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DefencePost-budget sectoral point of view
Union Budget 2015Inspiring confidence,
empowering change in India
Table of contents
1. Context
2. Key policies/fiscal and tax proposals
3. Unfinished agenda
© 2015 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated
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Context
Where are we India, today completely understands its risks, from outside and within. A precarious neighbourhoodowing to cross-border unrest, infiltration, illegal immigration and increasing domestic threats in the name of naxalism are key concern areas requiring the government's immediate attention. India also desires to assert its presence as a major regional player.
India needs to build a strong, technologically advanced armed force. Being one of the world’s largest defence spenders with an estimated spend of over two per cent share of its GDP, India is yet not quite where it ought to be, due to the following reasons:1
• It is majorly dependent on imported defence equipments and has a very nascent domestic manufacturing base. Approximately 70 per cent of its defence equipment is imported making it the world’s largest importer1
• Of the total defence equipment held by the Indian armed forces, a meagre 15 per cent can be described as leading while nearly 50 per cent has become obsolete, raising serious questions about India’s war-preparedness1
• While sincere efforts have been made by DPSUs, to boost indigenous R&D, India has unfortunately not been able to keep pace with global standards
• The Indian private sector has been systematically alienated from defence R&D and manufacturing, due to an unexplained trust deficit or insecurity. This is changing gradually.
Given the above facts, self reliance in defence technologies ought to be one of the key priority areas for the Indian government.
Key issues/challenges• Shortfall of investment in technology innovation and upgradation
• Complex policy environment coupled with bureaucratic delays in procurement
• Lack of tax incentives and monetary support for defence manufacturing which suffers from lumpy investments, limited order size and a prolonged gestation period
• Lack of basic infrastructure and availability of special raw materials.
What was expected• Infrastructure status for the sector to facilitate tax concessions/benefits for manufacturers and
availability of capital liquidity to fund such high capital intensive projects
• Focussed and harmonised plans for development and upgradation of the Indian defence manufacturing industry and encouraging participation of private industrial houses in the defence manufacturing space
• Revamp of the Defence Procurement Procedure (DPP) including the policy and mechanism of defence offsets; setting the context for a clear, shorter and simpler DPP
• A clear roadmap for enhancing efficiency and effectiveness of DPSUs leveraging on the vast infrastructure possessed by them
• Explicit tax incentives/tax holidays so as to incentivise in-country manufacturing of A&D components and sub-systems.
1. http://dipp.nic.in/english/Discuss_paper/DiscussionPapers_17May2010.doc
© 2015 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated
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Key policies/fiscal and tax proposals
Key AnnouncementsPolicy• Proposed allocation for the defence sector for the current financial year is INR2,46,727 crore
(approximately USD41 billion), an increase of around 11 per cent over the last year’s allocation of INR2,24,000 crore (approx. USD37 billion). Allocation in the interim budget was INR2,29,000 (approx. USD38.38 billion).
• Details about the funds allocated to different wings of the armed forces and the split between capital and revenue expenditure are awaited.
• No change in foreign investment cap for the defence sector which has been retained at 49 per cent.
• In the past fiscal year, the government has brought about the much needed clarity regarding industrial licensing . This includes specifying a precise list of products entailing industrial licensing, doing away licensing requirements for dual-use equipment, enhancing the validity of industrial licences, etc.)
• The government has undertaken significant measures for export liberalisation and rationalisation by providing easy finance, incentives and a thrust for exports through the defence offset policy
• The Finance Minister has proposed to do away with the distinction between different types of foreign investments, especially between foreign portfolio investments and foreign direct investments.
Direct tax• Surcharge for domestic companies increased form 10 to 12 per cent for domestic companies having
a taxable income in excess of INR10 crore. Consequent increase in effective tax rate, Minimum Alternate Tax (MAT) and Dividend Distribution Tax (DDT)
• Effective tax rate for domestic companies increased from 33.99 to 34.61 per cent. Effective tax rate for MAT increased to 21.34 per cent (from 20.96 per cent) and effective tax rate for DDT increased to 20.35 per cent from (19.99 per cent)
• No change in corporate tax rates for foreign companies
• It is proposed to reduce rate of corporate tax rate for domestic companies from 30 to 25 per cent gradually over the next four years
• Rate of taxation for Indian sourced royalty and fees for technical services (earned by non-resident taxpayers) reduced from 25 to 10 per cent
• Regime of wealth-tax abolished and replaced by an additional two per cent surcharge on taxable income above INR1 crore
• Significant clarifications regarding indirect transfer provisions (including threshold limit for applicability of provisions, valuation date, etc.) introduced
• Applicability of GAAR deferred by two years. Further, provisions of GAAR to only apply, prospectively
• Concept of Place of Effective Management (POEM) introduced to determine residential status of a company in India
• Special tax incentives in the form of additional investment allowance and enhancement of additional depreciation (from 20 to 35 per cent) introduced for encouraging manufacturing in the states of Telangana and Andhra Pradesh
• Transfer pricing provisions on specified domestic transactions amended to only include transactions in excess of INR20 crore.
