Basic customs duty (BCD) on the import of solar cells and modules was announced at 20% in the Union Budget for 2020-21. While the exemption on this duty remains in place, the change has raised a lot of eyebrows throughout the solar sector, as this could potentially impact solar tariffs adversely.

Industry experts say that the reason for the seemingly abrupt hike was for the sake of legislative convenience. Tariff rates can only be amended through bills or acts and not through notifications in gazettes.

The move has led to speculation as to what would happen after the expiry of the existing 15% safeguard duty (SGD) on imports at the end of July 2020. The Ministry’s intent behind this revision points toward imposing a ‘permanent’ duty on imported solar cells, but there is no clarity right now, and the government has created new uncertainty in the industry already struggling with multiple challenges and coming off a weak 2019. Mercom contacted officials from the Ministry of Finance and the Department of Economic Affairs, but they declined to comment.

It is still unclear if the new basic customs duty will come into effect once the exiting safeguard duty expires. The exemption on customs duty has been in place since March 2005. The industry is now concerned about whether the exemption on duty will be lifted after the expiry of safeguard duty in July or remain.

Tariff items split

During the budget session, the Ministry of Finance (MoF) split the earlier tariff item 8541 40 11 (solar cells whether or not assembled in modules or panels) into two; 8541 40 11 (solar cells not assembled) and 8541 40 12 (solar cells assembled in modules or made up into panels) and proposed a basic customs duty of 20% on both the tariff items. This change allows for the government to set separate tariffs for solar cells and modules, whereas earlier (before exemption in 2005), they were the same at 12.5% for both.

Another change made in the latest Union budget was the removal of the exemption on social welfare surcharge (SWS) on solar cells and modules. This was introduced in the 2018 union budget and was set at 10% of all customs duties except safeguard duty, countervailing duty (CVD) and anti-dumping duty (ADD). It should be noted that it is currently only applicable to IGST and not on safeguard duty.

If the exemption is lifted completely, there could be an about ₹0.25 (~$0.04)/kWh increase in solar tariffs; an industry source told Mercom.

Possible scenarios

There are a few possible ways this could turn out based on the current industry consensus. Each scenario has repercussions of its own.

Currently, with the existing 15% safeguard duty, the final duty implication is 20.75%

One possibility is that the exemption on BCD will be withdrawn entirely after safeguard duty expires in July. This would result in higher costs for developers as they would have to pay a BCD of 20% on the cost of the imported product, 10% of SWS on BCD with IGST on the total. This would result in a total tax incidence of 28.1%.

The second, and the most likely scenario based on general industry consensus, is that BCD will be levied with different rates for cells and modules after the expiry of safeguard duty. The BCD on solar cells could be 12.5% (the assumption is based on the previous duty of 12.5%, which existed before it was exempted in 2005)  and 20% on solar modules. This would mean a tax implication of 19.4% on solar cells and 28.1% on solar modules. In this scenario, the overall tax incidence on importers of cells would remain around current levels while the tax incidence on solar module importers would be increased.

Previously, many companies in the solar Micro, Small, and Medium Enterprises (MSMEs) segment told Mercom that policy measures like safeguard duty and the domestic content requirement (DCR) program have created more hurdles rather than simplifying issues.

The third possibility is that the exemption on the BCD would be removed with immediate effect with the 15% safeguard duty is still in place. This is the worst-case scenario where the total duty implication would be 43.85%.

The last scenario is with the assumption that the exemption on basic customs duty will remain in place, and only 5% IGST (Integrated goods and services tax) would be imposed. Under this scenario, the total tax incidence on importers of solar modules and cells will be only 5%.

According to the current market consensus, this scenario is highly unlikely as this would allow for developers to more easily procure modules and cells from countries like China. This would adversely affect domestic manufacturing as developers would shift to cheaper and more efficient Chinese components.

Lessons from the safeguard duty regime

The safeguard duty on imports of solar cells and modules from China and Malaysia was announced in July 2018 to protect domestic cell and module manufacturers. The duty was set at 25% for the first year, followed by a phased down approach for the second year, with the rate reduced by 5% every six months until the duty is set to end after July 2020. Since a majority of solar projects at the time were already under development when the safeguard duty was announced, they filed petitions under the “Change in Law” clause.

Imposing the safeguard duty forced developers to bid higher to compensate for the higher module prices, but that caused government agencies to cancel auctions retroactively. Solar developers who were given refuge under the “change in law” clause since their projects were under development are still waiting for reimbursement.

