Ratna Sansar Shrestha
The financial issues in the context of hydropower development from the private sector’s perspective can be broadly categorised into tax issues (revenue stream for HMGN Treasury) and non-tax issues.
3.1 REVENUE STREAM FOR HMGN TREASURY
Inviting private sector to invest in hydropower development is tantamount to allowing a person (both natural and otherwise) or a group of persons with spare funds or those who can mobilise/raise fund to exploit Nepal’s national resource for profit. An investor cannot be blamed for trying to recover his investment and earn a decent return thereon because the investor deserves to profit for risking his own fund in a hydropower project or to profit from his effort of mobilising/raising fund from those who can spare it for the purpose of exploitation of Nepal’s water resources. No one will bother to invest if there is no hope for any return.
However, if such investor has used fund (own or borrowed) for the purpose then Nepal also has allowed him to use its national resources. In other words Nepal invests its national resources in partnership with the developer, in the lines of a joint venture. Allowing private sector to exploit Nepal’s hydropower potential is in no way similar to allowing them to set up a factory.
Therefore, the profit must be shared between the investor and the nation if not equally, then it must be shared equitably; as revenue stream for HMGN Treasury, interest for the Lenders and residual profit without having to pay income tax for the developer. However, such profits to the investor, revenue for HMGN, etc. will affect the fixation of or negotiation for the rate of tariff as the tariff agreed will depend on the cost of production to the developer and a decent margin to cover for overhead including what he has to pay the government as taxes and his own profit. This is the social engineering facet of hydropower development, dealt with in the preceding pages somewhere.
There are a number of forms in which HMGN shares in with the investors like, royalty, export tax, import duties, value added tax, etc. The hydropower development policy has categorically exempted an investor from income tax for ever for a plant of up to 1,000 KW capacity and for the first fifteen years of commercial operation for plants with capacity of more than 1,000 KW. Even after the first fifteen years income tax gets levied at a rate lower by 10 percentage points than the rate prevalent at that time in the case of plants with capacity of more than 1,000 KW.
A developer pays royalty into HMGN treasury for being allowed to exploit the nation’s natural resource. Present hydropower development policy has two-tier royalty rates. The first tier for the first fifteen years from the date of commercial production and the second thereafter.
No royalty is levied on hydropower projects of up to 1,000 KW capacity pursuant to clause 4(f) of the published policy. However, there is no direct articulation to this effect in the Act except that Section 3 of the Electricity Act states that no license is required to develop a plant of the capacity of up to 1,000 KW and under Section 11 only a licensee is required to pay royalty as such. The recent policy decision of waiving the requirement of license to develop projects of up to 10 MW capacity of the new government has ramifications on HMGN’s royalty income due to this very reason.
There is a huge debate as to whether there should be different royalty for project generating electricity for domestic consumption versus export purposes. Electricity generated for domestic consumption enhances value to the country’s economy, as it is a catalytic agent for further development. It helps Nepal in many ways for all round development as electricity triggers industrial development, development of communication and transportation, production of implements and fertilisers for enhancement of agricultural production, electrification of each and every village resulting in emancipation of the rural populace from darkness and so on and so forth - all of which helps increase the standard of living of the common Nepali. Therefore, this group of people advocates that royalty should be different for export oriented hydropower plant from that of a project built for domestic consumption.
Royalty paid by a developer goes into the national treasury; co-operation at the local level is not easily forthcoming, as they do not stand to benefit from the project directly. Therefore, it is being strongly felt that arrangement should be made in the legislation to have certain portion of the royalty paid to HMGN to go to the local level. Sometime back HMGN had announced a policy that 2% of the electricity produced should go to the local level. However, no changes have been made in the legislation in line with such an announcement.
3.1.2 Import Duties
Many in the hydropower sector have perceived (or taken it for granted) that hydropower projects are entitled to exemption of import duties (except for 1% custom duty) on all of its imports (all equipment and materials) and many still continue to do so; the phrase “import duties” here is being used to denote all taxes and duties that are levied on imports like, custom duty, VAT (previously sales tax), etc. However, HMGN has been granting and is prepared to grant such exemption of import duties (alternately also called import duty facility) only on plant, equipment and machinery (including spares thereof not exceeding 10% of the original cost of the plant, equipment and machinery) necessary for construction of the plant during the construction phase of the Project in accordance with the Sub-Section (7) Section 12 of the Electricity Act, 2049, promulgated in December 1992. This means non-availability of import duty exemption facility on the imports of non-construction equipment (vehicles, communication equipment, office equipment, etc.) and all materials, including the construction materials. Following table lists different taxes and duties attracted or not attracted by various imports:
This issue entails additional cost of 2.52% of the total project cost to a developer (having to pay full custom duty instead of at the rate of 1% and full VAT on materials, non-construction equipment and spares thereof).
188.8.131.52 Correct Interpretation
This calls for close examination of this controversial Section. Following is the verbatim excerpt of the English translation of the Sub-Section (7) Section 12 of Electricity Act, 2049 published by EDC in January 1993:
(7) Customs duties and sales tax shall be levied as per the prevailing schedule for import of construction equipment, machines, tools and equipment required for repair and maintenance as well as the spare parts thereof for hydro-electricity generation, transmission or distribution which are produced and sold by local industries. Only one (1) percent customs duties shall be levied for the import of materials, which are not produced in Nepal and no charge for import license and sales tax, shall be levied for such imports.
