Fiscal approaches and tax breaks for energy conservation

a Energy Conservation Act

Recognising the considerable loss of energy due to various reasons narrated above, the Central Government enacted a Energy Conservation Act, 2001.

The provisions of this Act regarding Designated Consumers provide for the following:

• notifying energy intensive industries and other establishments as designated consumers.

• establishing and prescribing energy consumption norms and standards for designated consumers.

• directing designated consumers and energy intensive industries to get an energy audit conducted by an accredited energy auditor in the specified manner and intervals of time.

• directing designated consumers to furnish information with regard to energy consumed and action taken on the recommendation of the accredited energy auditor to the designated agency.

• directing designated consumers to designate or appoint certified energy manager in charge of activities for efficient use of energy and its conservation.

• directing designated consumers to comply with energy consumption norms and standards.

• directing designated consumers who do not fulfill the prescribed energy consumption norms and standards to prepare and implement schemes for efficient use of energy and its conservation.

b Energy Audit

Due to a fall in the production in oil and natural gas in India, the rising petroleum pool deficit and the need for more energy, the use and conservation of energy in industry is being studied.

Studies by a Commission of the International Chamber of Commerce on Energy (”ICC”) disclosed an interesting aspect of industrial energy conservation. In the chemical, cement and steel industries, a remarkable reduction in energy consumption in absolute terms has taken place since 1974. The reduction in energy consumption in absolute terms has taken place since 1974. The ICC survey reveals that the reduction in energy consumption has been mainly brought about by existing capital equipment and minor substitution methods, and not by major plant replacements. This was accomplished in the countries surveyed by raising plant efficiencies, changing processes, lowering simultaneous loading (maximum demand), and flattening the load demand curve through the introduction of ”off peak rates”. In India, similar steps are greatly overdue.

One of the fiscal approaches that has resulted in the dramatic reduction in energy consumption is the energy audit. Energy wastage and inefficiencies cannot be revealed completely in industrial plants without energy audits, which are now regularly performed in the developed countries of Western Europe, and in Japan and United States.

Like financial audits, energy audits are invariably carried out by independent consultants who also involve plant employees with the various phases of the audit. Theoretically, the audit has the effect of creating energy consciousness, as has been the case in European, Japanese and US firms. A good audit firm also creates systems for their clients to measure and monitor energy utilisation.

In a typical energy audit, the auditing firm first proceeds to collect the basic data with the assistance of a liaison officer. The team proceeds to record plant consumption, to determine the manufacturing processes followed by the plant staff, and thereafter to analyse the data collected in order to make a preliminary assessment of actual performance against the performance that is feasible as a result of alterations and minor layout changes on the basis of the existing plant facilities. The term finally proceeds to asses the energy savings in financial terms which can be brought about on a minimum expenditure basis by utilising the existing plant facilities.

An economic analysis is prepared for the client that calculates the expenditure against savings. In the case of reasonably well-run firms, the savings range from 10 % to 15 % of the total annual energy expenditure.

In India, energy audit needs immediate encouragement. It is essential to improve energy efficiency. Energy audit should be on a voluntary basis. At present, the cadre of trained energy auditors in India is almost none or negligible. Furthermore, the mandatory approach may degenerate into a costly formality.

Energy audit is essential to identify critical areas of inefficient energy use and to suggest remedial measures. It will be in the long term national interest to organise consultancy firms of energy auditors. For this purpose, even the help of foreign experts may be taken, at least in the initial stages. To encourage the establishment of such auditing firms, foreign technicians employed by them may be treated as technicians for the purposes of the Income-tax Act 1961 (IT ACT) [Sec 10(5B) of the IT Act]. The new energy audit firms may be treated as innovative units and may be given total tax exemption in respect of their income for the first five years.

c Management: foreign technicians

To accelerate the tempo of energy development, foreign skill in sophisticated technological fields is urgently needed. Section 10(5B) of the IT Act provides attractive tax benefits for ”foreign technicians”. In the case of technicians for whom an Indian employer pays tax on the whole remuneration, the tax paid by the employer is not treated as income of the technician; there is no tax on tax. This exemption is available for a period of 48 months from the date of employment.

The term ”technician”, as defined in the IT Act (Explanation to Sec. 10(5B) of IT Act.), includes experts in the generation of electricity or any other form of power. Experts in energy or power distribution, as distinguished from generation, are not treated as technicians. Similarly experts in energy or power management have also been excluded from the definition of a ”technician”. The present provisions of the IT Act were drafted at a time when energy conservation was not considered as important as it is today; hence, the existing definition of a technician also does not include experts in the conservation of electricity or any other form of power.

