How to do Business in tHe indian infrastructure industry written by

Transcription

How to do Business
in the Indian Infrastructure Industry
written by
How to do Business in the Indian Infrastructure Industry
Index
1
Authors
Arvind Mahajan
Partner and Head
Energy and Natural Resources
T: +91 22 3090 1740
E: arvindmahajan@kpmg.com
Hemal Zobalia
Partner
Tax and Regulatory
T: +91 22 3090 2706
E: hemalzobalia@kpmg.com
Anand Jain
Associate Director
Energy and Natural Resources
T: +91 22 3090 2479
E: anand2@kpmg.com
Graphics
Sunshine Creations
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The KPMG name, logo and “cutting
through complexity” are registered
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or any of its member firms.
Printed in the month of October 2011
Infrastructure
page 3 - 16 >>
3
Current Scenario
A fascinating growth story has been unfolding in India
In order to sustain this rate of economic growth,
over the past two decades. Its GDP has zoomed from
India’s Planning Commission has estimated that
USD 270 billion in 1991 to USD 1700 billion in 2011,
investment in infrastructure - defined broadly to
making India’s economy the 10th largest in the world .
include road, rail, air and water transport, electric
According to some estimates, India will become the
power, telecommunications, water supply and
world’s third largest economy by 20502. This ongoing
irrigation - would need to increase significantly, which
growth is being fuelled due to rapidly developing
would entail a private sector outlay of almost USD
services and manufacturing sectors, increasing
1024 billion over the Twelfth Plan period (2012-17).
1
consumer demand and government commitments
to rejuvenate the agricultural sector and improve the
• A 1.2 billion population and a 250 million labour
economic conditions of India’s rural population.
Even with a somewhat slower rate of growth
during the current global economic uncertainty, the
Indian economy is still expanding significantly, and
substantial investment in infrastructure continues
to be required in order to sustain India’s economic
progress. The country’s capacity to absorb and
benefit
from
new
technology
and
Some of the key factors driving this demand are3:
industries
depends on the availability, quality and efficiency of
more basic forms of infrastructure including energy,
water and land transportation. In some areas, roads,
rail lines, ports and airports are already operating at
capacity, so expansion is a necessary prerequisite to
further economic growth.
force, which is driving consumer demand for
basic goods and value added (manufactured)
goods and services;
• Urban migration along with development of rural
hinterland;
• India’s democratic process is sustaining the
development process irrespective of political
ideologies of governments;
• Coalition system and public investigations make
decision making processes democratic and
inclusive4.
As far as the performance during the current Eleventh
five year plan (2007-12) is concerned, according to
government estimates, it is 94 percent on target5.
India GDP (in USD billion)
Electricity constitutes the largest share of the pie,
1700
1800
1600
1400
with nearly a third of all investments going towards
it. The second largest sector was Telecom, which has
1200
1000
witnessed strong private sector participation over the
800
past decade. Some of the other large sectors were
600
Roads, Railways and Irrigation. Some of the upcoming
2011
2010
2009
2008
2007
2006
2005
2000
0
sectors included Airports, which has seen the PPP
1995
200
1991 270
400
model successfully implemented in the modernisation
of the Delhi and Mumbai airports recently.
India GDP 1991-2011
1 IMF Data Bank http://www.imf.org/external/data.htm
2 http://www2.goldmansachs.com/ideas/brics/book/BRIC-Full.pdf
4
3 http://planningcommission.nic.in/infra/infra1011/infratargets.html
4 http://www.eria.org/research/images/pdf/PDF%20No.2/No.2-part2-4.India.pdf
5 http://planningcommission.nic.in/plans/planrel/fiveyr/11th/11_v1/11v1_ch12.pdf
To continue such high investments in the sector,
11th plan (2007-12) sector
breakdown 100% = USD 500 bn
better governance will hold the key. Currently,
governance is the weakest link that is discouraging
Airports
2%
Oil & Gas
6%
investors from investing in this sector. To finance
the large sum of nearly USD 1 trillion to meet the
Ports
2%
investment needs of infrastructure over 2012-17, the
Indian government will have to reform its institutions
Water
6%
for service delivery and revenue recognition8.
Elecricity
32%
Irrigation
12%
Currently, India also suffers from among the weakest
urban local governments in the world, both in terms
of ability to raise resources and financial autonomy.
Railway
10%
Thus, apart from better governance structure, a
Roads
13%
Telecom
17%
stronger political and administrative ecosystem to
collect taxes will also be required to give boost to
investments in the sector.
Sector Breakdown (2007-12)6
The graphic below gives a breakup of the share
of public/private investments in each sector under
the Eleventh five year plan. A quick glance tells
us that in Telecom, Ports and Airports, it is private
sector investment that constitutes a majority of
the investments made. On the other hand, limited
private sector participation is seen in railways and
water supply projects.