The first sentence of this Section says nothing but state the obvious that full import duties will have to be paid on import of construction equipment, machines, tools and equipment as well as the spare parts thereof required for construction and operation of hydro-electricity generation, transmission or distribution plant. Such a statement sounds rather redundant. However, the necessity of such repetition of the obvious is made clear by the last part of the sentence: “which are produced and sold by local industries.” In other words full import duty must be paid for importing any of these items if such items are available from Nepali manufacturers. This in effect hints at the possibility of different treatment with regard to import duty if such items are not manufactured in Nepal. Unfortunately, however, the availability of such facility on import of plant, equipment and machinery and spares thereof, which are not produced in Nepal, is not expressly articulated anywhere and with regards to matters concerning exemption from paying Government revenue to HMGN such exemption needs to be expressly laid down. Therefore, the first sentence does not do anything but is limited to saying the obvious.
If, then, one is to read on the next sentence in isolation of the first sentence, one would come to the conclusion that 1% custom duty facility is available on materials if such materials “are not produced in Nepal.” Care should be taken to note that the sentence mentions materials only and no mention is made of plant, equipment, machinery, etc. and the spares thereof in this sentence; nor anywhere else in the whole Act with regard to import duty facility on them. Which will mean that full import duty is applicable on “import of construction equipment, machines, tools and equipment required for repair and maintenance as well as the spare parts thereof for hydro-electricity generation, transmission or distribution” irrespective of whether such items are locally produced or not. This is diametrically opposite of HMGN’s stance and, however, this interpretation does not do any good for developers either.
This faulty interpretation leads people on such a tangent that the import duty exemption facility is available only on MATERIALS that are not produced in Nepal and the first sentence was redundant after all. But the fact of the matter is if a developer is to advocate such an interpretation it will have to be prepared to pay full duties on all equipment, plant and machinery and spares thereof. This will be a disastrous interpretation for a developer as it will become entitled to exemption of import duties (except 1% custom duty) on imports of around 7.5% of the total project cost while its imports of all equipment, plant and machinery and spares thereof estimated to amount over 44% of the total project cost will attract full import duty. In which case the additional cost of import duties for a developer will be more than 15% of the total project cost.
In order to arrive at the correct interpretation, the two sentences in the Section in question needs to be read together, thus, putting them in proper perspective in order to arrive at sensible interpretation which does not result in any sentence becoming redundant. Such an interpretation will mean that:
Only 1 percent customs duty will be payable on import of plant, equipment and machinery as well as the spare parts thereof, required for construction and operation of hydro-electricity project involved in generation, transmission or distribution and no charge for import license and sales tax shall be levied on such imports if such items are not produced in Nepal.
184.108.40.206 Defective Translation
At times the problem is explained away by ascribing it to the bad translation of this portion of the legislation, therefore, now let us examine the translation. One has to admit that this is not the best translation. It could have been better translated, from the standpoint of grammar, syntax, etc. However, dispassionate and detached interpretation of even this bad translation leads to the same conclusion as one has done above if the two sentences are interpreted in isolation of each other. On the other hand, interpretation of this bad translation leads to the same conclusion and effect as per the stand taken by HMGN agencies based on their interpretation of the Section in Nepali as explained above if it is interpreted by putting both the sentences in its proper perspective and context. At the most one can deem it a case of bad drafting. Addition of a single word “such” in front of the word “materials” in the second sentence (both in Nepali and the English version) would have eliminated the potential for the confusion that is reigning at the moment .
In a sense there is a kind of mutually exclusive choice available to a hydropower developer under this provision of the Electricity Act. Aim to have the second sentence of this Section interpreted with especial focus on the word “MATERIALS” and be prepared to pay full import duties on all items of import except materials. Or have the Section interpreted in full (both sentences read together by putting the two sentences in the proper perspective such that any sentence does not become redundant) and come to an agreement with the correct interpretation of the provision.
220.127.116.11 Plant, Equipment and Machinery Produced in Nepal
It is clear from the above discussion that import duty facility is not available on all materials and non-construction equipment irrespective of whether those are manufactured in Nepal or not. However, in the case of plant, equipment and machinery and the spares thereof there is no exemption on their imports if these are produced in Nepal. The question that arises in this regard is what happens when specific quality is not available from Nepali manufacturers in right quantity and at right time. A developer needs each such item of specific quality standard, at a particular time and within reasonable price. Who is to certify the unavailability of the particular item of specific quality at reasonable price? What needs to be borne in mind is the fact that if a developer can avail of such items of reasonably acceptable quality at reasonable prices at appropriate time from Nepali manufacturer, then they will never take the trouble of having to import such items from foreign countries which involves certain amount of lead time even requiring advance outlays.
18.104.22.168 Spare parts
The Section 12 (7) of Electricity Act, 2049 which is being extensively discussed in the last couple of pages categorically includes spares of the plant, equipment and machinery required for the construction in the items that could be imported with import duty facility without any ceiling whatsoever. There is no ceiling fixed for the import of spares in this Section. The only condition imposed is that such items should not be produced in Nepal in order for it to be entitled to the import duty facility.