It is necessary to amend Section 10(5 B) to include experts in the conservation of energy. (In fact, the phrase ”electricity or any other form of power” is now outdated and it needs to be substituted by suitable phraseology to cover the wider concept of energy and all other forms of power). It is also desirable to include experts in energy distribution and energy management in the definition of technicians so that wherever necessary foreign expertise can be used to reduce transmission losses and to revamp energy management in Electricity Boards and similar energy authorities.

Indeed, to avoid frequent amendments to the definition of ’technician”, the IT Act confers a power to the Central Government to notify (explanation (iii) to Sec.10(5 B)) in appropriate circumstances some new fields in which experts can be treated as technicians; if they satisfy all the conditions. This will enable a tax free salary for a period of 48 months for them. The government should use this power liberally and notify experts in the following fields as technicians:

• experts in the distribution (as distinguished from the generation) of power;

• experts in energy management;

• qualified energy auditors; and

• experts in the education of, and the training in, energy conservation.

d Modernisation

There is an urgent need to modernise boilers, to update furnace deign, to adopt heat recovery methods and to install adequate instrumentation to improve efficient energy use in industry.

For this purpose, the Economic Administrative Reforms Commission (Report of the Economic Administrative Reforms Commission 1984) had advocated the approach of liberal rates of depreciation. The Central Government has accepted this approach. The attractive rates of depreciation provide for energy conservation devices and equipment are discussed later.

e Research and Development

All revenue and capital (excluding price of land) expenditure incurred on in-house research are allowed as deductible expenditure under the IT Act (Sec.35 of the IT Act). An amount equal to one and one fourth times any sum paid to a university or government approved research institution is also deductible. The authority to grant approval is the Director General (Income Tax Excemption) in concurrence with the Secretary Department of Science and Industrial Research, Govt. of India. Even a lump-sum payment to a private researcher for exclusive research has been allowed by the Delhi High Court (Crescent Capacitators v. CIT. (1984) 149 ITR 285 (Delhi). These liberal provisions should be availed of especially in respect of expenditure incurred on research in the field of energy conservation.

To reduce the substantial losses in the generation of energy, there is a need for continuous innovation. A newly developed device known as the Magneto Hydrodynamic Device (”MHD”) reduces energy loss to 35 % [Roughly 70 % of the energy is lost when coal is burnt in a thermal power plant [see paragraph 2]. It is suggested that when an innovative device like MHD is used for the purposes of energy generation, it should be fully depreciated in the year of installation. The same concessional approach should apply to other new or novel methods to achieve energy efficiency.

f Education and training

Workers and supervisory staff in a factory should be educated about energy loss and trained in methods of energy saving. Those conscious of the importance of energy conservation and skilled in the techniques of energy saving can make a perceptible difference in energy consumption patterns.

g Foreign participation

(i) Foreign collaboration in the manufacture of energy-saving devices is welcome if it conforms to approved norms and is conducive to achieving technical efficiency and lower production costs. Foreign partners can either supply technical know-how or advice, or provide foreign currency finance either in the form of investment or loan.

Royalties, technical service fees, dividends and interest received by foreign companies or other non-residents are taxed on a gross basis without deductions.

India has expanded its treaty network considerably after 1976. The IT Act makes a provision (Sec. 90 of the IT Act as amended by the Finance Act 1991) that if the tax regime under the IT Act is more beneficial as compared to the regime under a tax treaty, the more beneficial tax regime (that is, the one under the IT Act) will be applicable. Conversely, Indian courts have also ruled that if the provisions of the tax treaty are more favourable as compared to the provisions of the IT Act, the provisions of the tax treaty will prevail (CIT v. R.M. Muthaiah, (1993) 202 ITR 508 (Karnataka High Court)).

Income tax is levied at the following concessional rates:

• royalty and technical service fees 20 % [Sec. 115 A of the IT Act as it stands after its amendment by the Finance Act 1997].

• interest 20 %

  In some specific Double Taxation Avoidance Agreements (e.g. with Germany) rates provided for royalty, fees for technical services and interest are as low as 10 %.

• dividends paid by domestic companies on or after 1 April 2003 are exempt from tax.

No surcharge is payable on income tax calculated at the above rates. The rate of tax on income tax from sources other than royalty, technical service fees, interest and dividend of a foreign company is 40 %.

(ii) Foreign companies and non-resident individuals can participate in India’s energy projects, including the manufacture of energy saving devices, by forming an Indian company. In fact, this is a more desirable approach from a long term perspective.

It may be useful here briefly to note the provisions of the Companies Act 1956 (”CA”) for the formation of an Indian company.

According to the CA, the following number of persons are required to subscribe their names to a Memorandum and Articles of Association.

• for forming a public company: seven; and

• for forming a private company: two.

