The government has formed a committee to finalise a proposal for reducing tax on offshore engineering, procurement and construction (EPC) supply contracts relating to 1,124-megawatt Kohala and 700MW Azad Pattan Hydropower Projects.

At present, there is 2.1% withholding tax that has exposed companies to an additional tax and cost, according to a brief on the tax levy on offshore supply contracts prior to the Finance Act 2018 and changes in the tax regime enacted through the Finance Act 2018.

A meeting was apprised that the Central Board of Revenue, Azad Jammu and Kashmir (CBR AJK) was willing to reduce the tax rate on offshore EPC supply contracts from the current 2.1% to 1% provided the same was amended by the Federal Board of Revenue (FBR).

The FBR was of the view that being the final tax on offshore EPC supply contracts, the reduction in the tax rate would be decided by the FBR chairperson after due approval from the competent authority.

The Power Division informed the meeting that China Three Gorges Corporation, as the main sponsor, was developing the Kohala Hydropower Project located on Jhelum River in AJK while China Gezhouba Group Company Limited, as the main sponsor, was developing the Azad Pattan Hydropower Project. Both the projects were also part of the China-Pakistan Economic Corridor (CPEC).

Private Power and Infrastructure Board (PPIB) issued the Letter of Support (LoS) to the Kohala Hydropower Project dated December 31, 2015 and to Azad Pattan Hydropower Project on June 30, 2016. Both the projects were nearing financial close as per the deadlines specified in their respective LoS.

Both the companies had raised the issue that at the time of announcement of the Policy for Power Generation Projects 2002, there was no tax on payments made to an offshore supply contractor.

Accordingly, the Kohala project executed its EPC contract dated January 21, 2017 while the Azad Pattan project executed its EPC contract dated June 11, 2017 without taking into account any tax on the offshore EPC supply contract. Similarly, no such tax component was included in tariff determinations for the projects.

However, the Finance Act 2018 broadened the tax net to the offshore supply contractor through an amendment to the Geographical Source of Income, Section 101(3)(e) by including the business income of a non-resident person as Pakistan-source income irrespective of whether or not the title of goods passes outside Pakistan, if the import is part of overall arrangement for the supply of goods, installation and construction which are undertaken or performed by the associates or its permanent establishment.

Similarly, Section 152(4B) inserted in the Income Tax Ordinance vide Finance Act 2019 provides that in case any payment constitutes part of an overall arrangement of a cohesive business operation, it shall be made after deduction of 2.1% withholding tax as the minimum tax on an offshore EPC supply contract.

Provided that the credit of the tax so deducted shall be available to the permanent establishment of the non-resident accounting for overall profits arising on the overall cohesive business operation. However, through the Finance Bill 2020 such withholding tax has been reduced from 2.1% to 1.4% but the tax so withheld is not “final” and “fixed”.

The Power Division further informed the meeting that in light of the aforesaid amendments, the Kohala and Azad Pattan projects would withhold 1.4% income tax on the value of offshore EPC supply contract and subsequently the offshore supply contract(s) of both companies shall be required to pay tax in respect of offshore EPC supply contract(s) as per applicable corporate income tax rate, which was not payable at the time of signing the EPC contract and correspondingly was not part of the National Electric Power Regulatory Authority (Nepra) tariff determination.

This matter had also been included in the tripartite agreement dated June 25, 2020 executed between the government of Pakistan, government of AJK and Kohala Hydropower Project.

The Power Division submitted a proposal for consideration of the Economic Coordination Committee (ECC), which said “the rate of withholding tax on value of offshore supply contract of an independent power producer shall be 1% provided, (i) PPIB has issued Letter of Support for the project, (ii) its EPC contract has been executed and submitted to Nepra for EPC stage tariff determination prior to the enactment of Finance Act 2018 and (iii) offshore supply contract arrangement of offshore supply contractor having permanent establishment in Pakistan falls under the purview of cohesive business operation as contemplated under Income Tax Ordinance 2001. Such 1% tax shall be full and final liability of the offshore supply contractor.”

The ECC considered the summary dated February 15, 2021, submitted by the Power Division and titled “Tax on Payments to the Offshore Supply Contractor”, and constituted a committee under the chairmanship of special assistant to prime minister (SAPM) on power, comprising SAPM on revenue, SAPM on petroleum, Power Division secretary, Law and Justice Division secretary, FBR member and PPIB managing director, to deliberate on the issue in a holistic manner and submit recommendations to the ECC for its consideration.

Published in The Express Tribune, February 25th, 2021.

Like Business on Facebook, follow @TribuneBiz on Twitter to stay informed and join in the conversation.