However, on the basis of certain internal circular, which has not been made available to the developers, the import duty facility on spares is being arbitrarily limited to 10% of the original value of respective equipment. This is bad administration of law and under the existing Section 12(7) spares of construction plant, equipment and machinery should be exempt in full to the extent required for the execution of the Project.
22.214.171.124 Root Cause of the Problem with respect to Import Duty
There are hydropower projects under construction now which are entitled to full import duty facility on all imports (including NON-CONSTRUCTION EQUIPMENT AND MATERIALS) which are (1) in public sector, (2) being constructed on non-commercial basis and (3) funded with foreign grant which does not get repatriated. Whereas import duty facility on the same level is not grated to hydropower projects which are (1) in the private sector, (2) under construction on full commercial basis, and (3) its foreign investors repatriate their investment and return thereon as does the local investor stand to get their rightful return. Upon completion of the construction of such non-commercial projects, the entire Project gets handed over to HMGN. Whereas the private developer runs the plant for a specific period of time and keeps (or takes away) the profit earned from such operations.
As is normal there are also two schools of thoughts on this issue, too. One school subscribes to the idea that a fully commercial project cannot be expected to receive facilities on par with a non-commercial one. While another school of thought advocates that this is a glaring proof of lack of level playing field between public and private sector. As the private sector is being invited due to lack of fund with HMGN maximum facilities must be granted to the private sector to encourage them to invest in Nepal.
However, a middle path does exist between these two camps. An investor, national and/or foreign cannot be blamed for trying to recover his investment and earn a decent return thereon. No one will bother to invest if there is no hope for any return. Therefore, the fixation of or negotiation for the rate of tariff will depend on the cost of production to the developer and a decent margin to cover for overhead and profit. Moreover, a national perspective is required in case of non-export project as levy of full import duty results in higher tariff and ultimately the incidence of such taxes and duties fall on the consumers. In view of this the middle path is to provide level playing field between commercial and non-commercial projects by treating both of them at par. Meanwhile care should be taken to ensure that availability of full import duty facility is fully reflected in the tariff charged to NEA. This will warrant substantive transparency on the part of the developer and will require instituting control systems to check misuse of such facility. This results in nation being poorer by the amount the Government Treasury is deprived of the fund from such taxes on non-construction equipment and materials but electricity with its potential for becoming a catalytic agent of development becomes available at affordable price to the consumers and the nation.
3.1.3 Value Added Tax
With the coming into force of the Value Added Tax (VAT) Act, 2052 four enactment related to various taxes got repealed. Two of them that are pertinent to a hydropower project are Sales Tax and Contract Tax. Each of these spells a special kind of trouble for a hydropower developer.
126.96.36.199 Sales Tax
The Section 12(7) of Electricity Act, 2049 has made provision for exemption of sales tax on the imports of plant, equipment, machinery and the spares thereof. A number of hydropower projects under construction during the transition period got embroiled in trouble due to this. HMGN machinery refused to grant VAT exemption on the imports of plant, equipment, machinery and the spares thereof as VAT was not expressly exempted by the above Act. A few developers overcame the problem by getting an executive order issued by HMGN in this respect. However, this does not spell respite for other projects under construction or those on the anvil. The surest way to solve this problem is to amend the above mentioned Section of the Act by replacing the words Sales Tax with VAT in the Section 12(7). In order to eliminate confusion in the interim, HMGN must publish a policy decision notification in Nepal Gazette to the above effect.
188.8.131.52 Contract Tax
The VAT is payable, in lieu of contract tax, on the contract invoices with certain exceptions. However, construction contracts that were signed prior to VAT becoming applicable do not need to bother about VAT unless they choose to do so.
Under Contract Tax Act, 2023 only civil type of work attracted contract tax rest of all being expressly exempted.
However, this Act spelt trouble for “Turnkey” or “EPC” (Engineering, Procurement and Civil works) contracts. The Tax Authorities tended to interpret it in a way that took away such exemptions if an activity not attracting such tax was clubbed together with those attracting such tax. The legislators never intended this and bureaucrats should not twist the provision of this Act in such a way. The Act brought only civil type works and local supply works above a limit under its purview and they envisioned raising tax from these activities. Contract for (a) supply of equipment from foreign countries and (b) consultancy works were specifically exempted. The authorities have interpreted the legislators' mind to mean that one needs to have a separate contract for such activities in order to be entitled to the exemption. In this age and time and for a complicated structure like hydropower plant turnkey or EPC contract makes a huge difference in terms of whether the project gets completed at all. Comparing the above chart with the following one can see the anomaly:
Therefore, this interpretation is unwarranted and the activities that are expressly exempted from the purview of contract tax must be entitled to such exemption even if these activities are clubbed together with other activities attracting taxes in the signed contract.
