The special tax regime for hydropower

On regulations and reporting for power companies covered by the special tax regime for hydropower. Power companies are subject to special rules on the taxation of income related to the production, sale, transfer or distribution of hydropower.

Introduction

Power enterprises are subject to special rules regarding the taxation of income relating to the production, sale, transmission, or distribution of hydropower. The current rules are set out in chapter 18 of the Taxation Act, and means, among other things, that the owner of a power plant over a certain size (with generators that in the income year have a total stamped output of 10,000 kVA) must pay a special ground rent tax to the state, in addition to tax on ordinary income. In addition, chapter 18 contains rules regarding natural resource tax to the municipality and the county council, and special rules for calculating the property tax basis for assessment of property tax and rules regarding the valuation of power generation facilities.  

While the intention of the natural resource tax only is to redistribute the tax revenue from the state to the municipalities and the county councils, the ground rent tax is a special tax in addition to tax on ordinary income and any property tax issued to the power generation facilities. The ground rent tax for power enterprises was introduced with the 1997 power tax reform to ensure that society was able to take part in the extraordinary excess return that arises from power plant owners being able to use hydropower for power production. Because of the ground rent tax rules, power enterprises will with effect from the 2022 income year be subject to a marginal tax burden of 67 percent. High-price contributions are additional but will not be discussed further in this article as this is an excise duty and consequently not part of the special tax regime for hydropower. The hydropower industry is consequently the industry that in addition to the petroleum, wind, and breeding industry is taxed at the highest tax rate in Norway.   

The focus in this article will be on the rules for calculating the ground rent tax, and the proposed changes in the National Budget for 2023. From and including the 2021 income year, the ground rent tax was converted to a cash flow tax, and the rules regarding cash flow tax will also be explained below. In addition, the natural resource tax and the special rules for calculating the property tax basis for the power generation facility will be briefly accounted for.  

More on ground rent tax

The owner of a power plant with a rated power output of 10,000 kVA or more must pay ground rent tax to the state. Who is the owner of the power plant, and thus the right taxpayer for the ground rent tax, must be decided based on a concrete assessment, and it’s the actual ownership that is decisive. It’s the individual power plant that is the unit for calculation of the tax. The fact that it’s the production at the individual power plant that is to be taxed also ensures that the ground rent tax stays in Norway, even if the power plant is sold to foreign owners.  After the implementation of the cash flow tax, the rate of the ground rent tax is set at 57.7, and the specific rules regarding the calculation base follows from section 18-3 of the Taxation Act.  

The calculation of the ground rent income is based on a standardized market price where the main rule is that the power plant’s production in the income year is multiplied by the spot market price set in the power market. There are exemptions from the main rule for some of the power plant’s power supplies which are to be priced at contract price. The exemptions are governed by positive law and apply to licenced power supplies, certain long-term contracts, and power that the industry produces and consumes in its own operations. From the 2023 income year, it’s suggested to make exemptions for certain fixed price agreements on certain specific conditions. In the calculation base for the ground rent income, gains on realisation of fixed assets, public support for production of new hydropower and income from issued electricity certificates are also included.  

The owner of the power plant will in the calculation base receive a deduction for operating expenses that regularly follows from power production. The cost must be or going to be related to the power production at the power plant. This sets out a narrower term of association than in ordinary income, which has raised several disputes before the courts. Costs that relate to parts of the power plant owner’s business other than the power production is not deductible in the ground rent. It’s specified in the legislation that sales costs, transmission costs and financial costs shall not be deductible. You can neither claim deductions for costs for renting waterfall rights. The background for this is to make sure that the entire ground rent is taxed, and to avoid tax motivated undermining of the ground rent. Other costs that are deductible from the ground rent are licence fees and property tax for the power plant, and on certain conditions costs incurred during the time of construction.  

The owner of the power plant will further receive deductions for depreciations of fixed assets linked to the power production. Investments that required capitalisation after 1 January 2021 can be deducted directly, see the explanation below. Exemptions apply to the acquisition of time limited waterfall rights that, regardless of the time limit, are not to be depreciated, and acquisition of existing power generation facilities. The fixed asset must be linked to the power production to be depreciated, and the act thus sets out the same terms of association as for operating expenses. Power generation facilities follow the ordinary rules concerning declining-balance depreciation and amortisation in sections 14-40 and onwards of the Taxation Act, with different percentage rates for the different fixed assets. For some specific fixed assets in power generation facilities however, rules apply that the fixed assets should be depreciated on a linear basis over its life expectancy to best reflect the economic loss of value. From and including the 2021 income year the system was converted from a periodised ground rent tax, where the investment will be deducted through annual depreciations and an uplift during the life expectancy, to a cash flow tax with direct deductions the year the investment required capitalisation. The depreciation deduction is therefore only relevant for investments that required capitalisation before this time.   

