One nation, one tax, one market – the essential ideology on which the goods and services tax (GST) is grounded is something that has been mooted for over a decade now. The regime is finally here and will be implemented with effect from July 1, 2017. Expected to be a game-changing reform for the Indian economy, GST is aimed at facilitating the development of a common market, simplifying the current indirect tax system and lowering the cost of doing business. While the benefits of GST are beyond doubt, businesses and industries across sectors are struggling to assess the impact of its implementation on their operations and plans. Renewable energy is one such sector, which has so far benefited from multiple tax exemptions in terms of concessions on value added tax (VAT) and excise duty in some states and has been lobbying hard for exemption from GST. Much to its disappointment, the government has brought the sector under the GST umbrella. As a result, the indirect tax reform through GST will likely increase renewable energy costs and pricing.
According to a study by the Ministry of New and Renewable Energy on the implications of GST on the delivered cost of renewable energy, there will be a 12-16 per cent increase in costs for grid-connected solar photovoltaic (PV) projects and a 16-20 per cent increase in costs for off-grid solar projects. It also envisages an 11-15 per cent increase in wind energy project costs. However, it is not so simple to quantify the impact. There are several aspects and perspectives that need to be considered while evaluating the real pitfalls or benefits that the new regime may bring in.
Taxes then and now
Currently, multiple indirect taxes are levied on transactions. While some of these are collected by the central government (additional duty of customs, special additional duty of customs, central excise, service tax, central sales tax, central surcharges and cess related to the supply of goods and services), others are collected by the state governments (state VAT, luxury tax, octroi, entry tax, purchase tax, entertainment tax, state surcharges and cess, etc.). However, the renewable energy sector enjoys several tax exemptions. For instance, most states levy 5 per cent VAT on solar modules. However, the actual tax rate levied in practice is zero because of the waiver on import duty and VAT in many states.
The roll-out of GST will end the current tax exemptions, subsidies and tax holidays. The new tax structure has four broad slabs – 5 per cent, 12 per cent, 18 per cent and 28 per cent – along with a cess on luxury and demerit goods. Renewable energy equipment has been classified under these slabs, with the maximum number of products falling in the 5 per cent category.
The GST rate schedule, which was announced after the GST Council meeting held on May 18, 2017, indicated a 5 per cent GST rate for renewable energy devices and spare parts. However, PV cells, whether or not assembled as modules or made up into panels, were separately included in the 18 per cent tax slab. Official confirmation from the finance ministry after the GST Council meeting laid all uncertainties to rest, confirming a 5 per cent rate for all equipment and devices.
Losses and gains for renewables
While on the surface it may appear that renewables have been given a fair treatment in the GST regime, many industry experts state that a sector that has so far enjoyed tax exemptions, has been served a tax plan that could cause a lot of pain. The impact of GST will be negative, though marginally, for both the solar and wind segments due to the increase in capital costs and thus tariffs.
The key contributors to the increase in solar tariffs after GST implementation would include an increase in operations and maintenance (O&M) costs, component costs, as well as civil work costs. The increase in solar tariffs will also vary across states. These will be higher for states such as Rajasthan and Haryana, where VAT and entry tax exemptions are currently applicable for solar equipment, as opposed to Andhra Pradesh and Gujarat where VAT and entry tax exemptions are not provided.
According to Sabyasachi Majumdar, group head and senior vice-president, ICRA, the impact of GST on capital costs for new solar projects is estimated to be limited to about 6 per cent, which would translate into an increase in the levellised cost of generation by Re 0.11-Re 0.22 per kWh for such projects. Mercom Capital, on the other hand, states that the effect of a 5 per cent GST rate on a solar project will be between 3.5 per cent and 4.5 per cent depending on certain variables unique to the projects and location. Given that solar power tariffs have declined steeply in the past four to five months to an all-time low of Rs 2.44 per kWh, an impact of this level cannot be ignored because this will imply that developers will have to incur much higher capital expenses as against the cost envisaged at the time of bidding. The winning bids in the last few tenders are a result of hypercompetition in the market, implying single-digit returns. A higher-than-assumed cost may further erode margins.