This problem seems to have been handed down to the present time even after enforcement of VAT. Once the words “Sales Tax” in Section 12(7) of Electricity Act, 2049 gets replaced by “VAT” then a contract for the import of plant, equipment, machinery and spares thereof will not attract VAT. However, subsequent to this also all payments to the contractors for product or services delivered locally and all imports from overseas will still attract VAT with the exception of the import of plant, equipment, machinery and spares thereof. What happens in case of Turnkey or EPC contract is not clear and nor is it tested yet. However, potential exist for a conservative Tax Officer to interpret it in such a way that if the portion that is exempt from VAT is clubbed together with non-exempt one in the signed contract, then VAT will be levied on the entire contract as explained in the following diagram:
184.108.40.206 VAT on Input versus OutputNo VAT is payable on the electricity as the output. This ruled out the possibility of hydropower developers registering with VAT Office with serious consequences. In order to encourage Nepali businessmen to register with VAT HMGN formulated a policy under which an importer is levied double of the prevalent rate of VAT if the importer is not registered with VAT Offices. The hydropower developers who were denied registration are also being charged penal rate of VAT on their import of non-construction equipment, materials and spares exceeding 10% of the original value. This does not make any sense. HMGN denies the registration and then levies penal rate for failing to register. This has a potential for increase in the project cost by 1.18%. Such kind of anomaly can be abolished by (a) either registering hydropower developers as zero (0) VAT establishment, or (b) exempting them from such penal rate of VAT for being denied registration by HMGN itself.
There is another way out of it, which is although scientific, however, will not be palatable to the most. That is not to grant exemption from VAT to electricity and, this will allow hydropower developers registration with VAT Offices. This provision will allow the developers to offset VAT paid by it against the VAT that it collects from NEA. However, this will jack up the electricity tariff for the consumers and such an increase will be difficult for HMGN to handle.
3.1.4 Export Duty/Tax
Electricity Act did not fix the rate of Export Duty . This is being deemed as lack of transparency by certain quarters. However, in doing so the legislators, in fact, had allowed latitude to HMGN to fix the rate of export duty (Sub-section 3 of Section 22 of the Electricity Act) and HMGN, in its turn, has left it for negotiation with the exporter (Rule 27 of Electricity Regulation, 2050). HMGN is empowered to determine the rate of export duty/tax by an agreement with the developer. This stipulation takes on board the fact a standard rate for all projects may not be feasible because each hydropower site is unique their benefit potential tend to be different from each other. Thus the amount HMGN is entitled to receive could be different from one plant to another.
The liberalised regimen of international trade envisaged by WTO does not permit levy of export duty/tax. Besides, as all exports from Nepal do not attract export duty/tax (a very small service fee is being charged), it could be deemed illegal to charge export duty/tax on electricity. The ground for such contention could be discrimination or unequal treatment (infringement of fundamental right enshrined in the constitution).
The way out of this predicament could be a royalty plan with base rate structure for all hydropower producers in general and additional royalty for exporters titled “export royalty.” As it exists now with the case of export duty/tax, the export royalty payable by an exporter could be left for negotiation with the individual exporters.
3.1.5 Income Tax Holiday
Under Section 12(3) of Electricity Act, 2049 a hydropower producer is exempt from the levy of income tax for first 15 years from date of the commercial generation of electricity. Even after that the income tax gets levied at a rate lower by 10 percentage points than the rate prevalent at that time . Moreover, under Section 12(1) of the same Act, a developer of a plant up to 1,000 KW does not have to pay any income tax ever.
In the case of certain developers the income tax authorities are prepared to grant tax holiday of 5 years only, reportedly, pursuant to Industrial Enterprises Act, 2049. If it is true then it is misapplication of the law. A hydropower developer, although being covered by the definition of “energy based industry” of this Act falls under the purview of the Electricity Act, with respect to various facilities and other matters specifically covered by this Act.
3.1.6 Local taxes
Collection of local taxes by erecting barricade has become a very painful experience besides other misunderstandings it is creating. Executives of certain developers thought that octroi (one of the forms of local taxes) is basically road cess (vehicle toll). They feel that it should be abolished or at least VAT and octroi should be combined, thus, freeing the developer from the problem of barricades.
Whereas another group of developers feels that royalty paid by a developer goes into the national treasury; co-operation at the local level is not easily forthcoming. Therefore, it is being strongly felt that arrangement should be made in the legislation to have certain portion of the royalty paid to HMGN go to the local level.
At present various local governments are extracting local taxes, service fee, etc. on the import of items that are not entitled to duty exemption like non-construction equipment, materials and spares exceeding 10% of original value, if it is deemed that the imports are for use or resale in the specific locality of the particular Municipality.
3.1.7 Change in law
In order to protect a developer from the financial impacts of future changes in law including increases in tax rates a mechanism has been instituted in project documents (mainly in Power Purchase Agreement) of certain developers for the amelioration of the financial impact of change in law (it is supposed to work both ways, though) through adjustment in tariff rate. However, such “change in law” provision is ineffective to an extent as it ties up a lot of fund of a developer initially if the changes are adverse. Besides such an arrangement ends up costing more to HMGN, NEA and ultimately consumers because the developers will recover their financing cost of the fund tied up as such along with their additional expense.
Therefore, there is a need for incorporation of a provision in the Electricity Act stating that no additional or new tax, fee, etc. (whatever name is used) shall be levied by any governmental agency including local government on a hydropower developer, other than those mentioned in the Act. However, this could work adversely for HMGN Treasury and Nepali consumers if the positive financial impact of future changes does not get adjusted. In addition, hence, there should also be a provision in Electricity Act saying that the tax rates shall stay same as at the time of execution of PA for each specific individual developer impervious to changes made in the future.
Bottom-line is to ensure that the total payments to HMGN not to exceed certain level, nor does it fall below the bottom-line.