It is not necessary that the subscribers should have any personal beneficial interest in the shares subscribed by them. All of them may be nominees of a single person (such as another company including a foreign company). The subscribing of their names may be a mere formality. [Saloman v. Saloman (1897) AC 22 (HL)]; because the Indian Companies Act is based on the UK legislation, the House of Lords’ decision is highly persuasive.

A partnership firm is not a judicial person. It cannot sign the Memorandum of Formation of a company. The Registrar of Companies will not accept the signature of the firm as subscriber. [Dunster’s case (1894) 3 Ch. Appeals 473].

According to Company Law Board’s instructions (Circular No. 128/HCC/64 dated 27 July 1964), an agent may sign a Memorandum of Formation of a company on behalf of a subscriber if he is authorised by power of attorney to do so. Non-residents cannot be subscribers to the Memorandum or the Articles of Association of a company without the general or special permission of the Reserve Bank of India (”RBI”) as per the provisions of the Foreign Exchange Regulation Act 1973 that also indicate that without the RBI’s permission even resident foreigners cannot be subscribers.

Under India’s New Industrial Policy, 51 % foreign equity participation is automatically permitted by the RBI. Automatic permission is given within 60 days of the application providing the requisite details and compliance with the prescribed parameters.

(iii) Energy services companies

The Confederation of Indian Industry (CII) is in talks with multilateral lending institutions Asian Development Bank and USAID, as well as ICICI Bank for setting up Energy Services Companies (ESCOs). The ESCOs would fund energy conservations measures, such as purchase of energy conserving equipment.

According to sources, one of the main reasons why companies are not coming forward to implement energy conservation measures is the absence of funding mechanisms. The ESCOs are meant to fill this gap.

Mr R.S. Mani member, Energy Efficiency Council of CII, told the press that the ESCOs will provide venture capital for taking up energy conservation measures.

h Higher depreciation

To encourage energy conservation, depreciation rates on energy saving devices used in business have been raised to 100 %, by amending the IT rules by an amendment dated 2 April 1983, effective from the assessment year 1984–85. The assets for which the depreciation allowance is allowed at 100 % of the written down value are noted below.

Energy-saving devices, being:

(i) Specialised boilers and furnaces:

• Ignifluid/fluidised bed boilers

• Flameless furnaces and continuous pusher type furnaces

• Fluidised bed type heat treatment furnaces

• High efficiency boilers (thermal efficiency higher than 75 % in case of coal fired and 80 % in case of oil/gas fired boilers).

(ii) Instrumentation and monitoring system for monitoring energy flows:

• Automatic electrical load monitoring systems

• Digital heat loss meters

• Microprocessor-based control systems

• Infrared thermography

• Meters for measuring heat losses, furnace oil flow, steam flow, electric energy and power factor meters.

• Maximum demand indicator and clamp on power meters

• Exhaust gases analyser

• Fuel oil pump test bench

(iii) Waste heat recovery equipments:

• Economisers and feed water heaters

• Recuperators and air pre-heaters

• Heat pumps

• Thermal energy wheel for high and low temperature waste heat recovery

(iv) Co-generation systems:

• Back pressure pass out, controlled extraction, extraction-cum-condensing turbines for co-generation along with pressure boilers.

• Vapour absorption refrigeration systems

• Organic rankine cycle power systems

• Low intel pressure small steam turbines

(v) Electrical Equipment:

• Shunt capacitors and synchronous condenser systems

• Automatic power cut off devices (relays) mounted on individual motors.

• Automatic voltage controller.

• Power factor coller for AC motors

• Solid state devices for controlling motor speeds

• Thermal energy efficient stenters (which require 800 or less kilocalories of heat to evaporate one kilogram of water)

(vi) Burners:

• 0 % to 10 % excess air burners

• Emulsion burners

• Burners using air with high pre-heat temperature (above 300[o] C)

(vii) Other equipment:

• Wet air oxidation equipment for recovery of chemicals and heat

• Mechanical vapour recompressors

• Thin film evaporators

• Automatic microprocessor based load demand controllers

• Coal based producer gas plants

• Fluid drives and fluid couplings

• Turbo chargers/super chargers

Previously, energy-saving devices were not treated as separate items but were grouped under the general category of plant and machinery and could only qualify for the depreciation rate of 15 %.

At present, Rule 5 of the Income tax Rules has been specifically amended to allow energy-saving devices to claim a depreciation rate of 100 %. This liberal depreciation allowance has been extended to include plant and machinery installed for the manufacture of energy-saving devices.

The above provision has the effect of allowing energy-saving devices to be entirely written off in the year of installation.

The tax laws are also liberal in the matter of utilisation of the internal funds resulting from these depreciation allowances. There are no restrictions on such funds; they may be used either for capital formation or for dividend distribution, and need not be retained as reserves.