100%
44%
16%
82%
4%
0%
0%
80%
64%
96%
41%
80%
84%
100% 100%
20%
Public
Storage
4%
Airports
Water Supply
Irrigation
Roads &
Bridges
Elecricity
Railways
18%
0%
59%
36%
56%
Telecom
20%
96%
Ports
40%
Oil & Gas
Pipelines
60%
Private
Public-Private breakup (2007-12)7
6 http://planningcommission.nic.in/infra/infra1011/infratargets.html
7 KPMG Analysis
8 Report on Urban Infrastructure and Services
5
Structure of government /
regulatory bodies for various sectors
The Government of India is committed to improving
concerned bodies include the Cabinet Committee
the level and the quality of economic and social
on Infrastructure, the Department of Economic
infrastructure services across the country. In
Affairs and the Public Private Partnership Approval
pursuance of this goal, the Government envisages a
Committee. At the State level, you have the various
substantive role for Public Private Partnership (PPPs)
State Planning Departments, as well as agencies
as a means for harnessing private sector investment
like the Punjab Infrastructure Development Board
and operational efficiencies in the provision of public
(PIDB), and the Haryana State Industrial Infrastructure
assets and services.
Development Corporation (HSIIDC).
As far as the decision making bodies for the
Similarly, we have separate authorities for individual
Infrastructure sector are concerned, the Planning
sectors like the National Highway Authority of India
Commission drafts the model bid documents
(NHAI) for the Roads sector, the Human Resources
and concession agreements for National & State
Development Ministry for Education, and the Airports
Highways, Airports, Ports and Railway PPPs. At the
Authority of India (AAI) for looking after Airports.
level of the Central Government, some of the other
Centre
Union Ministries drive/
aid in formulation of
sector specific policies
and provision of public
services under their
purview
State
Planning / Policy Making Bodies
•Planning Commission (PC)
•State Planning Departments
•Cabinet Committee on Infrastructure (CCI
-chaired by PM)
•State PPP Agencies
•Punjab Infrastructure Development Board (PIDB)
•PPP Cell in Infrastructure Development Department
(IDD) in Govt. Of Karnataka
•Haryana State Industrial Infrastructure Development
Corporation (HSIIDC)
•Department of Economic Affairs (DEA)
•PPPAC –Public Private Partnership
Approval Committee
Centre
State
Departments in the
State Govt. define
state level policies and
execution of projects/
provision of services
under their purview
Local Govt.
BodiesImplementing & Regulatory Bodies
Concessioning Authority
Regulatory Body
Regulatory Body
Regulatory Body
Roads
NHAI
NHAI
SRDC
SRDC
NA
NA
Ports
Major Port Trust
TAMP
NA
NA
Airports
Airports Authorityof India
(AAI)
AERA,
DGCA
State Govt. / AAI
AERA,
DGCA
NA
NA
Power
DISCOM
CERC
DISCOM
SERC
NA
NA
Urban Infra
NA
NA
NA
NA
ULB’s
In process
Education
MHRD
MHRD
Deptof Education
MHRD
NA
NA
Health
NA
NA
Dept of Health
Ministry of Health
NA
NA
Govt. bodies involved in PPP
6
State Port Agency
Acronym
Name
AAI
Airport Authority of India
AERA
Airports Economic Regulatory Authority
CERC
Central Electricity Regulatory Commission
DGCA
Directorate General of Civil Aviation
DISCOM
Distribution Company
MHRD
Ministry of Human Resource Development
NHAI
National Highways Authority of India
SRDC
Shahjahanabad Redevelopment Corporation
TAMP
Tariff Authority for Major Ports
ULB
Urban Local Bodies
Glossary of terms used above
7
Public Private Partnerships: an Indian Perspective
As defined by the Govt. of India, PPP means an
arrangement between a government or statutory
entity or government owned entity on one side
and a private sector entity on the other, for the
Chandigarh
provision of public assets and/or related services
Jaipur
Ajmer
for public benefit, through investments being made
by and/or management undertaken by the private
New Delhi
Agra
Jhansi
Mundra
sector entity for a specified time period, where
there is a substantial risk sharing with the private
sector and the private sector receives performance
linked payments that conform (or are benchmarked)
to
specified,
pre-determined
and
measurable
Pipavav
JNPT
Mumbai
Dabhol
Kolkata
Nagpur
Hyderabad
Raichur
Bengaluru
performance standards1.
Krishnapatnam
Ennore
Chennai
Cochin
Opportunities for PPP across the value chain
Looking over the past two decades, PPP first started
in India in a big way with the Dabhol Power Project,
which was setup by Enron in Western India in 1992 .
