The UPA may have set an ambitious target of 15,000 MW of fresh power capacity in 2009-10 as part of its thrust on big-ticket spending on infrastructure projects to revive the flailing economy. But a decision by the Central Board of Direct Taxes to withdraw beneficial tax treatment to power projects executed on a turnkey basis with foreign partners, ostensibly to avoid its misuse, threatens to derail investments in the entire energy sector.
Citing misuse, the CBDT last week withdrew an internal circular of 1989 that dealt with taxability of income of non-residents executing power projects on a turnkey basis involving activities carried out in India and abroad.
The move is expected to make executing infrastructure projects costlier, as the tax liability of foreign contractors will now increase. Tax experts pointed out that the decision would not only impact power projects but any infrastructure project being done on a turnkey basis, such as oil refineries, LPG contracts and even fertiliser plants.
Although the 1989-instruction was specifically for power plants, many courts of law allowed it to be used for other turnkey projects as the underlying principle was similar. ?It will affect EPC contracts, especially those in the power sector where two or more foreign companies signed an agreement with Indian entities or PSU undertakings,? summed up Sandeep Ladda, associate director, PricewaterhouseCoopers.
?This is the year of infrastructure; and foreign contractors are interested in exploring various opportunities in Indian infrastructure sector. Withdrawal will not only create uncertainty, but also increase the level of tax risk of doing business in India; and thereby, increase the effective costs of setting up infrastructure projects,? said Samir Kanabar, partner, Ernst & Young.
Under the 1989 instruction, such consortia were not treated as an association of persons (AOP) for tax purpose, and so could pay income tax at a lower rate along with enjoying foreign tax credit. It also gave out tax sops on profits from sale of equipment and materials on an FOB basis, delivered at a port outside India as well as civil work contracts executed in India and contracts for erection, testing and commissioning of machinery. Fees paid by such consortia on planning, design and engineering services were treated as technical services and were not treated as royalty income for tax purpose.
Explaining the reasons for withdrawing the instruction, the CBDT noted in a recent missive to field formations: ?The instruction quite clearly covers a specific situation in which there is actually a consortium of foreign companies. But in practice, the assessees rely on the instruction for not only the power projects but other projects as well. Further, a single project is split into various components like offshore supply of equipments or services, onshore supply equipments and onshore services? Thus, consortiumof foreign companies is not in existence but is created to take advantage of the instruction.?
Significantly, the board has not clarified from when the withdrawal is effective. Ladda said the instructions seem to be from a retrospective date.
?The CBDT has clarified that the withdrawal of the instruction will not in any way prejudice the plea of the income-tax department, in any appeal, reference or petition, and it will not apply to a particular case on the given facts, even though it was in force at the time of making the assessment,? he pointed out.