The Goods and Services Tax (GST), likely to be implemented in a few months, will mark the beginning of a new era in indirect taxation. The system is currently fraught with challenges such as multiplicity of taxes, the cascading effect of taxation and double taxation. GST will have an impact on the entire value chain of operations, and will have far-reaching implications for all industries across all sectors. The power sector is no exception to this. In its present form, the model GST law is expected to lead to a significant increase in the cost of electricity. This is because not only is the electricity sector excluded from the GST regime, but it is also likely to lose out on the various tax exemptions and concessions under the new set-up.
Power Line presents a brief overview of the progress of GST in India, the status of electricity under the GST regime and its likely impact on the sector…
GST in India
GST is a value-added tax (VAT) that is levied at all points in the supply chain, with credit allowed for any tax paid on procured inputs. The roll-out of GST will not only simplify taxation anomalies and procedures, but also reduce the transaction cost by removing the cascading tax effect. It will transform India into a single market, and increase the tax base by imposing a comprehensive tax and ensuring an efficient tax administration.
The ball was set in motion for the introduction of the GST regime in India when the Rajya Sabha passed the landmark constitutional amendment bill for GST in August 2016. This was followed by approval from the President of India in September 2016. In the same month, the cabinet notified the formation of the GST Council, a federal forum established for implementing the new tax regime. The council has had several meetings since, though the progress has been uneven.
Considering the country’s federal structure, the government has adopted a dual GST model, wherein the tax will be levied concurrently in the form of central GST (CGST) and state GST (SGST). The features of the CGST and SGST will remain the same across all states. In addition, an Integrated GST (IGST) will be implemented for interstate trade in the country. This will be an aggregate of the CGST and the SGST of the destination state. The GST Council has decided on a four-tier GST tax structure of 5 per cent, 12 per cent, 18 per cent and 28 per cent.
Several loose ends need to be tied up before the new tax regime can be implemented. At present, there is a lot of uncertainty regarding the taxation rates, the registration threshold for states, taxation of interstate trade and the compensation to states for revenue loss. Therefore, it is unlikely that the government will be able to introduce GST on April 1, 2017 as scheduled. The finance minister recently indicated that the roll-out may be deferred to June 1, 2017. Nonetheless, given the pace of progress, it is expected that GST will become a reality in India during the current year.
Status of electricity under GST
The sale or consumption of electricity is currently outside the purview of the GST framework. This is because the constitution treats taxes on electricity and water separately from taxes on other goods and services. Amending Entry 53 of List II (State List), which includes electricity, was neither considered in the First Discussion Paper on GST published in 2009, nor was it recommended by the Empowered Committee and the Parliamentary Standing Committee at later stages.
Under the currently proposed regime, while most or all of the inputs used in electricity generation and supply will be covered by the GST framework, the end-product, electricity, will be excluded. This will lead to a significant increase in electricity generation and supply costs as credit for taxes paid on inputs used, both in construction and operations, will not be allowed. This effectively implies that taxes paid on procurements will be included in the total costs. To address this issue, the Thirteenth Finance Commission has suggested in the Report of the Task Force on Goods and Services Tax, 2009 that electricity should be part of the integral comprehensive GST base and treated as a normal good. The electricity duty levied by the states should thus be subsumed under the SGST.
Industry representatives have also been demanding the inclusion of electricity in GST through various forums. This issue was recently raised by the Indian Electrical and Electronics Manufacturers’ Association in its pre-budget memorandum to the Ministry of Finance.
Notably, GST can be extended to electricity without amending Entry 53 as Article 246A empowers the central and state governments to impose GST, notwithstanding anything stated in Articles 246 and 254. This implies that a part of the electricity duty can be replaced by GST, which will be fully creditable, while the state governments levy a supplementary tax to GST, if needed.
Rise in costs
The introduction of the GST regime is expected to lead to a 12-18 per cent rise in the cost of electricity. This is not only because the tax paid on inputs going into the process of generation and supply will be non-creditable, but also because GST is likely to increase the overall tax burden on the sector.
