Recent modifications to rules and regulations by four major Chinese governmental institutions will encourage private companies to decrease the environmental impact of their operations. The State Council’s new
Opinion on Accelerating the Implementation of Energy Management Contracting to Promote the Development of Energy Saving Service Industry
report provided for new rules to be issued by the National Development and Reform Commission, the Ministry of Finance, the People’s Bank of China, and the State Administration of Taxation. The rules center on Energy Service Companies (Escos), and provide incentives through income tax deductions, value-added tax and Business Tax exemptions, government-encouraged financing, and direct government subsidies.
Generally, Escos are able to reduce their customers’ energy consumption through Energy Management Contracting, or EMC. This process involves a contract that promises reduced energy consumption from the consumer in return for payments from the customer’s resulting expense reductions. This process avoids any net increase in the customer’s expenses or capital investment, allowing the company to undertake capital-intensive energy-reduction projects that it otherwise may have been avoided.
One new tax benefit for Escos will come in that all revenues from EMC projects will be exempted from Business Tax and value-added tax during a temporary period, and be subject to a lower rate after the temporary period expires. Additionally, an Esco’s net income derived from an EMC project will also be exempted from enterprise income tax for three years, and then will be decreased by 50% for the following three years. Furthermore, if an Esco transfers any equipment to a consumer at the end of an EMC project, the new regulations will allow the Esco to complete this “free of charge” without recognizing any revenue and subjecting themselves to additional tax liability.
Consumers of Escos will also see significant new incentives. Any asset transfers from an Ecso to a company will not create any mandatory accounting or tax burden on the recipient – they will be allowed to treat the transferred assets as fully amortized and depreciated. Government and public institutions are currently deterred from participating in Escos by the current public finance management system, but under the new regulations, they will see preferential accounting changes. They will be able to treat any monies received under an EMC as an “energy expense,” and any asset received as a “donation,” in order to reduce their tax burden.
All of the tax incentive measures should have a strong effect to increase energy-saving EMC projects in China. The new regulations will help Escos and EMC gain government support and private investment, allowing their expansion and increased profitability. This will help China’s efforts to conserve energy, as well as localize the generation of renewable energy, and shift more of the workforce from commoditized manufacturing into higher-value services. Lehman, Lee & Xu applauds this step, and encourages the Chinese Government to implement further measures to encourage the growth of Escos (such as allowing utility-providers to finance Esco projects, incentivizing Escos in leasing scenarios, encouraging energy audits, and arranging state-backed guarantees for tradable securities based on energy savings or EMC revenues).