The Government’s Policy for Power Generation Projects 2002 contemplated a two-part tariff: Energy Purchase Price (EPP) and Capacity Purchase Price (CPP). Paragraph 21 stated that companies covered by the policy would be completely exempt from income tax, including turnover-rate tax and withholding tax on imports. The policy provides historical context; statutory entitlement is governed by the Income Tax Ordinance, 2001 and the conditions in its Second Schedule.

Section 11 of the Income Tax Ordinance, 2001 classifies income under heads including “Income from Business” and “Income from Other Sources”. Section 18 charges the profits and gains of a business under “Income from Business”, while section 39 applies to income not included under another head and not otherwise exempt. An invoice label is not by itself conclusive. The payment’s nature, source, contractual basis, project activities and supporting records must be considered.

Section 53 gives effect to exemptions in the Second Schedule subject to their stated conditions and extent. Clause (132) of Part I covers profits and gains derived by a taxpayer from an electric power generation project set up in Pakistan on or after 1 July 1988. The project and company must meet the clause’s conditions, and the income must be derived from the qualifying project.

An Islamabad High Court decision in 2022 considered CPP under clause (11A)(v) of Part IV of the Second Schedule. In Commissioner Inland Revenue (Legal), Corporate Tax Office, RTO, Islamabad v. Foundation Power Company (Dharki) Ltd., I.T.R. No. 51/2020, decided on 18 July 2022, the Court treated it as important that CPP arose under the same PPA as the sale of electricity. It held, on the facts before it, that CPP could not be bifurcated and treated as a receipt from other sources merely because it was separately identified under the PPA. This was a case-specific conclusion, not a rule for every capacity payment.

The Supreme Court’s decision in Commissioner of Income Tax, Companies Zone, Islamabad v. M/s Fauji Foundation Limited, 2023 SCMR 1694 = 2023 PTD 1590, says that classification between business income and income from other sources requires considering the company’s objects, memorandum or foundation documents, functions, actual work, tax returns and treatment of income. The case concerned bank-deposit interest, not CPP, but its fact-based approach is relevant.

UCH Power (Pvt.) Ltd. v. Income Tax Appellate Tribunal and others, 2010 SCMR 1236 = 2010 PTD 1809, is a limitation on a broad exemption claim. It concerned interest on bank accounts of private power-generation companies. The Court held that the interest was separate income from other sources and was not covered by the power-generation exemption under the old Income Tax Ordinance, 1979. It did not concern CPP. It shows that the statutory head and actual source of a receipt matter.

Minimum tax is separate. Section 113 of the Ordinance contains the minimum-tax rule. Clause (11A)(v) of Part IV of the Second Schedule states that section 113 does not apply to companies qualifying for exemption under clause (132), in respect of receipts from sale of electricity. It does not expressly mention CPP. In comparable circumstances, the same-PPA reasoning may support an argument for treating CPP with electricity-sale receipts, but that is not automatic and requires analysis of the statute, PPA and facts.

Are capacity payments taxable? There is no blanket answer. Where CPP arises under the same PPA as the sale of electricity and is connected with the project’s core power-generation business, the reasoning in Foundation Power supports an argument that it is business income rather than income from other sources. For a project meeting clause (132), that argument may support exemption under clause (132), while minimum-tax treatment must be considered separately under clause (11A)(v). The result depends on the statutory conditions, the PPA, the project’s activities and the supporting record.

This article is for general information only and is not legal or tax advice nor does it represents the professional legal opinion on behalf of the firm. The law and statutory text should be checked for amendments before publication, and the result in a particular matter will depend on the applicable PPA, project eligibility and factual record.