220.127.116.11 The Bottom-line
It is very easy to discuss bottom-line but very difficult to get across the message in the narrative only. Therefore, I request the indulgence of the readers to discuss a model from which one can arrive at ballpark figures for how much does the developer stands to earn and how much finds its way into HMGN Treasury. In this model we will take a preview of various scenarios like the time prior to introduction of VAT, post VAT and subsequent to proposed amendments.
The model is based on a hydropower plant with 100 MW capacity, producing 583 GWh of energy (energy factor 66.6%) in a year for domestic consumption and expected to cost about US $ 2,000 per KW of the installed capacity which is to be fully funded from foreign sources. It will earn an annual revenue of US $ 35 million based on the currently prevalent tariff rate of 6 ¢ (US) per KW/h (without yearly escalation) most of which will be repatriated.
18.104.22.168.1 Domestic Use of Electricity
The return on equity to the investors, presuming a debt/equity ratio of 75:25, will amount to US $ 8 million a year . HMGN will receive US $ 0.153 million as royalty on the installed capacity at the rate of Rs 100 per KW and US $ 0.7 million as 2% of tariff; US $ 0.853 million in total .
Prior to introduction of VAT, the project will pay US $ 2 million as import duties if it is granted full exemption on all imports including materials and non-construction equipment and the contract tax of US $ 3.6 million during the construction period. If the developer is not granted import duty exemption on materials and non-construction equipment then it will have to pay US $ 6 million in total as import duties. In the post VAT introduction scenario the import duty paid will amount to US $ 4.4 million if he is not granted exemption on materials and non-construction equipment and the project will pay net VAT of US $ 5.3 million after recovering the VAT it would have paid on the import of materials and non-construction materials. However, if the project is granted import duty facility even on materials and non-construction equipment then it will be paying import duty of US $ 2 million and VAT on contract invoice of US $ 6.95 million.
Hence the bottom-line is that during the first fifteen years of operation of the plant HMGN receives 2.437% of the annual revenue while the investors get 22.857% in an average year and during the construction period HMGN receives one time payment of revenue ranging between US $ 5.6 million to US $ 9.7 million depending upon various levels of exemption granted to it.
What needs to be borne in mind is the fact that the royalty is the only revenue that HMGN earns from a hydropower project in its first fifteen years of operation. But the nation stands to gain in other ways due to generation of electricity for use domestically.
22.214.171.124.2 Export of Electricity
All of these do not happen when the electricity is exported. Nepal is entitled to receive certain indeterminate export duty/tax in lieu of these non-monetary gains from an exporter. Therefore, Nepal cannot be faulted for expecting more revenue from a hydropower project built to export. In this connection it will be appropriate to note that the developers of West Seti Project agreed to make 10% of the electricity generated available to Nepal free of cost or cash in lieu of the 10% of the electricity generated, over and above the royalty and export duty/tax that is due from them.
3.1.8 Incidence of Tax
A discussion of taxes also requires a close examination as to who does actually bear the burnt of such taxes. Following chart depicts the actual incidence of taxes in the case of a hydropower project generating electricity for domestic consumption:
3.2 NON-TAX FINANCIAL ISSUES
Taxes are financial question both to HMGN, the recipient of such taxes and tax payers on whom such taxes get levied. Besides taxes, there are other financial issues that deserve certain amount of attention in this report.
3.2.1 Tariff to be paid by NEA (Buy Back Rate)
The hydropower developers, especially ones planning to develop relatively small plants, are clamouring for fixation of a flat rate for purchase of power by Nepal Electricity Authority (NEA). For this group this lacuna itself manifests the lack of a clear commitment from NEA to buy from the private producers. However, the recently formed new government has endeavoured to alleviate the situation by agreeing to buy electricity generated by plants with the capacity between 1 MW to 10 MW, not exceeding 50 MW in total after 2003. The unarticulated part of this policy statement is the fact that NEA will not buy any more power from private producers till the end of 2002 except for the electricity generated by the plants of up to 1,000 KW capacity.
126.96.36.199 Single Rate v. Multiple Rate
There is another facet of this issue which is that NEA has not yet been fixed a buy back rate for the purpose of buying power from the private sector. On the other end of the spectrum NEA is concerned that they will be forced to buy energy from private producers during the monsoon when their own projects will be producing surplus energy, is also valid. Because at the moment NEA is having to pay the same price to the private hydropower developers irrespective of whether it is peak energy, or primary (base) energy or secondary (excess) energy. Questions are being raised whether such a system is sustainable in Nepal?
This might be resolved to an extent, informed sources are convinced, by setting up a two-tier purchase price for buying power from private producers, one for the dry season and a second lower one for the wet season. The alternative is to fix different rates for peak energy, base energy and excess energy. This scribe is given to understand that Thai-Laos agreement stipulates 7.6 ¢ (US) for peak energy, 4.5 ¢ to 5 ¢ for base energy and 2 ¢ for excess energy. This will go a long way in discouraging producers from building oversized plants, which are designed to produce large amounts of energy only during the wet season. The main aim of this exercise, also the result thereof, will be to limit secondary energy to a certain percentage of firm energy.
