About GST & its Purpose

Goods and Services Tax or GST was implemented in India on July 1^st, to replace multiple central and state taxes and to bring a better uniformity in the overall indirect tax structure. Its intention is to smoothen the way business is done in India. The implementation of GST intends to improve the competitiveness of Indian goods and services in the international market and increase exports.

Implemented from the 1^st of July, GST is said to be the biggest tax reform in the history of independent India and has taken almost 18 years to be passed after it was first proposed in 1999 by the Vajpayee government. The new law is expected to help the overall economic growth as it will sharply reduce transaction costs while dramatically increasing tax compliance. A non-profit organization Good and Services Tax Network (GSTN) has been formed where returns and payments have to be filed. The complete movement of all tax related information and payments will considerably increase the government’s ability to crack down on tax evasion. The people of India are trying to adjust to the new scenario with challenges in compliance and implementation, but hope for more clarity with the passage of time.

Rate of GST on Renewable Energy

GST has been imposed uniformly on most goods and services barring a few that are exempted. The rate of tax also varies in between four tax slabs – 5%, 12%, 18% and 28%.

It is therefore natural that the booming renewable energy sector in India also comes under the scope of GST. However, to maintain the attractiveness of the sector and to encourage further installations, the government has wisely put the solar and wind sectors in the 5% tax bracket.  This is a sensible move as renewable energy needs to be actively promoted by the government in order to meet its climate change commitments under the Paris agreement. Besides helping fight pollution, renewable energy also has a key role in reducing massive fossil fuel imports and improving India’s overall energy security situation.

Taxes on consumption or sale of electricity are exempt from GST. Hence, electricity generated from renewable energy sources would continue to be taxed by the respective State government. However, taxes on various capital goods and input services (capital cost and operation & maintenance costs) used for generation of renewable energy will fall under the GST regime. GST paid on the input side (eg. on procurements) would form part of the cost which cannot be offset against electricity duty.

Most other renewable projects and equipment including wind mills, waste to energy plants, tidal energy plants and bio-gas plants and even solar power based devices or generating systems have been classified under the 5% rate bracket.

Renewable energy developers had earlier expected total exemption from GST, but given the falling tariffs and improving dynamics of the sector, the government expects the sector to be self-sustainable on its own very soon. Hence it chose the lowest tax bracket for various solar and wind components such as:

1) Solar water heater and system

2) Renewable energy devices & spare parts for their manufacture:

a) Solar power based devices

b) Solar power generating system

c) Solar lantern/solar lamp

d) Wind mills and wind operated electricity generator

However, for very small installations in the residential sector of 100 kW in size, solar inverters will attract 28% GST. Similarly, services provided by wind equipment manufacturers (engineering services) to set up projects for developers will fall in the 18% tax bracket (up from 12% earlier). Also, solar projects involving civil and works contracts will be taxed at 18%.

You can check out  MNRE explaining the tax structure for solar and wind – both for grid connected and off grid systems.

Impact of the new GST Law

Renewable energy is a sector which has so far been benefiting from numerous tax exemptions. Earlier solar components including solar modules were subject to concessions on value added tax (5% VAT which was ultimately waived off in many states) and exemptions from excise duties in most states. The new tax regime imposes a 5% GST on solar components.

The Wind and solar equipment were subject to a VAT of 5% and service tax on erection and construction services were 15%. After the implementation of GST, equipment would attract a 5% GST, whereas services would be subject to 18%.

As a result, capital costs and tariffs of various renewable energy projects are expected to increase. However, Mr. Piyush Goyal has reassured that a smooth transition process will be followed which will grant additional savings for the developers.

In contrast to solar and wind going up from 0 to 5%, the taxes on coal have come down from 11.69% to 5%. The government’s intention to put coal at par with solar proves that the country is moving towards grid parity.

Who will bear the Additional Cost

The companies would need to revisit their procurement strategies to minimize the loss of tax credits. It is expected that any increase in cost would be passed through to the buyer. A buyer can claim input credit of GST, once the same tax has been paid by the supplier. But given the complexities of power purchase agreements, DISCOMs will be reluctant to hike tariffs given that auctions are already happening at record-low levels and many states are facing a situation of power surplus. As a result of the imposition of GST, tariffs will increase but this will vary from state to state. For example, solar equipment was earlier exempt from VAT an entry tax in Rajasthan and Haryana but would be taxable now.

Solar bids have reached levels as low as INR 2.44 per unit while wind power is at INR 3.46 per unit, but this has resulted in single-digit returns. A higher cost as a result of GST may further erode margins in the short term.  However, falling input costs are expected to neutralize the effect of GST on prices over the long term.

