Tax incentives are also given in favor to developing this renewable energy ... Renewable energy flows involve natural phenomena such as sunlight, wind, tides, ...
Income Tax Incentives on Renewable Energy Industry: Case of USA, China, and Indonesia Yunita Anwar, BINUS University, Jakarta, Indonesia Martin Surya Mulyadi, BINUS University, Jakarta, Indonesia
ABSTRACT Renewable energy is derived from natural processes that are replenished constantly. In its various forms, it derives directly from the sun, or from heat generated deep within the earth. Included in the definition is electricity and heat generated from solar, wind, ocean, hydropower, biomass, geothermal resources, and biofuels and hydrogen derived from renewable resources. USA and China is market leader and the most attractive market for renewable energy investment. Moreover, they also lead in wind energy sector. Tax incentives are also given in favor to developing this renewable energy industry. Indonesia as a developing country could learn and review incentives given by USA and China specifically in wind energy industry. Our study show that Indonesia might consider give a reduction on income tax rate rather than reduction on net income amounted 30% of investment allocated during six years. Reduction in income tax rate create higher shareholders’ value than reduction on net income based on investment. Besides, Indonesia can also consider giving tax credit for personal and corporate taxpayer who install a renewable energy system in their office or residence. This tax credit will indirectly boost sales of renewable energy industry and increase the attractiveness of Indonesia as a place of investment. This two option can be considered as Indonesia has a huge potential for investment in renewable energy industry. Cite this paper as: Anwar, Y., & Mulyadi, M. S. (2011). Income tax incentives on renewable energy industry: Case of USA, China, and Indonesia. The Business Review Cambridge, 17(2), 153-159. INTRODUCTION Renewable energy is energy which comes from natural resources such as sunlight, wind, rain, tides, and geothermal heat, which are renewable (naturally replenished). In 2008, about 19% of global final energy consumption came from renewables. New renewables (small hydro, modern biomass, wind, solar, geothermal, and biofuels) are growing very rapidly. Wind power is growing at the rate of 30% annually, with a worldwide installed capacity of 158 gigawatts and is widely used in Europe, Asia, and USA. Climate change concerns, coupled with high oil prices, peak oil, and increasing government support, are driving increasing renewable energy legislation, incentives, and commercialization. New government spending, regulation and policies helped the industry weather the global financial crisis better than may other sectors. Main objective of this study is to compare income tax incentives given from government to renewable energy industry. We compare between USA, China, and Indonesia; in order to have a better view regarding income tax incentives given by governement of USA and China which might be adopted by government of Indonesia if it is feasible. According to Ernst & Young’s most recent Renewable Energy Country Attractiveness Indices report, China now stands alone as the most attractive market for renewable energy investment in the world, a position it had previously jointly held with the USA. LITERATURE REVIEW Overview of Renewable Energy Renewable energy flows involve natural phenomena such as sunlight, wind, tides, and geothermal heat. Renewable energy is derived from natural processes that are replenished constantly. In its various forms, it derives directly from the sun, or from heat generated deep within the earth. Included in the definition is electricity and heat generated from solar, wind, ocean, hydropower, biomass, geothermal resources, and biofuels and hydrogen derived from renewable resources. (International Energy Agency, 2002). Renewable energy replaces conventional fuels in four distinct area: power generation, hot water/space heating, transport fuels, and rural (off-grid) energy services. Indonesia’s Renewable Energy Potential