188.8.131.52 Methods Recognised by Law
Section 21 (2) of the Electricity Act makes provision for determining the rate of electricity “on the basis of (a) fixed percentage of avoided cost or (b) an addition to the generation cost, or (c) fixed percentage of average tariff of NEA.” It is obvious from this that the Act has not envisaged fixing different rates for primary and secondary energy, nor for the peak energy. In all the PPAs that have been signed so far it seems that the first and last method did not get used at all. Fact of the matter is that there is lack of transparency as to which method was actually used and justification of why did NEA buy at any specific price has never been made public. However, there are indications that the second method has been used in some form or other in all the PPAs signed so far. The requirement is to come to a clear agreement with the developer as to which method is to be used and then use that method without beating around the bush.
In contrast to the two methods that have not been used so far, in the case of the method involving an addition to the generation cost, full transparency on the part of the developer as to how did the developer arrive at a certain figure as its generation cost becomes sine qua non or simply mandatory and this method also calls for definition/determination as to the “addition” to the generation cost. Over time, 16% has been tossed around as the appropriate rate of “addition.” Suggestions are being advanced that formulae must be incorporated in the legislation to provide certain fixed return on investment.
The determination of the tariff by the second method will involve a two-phase process. In the first phase the parties will need to arrive at the estimated of total cost of the project. Simultaneously with this, an agreement will have to be reached as what is the reasonable “addition” a developer should be allowed. The two of these components should culminate into a tentative rate of tariff for the purpose.
In the second phase the developer will have to call for competitive bids/tenders for various (or single, if turnkey or EPC contract) contracts and the revised estimate of total project cost will have to be worked out on the basis of result of bidding/tender of the construction contract(s) and the revised “interest during construction,” and any other revision based on further information becoming available. Working out the required rate subsequent to provision of the “addition” will result in the specific developer’s final tariff.
This aspect is the manifest reason for the issue of conditional license to a developer requiring it to have its Power Project Agreement (PPA) with NEA amended to curtail excessive return on investment that became apparent after the PPA was signed. This particular developer cannot be blamed for holding a grudge against HMGN, as it has not required other developers whose total project cost has also reportedly gone down (with the resulting effect of enhancement of return on investment). For the sake of argument they are even opining that other developers also must be made to confide in HMGN as to their actual return on investment at present and told to make adjustments in the tariff if the rate of return seems excessively high.
3.2.2 Tariff for Consumers
It goes without saying that the rate at which NEA buys from hydropower developers dictates the tariff charged to the Nepali consumers. Therefore, if the standard of living of the Nepali consumers is to at least stay where it is now instead of it taking a nosedive NEA’s buying rate should not result in the consumers having to pay exorbitant rates. However, this is easier said than done.
The current hydropower development policy allows direct sale of electricity to consumers. It is manifest in Section 18 of Electricity Act, which states that “notwithstanding anything written in Section 17, one who distributes electricity in isolation of the national grid shall be entitled to fix the electricity tariff and other charges for the electricity distributed.” The Section 17 referred to in this section deals with the constitution of Tariff Fixation Commission (TFC) and its working procedure. In this backdrop it should not be necessary for a private hydropower producer to go to TFC. However, for some reason it is made mandatory to have the tariff fixed by TFC to fix the rate that it can charge the consumers. They do not object to having to go there but certain developers are of the opinion that it is not responsive.
Certain potential developers feel that the repatriation function has not undergone a test. However, on the contrary, the wording of the Electricity Act on the subject of repatriation of foreign currency is categorical and clear. In as much as the repatriation of foreign currency for debt servicing (repayment of principal and loan thereon) is concerned this provision asserts in no uncertain terms that necessary convertible foreign exchange will be made available by HMGN. Similarly, this provision is equally clear with regard to repatriation of investment in convertible foreign exchange, which involves repatriation of dividend on equity investment and repatriation of the proceed from the sale of such equity.
184.108.40.206 Present Surplus of Foreign Exchange Receipt over Expenditure
However, in this respect the applied aspect is equally or more important than the provision of law as it entails the capacity of the national exchequer to meet the requirement of convertible currencies. In other words one needs to stand on terra firma while judging such a delicate issue.
The surplus of receipt over expenditure of foreign exchange in the fiscal year 1996/97 was equivalent to Rs 3,458.9 million . Whereas as explained in the preceding pages a model 100 MW hydropower project will need to repatriate US $ 35 million in a year, if it is to be allowed to repatriate the full proceeds of the revenue generated by such a plant and such an amount is equivalent to Rs 2,275 million at the rate of exchange of Rs 65 per US Dollar. This constitutes 65.77% of the surplus for the year for which record is available. This statement should not be construed to mean that the surplus will not increase in future, while it is also very clear that electricity consumed domestically will only contribute to increase in such surplus, at best, indirectly.
220.127.116.11 Repatriation Facility for the Power Exporter
In contrast to some developer’s apprehension the wording of this Section 13 is too wide as it does not preclude this facility to the exporters of electricity. However, it will turn out to be horrendously disastrous/dangerous for Nepal from the standpoint of convertible foreign exchange if an exporter to India wanted to have his Indian currency revenue stream converted to hard currency in Nepal under this provision. The repatriation facility cannot be made available for an export oriented, decent sized hydropower project .
