Captive power in transition: Electricity (Amendment) Rules 2026, draft National Electricity Policy and evolving tax treatment

India’s captive power plant system has been governed for over two decades by the Electricity Act, 2003 and the Electricity Rules, 2005, allowing companies to generate electricity for self-use instead of depending on electricity distribution companies, helping them avoid high costs and unreliable supply. Over time, this system became widely adopted by industries across sectors. However, the legal framework was far from perfect and created several problems, including lack of clear definitions, divergent interpretations by State Electricity Regulatory Commissions, and frequent litigation particularly regarding how ownership and electricity usage conditions should be calculated in complex group structures.

To address these challenges, the government introduced the Electricity (Amendment) Rules, 2026, which significantly revise the earlier rules, and also proposed the Draft National Electricity Policy, 2026, to replace the old policy and guide the future development of the power sector. Simultaneously, the tax treatment of captive power plants under the Central Goods and Services Tax Act, 2017 particularly the availability of Input Tax Credit (“ITC”) on capital expenditure has emerged as a critical commercial consideration.

Thus, the present framework of captive power in India is shaped by three key elements: (a) updated electricity rules, (b) a new policy direction, and (c) evolving tax treatment, which together determine how the system will function going forward.

The legislative basis for captive generation derives from Section 9 read with Section 2(8) of the Electricity Act, 2003, which permits any person or company to establish a captive generating plant primarily for its own use. The Electricity Rules, 2005, prescribed two conditions: collective ownership of at least 26% of the plant, and consumption of at least 51% of the annual generation. Compliance confers exemption from cross-subsidy surcharge and additional surcharge, making captive power significantly cheaper than purchasing electricity from distribution companies.

However, although these conditions appeared straightforward, they became difficult to apply in practice as companies began operating through complex structures such as subsidiaries, holding companies, and special purpose vehicles especially in group captive and renewable energy arrangements. This created confusion regarding who qualifies as an owner and whether consumption conditions were truly met. Multiple disputes arose, and the Supreme Court of India was called upon to interpret these provisions in several cases involving group structures. Despite judicial intervention, different State Commissions continued to apply the law differently, resulting in persistent uncertainty. The Electricity (Amendment) Rules, 2026 therefore represent not a minor revision, but a necessary step to restore clarity and uniformity to the captive power regime.

The amended rules introduce five significant changes that make the captive framework more practical and commercially secure.

Firstly, the definition of “captive user” is expanded so that a company, its subsidiaries, holding company, and related entities are treated as a single user, eliminating the earlier problem of denial of captive status due to dispersed group ownership.

Secondly, in projects set up through Special Purpose Vehicles (SPVs), specific generating units may be designated as captive, rather than applying conditions to the entire plant, providing critical flexibility for renewable energy projects.

Thirdly, for group structures (Association of Persons), consumption is expected to be proportionate to ownership. However, only the excess portion consumed by any one member will attract charges, rather than penalizing the entire group.

Fourthly, electricity stored in batteries (e.g., from solar or wind plants) and later consumed is expressly recognised as captive consumption, supporting modern energy storage configurations.

Lastly, a structured verification system is introduced: State agencies and the National Load Dispatch Centre will verify compliance, and no additional charges will be imposed during the verification period unless non-compliance is conclusively established. Collectively, these reforms reduce litigation risk and strengthen the commercial viability of captive power projects.

The Draft National Electricity Policy 2026 updates the 2005 framework to align with India’s "Viksit Bharat 2047" vision. For the captive sector, it proposes reducing cross-subsidy (CSS) and additional surcharges (AS), potentially exempting manufacturing and transport sectors entirely. While these reforms, alongside tariff revisions, aim to stabilize struggling DISCOMs, this could also make grid power more competitive, captive power remains attractive for its economic benefits.

Broadly, the policy targets net-zero emissions by expanding renewables and battery storage. Despite evolving pricing, industries will likely prioritize captive power to ensure supply reliability, energy security, and corporate sustainability goals.

The GST treatment of captive power infrastructure must be assessed alongside the regulatory framework, as both determine ITC availability. Under Section 16(1) of the CGST Act, ITC is available on goods and services used in the course or furtherance of business. However, Section 17(5)(d) blocks ITC on the construction of immovable property on one’s own account. The critical exception is “plant and machinery” i.e. apparatus and equipment fixed to earth by foundation or structural support used in business, excluding land, buildings, and civil structures. The central question, therefore, is whether a captive power plant qualifies as plant and machinery (ITC eligible) or as immovable property (ITC denied).