Under the current regime, different tax rates are applicable depending on the nature of procurement. These include a generic excise duty of 12.5 per cent, a service tax of 15 per cent and a VAT of 5-14 per cent. Against this, the GST framework will introduce a single tax rate ranging from 18 per cent to 22 per cent for goods and services, leading to an increase in the tax burden.
Further, a substantial increase in electricity prices is being anticipated given that the fiscal incentives currently available to the sector are likely to be discontinued under the GST framework. For instance, transmission and distribution (T&D) services are currently exempted from service tax. If the exemption is rolled back, the cost to T&D companies is likely to increase by more than 5 per cent.
Similarly, power companies are currently charged a concessional tax rate of 2 per cent for interstate procurements. This is also likely to be discontinued going forward. Instead, these transactions will be taxed at about 20 per cent (average assumed) under the IGST. There is a concept of deemed exports in the model GST law, which may be used to continue some of the concessions, but it is not clear whether that will happen. Even if it does, the IGST on deemed exports will be payable and can be claimed only later as a refund.
The renewable energy sector is likely to be most severely hit under the new set-up. The government currently promotes the sector through various tax concessions or exemptions, including customs duty exemptions or concessions on import of goods and excise duty exemptions or concessions on the procurement of inputs. Exemptions or concessions are also provided under various state VAT legislations, on the sale of goods to be used for renewable energy generation. In addition, the sector enjoys a number of fiscal incentives including a 100 per cent tax holiday on earnings for the first 10 years of project operations. These incentives are likely to come to an end in the new GST regime, leading to a substantial hike in generation costs.
The Ministry of New and Renewable Energy released a paper on the implications of GST on the delivered cost of renewable energy, stating that with the implementation of GST, the levellised tariff for grid-connected solar photovoltaic (PV) plants will increase by 12-16 per cent, while that for off-grid solar PV plants will increase by 16-20 per cent. Meanwhile, wind energy projects will be costlier by 11-15 per cent, wind solar hybrid projects by 11-17 per cent, biomass projects by 11-14 per cent, biomass gasifier projects by 11-14 per cent and small-hydro projects by 1-11 per cent.
Impact on PPAs and contracts
Most power purchase agreements (PPAs) provide for the pass-through of indirect taxes by including their costs in the contract price. These agreements also allow for an adjustment of the contract price in the event of a change in law or force majeure. The introduction of GST is most likely to be deemed as such an event. However, in case of an absence of such a clause, the introduction of GST is likely to significantly increase power costs for discoms. Further, it remains ambiguous if the change in the taxation law would be considered as force majeure in cases where GST is implemented after the pre-bidding stage but before the signing of the PPA.
Meanwhile, the new tax regime may make things simpler for engineering, procurement and construction firms engaged in both manufacturing of goods and rendering of services. Currently, they pay both excise duty and service tax but will now pay a single tax because of the uniform treatment of all aspects of “works contracts” as services under the model GST law. In some cases, the new regime will also mean the avoidance of double taxation, because of the single tax structure and tax credit available at each stage of transaction. Thus, GST could mean a significant reduction in total tax costs. It could also reduce tax disputes and litigation. Further, under the new regime, both interstate and intra-state sales will be subject to the creditable system. Earlier, interstate sales were not creditable, so the contactors sought to structure “in-transit” sales, which were questioned by the tax authorities.
In sum
The introduction of GST is a major step towards a much-awaited indirect tax reform in India. However, by deciding to exclude electricity from the GST framework, the government has missed an opportunity to design a comprehensive taxation structure for the country.
There is an immediate and urgent need for the government to address the issue. Electricity is a basic input in manufacturing, and any rise in its prices will increase inflation and decrease export competitiveness. The cost rise will also have an adverse impact on the financial health of power utilities that are already in the doldrums. Further, the discontinuation of tax exemptions and concessions will seriously affect the viability of renewable energy projects, making it harder for the country to achieve the 175 GW of green capacity target by 2022. It is thus crucial that the government rationalises the GST tax treatment for electricity.