3.2.4 HMGN Guarantee
Generally financial institutions feel comfortable in lending money against the collateral of tangible property that too up to a certain percentage of the value of such property leaving a decent margin. However, they are not averse to allowing an established institution to borrow on the basis of its Balance Sheet. The financiers even lend money against third party guarantee from a person with reasonable credit rating. But in Nepal HMGN has a policy not to stand guarantee for loan taken by private sector. [Even the national flag carrier, a public sector enterprise fully owned by HMGN, was, reportedly, denied HMGN guarantee in order to finance acquisition of additional aircraft.]
But developers are loath to stake their tangible property in developing a hydropower project. They prefer non-recourse project financing. For this purpose lenders insist on counter guarantee from HMGN for the performance of buyer of power, NEA in this instance. HMGN provided such counter guarantee to certain developers. Now it has declined to provide even such counter guarantee.
There is no direct provision for the purposes of HMGN standing guarantee as such in the policy or the Act. However, Section 9 of the Electricity Act makes an indirect reference to the “guarantee for the necessary capital to be invested” in connection with a stipulation that HMGN can enter into an agreement with a licensee . In other words there is no provision which categorically makes it mandatory for HMGN to stand guarantee of the investment. Meanwhile, it has to be admitted that the intention of the legislators was for the HMGN to enter into an agreement with a bulk producer of power to stand guarantee for the necessary capital that needs to be invested in a hydropower project. In a way it could be concluded that the whole thing has been left to the discretion of HMGN in order for it to decide on the basis of case by case merit. It is important to note here that HMGN standing guarantee to a mega sized or export oriented project will have to be precluded from such facilities.
3.2.5 Terms of Credit
Hydropower development policy has formulated that “financial institutions shall make available concessional loans” to the national private sector for generation and distribution of up to 1,000 KW hydropower . But nothing has happened so far. The only groups of borrowers that are entitled to confessional loan are what are termed as “deprived sector” and hydropower sector is not defined as the deprived sector. Far from making any concessional loan, the financial institutions of Nepal even do not have the hydropower sector included in its definition of “priority sector” for investment purposes.
3.2.6 Fund Raising
For the purpose of raising fund for the development of hydropower HMGN needs to make arrangement conducive for the placement of financial instrument in overseas market e.g. Global Deposit Receipt. Activation of local capital market will also help mobilise fund from within Nepal. For this purpose Securities Exchange Board (SEB) needs to grow some relatively effective teeth in the lines of such authorities in the Western countries in order for the general public to feel confident of such manner of capital mobilisation.
In this connection doubts were raised that listing is not permitted for electricity generation industry by the SEB. The supposed rationale behind such restriction was to stop foreign entities unloading their holdings in hydropower companies. This apprehension is unfounded.
3.3 CONCLUSION AND RECOMMENDATIONS
Any and all questions have financial impact, the only difference will be whether direct or indirect. The corrective measures with respect to financial issues alleviate the problems of involvement of private sector in hydropower more forcefully. Therefore, following changes are recommended.
3.3.1 Revenue Stream for HMGN Treasury
This study has arrived at following recommendations, which are of great importance to a private hydropower developer. However, this should not be construed to be one-way street as if the private sector does not get attracted then there will be no development of the hydropower.
Arrangements should be made in the legislation to have certain portion of the royalty paid to the local level in order to have co-operation at the local level readily forthcoming.
18.104.22.168 Import Duties
22.214.171.124.1 Level playing field between commercial and non-commercial projects must be provided by treating both of them at par in respect of import duties. That is a private sector project also needs to be allowed to import all that is necessary for the implementation and operation of the project including construction materials and what are deemed to be non-construction equipment and, however, ensuring that availability of full import duty facility to a fully commercial project is fully reflected in the tariff charged to NEA. On the contrary if the present regimen of import duty facility is to be found adequate then the Section should be reduced to one sentence thereby reducing the chances of misleading its readers.
126.96.36.199.2 Import duty facility must be made available even in case a specific item is produced in Nepal if such item of certain quality standard is not available in the right quantity at the right time.
188.8.131.52.3 Similarly, it is ridiculous to disallow import duty facility on spares exceeding 10% of original price.
184.108.40.206 Value Added Tax
220.127.116.11.1 The words Sales Tax needs to be replaced with VAT in the Section 12(7) and in the interim HMGN must publish a notification in Nepal Gazette to the same effect.
18.104.22.168.2 Exemption granted by law must not be taken away mainly because of the contract documents are structured. If the legislators intended to exempt contract or VAT, as the case may be, the developer should not be deprived of such exemptions merely because of completion guarantee compulsion requiring signing of Turnkey or EPC contract.
22.214.171.124.3 In order to abolish the practice of charging penal rate of VAT at 20% on the import of non-construction equipment, materials and spares exceeding 10% of the original value, hydropower developers must be registered as zero (0) VAT establishment.
126.96.36.199 Export Duty/Tax
It is possible that WTO may not approve of export duty/tax. Moreover, as all exports from Nepal do not attract export duty/tax (a very small service fee is being charged), it could be deemed illegal to charge export duty/tax on electricity on the grounds of discrimination or unequal treatment (infringement of fundamental right enshrined in the constitution). It is recommended that royalty should have a base rate structure for all hydropower producers and additional “export royalty” payable by the exporters. As it exists now such additional “export royalty” payable by an exporter could be left for negotiation with the individual exporters.
