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Budget 2015: Tax Exemptions To Boost Defence Manufacturing

Published on Wed, Feb 25,2015 | 17:39, Updated at Wed, Feb 25 at 17:39Source : 

                   By: Ajay Rastogi, Partner – Tax & Regulatory Services, PwC India

Technology plays an important role in the development of any sector, particularly in defence. While the “Make in India” journey is on, India is continuing to develop its capabilities, but for a short to medium term, it would rely to an extent on more developed countries for latest technologies in the defence sector.

The high cost of developing and buying technology is a key impediments and any effort for bringing down the cost would indeed have a positive impact.  Taxation is an important tool that can be used to bring down the cost of technology and ultimately, the cost of defence manufacturing in India.

The income of a foreign company with a taxable presence is taxed at 40% (net of the costs incurred), whereas income pertaining to services which are considered in the nature of fees for technical services (FTS) or royalties is taxed at 25% (or at a concessional rate under treaties) on a gross basis.  Taxing income at 25% gross would mean assuming a profit rate of more than 60%, which is very high.

Most of the double tax avoidance treaties that India has entered into have a rate of 10/ 15% for royalties/ FTS and accordingly if a treaty country is involved in exporting the technology, the tax rate could come down from 25% to 10%/ 15%.  However, as India is actively opposing treaty shopping, furnishing of tax residency certificate along with a self-certification under statutory form 10F have been made mandatory for claiming the treaty benefits.  Further, to be able to monitor these international transactions, registration of all foreign companies with tax authorities (by taking PAN) have been made compulsory, else a punitive provision of applying withholding at least at 20% gets triggered.

The introduction of these provisions certainly has a rationale, but they definitely act as deterrents.  Mandatory requirement of registration with Indian tax authorities coupled with an obligation to file a tax return seriously mar the interest of foreign companies to do business with Indian companies.  Especially if the foreign companies are not too large, the business opportunity does not excite them given the reputation that Indian tax officers have earned over these years.  In many cases, the foreign companies may enter into net of tax contracts, in which case the effective tax rate would increase to approximately 34% on gross basis without deduction of expenses.  This is too large a cost for Indian manufacturers and will make them uncompetitive and defeat the very purpose of “Make in India” campaign.  As the Government seeks to improve the ease of doing business, an important area to start with would be to relax the procedural requirements.  Withholding of tax out of the fee by the Indian payer should end the obligation of the foreign company, which is only providing the technology from overseas.  There should absolutely be no need for them to register in India and do filings.  The legislature need to have rules to ensure that the tax withheld is appropriate and is deposited on time in the Government treasury.  A filing by foreign companies is not the right solution. It needlessly increases transaction costs for the companies and burden of work for the authorities.

Additionally, it is also worthwhile to note that while tax law does not provide for any specific exemption from tax on business income earned by a taxpayer, it does contain a provision for tax exemption on income in the nature of FTS/ Royalties.  It provides that any income arising to a foreign company (as notified by the Central Government), by way of royalty or FTS, received in pursuance of an agreement entered into with Government for providing services in, or, outside, India in projects connected with the security of India, will be exempt from tax in India in the hands of the foreign company.   

Since Government defence projects are connected to the security of India, several foreign players enjoyed exemptions in the past relating to contracts entered into with Central Government, and involving technology payments. While exemption is available on contracts entered into with Central Government, it is important to clarify that such exemption would also be available where a contract is between foreign companies and DPSUs, if ultimate delivery is to Government. Furthermore, foreign companies enter into lump sum composite contracts with Central Government for supply of equipment, technology and technical services, wherein the compensation of each component is not separately identified.  It is also important to clarify that tax exemption would be available on Royalty/ FTS payments included in such composite contracts on a reasonable basis.   

Private players are to play an important role in the Government vision of achieving self- reliance in defence manufacturing. The Indian companies would continue to collaborate with foreign defence players, and the defence equipment manufactured by them could either be delivered to Government or, in some cases, exported out of India. It is important to provide a level playing field to them as well and thus similar tax exemption as available for Government contracts should be provided to them as well.

The defence sector is looking for more support from the Government and such beneficial provisions would go long way in encouraging foreign players to establish newer ties with Indian companies. These procedural clarifications and changes would not have any significant impact on revenue component compared to their potential benefits of energizing the “Make in India” campaign. They are low hanging fruits. The 2015 budget will be announced in a few days and the defence sector is hoping that some of the recommendations made above become reality.

( Shailendra Gupta, Manager, PwC also contributed to this article)


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