2
Golden Quadrilateral
NS Corridor
EW Corridor
PPP Port Projects
While PPP was seen initially to bring in private funds
PPP Airport Projects
to fill in government shortfalls, it is now seen to
Healthcare PPP projects
provide multiple benefits across various sectors.
Education PPP Projects
There has been a gradual change in mindset of
Power PPP Projects
the government with respect to need for PPPs to
Gas PPP Projects
overcome a financing crunch, increase in efficiencies,
Water PPP Projects
and ease off the load on government bandwidth for
PPP projects across India
development work. Bringing in private investment
into infrastructure has also allowed the government
Various PPP Models in India
to use public funds for social obligations.
Some of the key PPP models prevalent in the Indian
Energy
Transport
Social
Urban Infra
context are3:
•Case II bids
• Toll roads
• Hospitals
User-Fee Based BOT models - Medium to large scale
• UMPP
• Terminals • Schools
in Major
ports/ Non
Major ports
• Water Supply
and sanitation
• Solid Waste
Management
transport sub-sectors (roads, ports and airports).
• Power
transmission
• Power
Distribution
• Airports
PPPs have been awarded mainly in the energy and
Although there are variations in approaches, over
the years the PPP model has been veering towards
competitively bid concessions where costs are
Sector wise PPP opportunities
recovered mainly through user charges.
1 http://www.pppinindia.com/Defining-PPP.php
2 http://www.rediff.com/money/2001/apr/26enron1.htm
3 http://www.pppinindia.com/pdf/draftnationalppppolicy.pdf
8
Annuity Based BOT models – In sectors/projects
Special Purpose Vehicle - The creation of a separate
not amenable for sizeable cost recovery through
commercial venture called a Special Purpose/
user charges, owing to socio-political-affordability
Project Vehicle (SPV) is a key feature of most PPPs.
considerations, such as in rural, urban, health and
The SPV is a legal entity that undertakes a project
education sectors, the government harnesses
and negotiates contract agreements with other
private sector efficiencies through contracts based
parties including the government. An SPV is also the
on availability/performance payments. Implementing
preferred mode of PPP project implementation in
annuity model will require necessary framework
limited or non-recourse situations, where the lenders
conditions, such as payment guarantee mechanism
rely on the project’s cash flow and security over its
by means of making available multi-year budgetary
assets as the only means to repay debts.
support, a dedicated fund, letter of credit etc.
Government may consider setting-up a separate
window of assistance for encouraging annuity-based
Procurement process across different sectors
PPP projects. A variant of this approach could be to
There are certain common steps involved in the
make a larger upfront payment (say 40% of project
procurement process in countries that have a
cost) during the construction period.
matured PPP programme. Although the details of
Performance Based Management / Maintenance
contracts – In an environment of constrained
economic resources, PPP that improves efficiency
each of these common steps may vary and differ
in approaches, their purpose is very much similar.
Generally, the following steps are taken:
will be all the more relevant. PPP models such as
• Assessing interest of the private sector
performance
• Prequalification of bidders
based
management/maintenance
contracts are encouraged. Sectors amenable for
such models include water supply, sanitation, solid
• Information exchange and feedback from the
waste management, road maintenance etc.
Modified
In
Design-Build
traditional
(Turnkey)
Design-Build
(DB)
• Request for proposal from prequalified bidders
Contracts
-
contracts,
a
private contractor receives a fixed-fee payment on
completion. The primary benefits of DB contracts
include time and cost savings, efficient risk-sharing
bidders
• Finalization and issuance of final tender
• Evaluation and selection of preferred bidder
• Contract negotiation, award and financial close
and improved quality. Government may consider a
In the Indian context, the Transportation and
“Turnkey DB” approach with the payments linked to
Energy sectors have evolved with standardized
achievement of tangible intermediate construction
bid processes and transparency in award of PPP
milestones (instead of lump-sum payment on
projects – especially those given by the Central
completion) and short period maintenance / repair
Govt. Similarly, the consultation process is well
responsibilities. Penalties/incentives for delays/early
established in Energy and Transportation sectors.
completion and performance guarantee (warranty)
However, social sector and state level PPPs are yet
from private partners may also be incorporated.
to mature.
9
Public Private Partnerships: an Indian Perspective
Sector
Power
Oil & Gas
Roads
Airports
Key projects
Power plants,
City Gas Networks National Highways
Transco & Discoms Gas Trans lines
State Highways
Airports
Model concession
agreement
Yes
Yes
Yes
Yes
Standard Bid Docs Yes
Yes
Yes
Yes
Bid process
Competitive
2 stage
Competitive
1 stage
2 stage bidding
2 stage
Evaluation criteria
Levelized Tariff
Tariff + Infrastructure commitment
Technical Capability
Minimum Net Worth
Past experience and
concept plan1
PPP process4
Past track record
The last decade has seen increasing participation from the private sector in PPP projects. In social sectors,
the private sector has been active in setting up medical and educational institutions as per Government laws
and guidelines. Private investment in Premium/ specialty services have dominated basic public health services
infrastructure, in the absence of viable revenue risk sharing mechanism for PPPs.
