Rationalising taxes to boost defence manufacturing

Updated: Jun 26 2009, 05:53am hrs
Dhiraj Mathur
India has established itself as a low cost, high skill manufacturing hub in a number of sectors. The aerospace and defence sector represents the next frontier to be breached. Strategic security concerns coupled with obsolescence are driving a defence capital acquisition programme of unprecedented proportionsan estimated $30 billion over the next five years. The government also has a target of 70% indigenisation in defence procurement. The defence offset programme provides a huge opportunity for Indian industry to enter this sector through JVs. However, the present indirect tax structure discourages domestic manufacture against direct supply from overseas.

A domestic manufacturer faces multiple Indian taxes: excise duty, state VAT /central sales tax and service tax on input services. Some of these stick as costs. On the other hand, a foreign OEM executing a supply contract for the MoD from overseas enjoys various tax and duty exemptions. Hence a level playing field must be provided to domestic manufacturers. The following model illustrates the unequal burden faced by Indian manufacturers while executing a defence supply contract vis-a-vis foreign vendors directly exporting to MoD.

The tax differential between domestic and foreign supply can be as high as 30%. Thus the current tax and duty regime makes domestic manufacturing uncompetitive in a competitive bidding process and in fact provides incentives for only sub-system and component manufacturing in the country with integration and final assembly being done offshore.

The aerospace and defence industry is a greenfield industry with huge potential for employment and technological advancement apart from its strategic importance. In order to give a boost to domestic manufacturing and catalyse growth in the Indian industry, there is therefore, a need for rationalising taxes and providing focused incentives similar to those that have been extended to sectors like IT and ITES. These could include excise duty waivers, customs duty rationalisation and service tax exemption, both within and outside an SEZ environment.

Alternatively, supplies to MoD/DRDO, can be granted status of deemed exports under the Foreign Trade Policy. Such a status would entitle domestic manufacturers to exemption from excise duty on finished products, advance authorisations for duty free import of raw materials and other deemed export drawback benefits.

70% indigenisation requires a strong and vibrant domestic industry. A focused approach is essential to build the domestic industry and reduce the countrys historic dependence on overseas defence procurement. Rationalisation of the present tax regime is one key step towards realising the full potential of Indias defence sector.

The writer is executive director, tax and regulatory services, PwC