Legal Regime: Existing contractual framework and impact of GST

Existing contractual framework and impact of GST

Electricity being a concurrent subject in India, both Parliament and the state legislative assemblies can legislate on it. Currently, electricity generation and supply are regulated under the Electricity Act, 2003, which aimed to establish a licence-free generation regime, set up independent regulatory commissions at the central and state levels, reduce government interference in the sector and introduce measures conducive to the development of the industry. In pursuance of this act, the Central Electricity Regulatory Commission (CERC) and the state electricity regulatory commissions (SERCs) were established to regulate the tariff of generation companies as well as other licensees. While the CERC is responsible for the tariffs of central government companies and interstate tariffs, the SERCs are responsible for tariffs pertaining to intra-state sales. The renewable energy industry too is governed directly by the laws and regulations applicable to the power sector.

Contractual framework

A typical renewable energy project involves the interaction of various organisations with each other at multiple levels. The contractual framework for such projects broadly comprises financing agreements with the lenders, equity injection contracts with the promoters, power purchase agreements with offtaker companies, operations and maintenance agreements, land lease agreements and engineering, procurement and construction (EPC) contracts. Of all these, EPC contracts are the most varied and hence face the most scrutiny.

EPC contracts

EPC contracts can be broadly classified as turnkey contracts, under which a contractor completes a project and hands it over in a fully operational form to the client; and split contracts, under which the client engages different organisations to complete different parts of the project. Split contracts include offshore supply contracts, onshore supply contracts, works contracts, service contracts and wrap/ umbrella contracts. Earlier, different contracts used to attract different taxes, but now, with the introduction of the goods and services tax (GST), most EPC contracts will be taxed only under the GST regime.

EPC contracts face significant challenges as far as their formulation and implementation are concerned. These contracts must clearly outline the specifications of the project, including the cost of components, electrical balance of plant, balance of system costs and grid connection costs. In addition, EPC contracts must specify the owner’s responsibilities, including obtaining upfront regulatory and land clearances, and right of way for internal transmission lines, approach roads, etc.; setting up transmission and interconnection networks (including approvals) prior to testing and synchronisation; and providing water and electricity connection points at the site during construction. Further, the contract must state the specified milestones and scheduled commissioning date, extension of time in certain cases, specified milestone payments and stage of title transfer, and risk transfer. EPC contracts must explain the performance and technical parameters and testing procedures to be followed. This should include the compensation to be paid by the contractor in case of failure on its part to comply with the prescribed standards as well as the contractor’s rights to rectify and perform retests. EPC contracts must be carefully drafted, taking into account these parameters as they are vital to the contractual framework of any project.

Impact of GST

The new GST regime will have a significant impact on the structuring of EPC contracts. Despite electricity itself being outside the GST regime, taxes on capital goods, inputs and services have been subsumed under GST. GST on solar equipment (renewable energy devices, solar power generating systems), and photovoltaic cells has been set at 5 per cent. Taxes like countervailing duties and special additional duties would be subsumed in GST, and only basic customs duties and GST will apply to imports of components such as solar modules. The existing EPC contracts will have to be redrafted to take into account GST-related changes, and the clauses in the existing contracts dealing with taxes will need to be reworked.

Future outlook

The legal regime for the renewable energy sector, while being fairly complex, is robust and transparent. The implementation of the GST regime, greater standardisation and better drafting of EPC contracts will further strengthen industry operations. However, the introduction of GST may have cost implications for renewable energy companies in the short run due to both the reworking of existing contracts and the loss of tax exemption that was available under the earlier indirect tax regime. In the long term, however, when companies get used to the GST regime and new policies on tariffs and competitive bidding are in place taking into account the GST regime, the sector can expect more streamlined functioning and sustainable growth. n

Based on a presentation by Pallavi Bedi, Partner, Luthra and Luthra