a harmonisation of rates of sales tax between the states. The states which have high rates are putting themselves at disadvantage. For example, Gujarat is killing industries with extremely high level of taxes on Naphtha and Gas. It was pointed out that in China

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industrial power costs Rs. 2.50 and in Gujarat we are paying Rs. 5.00. If the cost of power is not brought down India can never be a manufacturing country. Govt. at the Center should realise that fuels are of national importance. Particularly naptha/gas should be declared as Declared Goods and therefore subject it to only CST rate of maximum 4% rather than continuing with 22%. Electricity must be treated as zero rated goods so that all taxes paid up to that point can be claimed back. SEBs are bearing the burden of development of the power sector. The Central Govt. has to share this burden. Import terminals and pipelines must get equal fiscal treatment. They should be recognised as infrastructure facilities and get lower customs duty. There is need for improvement in efficiency of tax collections at all levels. A way must be found to bring in a modified VAT instead of sales tax to exempt customs duty on crude oil for power generation. Giving a specific duty exemption to crude oil for power generation is worth considering, as there is no question of leakages. A sales tax holiday for 5 years for new power projects might also be examined. The total impact of taxes, in case of coal is 23.2 paisa / KWH, incase of Naphtha 67 paisa / KWH and in case of gas we get a variation of 25 paisa to 43 paisa per KWH. Exemption of customs duty to mega power projects is a little illogical because mega power projects are by definition lower cost projects. Exemption of customs duty should be offered to power projects as a whole. Deemed export benefits should be extended from mega power projects to all power projects. States should be requested to exempt fuel from sales tax and electricity duty for power plants, including transmission and distribution. At least these taxes should be exempted for a minimum period of 5-10 years to enable quick capacity addition. Withholding tax on external commercial borrowings was withdrawn last year. This does not make any sense as nobody can take its advantage. Regarding tax incentives the retail investors should get tax holiday benefit made available to them as it is available to power companies. 10(23G) benefits should also be made available to retail investors. Hedging cost should be allowed for tariff (to which CERC has now agreed). Stamp duty is a major cost in new projects; eg., in case of Hirma Project the cost of stamp duty alone was around Rs. 400 crores. Stamp duty exmption should be considered. R&D cess on development and design form O&C might be waived off. Exemption of MAT for projects subjected to tax holiday needs to be made. 10 (23 G) is available to only those projects which are commissioned before March 2006. Hence the existing projects may not be able to take its advantage. When government or Power Minister says that we need to reduce the cost of power, it should be pointed out that the existing taxes and levies are responsible for high costs of power. Therefore various ministries and Chief Ministers of States must together and in a holistic and coordinated way work out a better taxation structure. PFC, NTPC, Ernst & Young, J Sagar Associates, Bina Power offered their support to IPPAI to form a working group to analyse the impact of taxation on the Power Sector and what reforms are needed in the present taxation structures.

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