Introduction of low cost-no frills airlines and increased competition have deterred airline companies from increasing fare rates to earn profits. On the cost side, there has been an increase in aviation fuel costs and maintenance charges of aircrafts operated by such companies. As a result, the bottomline of the airline companies bears the brunt of high cost and low revenues. Tax costs on operations borne by airline companies further reduce the margin earned on operations.
Generally, aircrafts given on lease by foreign companies come with net of taxes arrangement, ie tax, if any, on lease rental income of aircraft is to be borne by the Indian company taking aircraft on lease. This increases the cost of leasing for lessee.
Presently, section 10(15A) of the Income tax Act, 1961 (Act) provides for income tax exemption to foreign company on lease rentals paid by an Indian company acquiring an aircraft, subject to obtaining the approval from the Central Government in this regard. However, this tax exemption comes with the sunset clause being made applicable to agreements entered into on or before 31 March 2007.Although there have been representations made by major airline companies to Government to re-introduce and extend the tax exemption to agreements entered after 31 March 2007, the Finance Minister has not considered the same in the Finance Act, 2007, enacted on 11 May 2007.
In absence of tax exemption under section 10(15A), under the provisions of Income tax Act, the lease rentals paid by Indian company to a foreign company for use of an aircraft may be construed as royalty. The lease rentals would be taxable in India @ 10.5575% (including surcharge of 2.5% plus education cess of 2% and additional education cess of 1% on tax and surcharge) on gross basis as per the provisions of section 115A of the Act.
Further, in cases where the tax on the lease rentals is required to be borne by the lessee (Indian company) under the lease agreement, the tax will be grossed up as per section 195A of the Act. On account of the fact that section 10(15A) exemption will not be available and tax will be grossed up, aircraft leasing cost is expected to shoot up by approximately 12 per cent - a move that could deter new entrants and existing players from leasing more aircrafts.
Thus, though the exemption under section 10(15A) (under domestic tax law) is not available on lease rental income arising from agreements entered after 31 March 2007, it may be useful to evaluate the provisions of relevant Double Taxation Avoidance Agreements (DTAAs) entered into by India with the country in which the foreign lessor company is a tax resident. The income of a foreign company can be taxed as per the provisions of Income tax Act or DTAAs, whichever is beneficial.
Under most DTAAs, consideration for leasing of aircraft receivable by foreign company may be constituted as royalty. However, certain DTAAs provides for exclusions in the definition of royalty for certain types of income. The provisions of the relevant clauses may be evaluated on a case to case basis to examine whether there is any beneficial provision for taxability of lease rentals payable to foreign company. Further, one needs to examine the contents of the agreement to ascertain whether the lease is a dry lease or a wet lease and then analyze the applicable provisions of the DTAA.
Separately, it is worthwhile to note that section 10(15A), does not cover payments in connection with providing spares, facilities or services in connection with the operation of leased aircraft. Commercially, most airline companies enter into an agreement with the lessor company of the aircraft for supply of spares, maintenance facilities, repair and overhaul services, provision of training, crew etc for the leased aircraft. The reason for this is that the lessor company being the owner of the aircraft is better equipped for providing spares and maintenance facilities etc. Taxability of such incidental income of the foreign company may be construed to be fees for technical services (FTS) under the Act and taxable at 10.5575% on gross basis.
Although, it may be noted, based on a Delhi Tribunal judgement in the case of Lufthansa Cargo India (P) Ltd. V. DCIT (91 ITD 133), an argument exists that maintenance charges paid for carrying out routine repairs/ checks on an aircraft does not constitute FTS under the provisions of section 9(1)(vii) of the Act. However, the tax department may hold a different view on taxability and may contend that such income be considered as FTS. One may look at the relevant provisions of the DTAAs to mitigate such tax costs, arising from incidental services to leasing transaction. The definition of FTS differs in various DTAAs and there may be beneficial provisions which can be availed by lessor companies for mitigating such tax costs.
Chaufla is director and Mehta is assistant manager at Business forSocial Responsibility (BSR), KPMG