Also, sectors such as Transport and Energy have shown a higher degree of private sector participation than
others which can be attributed to the regulatory maturity acquired over a longer period of experimentation
and deliberations.
Ports: TAMP Act
Roads: First BOT Project
Ports: First private
investment –NSICT
Gujarat announced Port
Policy, strongly focused
on PSP (Mundra, Pipavav)
1992
1994
Health: Various Policies and Plans
like NHP-2002, NRHM-2005, Planning commission etc. laid down
the case for PPP in healthcare
1998
2000
2002
Power: Electricity Act
Power: First PPP
Power Plant –Dabhol
Power Station
Health: First PPP
-Karnataka KarunaTrust
Water: First PPP
initiatives. Entry of several
international players
Timeline of PPP projects in India5
4 http://www.pppinindia.com/The-PPP-Process.php
5 KPMG Analysis
10
Education: Enhanced focus on
PPP Initiatives by centre and State
•AdarshSchools in Punjab
•Residential Schools in AP
Ports: Revised
guidelines for
tariff fixation
Roads: First
Annuity Project
1996
Airports: AERA Act
Roads: Revised Bid Documents
Ports: Guidelines for Setting Tariffs
for PPP Projects at Major Ports
2004
2006
Oil & Gas: PNGRB
ActPower: First Case
1 bid organised by
Gujarat &First UMPP
LoIto Private Player
Water: Several projects take off
while several abandoned due to
consumer NGO resistance/negotiation failures
2011
2008
Oil & Gas: First city
gas bid invited for 7
cities Bid for first gas
transmission pipeline
Power: First
Distribution Franchise
Water: Development
of more evolved
contracting
mechanisms. High
private sector interest
Delving into the past track records for the various
Airports
sectors, some numbers stand out:
More than USD 6 billion has been invested in
Power
Out of the total installed capacity of ~174 GW (as
of March 2011), the private sector contribution was
modernization of airport infrastructure. Airports
at Delhi, Mumbai, Bengaluru and Hyderabad have
been developed through PPP structures.
~ 37 GW.
Roads
Private investment in National Highways is 27% of
the total investment and for State Roads, it is 7%.
11
Potential investments in projects in next 12-18 months
The investment requirements in some key sectors
UMPP’s being planned in Maharashtra and Tamil
during the 12th five-year plan (2012-17) are1:
Nadu; Hydro projects awarded under the BOO and
• USD
50.8
billion
for
modernization
and
upgradation of highways
BOOT model are being developed in North-Eastern
states; Transmission projects being developed under
the IPTC & JV route. Moreover, for the downstream
• USD 9.25 billion for civil aviation
gas distribution segment, bidding is envisaged in
• USD 11.5 billion for ports
more than 100 cities in the next 4-5 years.
• USD 69.39 billion for railways
Transport
A large number of new infrastructure projects are
The spend on airports is expected to double in the
being lined up across various sectors over the next
next 5 years and the size of private investment is
year. Investment is estimated to zoom to USD 256
estimated to be USD 10 billion. The development
billion by FY 2017.
of the Navi (New) Mumbai international airport is
being watched with interest. It is the first case of a
second airport for a large metropolis (population of
Infrastructure Investments till 2017 (USD billion)
20 million) in India. The Greenfield airport at Kannur
300
256
221
199
200
153
150
Spend as
% of GDP
5.03 6.4
74
88
98
international airport in Kerala.
Social
130
Eleventh
7.2
7.5
8.4
9.0
9.5
FY 17
FY 16
FY 15
FY 13
FY 12
FY 11
FY 10
7.9
9.9 10.3 10.7
Average for the X plan
3
Infrastructure investments till 20172
Looking at some of the key sectors in more detail, we
find a robust pipeline over the next 12-18 months:
Energy
A large number of power generation, transmission
and distribution sectors are coming up across the
length and breadth of India. Increasingly besides
private participation in conventional generation,
substantial private sector interest has been generated
for solar generation. Some of the key projects include
1 IBEF: Discover Opportunity India Infrastructure
2 Planning Commission of India – Infrastructure Report
12
is another interesting project. It will be the 4th
Five-Year
Plan
proposed
to
explore
possibilities of PPP in setting up 20 IIITs, 300
FY 09
0
10Th Plan
50
FY 07
(Base)
60
FY 08
100
112
226
176
FY 14
250
+15% p.a.
Polytechnics and 2500 model schools. Corporate
companies with a minimum net worth of INR 2.5
million are eligible to set up schools under this
model.