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Indonesia has a large new and renewable energy potential, which includes 450 megawatts of mini/micro hydro power, 50 gigawatts of biomass, 4.80 KWh/m2/day solar power, 3-6 M/sec wind power, and 3 gigawatts of nuclear energy. Currently the development of renewable energy is regulated by Presidential Decree 5/2006 regarding the national energy policy. The decree states that the contribution of new and renewable energy in the 2025 national primary energy mix is estimated at 17%, consisting of 5% biofuel, 5% geothermal power, biomass, nuclear, hydro, and wind, and also liquefied coal at 2%. The steps needed for biomass development involves waste recycling from the farming and forestry industry as a source of energy which is integrated with its respective industry, integrating biomass development with the local economic development, boost the fabrication of biomass energy conversion technology including its supporting sectors, and increasing research and development of waste recycling, including city waste, for energy. Efforts to develop wind energy includes its development for both electricity and non-electricity usage (as a pump for irrigation and clean water), development of small scale (10 KW) and middle scale (50-100 MW) wind energy technology. Development of solar energy includes the use of solar powered power plants in the rural and city areas, supporting the commercialization of solar powered power plants by maximizing the private sector role, development of domestic solar powered power plants industry, and the creation of an efficient funding system through the involvement of the banking sector. To develop nuclear energy, the government needs to take socialization measures to gain the support of the public and coordinate with several countries to master its technology. In developing microhydro, the government needs to integrate the microhydro-powered power plants with the local economy, maximizing the irrigation potential for the power plant and developing the domestic microhydro industry, and developing several partnerships and funding patterns. To support development on renewable energy industry, government also give tax incentives as stated on Finance Minister Regulation 21/2010. The government believe with application of this tax incentives will encourage the development on renewable energy industry in Indonesia. USA and China China now stands alone as the most attractive market for renewable energy investment in the world, a position it had previously jointly held with USA, according to Ernst & Young’s most recent Renewable Energy Country Attractiveness Indices report. China’s rise offers a new and crucial opportunity. Paired, the two countries can float a tremendous clean energy market that could buoy the industry worldwide, or sink it if they fall. USA and China account for 42% of the world’s energy demand, and the world’s biggest coal consumers and the largest importers of oil. Both have aggresive goals to integrate renewable energy into their supply mix and they lead the way in wind power development. In 2009, China installed 13.8 gigawatts of wind power, while USA added 10 gigawatts; which is the top of other countries. Besides, existing capacity of wind power as of end 2009 shown USA and China are the leader in the world. USA and China face similar challenges in their power sectors. Both depend heavily on coal as core energy resource; it accounts for 50% of the electricity mix in the USA and 80% in China, which in turn makes the two countries the largest carbon dioxide emitters in the world. According to this factor, USA and China is the leaser on renewable energy investment, we would like to compare the income tax incentives given by the government of USA and China to the renewable industry, specifically in wind power industry. We chose wind energy industry as USA and China shown significant development on wind power industry, and also because of different tax incentives given to different renewable energy industry we will focus on a certain industry. Wind Energy Airflows can be used to run wind turbines. Modern wind turbines range from around 600 kilowatts to 5 megawatts of rated power, although turbines with rated output of 1.5–3 megawatts have become the most common for commercial use; the power output of a turbine is a function of the cube of the wind speed, so as wind speed increases, power output increases dramatically. Areas where winds are stronger and more constant, such as offshore and high altitude sites, are preferred locations for wind farms. Typical capacity factors are 2040%, with values at the upper end of the range in particularly favourable sites. Globally, the long-term technical potential of wind energy is believed to be five times total current global energy production, or 40 times current electricity demands. This could require large amounts of land to be used for wind turbines, particularly in areas of higher wind resources. Offshore resources experience mean wind speeds of around 90% greater than that of land, so offshore resources could contribute substantially more energy. Wind power is renewable and produces no greenhouse gases during operation, such as carbon dioxide
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and methane. We can see in figure 1 that demand of wind power keep increasing constantly every year, which shows a lot of opportunity in this industry.