Judicial and advance ruling authorities have reached divergent conclusions based on facts. In Re: Unique Welding Products Limited (2021), the Gujarat Authority for Advance Ruling (“AAR”), held that a rooftop solar system fixed using nuts and bolts without permanent earth-embedding does not constitute immovable property, allowing full ITC. In Re: Pristine Industries Limited (2021), the Rajasthan AAR similarly allowed ITC on a rooftop solar plant capitalized as plant and machinery. The Madras High Court in Thiagarajar Mills (P) Limited v. Additional Commissioner (CT), 2018 SCC OnLine Mad 13615, confirmed that ITC remains available even where electricity is generated at a remote location and transmitted through the grid, provided a clear nexus with taxable business activity is established.

A contrary position was adopted in Kanishk Steel Industries Limited (2025) by the Tamil Nadu AAR. There, electricity generated at a solar plant was transmitted through the state grid, with TANGEDCO issuing credits for consumption at a separate manufacturing unit. The authority held this did not constitute captive consumption, treating the grid-supplied electricity as an exempt supply and directing proportionate ITC reversal under Sections 17(2) and 17(3) read with Rule 43 of the CGST Rules. This ruling underscores that the factual characterisation of electricity flow is critical, especially in off-site and inter-state group captive structures.

The metering configuration i.e. net metering versus gross metering is a decisive determinant of ITC eligibility. Under net metering, the grid acts as a balancing mechanism, with no separate sale or invoicing of electricity, supporting the argument that no “supply” occurs, thereby avoiding ITC reversal. Under gross metering, the entire generation is supplied to the grid and electricity is separately procured for consumption, a structure that constitutes an exempt supply of electricity and triggers ITC reversal under Rule 43. The reasoning in Kanishk Steel aligns with this gross metering framework. Favorable rulings such as Unique Welding and Pristine Industries involved on-site installations with direct consumption and net metering, confirming that the metering mechanism is not merely a technical detail but a legally decisive factor.

When ITC claims are contested by tax authorities, captive companies adopt a structured defence.

Firstly, they characterise the power plant as “plant and machinery” rather than immovable property, supported by invoices, accounting entries, technical reports, and asset classification records, to establish that the plant is a business asset and not merely a civil structure.

Secondly, they argue that electricity generated is used for captive consumption not supplied to the grid and therefore does not constitute an exempt supply, even where it transits through the grid. The emphasis is on actual end-use: electricity is ultimately consumed in manufacturing or business operations.

Thirdly, they establish a clear nexus between the power plant and taxable manufacturing output such as steel, cement, or chemicals to justify ITC under Section 16(1). Where the final product is itself exempt, proportionate ITC reversal may be unavoidable.

Lastly, companies rely on favorable rulings and court decisions while maintaining robust documentation to withstand audits and litigation.

In essence, the defense strategy is to prove that the plant is a legitimate business asset, electricity is consumed internally, and that the overall activity is connected to taxable output, thereby making ITC legally admissible.

India’s captive power sector is being reshaped by the Electricity (Amendment) Rules 2026, the Draft NEP 2026, and the evolving GST framework. The new electricity rules provide much-needed clarity on ownership, group captive structures, and energy storage, significantly reducing litigation risks. Simultaneously, the Draft NEP 2026 promotes renewables and proposes reducing surcharges, though grid pricing reforms may eventually narrow the cost advantage of captive power.

However, GST compliance remains a complex hurdle. Classification of infrastructure as "plant and machinery" and the risk of Input Tax Credit (ITC) reversal under Rule 43 depend heavily on whether arrangements use net or gross metering. Recent jurisprudence favors direct on-site consumption but penalises grid-mediated structures. To succeed, companies must proactively align their operational models with both electricity and tax laws, maintaining robust documentation to defend their commercial benefits during India’s energy transition.

About the authors: Jyoti Kumar Chaudhury is a Senior Partner and Jatin Chaddha is an Senior Associate (Designate) at Hammurabi & Solomon Partners.

Disclaimer: The opinions expressed in this article are those of the author. The opinions presented do not necessarily reflect the views of Bar & Bench.

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