We also know that project development, tenders and auctions froze for approximately six months after the safeguard duty was imposed as government agencies began canceling tenders and renegotiating tariffs as none of the agencies wanted to pay for higher tariffs even though the bids were higher because of safeguard duty imposed by the government.

When bids started going higher, the government agencies began imposing ‘tariff caps’ where the bids can only go lower than the cap set by the government after which participation in the auctions started to fall leading to postponement and cancellation of multiple auctions which has resulted in solar installations declining year-over-year in 2019 by approximately 20%.

On the manufacturing side, the imposition of safeguard duty has created a shortage of domestically made solar cells in India. Many small module manufacturers have complained that there are only a few suppliers in India selling quality cells to module manufacturers.

Refuge under “Change in Law”

There is a possibility that project developers who placed bids based on the assumption that there would be no other duties after the expiry of SGD in July may file petitions under the “change in law” clause with the Central Electricity Regulatory Commission (CERC) for revised tariffs. This clause is applicable when there is a new law or a change in the tax structure or when a new tax is introduced.

The government has to clarify immediately if the imposition of BCD in the future will be covered under the “change in law” clause giving room for pass-through option or if the developers have to bid considering a certain percentage of BCD. In the past, auction activity has been stranded when the clarity was missing when SGD was imposed.

In one instance, the National Thermal Power Corporation (NTPC) had asked the bidders to revise and resubmit their bids for the 2 GW interstate transmission system (ISTS)-connected solar tender. The bidders were allowed to add the price they would be incurring due to the safeguard. So, the technical bid had an extra component, the cost each developer assumes will be added on due to safeguard duty. When the auction was held, one of the winning bidders had commented that they had added 10% to the initial tariff quoted as safeguard cost.

Or, the government agencies may just decide to scrap the auctions and start the tendering process again.

In a recent development, the National Solar Federation of India (NSEFI), in a letter to the Solar Energy Corporation of India (SECI), requested it to incorporate a clause about the applicability of BCD on imported modules and cells as in its future solar tenders.

Since SGD is set to expire on July 29, 2020, and the trajectory for BCD is uncertain; the Federation suggested that the inclusion of a clause allowing for BCD – if imposed after the expiry of SGD – to be considered under the “change in law” clause would be a good idea.

It explained that since the government has not lifted the exemption on BCD for now, developers would place their bids for future projects assuming 0% basic customs duty and safeguard duty after July 29, 2020.

To avoid complications and petitions because of this, the NSEFI suggested that the SECI include the clarification in the bid documents and power sale agreements (PSAs)of upcoming tenders, particularly the 1.2 GW SECI VIII Solar Tender.

Has this been thought through?

Months after imposing the safeguard duty to protect the industry, none of the stakeholders seem to be pleased. The solar cell manufacturing capacity has not changed significantly. The industry continues to be dependent on the Chinese market for the raw materials, be it cells or wafers or other components.

According to a solar module manufacturer, “unless the government offers some capital incentives, investing in cell manufacturing is very tough. We were contemplating a 500 MW solar cell manufacturing plant, but for that, the investment is ₹4 billion ($56.24 million) and this doesn’t include land and facility investment. Also, every 8-9 months the technology keeps changing. It is very capital intensive. Only with the government’s financial support will the cell manufacturing capacity in India increase, if not, no one is ready to take the risk.”

The government has to gauge the actual impact of safeguard duty to see how much the domestic industry has benefitted or suffered before deciding on how BCD should be implemented, said an industry executive who did not want to be named.

A phased implementation would probably be the best way forward, given that the government does its homework on whether safeguard helped in the growth of domestic manufacturing capacity, the executive added.

Winners and losers

If the BCD is imposed, the beneficiaries would be a small group of cell manufacturers who would be protected. Solar cell technologies are typically upgraded every 3-4 quarters which means additional R&D spending and capital costs to upgrade the cell manufacturing lines which would mean that most smaller manufacturers without the financial wherewithal would be left out. A module manufacturer told Mercom that domestic vertically integrated cell and module manufacturers would be using imported cells to make and sell modules to the domestic market while using their own cells to manufacture and export modules to countries like the US where modules can fetch a higher price.

Tariffs will rise after accounting for BCD, which will have to be paid by the DISCOMs. We all know how this story ends. Developers will again get stuck in the cycle of cancellations, renegotiations, change in law disputes, waiting for reimbursements will eventually lead to a slowdown in the industry, which is already teetering due to liquidity crunch, slowdown in the economy and weak demand.

Whatever the government’s decision is, the market needs clarity right away to plan and move forward.