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Indrect tax• With the FM referring to ‘GST’ several times in his speech, the government’s intention to rollout GST
from April 2016 appears positive
• Effective rate of Excise Duty increased from 12.36 to 12.5 per cent and education cesses have been subsumed
• Effective rate of Customs duty has been increased from 28.85 to 29.44 per cent
• Rate of service tax has been increased to 14 per cent and education cesses has been subsumed. Additional Swachh Bharat Cess at two per cent likely to be introduced.
• Service Tax exemption on construction, erection, commissioning or installation of to a new airport/port withdrawn.
• Service Tax exemption on services provided to the government in relation to construction, erection, commissioning of a civil structure other than for commercial use withdrawn.
ImpactA reasonable increase in the defence budget coupled with streamlining of policy initiatives towards creating a strong and integrated domestic defence manufacturing base showcases the vitality of the sector and the importance the government accords to it.
The government however, still needs to understand or analyse certain ground level issues and address them in an appropriate and timely manner so as to ensure the development of a strong indigenous manufacturing base. These include issues like FDI limit enhancement, improvement in the quality of manufacturing infrastructure and the pace of the defence procurement process.
SummaryAs far as the taxation regime is concerned, the budget seems to have fallen short of providing adequate incentives/benefits to the sector from both a direct as well as an indirect tax perspective. The budget could have introduced more tax incentives in aerospace and defence manufacturing by bestowing ‘infrastructure ‘status to the sector.
The Finance Minister could have introduced tax holidays/exemptions for companies engaged in manufacturing aerospace and defence components and sub-systems.
With an the enhanced allocation and the government’s intent to push ‘Make in India’ in aerospace and defence, the industry is optimistic about the upcoming opportunities and policy reforms under the new defence minister.
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Unfinished agenda
What remains • Facilitation of a conducive and pro-investment policy environment should be another focal point for
the Government, taking into account the best interests of various stakeholders. Currently, the sector is subject to numerous regulations and stringent monitoring which makes functioning for companies in this space quite difficult. To overcome such challenges, the government must work towards harmonisation of the policy environment including the FDI policy, licensing regime, offset policy, tax laws, etc.
• The government must channelise its efforts towards streamlining procurement processes, making them time effective and unambiguous. Similarly, the offset policy which has the potential to stimulate in-country defence manufacturing should be strengthened and made effective. Currently, these policies lack consistency and precision
• A relook at the operating mechanism of the public sector undertakings i.e. DPSUs, DRDO and OFB should be undertaken from the standpoint of productiveness, innovation, efficiency and utilisation. The government should analyse the gaps and take corrective action for their redressal
• Additional investment should be made towards technological upgradation. Institutions like DRDO should be strengthened to produce leading edge technology
• The Government should consider according ‘infrastructure’ status to the A&D industry and providing various concessions/benefits in the form of tax incentives to A&D manufacturers, both from direct and indirect tax perspectives, so as to augment domestic defence production
• While the Government significantly enhanced the FDI cap on the defence sector (from the erstwhile 26 to 49 per cent) in the previous budget, such policy initiatives have not yielded the desired results. The Government could reconsider enhancing the FDI cap to 74 per cent.
What is expected going forwardWith defence remaining within the government’s high priority focus area and in view of the government’s commitment towards fine tuning of policy and regulations, the sector may see a significant growth trajectory.
As a nation, we are certainly not lacking in terms of capability and resources. With an abundance of qualified manpower, skilled intensive manufacturing capabilities, a booming auto industry and a leading IT base, it is quite evident that India possesses the essential ingredients to burgeon a domestic defencemanufacturing base.
What is lacking is the inflow of sophisticated technology. With further enhancement of the of the FDI limit, critical technology may flow in. The government should provide a level playing field for the private players. Towards this, the concept of RUR (Raksha Udyog Rathna) should be reintroduced. An overhaul of the defence offset policy is urgently needed.
Today, the Indian industry is more confident about making significant investments in the defence sector. This has to be encouraged to enhance competition and improve the procurement options for the government.
The government must ensure in creation of a conducive policy environment with minimum red tapism, less intrusive monitoring and attractive incentives to promote domestic defence manufacturing . With a little more impetus from the government’s end, India could well become a major defence and aerospace manufacturing hub in 15-20 years.
The information contained herein is of a general nature and is not intended to address the circumstances
of any particular individual or entity. Although we endeavour to provide accurate and timely information,
there can be no guarantee that such information is accurate as of the date it is received or that it will
continue to be accurate in the future. No one should act on such information without appropriate
professional advice after a thorough examination of the particular situation.
© 2015 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All
rights reserved.
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