Missing Clarity on GST

There are many other small components required in a solar and wind power plant installation which has not separately been identified by the Indian government for the levy of GST. The clarity is still missing for the renewable energy sector.

According to a tweet by the Revenue Secretary, Dr Hasmukh Adhia, all solar equipment and its parts would attract 5% GST only.

All solar equipments and its parts would attract 5% GST only https://t.co/Dqcq2IctOQ

— Dr Hasmukh Adhia (@adhia03) May 28, 2017

Though GST will be applied to solar modules at a concessional rate of 5%, operational clarity for other capital goods used in solar projects is still lacking.

There is confusion in regards to the taxability of goods because many of the same components that go into a renewable energy project like cables, meters and the steel structures are taxed at higher rates (classified under the 18%-28% tax slab) for use in other industries.

For example, transformers used for solar projects are intended to be taxed at 5% but they are taxed at 18% for other applications. The developers are also not clear about how to claim the concessional 5% GST rate.

MNRE, as well as the finance ministry, need to come out with a mechanism to clear the air and resolve these vexing issues. In the absence of any specific notification for solar projects, capital goods such as inverters and module mounting structures will come under the 18% tax bracket whereas, cables and batteries will attract 28% tax.

Effect of GST on Prices of Solar Components

The proposed GST is expected to have an impact on over 10 gigawatts of solar energy projects. Project costs are expected to go up by 4%-5%, which seems reasonable given the drastic price fall in the Indian solar price (solar tariffs have dropped to as low as INR 2.44 per unit, becoming cheaper than the thermal tariffs). It is, therefore, expected that the tax structure will not have a significant adverse effect on the Indian solar industry. However, if only modules are taxed at 5% and other capital goods are taxed at rates between 18%-28%, the expected increase in total EPC cost would be around 6%.

An increase in operations & maintenance costs (O&M), components costs and civil work costs is expected, as a result of the imposition of GST. There might also be some issue around debt financing, refinancing and financial closure due to GST. The biggest negative impact of the price escalation may be on lenders unwilling to fund extra costs and projects getting canceled thereof.

Developers also fear that with prices becoming slightly higher, competition from the Chinese counterparts will further intensify. The prices of solar panels have hardened in the recent months with Chinese demand remaining strong as well as pull in from demand in the USA. Developers are stocking up on solar panels as higher solar import duties may be imposed in September due to the Suniva petition. This might, in turn, affect the profitability of the Indian solar developers who are already bearing the brunt of falling solar tariffs.

But given the rise in prices to be very insignificant in the long run and the improving dynamics of renewable energy in India, all these adverse effects should be transitory. There is almost no risk that India will not meet its 40% renewable energy capacity target by 2030. In fact, given that solar prices are expected to keep falling due to improving technology, the country might considerably exceed that target.

Effect of GST on Solar Operations

A little slack can be expected on the operational front as developers might have to look for additional funding for projects under construction, which might lead to delays in project completion.

As mentioned earlier, developers might face a tough time arranging for extra funds and might not be able to complete their projects on time. However, I doubt that given the rising popularity of solar in India and improving the price-performance ratio. The sector I feel that could be the most adversely affected is the residential rooftop solar sector in India. The rooftop segment has already been struggling to manifest in India. Various government schemes and policies to incentivize this segment have also failed to push growth in this segment.

Now additional price pressures in the form of GST could negatively impact the installation of solar rooftop on homes. India is a highly price sensitive market and given that a majority of Indians belong to the lower income strata, I foresee a lull in this segment.

Conclusion

MNRE is still working with the Ministry of Finance to come out with guidelines on improving the clarity regarding the imposition of GST in the renewable energy segment. India has set a mammoth target of installing 175 GW of renewable energy power by 2022 and has also made significant progress in this direction. The government would not want to slow down that pace as a result of GST. Almost 10 GW of India’s pipeline solar capacity will be impacted by an increase in indirect tax rates under GST and lack of clarity adds to the complexity.

Project delays, risk of litigation between project developers and DISCOMs and a slowdown in the rooftop solar market, are expected in the near future. Both costs and tariffs of wind and solar would increase over the short term. In the long run, GST provisions will not impact the long term prospects of the renewable energy industry. Any increase in tax rates will be offset by declining costs and as a result, GST will not have any material negative impact on the growth prospects of the industry.

In the long-term, the GST’s impact is likely to be evened out by falling costs. “We don’t need support of lower taxes to encourage renewable energy,” Goyal said on May 19. The Renewable Energy sector in India will also benefit from a faster growth in the Indian economy which will increase the overall demand for the Renewable energy ecosystem. The solar industry in India will face some short term pain but will gain in the long run.

Note: The article is written by me and was originally published in a leading renewable energy magazine in India, SmartEnergy. You can read the article on Page no. 44