Budget 2018 wish list: Tweak tax rules to boost capex in power sector

The government's initiatives aiming to deliver '24X7 power for all' and promote renewables as the future source of energy have led to calibrated reforms in the power sector in the past two to three years. The targeted 175 gigawatt (gw) renewables capacity by 2022 has had a decent onset with cumulative renewables capacity at around 60 gw. There is a need to accelerate the pace of new capacity addition over next five years or so to get even closer to the targeted capacity. Yet, the potential of renewables sector remains far from fully unleashed.

The investment drive towards clean energy projects arguably has witnessed intermittent setbacks, largely self-inflicted, owing to financing challenges and nosediving tariffs for solar and wind projects. Evolving tax policies have pushed the sector to the receiving end too. Sunset on tax holidays and limitation on tax deductibility of borrowing costs led to financing woes; GST transition has added to the overall cost of constructing solar and wind projects. Recurrent flip-flops on levy of anti-dumping duty and customs classification of panels have not helped the cause of investors either.

Yet the industry believes these are temporary hiccups. It is in this backdrop, the developers and investors will look up to the Budget to redeem legacy tax issues and for the power sector to be conferred a special infrastructure status through a more conducive regulatory and tax framework which encourages rapid capacity addition, including in newer areas of sustainability and energy efficiency.

From tax wishlist standpoint, an across-the-board reduction in the corporate tax rate, grant of investment-linked tax deduction and rationalisation of the minimum alternate tax (MAT) continue to be the two key asks of the power sector, both in the context of generation and distribution and transmission projects.

End of income-linked tax holiday with effect from April 2017 has impacted significant pipeline of capex investments. MAT liability (of 20% on book profits) materially neutralises the economic benefit of accelerated tax depreciation for special purpose vehicles. Further, introduction of weighted tax deduction for expenditures incurred on energy-efficient and emission reduction technologies could help catalyse large capex in cleaner technologies.

Limitation on tax-deductibility of interest cost introduced vide Finance Act 2017 as a measure to curb tax base erosion and profit-shifting, has hit the capital-intensive infrastructure (including power projects) the most. Given the highly-leveraged nature of capex, a '30%-of-Ebitda' rule for interest deductibility invariably causes material increase in overall cost of capital, and in some cases, renders investments economically unviable. It is imperative that for capital-intensive infrastructure projects, Ebitda-based interest disallowance is either withdrawn or rationalised.

GST levy on procurements for power projects perpetrates the inverted duty/ tax structure for the power sector, especially since generation/distribution of electricity is yet not subsumed in the GST fold. It is critical to redeem the added cost of constructing and operating such assets, by either exempting or zero-rating of all procurements for setting up and operation of renewable energy projects. To further promote solar roof tops, installation under EPC contract should be classified as 'solar power generating system' liable to GST at 5%. Exempting renewable energy certificates (RECs) from GST levy would also yield attractive, albeit marginal, incentive for developers. Besides, a policy guidance on consistent policy framing by states and measures to minimise payment defaults by utilities could relieve the overall stress of the renewables industry at large.

Overall, Budget 2018 presents an opportunity for the government to unleash significant investment potential in the power sector. Tweaking of tax rules to incentivise large capex could be one big step forward in this endeavour.

Sumit Singhania - Partner, Deloitte India