Figure 1. The adoption of wind power has been increasing USA Tax Incentives Wind energy are given tremendous boosts under the new law. The residential energy efficient propery credit (also known as the Code Sec. 25D residential alternative energy credit) has been extended and enhanced through Dec 31, 2016. Through 2008, the 30 percent residential alternative energy credit will continue to limited to a maximum of $2,000, plus $500 for each half kilowatt of wind turbine electric capacity. USA congress has reinstated, expanded and clarified the Code Sec. 25C residential energy property credit for property placed in service in 2009. A lifetime credit of up to $500 is available for non-business energy property that meets the requirements for qualified energy efficiency improvements or qualified residential energy property expenditures. The credit, subject to the $500 cap, is equal to the cost of residential energyefficient building property, plus 10 percent of the cost of qualified building envelope components. Up to $200 of the credit can be taken for the cost of windows. The new law also seeks to consumerize wind energy by providing incentives to put up a smaller wind turbine version of those huge propellers-on-a-pole versions now commonplace on may rural hillsides. A 30 percent credit has been created on the installation costs of small wind turbines (those with capacities of 100 kilowatts or less). This credit applies to both residential and commercial use. The credits for wind turbines (“small wind energy property”) are limited to 30 percent of their cost and are capped $4,000 annually. For a residence occupied by two or more individuals, the maximum wind energy expenditure is $1,167 per year per half kilowatt and a total of $13,333. Table 1 below presented tax incentives available in USA for wind energy industry, which include incentive for personal and corporate tax payer. Basically, income tax incentive given by USA government to wind industry energy is mostly indirect incentive (except for the third incentive below). By giving personal or corporate tax credit if they install a renewable energy system will indirectly boost sales of renewable energy (in this case: wind energy). Renewable energy industry in turn have increasing sales, and furthermore they also have corporate tax credit (third incentive) for electricity sold to an unrelated person that are generated by qualified energy resources. Type Personal Tax Credit
Amount 30% of expenditures
Maximum Amount Placed in services in 2008: $4,000 Placed in services after Dec 31, 2008: no limit
Corporate Tax Credit
30% of expenditures
Corporate Tax Credit
2.2¢/kWh
Placed in services April 10, 2008 to Dec 31, 2008: $4,000 Placed in services after Dec 31, 2008: no limit N/A
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Remarks A taxpayer may claim a credit of 30% of qualified expenditures for a system that serves a dwelling unit located in the USA and used as a residence. Credits are available for eligible systems placed in service on or before Dec 31, 2016. Eligible system size is 100 kilowatt/less. Per-kilowatt-hour tax credit for electricity generated by qualified energy resources and sold by taxpayer to an unrelated person during
the taxable year. Table 1. Summary of Wind Industry’s Income Tax Incentives in USA China Tax Incentives Based on collection and distribution rights, tax in China can be classified as central government tax, local government tax, and shared tax. Except for biogas and wind, renewable energy production is not eligible for specific tax incentives at the central government level. In September 2001, Adjustment of Value Added Tax (VAT) for Some Resource Comprehensive Utilization Products was issued by Ministry of Finance and the State Tax Administration. According to this circular, the VAT for using municipal solid waste for power generation will be collected first and then will be refunded back to the manufacturer. The VAT rate for wind power will be half of the general rate. Besides, they also subject to a lower income tax (15%, while general corporation subject to 33% income tax). China reduces around 55% of income tax for wind energy industry, which give wind energy industry’s effective rate is 45% of its original rate of income tax. Value added tax is not an income tax, though the reducing amount of VAT on wind power will indirectly increased sales of wind energy industry. In calculation of income tax effect, the reducing amount would not have direct impact to the industry. Table 2 present summary of tax incentives for wind industry in China. Items Value Added Tax Income Tax General Corporation 17% 33% Wind Energy Industry 8.5% 15% Table 2. Summary of Wind Industry’s Tax Incentives in China Indonesia Tax Incentives Indonesia also gives income tax incentives for renewable energy industry. There are five income tax incentives, VAT incentives, and also custom incentives. Because we are focusing on income tax incentives, VAT and custom incentives are not discussed in detail. VAT incentives given to import of taxable goods. In general practice, import of taxable goods are subject to VAT 10%. Although the mechanism for VAT in Indonesia is credited VAT In (VAT paid when buy/import goods) with VAT Out (VAT collected when sell goods), the 10% is burden the industry at first. VAT incentives given for import of machine and equipment, either in form of Completely Build Up or Completely Knock Down. But, sparepart is excluded from this incentive. Custom incentives are also given for renewable energy industry in order to boost investment in this sector. In income tax incentives, there are five incentives given by governemnt through regulation from Ministry of Finance as follows: 1. Reducing of net income amounted 30% of investment. These amount are allocated for six years, with each years’ amount is 5% of investment. In Indonesia, corporate income tax rate is 25% while for Micro, Small, and Medium Enterprise is eligible for 50% reduce from income tax rate. But for renewable energy industry most likely is not eligible for being qualified as a Micro, Small, and Medium Enterprise as it needs quite a lot of investment. 