International Competitive Bidding Process
In the International scenario, once a PPP project
government’s shortlist the most favorable bidders
scope has been structured and evaluated for
and invite them for bidding2.
bidding, governments should develop contract
and bidding documents. While interacting with
prospective bidders, governments should guard
themselves against any potential manipulation of
the PPP design and process of bidding to favour
any specific bidder. It should also be mindful that it
does not disclose any additional information to any
of the bidders1.
Competitive Bidding
Almost all the governments globally have set rules
requiring competitive bidding for procuring goods
or services from private sector. Most governments
rely on the use of competitive bidding process to
provide transparency in the procurement process
and to eliminate corruption. In addition, the process
During the entire bidding process, governments
of competitive bidding heightens competition
should keep the bidders informed on the various
and enables the governments select the best-
timelines, the sequence of activities, the decision
value proposal based on select criteria. The entire
points, and the decision makers to provide the
competitive bidding process can either be one stage
necessary transparency in the entire competitive
or two stages:
bidding process.
• Single-stage process: In the single stage process,
technical and financial bids are submitted together
Notification and Prequalification
at once in response to a request for proposals.
Once the government has finalized the project scope
and bidding contract documents, it has to take out
an official notification in local (and in some cases
international) print and electronic media to notify
the public of an opportunity to participate in a PPP
engagement. In response to the prequalification
documents, prospective bidders have to submit
• Two-stage process: In the two-stage process,
initially a technical response is submitted and
comments are provided to it. Later, in the second
stage, the technical bid is re-submitted after
addressing the comments along with a financial
bid.
information stating their qualification as a qualified
The competitive bidding for basic operation,
bidder.
maintenance, and service contracts is usually a
straight forward easy process as the scope of the
services is well defined. However, bidding process
Short listing of Bidders
becomes complex for projects that involves PPPs
Once
the
government
receives
all
the
like BOTs, concessions, and joint ventures as the
prequalification documents from the bidders, it
scope and starting information of such projects are
maps all the bidders on a predetermined scoring
often vague.
matrix to evaluate each of the bidders. The matrix
sets out criteria to score each of the parameters
and assigns respective weights. This score help
1 Implementing PPPs”, Asian Development Bank, 2008
2 Public-Private Partnership in Infrastructure”, UN Economic and Social Commission for Asia and the Pacific
13
Dispute Resolution
The legal basis for the settlement of disputes is
an important consideration in the implementation
of PPP projects. Private parties (concessionaire,
financiers and contractors) feel encouraged to
participate in PPP projects when they have the
confidence that the disputes between the contracting
authority and other governmental agencies and the
concessionaire or between the concessionaire and
other parties (for example, the users or customers
of the facility) can be resolved fairly and efficiently.
Disputes may arise in all phases of a PPP project,
namely, construction, operation, and final handover
to the central/state government.
The agreed methods of dispute resolution between
the parties are generally mentioned in the contract
agreement as allowed under the legal framework
Conciliation and mediation
A person or a panel appointed by the parties provides
independent and impartial assistance to them in
resolving a dispute. This process may end either in
the settlement of the dispute agreed by the parties
or it may end unsuccessfully.
Non-binding expert appraisal
A neutral third party provides an appraisal on the
merits of the cases of parties in dispute and also
suggests an outcome for their consideration. The
process is usually followed by negotiations between
parties.
Review of technical disputes by
independent experts
of dispute resolution in India. The legal framework
This method is often used for the settlement of
for dispute resolution is embodied in various legal
technical disputes between parties in contract. To
instruments and relevant rules and procedures
review disagreements, the contesting parties refer
of India. The legal instruments may include
such matters to an independent expert appointed by
the PPP/private contract law, company law, tax
them. The decision of the independent expert may
law, competition law, consumer protection law,
either be binding or non-binding, as agreed in the
insolvency law, infrastructure sector laws, property
contract agreement.
law, foreign investment law, intellectual property
law, environmental law, public procurement law or
Arbitration
rules, acquisition or appropriation law, and various
In this process, the matter in dispute is referred to
other laws.
a board or tribunal of arbitrators appointed by the
parties according to an agreed procedure set forth
The most commonly used methods for dispute
in the contract agreement. Such arbitration is held in
resolution include:
accordance with the rules and at a place as agreed
in the contract agreement. Any award made by the
Facilitated negotiation
A facilitator is appointed by the parties in the contract.
arbitral board or tribunal is binding on parties.