188.8.131.52 Income Tax Holiday
There should not be arbitrary discrimination in the administration of tax holiday under Electricity Act. Similarly, HMGN needs to conclude double taxation agreement with other countries, too.
184.108.40.206 Local taxes
Levy of local taxes must be stopped and an arrangement must be worked out for the sharing of royalties between HMGN and the local governments.
220.127.116.11 Change in law
A provision needs to be made in the Electricity Act stating that NO additional or new tax, fee, charge, etc. (whatever name is used) shall be levied by any governmental agency including local government on a hydropower developer other than those mentioned in the Act. In addition, there should also be a provision in the Act saying that the tax rates shall stay same as at the time of execution of PA for each specific individual developer throughout the tenure of the PA.
3.3.2 Non-Tax Financial Issues
Following recommendations are being made with respect to non-tax financial issues based on the finding of this study.
18.104.22.168 Tariff to be paid by NEA (Buy Back Rate) and Tariff for Consumers
Instead of a flat rate without discriminating between peak energy, or primary (base) energy or secondary (excess) energy, NEA should use three-tiered buy back rate in order to discourage producers from building oversized plants, which are designed to produce large amounts of energy only in the wet season, or by clamping limit on secondary energy to a certain percentage of firm energy. Moreover, care should be exercised that NEA’s buying rate should not result in consumers having to pay for electricity at exorbitant rates.
The wording of Section 13 of the Electricity Act with regard to repatriation of foreign currency must be amended to preclude the exporters of electricity from taking advantage of this facility, as, otherwise, it will be catastrophic for Nepal from the standpoint of convertible currency reserve if an exporter to India wanted to have his Indian currency revenue stream converted to hard currency.
22.214.171.124 HMGN Guarantee
A developer needs HMGN guarantee in order to make his project “bankable.” Therefore, HMGN will need to stand guarantee to a developer in some form or other (counter guarantee or loan guarantee) if it is serious about hydropower development except in the case of mega projects
126.96.36.199 Terms of Credit
It needs to make sure that the financial institutions are making provision to make concessional loan available to hydropower projects of appropriate scale.
1. In other words if a hydropower project does not need to get a license then it does not need to pay any royalty.
2. These many words in Section 12(7) would have been sufficient to convey the intention of the enactment in a crystal clear manner instead of repeating the obvious.
3. Nepali version of the hydropower policy actually does use the additional word “such” in this context in its Clause 4(h) in the appropriate place.
4. The words “export duty” is used in the Electricity Act whereas Electricity Regulation uses the words “export tax.”
5. The Rule 27 stipulates that the export tax payable for exporting electricity, pursuant to Sub-section (3) of Section 22 of the act, shall be as determined in the agreement between HMGN and the exporter.
6. It is mandated by Section 12(3) of the Electricity Act, which states that “the licensee who has obtained license for hydro-electricity generation, transmission and distribution shall be exempted from income tax for fifteen years from the date of generation, transmission and distribution of electricity for commercial purpose.”
7. Section 12(2) states that “the licensee, who has obtained license for hydroelectricity generation, transmission or distribution shall be levied an income tax lessened by 10% than the corporate income tax levied pursuant to the prevailing law.”
8. Under Section 12(1) “no income tax shall be levied to a person or a corporate body who is generating, transmitting and distributing hydroelectricity up to 1,000 KW.”
9. Assuming a return on equity of 16%.
10. All conversions are based on the exchange of rate of Rs 65 per US Dollar.
11. In view of lack of announcement with regard to this an assertion cannot be made in the affirmative or negative. However, the fact that weighted average rate of tariff charged by NEA is Rs 4.67 in fiscal year 1996/97 (total of net revenue from the sale of electricity was reported to be Rs 4,677 million and electricity sale totalled 1,000.56 GWh) precludes the possibility of the use of the last method.
12. Section 13 of the Act, under subtitle “facility of foreign exchange,” stipulates that “in case foreign currency has been invested in the generation, transmission or distribution of hydroelectricity as loan or share capital, HMGN shall make available necessary foreign currency at the prevailing market rate of foreign exchange for repatriation of investment or repayment of principal or interest on loan.”
13. Based on the report published by Nepal Rashtra Bank, which reported that total income of convertible foreign exchange was equivalent to Rs 38,280 million and the total expenditure of the same was equivalent to Rs 34,821.5 during fiscal year 1996/97. The Bank’s report was based on foreign exchange record.
14. A fairly small exporter will not make a big dent in the level of annual surplus of foreign exchange.
15. It is stipulated that “HMGN may enter into agreement with the licensee for bulk purchase of electricity, guarantee for the necessary capital to be invested or other financial and technical matters.”
16. The Clause 4(c)(5) clearly states that “if the national private sector desires to generate and distribute electricity up to 1,000 KW in any rural area by constructing a hydroelectricity plant, financial institutions shall make available concessional loans.”
17. In contrast to the set of teeth that is good just for a show.
This is the third chapter of the report on the Study of Legal Framework and Institutional and Regulatory Process for the Development of Private Power Projects in Nepal , prepared in the capacity of the Legal Specialist, in June 1998. A set of four separate working papers were presented in a one-day workshop on “Legal and Institutional Framework for Hydropower Development in Nepal” based on the above study, in June 1998.