2. Accelerated depereciation and amortization. In Indonesia, corporation allowed to choose straight line or double declining (exclusion for building assets) as its depreciation method. But Directorate General of Tax classify to a certain group. For example, a non-building assets is categorized under four groups (according to its nature) and building assets is categorized under permanent and non permanent. Below in table 3, we summarize the depreciation rate with straight line and double declining method under this incentives and without this incentives. Accelerated depreciation would only impacted as a time difference on income tax impact, not as a permanent difference. For example, in non building group I; with incentives that asset will be fully depreciated in 2 years, while without incentives that asset will be fully depreciated in 4 years. It means from year 5, they will not have impact toward net income (income tax). Type of Assets
Non Building – Group I Non Building – Group II Non Building – Group III
Depreciation Rate (Straight Line) With Incentives
Depreciation Rate (Straight Line) No Incentives
Depreciation Rate (Double Declining) With Incentives
Depreciation Rate (Double Declining) No Incentives
50%
25%
100%
50%
25%
12,5%
50%
25%
12,5%
6,25%
25%
12,5%
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Non Building – Group IV Permanent Building Non Permanent Building
10%
5%
20%
10%
10%
5%
-
-
20%
10%
-
-
Table 3. Summary of Depreciation Rate in Indonesia 3. Income tax on dividend to foreign taxpayer amounted 10% or with lower rate according to tax treaty between Indonesia and the dividend holder’s country. 4. Loss carry forward extended to more than 5 years, but not exceeding 10 years. For general taxpayer in Indonesia, loss carry forward maximum only for five years. 5. Exclusion from Income Tax Article 22 on import for machine and equipment (Completely Knock Down or Completely Built Up; sparepart is excluded from this incentive). In Indonesia, besides subject to VAT as we have discussed earlier for importing goods; it also subject to Income Tax article 22 (amounted 2.5% or 7.5%). The mechanism of Income Tax article 22 actually as a tax credit to be calculated in annual tax. So the exclusion from Income Tax Article 22 could leave the burden for corporation at the time they import the goods, but actually do not have significant impact on income tax calculation. RESEARCH METHODOLOGY We make comparison of tax incentives take place in USA, China, and Indonesia. As we have discussed that tax incentives in USA mostly have indirect impact to the net income (income tax) of renewable energy (wind energy) industry. So, we make comparison of tax incentives in China (reduced income tax rate) and Indonesia (reduced net income). As income tax incentives in Indonesia would take place at least six years, we do make a series assumption of net income for six years. We also make assumption of the investment expenditure by shareholders. Again, under assumption that net income is distributed directly to shareholders so we will measure effectivity of tax incentives by shareholders’ view. Shareholders’ view is maximizing value of its investment, so we could conclude that incentives which create maximal value to shareholder could see as an attractive destination as compared to the other.
SV I AINV
SVC AINV
NI I ,1 (1 r )
0
NI C ,1 (1 r )
0
NI I , 2 (1 r )
1
NI C , 2 (1 r )
1
NI I ,3 (1 r )
2
NI C ,3 (1 r )
2
NI I , 4 (1 r )
3
NI C , 4 (1 r )
3
NI I ,5 (1 r )
4
NI C ,5 (1 r )
4
NI I , 6 (1 r ) 5
NI C , 6 (1 r ) 5
NI I , y ( AI y 5% AINV ) (1 TR )
NI C , y AI y (1 45% TR ) Where: SVI SVC AINV NII,y NIC,y r AIy TR
= = = = = = = =
Shareholders’ value with Indonesian Income Tax Incentives, Shareholders’ value with China Income Tax Incentives, Assumed Investment, Net Income based on Indonesian Income Tax Incentives on Year-y, Net Income based on China Income Tax Incentives on Year-y, Indonesian Central Bank Rate, Assumed Income before tax on Year-y, Tax Rate. RESULT AND DISCUSSION
Comparison of Indonesia and USA USA give three income tax incentives, where two incentives are indirect incentives. Indirect incentives given by government of USA is a tax credit for either personal or corporate texpayer if they install a system of renewable energy. For a personal taxpayer, they can install at their residence, while for corporation they can 5