For investments that requires capitalisation, deductions are also given for an uplift. The uplift is assessed as an average of the taxable value of the fixed assets in the income year multiplied by a normal interest rate. The purpose of the uplift is to compensate for the disadvantage of having to capitalise and depreciate investments during the lifetime expectancy of the fixed asset, rather than being able to charge the investment costs as an expense directly. As the introduction of the cash flow tax means that the owner of the power plant gets a direct deduction for his investments, uplift deductions will be less relevant in future. 

Although the individual power plant is the calculation unit for the ground rent tax, coordination rules were introduced in 2007, which mean that negative ground rent can be coordinated based on other power plants that the taxable subject owns, or that are within the same group. Under the scheme, the power plant owner can receive an annual refund of the tax value in the event of negative ground rent income after coordination.  Negative ground rent from before 2007 cannot be coordinated and can only be carried forward against a positive basis in subsequent years from the same power plant. 

- section 18-3, subsection 3, letter a, no. 5 of the Taxation Act 

The hydropower industry is capital-intensive, and the investments in a hydropower plant often means large cash outlays in the initial phase of the project. For example, if the power enterprise spends on a dam installation, the investment cost will be deducted over 67 years, which is the lifetime expectancy of the dam according to current depreciation rules. With such a periodised ground rent tax, the tax creditors will consequently receive a large share of the creation of value from the initial phase, while the investor will only get back the invested capital towards the end of its lifetime expectancy.  

With effect from 1 January 2021, by law 21 December 2020 no. 164, it was decided to change the ground rent tax for hydropower production so that direct deductions are given for new investments in the basis for ground rent tax. Deductions are granted both for investments in new power plants and for reinvestments, upgrading, or expansion of existing power plants. Investments that can be deducted directly from the ground rent tax are capitalised and depreciated in the usual way when calculating ordinary income.  

 The condition that the fixed asset must be linked to the power production is retained for the investment costs that according to the new rules can be charged as expenses immediately. The taxation thereby follows the cash flow, instead of a periodised taxation of profits. The fact that the investment costs can be deducted already in the year in which the costs require capitalisation means that the investor receives a deduction even if there is no loss.  

The law amendment means that direct deductions are granted for investments that should have been capitalised and depreciated according to the previous rules. The cut-off time for the charging of expenses must be consistent with already established principles for capitalisation in tax law, and the deduction is given the year in which the cost is required capitalised in ordinary income. The requirement of capitalisation arises when the tax subject has received something of lasting value. Where the investment takes place over more than one income year, the requirement of capitalisation occurs continuously for amounts corresponding to the value of production at any given time. In such projects, the requirement for capitalisation arises before the right to depreciation.  

If the power generation facility is changed so that the ground rent income is no longer to be assessed, the taxable values for fixed assets that have been deducted immediately must be returned as income in the basis for the ground rent tax from this year onwards. It’s emphasized in the preliminary works (Prop. 1 LS (2020-2021)) that the recognition of income when downscaling is limited to tax-related remaining values used in the calculation of tax on ordinary income. 

As mentioned above, the uplift is intended to compensate for the fact that investment costs are deducted in the future. When investment costs can be directly deducted, the justification for an uplift disappears. Therefore, no deductions shall be made for uplift in the basis for ground rent tax for fixed assets that are directly deducted according to the new rules.  

The legislative change entails a two-track system in the ground rent tax. Based on the cut-off time described above, this means that investments made before 1 January should be capitalised with subsequent right to deductions for depreciations and uplift, while investments after 1 January 2021 can be charged as expenses directly.  

- see the Taxation Act, section 18-3, subsection 3, letter c

For the cash flow tax to be neutral, the tax base must reflect the cash flow used to assess the investment’s profitability before cash flow tax. In the Norwegian taxation system, all business activity faces a general tax on profits, the company tax of 22 percent. This is also paid by the power enterprises, including for business activity subject to ground rent tax. In the Norwegian taxation system, it is therefore the cash flow after company tax that is relevant for assessing the investment’s profitability before cash flow tax. 

To ensure a neutral ground rent tax, it was decided in December 2021 to introduce a sequential taxation that entails that ground rent tax related company tax is deducted from the basis for the ground rent tax. The ground rent tax rate therefore had to be adjusted upwards from 37 percent to 47.4 percent to continue the same effective marginal tax as before the changes, at 59 percent. From and including the 2022 income year, the effective ground rent tax is from 37 percent to 45 percent. That means that the formal ground rent tax rate is set at 57.7 percent and gives a total effective marginal tax of 67 percent.  