The facilitator aids the parties in resolving any
Adjudication by Regulatory Authority
dispute through negotiation, but does not provide
In some cases, statutory regulatory authority exists
any opinion but assists the parties in analyzing the
with powers to adjudicate upon disputes between
merits of their cases.
the contracting government agency and the
concessionaire. In such cases, matters of dispute
14
may be referred to the regulatory authority. An
investments from the foreign private sector are
appellate tribunal or a court of law as defined in the
expected.
contract agreement can consider an appeal against
specifies what methods of dispute resolution would
such adjudication.
be followed to settle any dispute arising between
Generally,
the
contract
agreement
the parties and the rules and procedures to be
Legal proceedings
followed for that. The United Nations Commission
In accordance with the legal provisions, parties in
on International Trade Law (UNCITRAL) has
dispute may go to the domestic judiciary for the
prepared a Legislative Guide on Privately Financed
settlement of their disputes.
Infrastructure Projects. Some of the major Indian
laws dealing with dispute resolution include the
For India, it is important that the settlement
Dispute Settlement Act (1940), National Highways
mechanisms
Act (1956), Indian Tolls Act (1851), Land Acquisition
considered
in
the
contract
agreement are in line with international practices
Act (1894) etc.
and requirements, particularly when large-scale
15
Conclusion
Overall, the opportunities to develop aconsiderable
By proactively selecting the right sectors, building
business in India are extremely promising for
proficiency, measuring risk, partnering with the
Infrastructure companies, if they
have carefully
right players and adapting their business models,
selected strong local partners, structured contracts
domestic and international private players can
prudently
where
capture the golden opportunity provided by the
appropriate, and taken a long-term, sustainable
Indian Infrastructure sector over the decade. The
outlook.
not
pool of potential opportunities can expand even
acknowledge the opportunity in good time may
further if the Indian government decides to open up
miss out on a critical opportunity to establish a
even more areas for private participation.
to
maximise
Foreign
tax
companies
benefits
who
do
long-term presence in oneof the world’s largest
growth markets.
16
Infrastructure
Financing in India
page 17 - 22 >>
17
Overview
Financing India’s mushrooming investments in
To meet the challenge, several initiatives by the
infrastructure remains a key focus area for policy
Government and the Banking industries have been
makers, developers and investors alike. Over the
implemented such as the creation of new funding
last decade, the Infrastructure sector has seen
institutions focused on infrastructure, enacting
a significant transformation. From being mostly
enabling policy for wider participation in financing
Government run and Government funded, it has
of infrastructure including FII investments, attempts
become a segment that is witnessing heightened
to develop the bond markets in India, adoption of
level of private participation and competition. The size
standard bidding documents and contract documents
and complexity of Infrastructure projects have also
for concessions and PPP projects that have gained
increased substantially with several Mega projects
the acceptance of lenders etc. Overall, the financing
requiring over a USD1 billion of investments being
industry has been able to provide for the increased
launched across sub sectors. Further, previously
investments in most sectors of Infrastructure. For
neglected areas of Infrastructure such as Urban
example, according to RBI estimates, the overall
Infrastructure, Oil and Gas exploration and transport
lending to infrastructure projects by scheduled
have also become buzzing areas of investments.
commercial banks grew at a CAGR of about 40
The Infrastructure financing apparatus in India,
percent between FY 2006-07 and FY 2010-11, with
has also been challenged to keep pace with this
total exposure of Indian banks to the Infrastructure
transformation and provide for the increasing scale
sector being in excess of USD 100 billion.
and complexity of funding requirements.
Total Funding requirements of the Infrastructure Sector
Indian Infrastructure Planned Investments
(USD BN)
2x
2.4x
1018
spending on the infrastructure sector will need to be increased to 10 percent of the GDP. This translates to an
estimated USD 1,024 billion investment over the 12th
five year plan (2016-17), double the amount planned
for the current five year plan period of 2007-12.
514
While the achievement of the Planning Commission’s
218
targets from past plan periods have fallen short, in
1
10th Plan Est.
2002-07
2
11th Plan Proj.
2007-12
3
12th Plan Proj.
2012-17
Figure 1: Planned Expenditure on Infrastructure
the fourth year of the current plan period, trends
suggest that actual investments may be close to
the envisaged levels (close to 90 percent), clearly
indicating that there has been considerable buoyancy
In 2007, the Government set a target of increasing the
in the Infrastructure sector in the past few years. This
total investment in infrastructure from around 5 per-
achievement is even more impressive, given the fact
cent of GDP to 8.4 percent by 2012. This translates to
that the global financial markets fell in the middle of
over USD 500 billion in five years. Going forward, the
this plan period, significantly impacting sentiments
Planning Commission of India has estimated that the
and liquidity.