install it on their office. Of course, there is certain limitation given, such as eligibility of system and also maximum tax credit. But, in general, this indirect incentive is attractive to encourage taxpayer to use the renewable energy system. Because if they do so, they will have tax credit for their income tax. In Indonesia, indirect incentives toward renewable energy (wind) industry only related to VAT and also Income Tax Article 22 (import) while actually it could not count as an incentive. For VAT when they imported goods, if they are a general corporation, the VAT In will be credited to VAT Out when they sell the product to customer. The difference between VAT In and VAT Out go directly to the government. It would not impacted anything, but the amount paid at first. The same condition also for Income Tax Article 22, if they are a general corporation, once they imported the goods they have to pay Income Tax Article 22 while in the end of year the amount paid calculated as tax credit. Indonesia should consider to issue a new indirect incentives like what have been doing in USA. By creating indirect incentives, people will be encouraged to use/buy from renewable energy industry. Although it gives tax credit to the buyer, indirectly higher sales to renewable energy industry will in turn create higher bottom line and also higher tax paid to the government. Besides, as USA altogether with China are the most attractive place for renewable energy investment in the world, Indonesia could also learn something from their fiscal policy regarding this industry. Comparison of Indonesia and China We use formula as stated in research methodology in comparing Indonesia and China. We make assumption that investment made of shareholders to renewable energy corporation is $1,000,000, while assumption on first year net income is $175,000. Net income assumed increase constantly by 10% each year. Indonesia Central Bank Rate which used as a discount rate is 6.5%, a rate constantly used as benchmark by Bank of Indonesia during 2010. Our results are summarized on Table 4 and Table 5 below. Amount in $ Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Assumed Income 175,000 192,500 211,750 232.925 256,218 281,839 Tax Incentives 50,000 50,000 50,000 50,000 50,000 50,000 Earning Before Taxes 125,000 142,500 161,750 182,925 206,218 231,839 Tax Rate 25% 25% 25% 25% 25% 25% Earning After Taxes 93,750 106,875 121,313 137,194 154,663 173,879 Shareholders’ Value 93,750 100,352 106,956 113,576 120,223 126,911 Table 4. Simulation on Shareholders’ Value using Indonesian Income Tax Incentives Amount in $ Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Assumed Income 175,000 192,500 211,750 232.925 256,218 281,839 Earning Before Taxes 175,000 192,500 211,750 232.925 256,218 281,839 Tax Rate 11% 11% 11% 11% 11% 11% Earning After Taxes 155,313 170,844 187,928 206,721 227,393 250,132 Shareholders’ Value 155,313 160,417 165,689 171,134 176,758 182,567 Table 5. Simulation on Shareholders’ Value using China Income Tax Incentives
SV
(338,231)
SV
11,876
As we can see above, simulation using several assumptions resulted in negative shareholders’ value using Indonesian Income Tax Incentives. While we use China Income Tax Incentives, with same assumption, we have positive shareholders’ value. We can conclude that China income tax incentives scheme is more attractive to shareholders than Indonesia income tax incentives. We believe that main objective of Indonesian government is to keep investors make a long-term investment in Indonesia so they allocate reduction of 30% from investment during six years. We also do aware that net income of renewable energy corporation is not as simple as increase 10% constantly per year. But, with assumption of ceteris paribus, we compare the same data and formulate using tax incentives scheme for each country and resulted on China is more favorable to investors. Given this result, Indonesian government and authority should also consider to give reduction on income tax rate for renewable energy industry. Besides the finding from our study that China income tax incentives scheme create higher shareholders’ value, China also known as the most attractive place for renewable energy investment in the world. CONCLUSION Renewable energy is derived from natural processes that are replenished constantly. In its various forms, it derives directly from the sun, or from heat generated deep within the earth. Included in the definition is electricity and heat generated from solar, wind, ocean, hydropower, biomass, geothermal resources, and biofuels 6
and hydrogen derived from renewable resources. USA and China is market leader and the most attractive market for renewable energy investment. Moreover, they also lead in wind energy sector, a sector which still have very high demand and very high opportunity to develop. Meanwhile, Indonesia, as a developing country also has large renewable energy potential, which include potential in wind energy. Given that USA and China has been in this business before Indonesia, we could analyze what incentives they gave to the industry so the industry could develop well. Specific incentives in this study is income tax incentives. From our study, we find out that most of incentives from USA mostly are indirect incentives which encourage people to buy/install renewable energy system and give them tax credit as return. This incentives could boost sales of renewable energy corporation. Indonesia could consider create an incentives similar like these. Both China and Indonesia give indirect incentives (as in VAT), but for Indonesia incentives for VAT and also Income Tax article 22 is not advantegous as it will only create time difference. We compare direct incentives between Indonesia and China by using some assumptions, where we found that income tax incentives from China is creating higher shareholder value. Income tax incentives in China is reducing on tax rate, while Indonesia give reducing on net income based on investment value during six years. From this study, Indonesia could also consider to give tax rate reduction for renewable energy industry.
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