1 Introduction

According to current estimates, the demand for commercial energy, oil, coal and other sources of power will increase threefold by 2005. The demand for domestic fuel and other energy needs will also soar similarly. The increase in consumption underscores the increased emphasis on energy conservation in line with increased energy generation. It has been estimated that nearly 25000 MW can be saved by implementing end-use energy efficiency and Demand Side Management measures. Efficient use of energy and its conservation assumes even greater importance in view of the fact that one unit of energy saved at the consumption level avoids 2.5 to 3 times fresh capacity creation. Further, such saving through efficient use of energy can be achieved at less than one-fifth the cost of fresh capacity creation (Comments by Mr Suresh P. Prabhu the then Minister of Power at the time of release of the Action Plan of Bureau of Energy Efficiency by the Prime Minister Mr. Atal Bihari Vajpayee on 23 August 2002). This articles briefly focuses on the fiscal approaches and tax incentives to encourage energy conservation.

2 Energy loss

Energy conservation does not mean a reduction in energy use at the expense of economic growth. It really means that energy should be used in the most productive and least wasteful manner. Some of the main factors contributing to energy losses are

  1. inadequate modernisation of plant and machinery and continued use of obsolete technology. Presently, there is a good case for machinery modernisation for effective energy conservation.

  2. the manufacturing and production processes used by different industries are different. There are no norms for measuring consumption of energy.

In quantitative terms, the energy reduction should be in absolute quantity, that is, measured with reference to ”output per unit of energy consumption”.

Energy audit in industrial establishments is almost non-existent in India – in the absence of an energy audit it is not possible to identify areas where energy use is inefficient. It is estimated that a 10 % reduction in energy losses would more than make good the current energy shortage. Some estimates of varying energy losses in different industrial sectors are as follows

(i). In a thermal power plant, roughly 70 % of the energy produced by burning of coal is lost in the air and cooling towers.

(ii). The aggregate loss in generation and transmission of power is about 20 %. [Report of the Seventh Finance Commission]

(iii). A German energy expert, Dr Alfred Schraund, has estimated that about 30 % energy saving can be effected in the Indian textile industry by employing control equipment and energy saving devices and processes and by making the operators and technicians aware of the magnitude of the huge energy loss.

(iv) According to one study, it is possible to obtain as much as 25 % saving in industrial energy consumption with the introduction of energy-efficient equipment and processes.

3 Energy taxes versus tax credits

The United States is the largest consumer and the greatest waster of energy. In the United States, the levy of higher sales tax on energy wasting appliances like stoves with pilot lights, frost-free refrigerators and dishwashers have been tried with varying degrees of success (Commoner Bary, ”A reporter at large”, The New Yorker). In India, as elsewhere, any increase of taxes is generally not welcome. The provision of tax incentives may perhaps prove to be more effective. This article therefore stresses the importance tax of incentives as a means of energy conservation.

The US model of tax credits in the residential sector may be studied in brief for initiating some thinking in that direction. President Carter’s National Energy Plan 1977 included insulation tax credits for home owners amounting to 25 % for the first USD 800 spent and 15 % for the next USD 1,400. Better insulation reduces heat loss and saves on energy for heating homes in the winter. In the State of Michigan, an attempt has been made by amending the property tax normally imposed on housing improvements. An Act (Public Act No. 293 of the State of Michigan, United States) of that State completely exempts insulation, storm windows and other expenditures on energy saving up to USD 4,000 from assessment for up to three years. The US experience of tax credits for energy saving deserves to be tried in India and other developing countries both in the commercial and residential sectors.

4 Approaches to energy conservation

The preceding paragraphs explicitly highlight the importance of better management and the need for modernisation and induction of sophisticated technology. Some specific areas where new fiscal approaches and tax concessions can play a significant role may be noted. These areas are:

(a) energy conservation act;

(b) energy audit;

(c) management;

(d) modernisation;

(e) research and development;

(f) education and training;

(g) foreign participation; and

(h) higher depreciation.

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.

5 Concluding remarks and suggestions

It is hoped that the discussion in this article will help increase the already growing awareness about energy conservation and the role that new tax laws can play. Saving energy is considerably cheaper and environmentally safer than developing new supplies.

In his message, at the time of releasing the Action Plan for energy conservation of the Bureau of Energy Efficiency of the Ministry of Power, the Prime Minister Mr Atal Bihari Vajpayee observed that the need for energy saving in a developing country like India is particularly important in view of India’s limited energy resources and the increasing gap between demand and supply. Efficient use of energy and its conservation is the key to sustainable development.

Experts have suggested that the cost of saving a barrel of oil or the equivalent amount of electricity or natural gas is about half that of producing the same amount of new energy, At this stage, it will be useful to note a few points for tax and other reforms:

  1. The suggestions made in paragraphs 4(c) and 4(e) need careful consideration.

  2. Under section 80-IA of the IT Act, a five year tax holiday, and a deduction of 25 % (30 % in the case of companies) in the subsequent five years, is granted to an undertaking engaged in the business of generation, or generation and distribution of power, and some other industries mentioned therein. The business of ”conservation of power” is not mentioned in that provision, Keeping in mind the importance of energy conservation, undertakings engaged in the business of ”conservation of power” should also enjoy similar tax incentives.

  3. Section 217 (e) of the Companies Act requires disclosure of prescribed particulars regarding the conservation of energy. The object of this disclosure is apparently to allow the Board of Directors and shareholders of the company to keep a watch on the energy conservation. This encourages energy saving in the manufacturing activities of the company. This criteria should be broadened to require the company to state whether it has employed qualified energy auditors to monitor the conservation of energy in its manufacturing processes.

Har Govind is an Advocate in the Supreme Court of India and the Delhi High Court. Mr Govind is also a Tax Consultant who advises on international tax matters, as well as corporate and anti-monopoly laws. He has held many distinguished positions in India; most notably, he was the Chief Commissioner of Income Tax, Delhi and a member of the Income Tax Appellate Tribunal. He was also the United Nations consultant on the restructuring of the Iraqi tax regime and a panel consultant to the World Bank. He has contributed many tax articles in national and international journals.

Lennart Staberg