Solar project developers also expect a significant increase in costs and delays, as they need to reassess the previous cost estimates and try to renegotiate the tariffs at which they have accepted the letters of intent or signed power purchase agreements. Meanwhile, discoms that are already struggling with poor financials are not likely to give in to developers’ pleas so easily. Financiers may also not be willing to renegotiate the terms and the amount sanctioned for project development. Therefore, in the short term, more than 10 GW of ongoing utility-scale projects would be adversely hit by the new rates.
Wind power projects could have a similar story. The wind segment seems to have shifted into a higher gear, with the aim of building large wind farms and adding at least 6 GW of capacity every year for the next five years. The country’s first-ever wind power auction in February 2017 witnessed a record low tariff of Rs 3.46 per kWh. As the sector moves away from the feed-in tariff (FiT) regime to a competitive bidding mechanism, there are expectations of prices falling further. This may not happen in the short term as developers and investors absorb the impact of GST.
On its part, the government has strongly defended the cost impact of GST implementation. “Tariffs for solar projects vary from project to project. The rise (in tax rate) will be compensated by the decline in corruption and operational difficulties,” stated Piyush Goyal, minister of state (independent charge) for power, coal, new and renewable energy and mines, at a media briefing.
Given that tariffs have come down significantly in the solar and wind power segments, and tax on coal has fallen to 5 per cent, timely approval by regulators for the pass through of any higher cost incidence in renewable energy due to a change in taxation which is permitted under a change in law, remains crucial from the developers’ perspective. As far as distribution cost is concerned, the lower tax rate for coal may affect consumers as the cost to the discoms will come down, but it is difficult to say whether the discoms will reduce tariffs for consumers. Since they are already facing losses, they may not pass on the cost reductions to the consumer. For manufacturers, GST may be beneficial over the long term, as many other variable taxes will be eliminated.
From 1981, when the concept of GST was first introduced in India, to 2017, when it is set to be implemented, it has been a long journey. Now, however, another journey is set to begin. There have been innumerable assessments and clarifications on GST and its impact on various sectors, but these are speculative. The actual impact can only be assessed once GST has been rolled out. At a broader level, several uncertainties remain regarding its implementation.
First, the effective functioning of the GST Network, the IT backbone of the new tax regime, is critical for the successful roll-out of GST. Another administrative uncertainty is regarding the consequences of the overlapping jurisdiction of multiple tax authorities. Suppliers operating in multiple states are required to register in every state where they operate. In other words, taxpayers will be in the administrative jurisdiction of all these tax authorities at the same time and could be audited by any of them. This imposes a huge compliance burden on taxpayers and opens the door for selective rent seeking. Revenue impact is the third area of uncertainty. Although GST was earlier intended to be revenue-neutral, this now seems uncertain.
The impact of GST on resource allocation is another area of ambiguity since products are taxed at different rates, which would change the relative prices of these products. Products taxed at higher rates will become more expensive relative to those taxed at lower rates. If demand is price sensitive, which is the case with renewable equipment, it shifts away from products that have become relatively more expensive.
Exactly what the picture will look like a year or so down the road is difficult to predict. What is clear though is that there will be significant resource reallocation effects across sectors and geographies.
The uncertainties notwithstanding, GST will, no doubt, be a major step forward in the country’s tax reform. The flaws can be reduced over time, if not eliminated. As far as the renewable sector is concerned, in the short term, both costs and tariffs for solar and wind should increase ideally by a marginal amount only under the FiT mode.
According to Vinay Rustagi, managing director, BRIDGE TO INDIA, the GST provisions will not impact the long-term prospects of the industry as an increase in tax rates will be offset by declining costs. Moreover, with the competitive bidding regime, the impact will be subdued. In fact, on the operational front, in the long term, the industry would feel the need to reassess its procurement strategies to minimise the loss of tax credits. GST will affect how companies operate their businesses and will call for a fundamental redesign of supply chains, making it not just a tax reform but an overall business reform.
In sum, a commercially viable, non-subsidy-dependent renewable energy sector will undoubtedly be more sustainable in the long run than a subsidy-driven one.