Only a specially calculated company tax linked to ground rent taxable activities is to be deducted from the basis for ground rent tax. The owner of the power plant may have activities other than hydropower production, and it’s not the assessed company tax for the company’s total activity that is deducted. This means that a specially calculated company tax must be assessed based on the same income and cost variables used in the assessment of ground rent tax. Therefore, no consideration shall be given to any divergent sales agreements or price hedging, results from other business areas, or financial results. Nor should deductions for natural resource tax be considered. Depreciation of fixed assets that are charged directly as expenses in the ground rent income, will nevertheless be deducted from the ground rent related company tax in the same way as in other ordinary income.  

Ground rent related company tax must be assessed per power plant. This is necessary since the ground rent tax is included as an element in assessing the property tax basis for each power plant. 

If the ground rent related company tax is negative, zero is deducted that year, and the loss is carried forward without interest until later income years. This means that future deductions for ground rent related company tax, when calculated as a positive amount, will be reduced. Ground rent related company tax loss will thereby constitute a separate carry-forward tax position. Tax on ordinary income (company tax), and any carried forward loss in ordinary income, will not be affected by the new ground rent related company tax calculation. 

When ground rent related company tax is deducted from the ground rent income, the basis for the ground rent tax is too low. To take this into account, and to maintain the same marginal tax rate of 67 percent as before the changes, the ground rent tax rate for the ground rent income is adjusted.  

The calculation is as follows: 

Previous ground rent tax rate = 45%. Along with the company tax rate of 22% after parallel calculations, it amounted to 67%. 
After cash flow tax and collaboration, the new ground rent tax rate is 57.7%. 
0.45/ (1-0.22) = 0.577 
Effective marginal tax rate: 0.22 + (1-0,22) * 0.577 = 0.67 = 67% 

Natural resource tax is paid to the municipality and the county council that are allocated the wealth of the power generation facilities. That means that the tax is distributed between the municipalities and the county council(s) where the zoning, waterfall, and power plant is located. As with the ground rent tax, the owner of the power plant is obliged to pay natural resource tax. The unit for the calculation of the natural resource tax is the individual power enterprise, and the tax is assessed based on 1/7 of the power plant’s total production of electric power for the income year and the six previous years. If the power plant has been in production for less than seven years, the income for the previous years is set at zero in the calculation. In these situations, the provision involves phasing in the tax. For the municipality, the natural resource tax is calculated with 1.1 øre per kilowatt hour, and correspondingly with 0.2 øre to the county council.  

The natural resource tax does not impose any additional burden on the tax debtor. The background and purpose of the provision is to have a redistributive effect by providing the host municipality and county council with funds as compensation for the intervention on nature in their area. Technically, this is done by claiming deductions for natural resource tax (NOK by NOK) in the stipulated equalisation tax to the state. For certain companies and instalments (see section 2-36 of the Taxation Act) that do not pay equalisation tax to the state, the deduction is given in assessed tax on ordinary income. Any natural resource tax that exceeds equalisation tax to the state may be carried forward as a deduction in subsequent years at an interest set by the Ministry in regulations (section 18-8-2, see section 18-8-1 of the FSFIN Regulations). 

Property tax for power generation facilities is based on the value at which the plant is assessed when determining the wealth and income tax the year prior to the fiscal year, see section 8B-1, subsection 1 of the Property Tax Act.  

The valuation method varies depending on whether the power plant in the income year has a rated power output of 10,000 kVA or more or has not been in activity.  

For power generation facilities with a generator of 10,000 kVA or more, the method in the Taxation Act, section 18-5, is based on a profitability calculation for the power generation facility. The starting point is the net present value calculation of net income over an unlimited period. Gross sales revenue is set at the average of the sum of each of the five last year’s spot market prices per hour multiplied by actual production at the power plant. Power extracted in accordance with the terms of licence (licenced power) is valued at achieved prices.  If the power plant has been covered by the valuation method shorter than five years, the average for these years is calculated. Similarly, deductions for costs are calculated according to the Taxation Act, section 18-3, subsection 3, letter a, no. 1 and 2 (operating expenses, licence fee, and property tax). In addition, deductions are made for obligatory tax on ground rent income for the power plant. The owner of the power plant will also receive deductions for the present value of future costs for replacements of fixed assets linked to the power production. A condition for deductions for replacement costs is that the fixed assets according to tax depreciation rules are considered to have a limited lifetime expectancy. 

Wealth in a power generation facility with a rated power output of 10,000 kVA or more in the income year is set at a taxable value as at 1 January in the tax assessment year. For installation parts in a power generation facility that has not been in operation, the value is set to invested capital as at 1 January in the tax assessment year. 

Reporting

Reporting within the special tax regime takes place in RF 1151, RF 1152, RF 1153, RF 1156, and RF 1161: