The run up to the annual Budget is invariably crowded by industry expectations and grand wishlists from across businesses. It is even more this time considering that the last fiscal year was marred by the pandemic and the economy is yet to regain its feet. Besides, bulging fiscal deficit and muted tax collections will constrain the government’s ability to indulge in significant non-plan expenditures. Clearly, the government has its task cut out to uplift the economy and steer it back onto the growth trajectory.

Over the past year when the world was locked down, the power sector in India bore the brunt just like many other sectors. The government announced relief packages to boost infrastructure; however, the sector still grappled with several challenges to keep afloat - sluggish power demand, inadequate financing, delayed or non-payment of offtake dues by discoms to independent power producers, grid congestion, to name a few. The pandemic-induced force majeure events aggravated challenges and has had a snowball effect on the economy. While the slide is far from fully contained yet, that ought to make a compelling case for the Budget coming up with new ideas and policy support for this critical infrastructure sector.

To deliver ambitious targets for renewable installed capacity, i.e. 227 GW (revised) and 500 GW by 2022 and 2030 respectively, from current capacity of 136 GW (as of December 2020), the sector will require considerable viability funding and other tariff and non-tariff support. The Budget presents a good opportunity to provide impetus to reviving growth and investments in the sector. Key objective should be to enable better liquidity, better funding support and rationalisation of onerous tax rules that saddle the sector with burdensome compliances.

Let us look at some direct tax propositions that the government may consider to alleviate liquidity stress of power companies. For one, the prevailing thin capitalisation rule under the Income-tax Act, 1961, limits tax deductibility of interest that enhances taxable profits of the business and leads to higher tax payouts. If anything, such a rule is an anomaly for businesses which are highly capital intensive and struggle to tap on cheaper funding sources due to market competitiveness. It is therefore only fair that application of the thin-cap rule is either withdrawn or at the very least, suspended for at least 3 years. This rather simple tax policy adjustment can enable investors to freely deploy development capital with a long-term commitment to large projects.

Another constraint emerges on account of an ambiguous rule limiting lower tax withholding (5%) to select debt instruments. Such limitation forces investors / developers to resort to domestic debts even if not as cost competitive as overseas borrowings. In order to enable funding arbitrage, especially given domestic lenders’ reluctance to take project development risks that severely impact financial closing for various projects, it is imperative that the benefit of 5% tax withholding should be indiscriminately applicable to wider set of debt instruments including Compulsorily Convertible Debentures and Non-convertible Debentures issued to all classes of overseas lenders.

There is no gainsaying that long-term investments in the sector must be promoted and well facilitated. A new tax policy was introduced by the government in Budget 2020 to promote foreign investments in infrastructure projects, per which, Sovereign Wealth Fund and Foreign Pension Fund are allowed tax exemption in respect of returns arising from 'qualifying investments' (an exhaustive and rather restrictive list of eligible investee entities). In order to fully tap benefits from the said tax policy, it is important that the Budget takes this well-intentioned legislation to its logical extension by granting tax exemption to investments in non-operating / holding companies investing in downstream project special purpose vehicles (SPVs), a quintessential investment structure for infrastructure projects in India. It will further provide tax certainty if a set of operational guidelines can be released that expressly notifies all eligibility conditions linked to the tax exemption. Both such measures would augment investments in the sector.

It is quite customary for investors in power sector to hold assets in multiple SPVs for multifarious reasons such as non-recourse funding, regulatory requirement, etc. The structure however is laden with inherent business inefficiencies, e.g. cash non-fungibility, under utilisation of tax and accounting losses, duplicated tax compliance burden, etc. Introduction of ‘group taxation rule’ would permit an effective utilisation of loss and avoid cash trap at a group level, besides enabling simplified tax compliance routines for large scale platforms investing into diversified portfolio of infrastructure assets.

From the standpoint of the Goods & Services Tax (GST) levy, it has been a long standing ask of the industry to include electricity within GST laws, to enable tax optimization across the value chain as input taxes on procurements become creditable. This will also help reduce the cost of generation, and in particular, would make the renewable generation a lot more competitive, especially given the ever-falling tariffs.

These fine adjustments in the tax legislations can definitely hold out another helping hand to the power sector that continues to carry tremendous potential to contribute to the government’s larger macro-economic goals of achieving rapid infrastructure development, increasing urbanisation and rural electrification.

Views are personal. Singhania is partner, Deloitte India. Agarwal is director, Deloitte India.

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