Hydropower projects encounter troubled sales tax waters

MUSHTAQ GHUMMAN

ISLAMABAD: The federal government is likely to grant blanket exemption from levy of billions of rupee sales tax on construction and related services for hydropower projects being constructed under the China Pakistan Economic Corridor (CPEC) arrangements, well-informed sources in PPIB told Business Recorder.

China Three Gorges South Asia Investment Ltd (CSAIL), a subsidiary of China Three Gorges Corporation, currently developing two hydropower projects in Pakistan, which are under the CPEC ie 720 MW Karot Hydropower project and 1124 MW Kohala Hydropower project, has approached PPIB for resolution of sales tax issue which, according to the firm, is the most critical impediment hampering the progress of hydropower projects by CSAIL under the CPEC.

The following hydropower projects were included in the list of prioritised projects in the CPEC agreement: (i) 870MW Suki-Kinari Hydropower project; (ii) 720MW Karot Hydropower project; and (iii) 1100MW Kohala hydropower project. The sources said, out of the three hydropower projects two projects ie Karot and Kohala, are being developed by CSAIL through its two Special Purpose Project Companies ie Karot Power Company Limited (KPCL) and Kohala Hydro Company Ltd (KHCL).

Karot Project is located in province of Punjab & AJ&K and Kohala Project is located in AJ&K. KPCL has started construction activities of Karot Project from its own equity and it is expected to achieve Financial Close by end December 2016. The development of Kohala Project is also moving at a fast pace and it is expected to achieve a Financial Close by December 2017.

As per Article 4 of CPEC Agreement the GoP committed the following: "Pakistan agrees to offer the most preferable conditions in terms of taxation ..." Provincial Sales Tax was levied by the provincial governments & AJ&K on services (specifically on construction services @ 16% in July 2015 by AJ&K and in July 2016 in Punjab) in their territorial jurisdiction.

Sales tax levied in AJ&K, Punjab and other provinces can be claimed as input sales tax by adjusting against the output tax after the Commercial Operations Date (COD) - in case of AJK-based project after 5 years of the COD as sales tax is exempt for first 5 years after COD in AJK - or a refund claim can be lodged with Federal Board of Revenue as per the provisions of the Sales Tax Act, 1990.

Under sales tax special procedures rules 2007, the output tax on electricity produced shall be charged on Energy Purchase Price (EPP) component of tariff at the prevailing rate after the COD, while there is no sales tax applicable on Capacity Purchase Price (CPP). The EPP is almost 4% of the total tariff and output tax will be insufficient to adjust the input sales tax paid on construction and operations. The following working will clarify the impact on Karot project in case company decided to claim the sales tax paid after the COD:

Sales tax on EPC contract is estimated at $171.96 million (to be paid during construction period of five years), output sales tax of 1-30 years would be $124.28 million per year based on EPP and input sales tax on O&M for 1-30 years of $74.57 million. The sources said, it is clear that sales tax paid during the construction period cannot be recovered even in the concession period of 30 years and $122.25 million will still be the shortfall. This working does not account for the impact of time value of money otherwise the shortfall would become even worse than the above number.

The sources further stated that keeping in view the issue of unadjusted input tax (during construction period & operations period) the only option as per the provisions of the tax laws is to submit a refund claim with FBR. As per the ground realities, it involves a rigorous follow up by the claiming company, complex procedures with FBR and unnecessary delays by tax department, which make it very difficult to get the refund that could result in serious cash flow problems for the project company.

EPC stage tariff was determined by NEPRA for Karot on April 27, 2016 without incorporating the financial impact of sales tax. Karot has already released mobilisation advance (10% advance payment) to the Engineering and Construction (EC) Contractor for preliminary activities and financial close was targeted for December 28, 2016. Sales Tax was not charged by EC contractor on advance payment, however, FBR issued an order to Karot to deposit Rs 345 million as sales tax on advance payment not charged by the contractor. The matter is currently under litigation.

Three Gorges claims that Karot project was required to achieve financial close by December 28, 2016 as per the Letter of Support (LoS) issued by Private Power & Infrastructure Board (PPIB). However, owing to levy of Sates Tax, the project cost has increased by around $172 million, which will be difficult for shareholders and the lenders to arrange.

"Even if the company somehow manages to get the financing for the additional cost, the ground reality is that the refund process takes much time and only the actual amount paid as Sales Tax is refunded after a long delay and so the financing cost of this huge additional cost would have to be borne by the project company, in any case, and the company could face serious cash flow problems," the sources quoted Three Gorges as saying.

The KHCL is currently finalising the EPC contract, and will be submitting EPC stage tariff petition to the CPPA-G/ NEPRA shortly. The company has decided that the sales tax will be made part of the EPC cost in the EPC Stage tariff petition in order to get it as part of tariff.

Three Gorges further stated that sales tax paid during the construction period cannot be recovered even in the concession period of 30 years and there will still be a shortfall of $104.60 million. The working does not account for the impact of time value of money otherwise the shortfall would become even worse than the above number. Moreover, it may also be noted that if NEPRA does not allow this cost in the tariff then KHCL would face similar difficulties as KPCL is facing right now.

The sources said, Chinese have argued that in order to give relief to the project companies involved in development of hydropower projects under CPEC agreement and to simplify the matters, specific exemptions may be given by Government of Pakistan from levy of Sales Tax on construction and related services in view of article 4 of CPEC Agreement and the huge financial implications of the Sales Tax on the viability and finance-ability of these projects

There is a recent precedence available in the matter wherein the Government of Sindh on February 26, 2016 has exempted whole of the tax on the services in respect construction services (including turnkey projects) in case of Thar coal based power projects.

The sources said, hydropower projects under CPEC are also based on indigenous resource like that of Thar coal based power projects and article 4 of CPEC Agreement also states the following: "Pakistan party agrees.....that such preferable conditions given to Chinese investor will not be inferior to those to any third country, under the applicable power policies"

"We believe that since the government has already given certain exemptions to Thar coal based power projects, so not giving the same or similar exemptions to hydropower projects under CPEC agreement would be against the letter and spirit of the CPEC agreement," the sources quoted Three Gorges as saying in its letter written to the MP PPIB.