18
Sources of Funds
An important fact about the USD 500 billion projected
of debt. Of that amount, 50 percent of the debt
expenditure in infrastructure is that an estimated 35-
shall come from Indian commercial banks with the
40 percent has actually come from the private sector,
rest being chipped in byinsurance companies, Non-
higher than originally envisaged and significantly
Banking Financial Institiutions (NBFCs) and External
more than the proportion achieved in previous plan
Commercial Borrowings (ECBs). After including a
periods. For the 12th Plan period, the contribution
private sector equity of USD billion 45, a funding gap
of the private sector is expected to be even higher
of 8 percent or about USD 40 billion still remains to
at 50 percent. Thus the role of the private sector
be plugged in.
and private finance shall expand considerably going
forward, with the government taking up projects
that are inherently not suitable for the PPP model
and providing financial support through viability gap
funding and other instruments to private developers
for qualifying projects.
a) Sources of Debt: As indicated above, close to 40
percent or USD billion 200 is required in the form
of debt funding for infrastructure in the current
plan period. This amount shall likely more than
double for the 12th Plan period on account of
higher overall spend as also the higher private
participation and hence lower proportion of
Government support. Some key features of the
Funding Gap
envisaged
8%
Budgetary Allocation
(Central & State Govts)
43%
debt funding available for Indian developers
currently are captured below :
Commercial Banks remained the dominant
source of debt finance, accounting for bulk of
Equity from
Private
Investors
9%
the total lending to the Infrastructure sector.
Much of the funding occurs at the SPV level
for private sector projects, with limited to no
ECB
6%
recource to the parent company. Typically, the
tenure of the loan does not exceed 10 to 12
Pension /
Insurance
Companies
3%
Non-Banking
Finance Companies
11%
years;
ECBs have become an increasingly popular
Domestic Bank
Credit
20%
Figure 2: Funding Pattern for the 11th Plan period
The above figure indicates the funding pattern for
the planned expenditure on infrastructure projects
during the 11th Plan period, computed by the
Planning Commission. A bulk of the spending (43
percent) is estimated to come from Central and
State Government’s budgetary allocations. A total of
40 percent of the expenditure shall be in the form
mode of debt financing for developers who
have the werewithal to tap overseas markets
on account of their lower interest costs.
For example, in FY 2010-11, a total of USD
16.7 billion was issued to the infrastructure
sector, up 50 percent from USD 11.14 billion
(Source: Indian Infrasturture, August 2011)
in the previous year. Export credit has also
been tapped by developers importing plant
and machinery equipment, especially in the
power sector where Chinese equipment has
19
Sources of Funds
gained currency among private developers;
institutions approved assistance of nearly
The India Infrastructure Finance Company
USD 23.5 billion (Source: Indian Infrastructure,
Limited (IIFCL) launched by the Government of
India in 2004 to provide take out financing for
infrastructure projects has sanctioned loans
worth over USD 5.3 billion (net sanctions) to
165 projects as of December, 2010 (Source:
IIFCL). Further, the Viability Gap Funding (VGF)
scheme launched by the government has
provided over USD 650 million in grant funding
to
various
infrastructure
projects
being
awarded to private players in the country;
While the Government has undertaken many
initiatives to develop the Bond market in India,
the appetite for corporate bonds remains limited
in the country. They constitute only about 15
percent of the trading in the bond markets,
largely of the larger industrial gourps in India.
Further, restrictions in trading and investments
in unrated bonds have kept banks and financial
institutions away from these instruments.
Recently, Infrastructure Finance Companies
(IFCs – classified as NBFCs that lend over 75
percent of their capital to infrastructure projects)
b) Sources of Equity: Typically, 25 to 30 percent of
the project costs of private developers are funded
through equity (although for certain sectors such
as Roads, equity finance has been as low as 20
percent). Major sources of equity for the private
sector are promoter’s equity, capital markets
thorugh IPOs and FPOs and Private Equtiy. Key
trends in the equity market are captured below:
 As infrastructure companies have gained in
size, many of them have looked to tap into the
capital markets to raise equity finance through
IPOs and FPOs. Between 2007 and 2011,
67 infrastructure companies have tapped
onto the stock market raising an aggregate
amount close to USD 19 billion throguh IPOs
and another USD 12.6 billion through FPOs
(Source: Indian Infrastructure, August 2011).
During the boom witnessed in the stock
markets, thes issues received very favourable
response from investors;
have been allowed to raise finance through
 Private Equity has significantly enhanced
bond issuance. However, markets have given
its participation in the Infrastructure sector,
a lukewarm response to these issues that have
especially in the Power sector and to a smaller
come out in the recent past. A key constraint of
extent in the tranport sector (primarily in Roads
the Bond markets continues to be the limited
and Ports). Overall, some 208 PE transactions
liquidity of these instruments;
took place across the infrastructure sector
Multilateral funding remains an important source
of grant and debt financing for government and
private sector infrastructure projects. Prominent
multilateral agencies active in India include the
World Bank, Asian Development Bank and
Japan International Cooperation Agency which
provide soft loans to infrastructure projects and
companies. Between 2007 and 2011, these
20
August 2011).
with an aggregate investment of over USD
15.5 billion (Source: Indian Infrastructure,
August 2011). Increasingly, structured private
equity investments have gained currency with
the investments being consumated through
Compulorily convertible debentures (CCDs)
or preferrence shares (CCPS) in the investee
company, which could be an SPV or a Holding
company of infrastructure assets.
Key Issues in Infrastructure Finance
The anticipated doubling of investment requirements
‘pre-investment rights’ for the foreign investors
for the Infrastructure sector will require infrastructure
is one of the prime reasons for lesser foreign
financing to be upscaled to handle the much higher
participation). As per the norms being prepared
quantum of funds required and the technical
for the fund, only the PPP projects will be eligible
complexity of future projects.
to draw funding from the Fund. The fund will
Indian
commercial
banks’
exposure
to
the
Infrastructure sector is already in excess of USD
100 billion. With their aggregate exposure to
issue negotiable bonds to investors. However,
an exit option will be available only after an initial
three-year lock-in period.
Infrastructure at approximately 14 percent (as on
Investment by Life Insurers: Pension funds and
November 2010) of total outstanding bank credit,
Insurance companies are well suited to invest
many of the commercial banks in India are close to
in infrastructure projects because of their long-
hitting the limit of group and single-entityexposure
term liabilities. However, their contribution to the
due to financing such largeticket investments.
sector has been small so far on account of two
Further, given the fact that deposits, which are
major reasons. While penetration of Insurance
essentially short term sources, constitute a bulk of
has grown significantly from less than 2 percent
sources of funds for Indian commercial banks, the
in 2000 to over 4 percent of GDP at the end
asset liability mismatch for long term infrastructure
of the decade, it still remains low compared
investments remains a critical issue. Thus, it is
to developed markets where penetration is
imperative that new sources of funds are identified
higher (USA and Europe: 9 percent, Japan:
and enabled to augment the supply of funds to the
10.7 percent). Secondly, current regulatory
sector. The Indian government is initiating several
norms restrict their access to the Infrastructure
reforms towards this end. Some of the major issues
sector as they are bound to invest 50 percent
that shall need to be resolved include the following:
of their funds in Government securities and of
Infrastructure Debt Funds: To date, debt financing
for infrastructure projects has largely been
confined to commercial banks. But these loans
are expensive and banks are fast approaching
their lending limits. The debt funds would buy
loans from the banks for projects that have
completed construction and launched commercial
operations. The Government has plans to create
an INR 50,000 crore (USD 11 billion) dedicated
the balance, 75 percent in paper rated AAA and
above. The Government is looking at reforming
these norms and Life insurers may be allowed
to invest in long-term infrastructure bonds for
refinancing green-field infrastructure projects.
These long-term financial instruments will help
life insurance companies develop their annuity
business by investing part of their funds in stable
infrastructure projects.
infrastructure fund and raise 40 percent of the
Creation of Infrastructure Finance Companies
corpus from overseas investors. The government
(IFC): NBFCs holding a minimum of 75 percent
had set a panel with an aim to raise INR 20,000
of their assets for financing infrastructure
crore, or USD 4.4 billion, from foreign pension,
projects can be classified as infrastructure
insurance and sovereign wealth funds, and the
NBFCs or IFCs. Classification as an IFC leads to
remainder from domestic institutions. (Lack of
ease in mobilizing funds at lower cost as well
21
Key Issues in Infrastructure Finance
as flexibility in infrastructure lending. The RBI
There was also a restrictive cap on interest rates,
has allowed scheduled commercial banks to
which affected infrastructure project financing
enhance exposure to infrastructure companies
since they are inherently riskier asset classes.
up to 20 percent of their capital funds. IFCs are
In particular, interest rate caps, restrict access
not subject to the borrower limits, which restrict
to different debt and quasi – equity instruments,
NBFCs from lending to any single borrower by
the pricing of which is commensurate with
10 percent of its owned fund, and any single
the higher risk exposure of these instruments
group of borrowers by 15 percent of its owned
compared to plain vanilla debt. However, the ECB
fund. Also IFCs can raise external commercial
policy has been relaxed considerably recently to
borrowings up to 50 percent of their owned
enable up to a USD 500 million per borrower per
funds automatically.
year for rupee of foreign currency expenditure
Attracting Foreign Funds: ECBs have typically
been a lower cost source of finance for Indian
developers than domestic loans even after taking
into account the cost of hedging. However, the
Government has placed some restrictive norms
in availing ECBs in order to curb the monetary
expansion effects of large foreign capital flows.
22
without prior approval from the Government and
all in cost ceiling were raised to 300 basis points
above LIBOR for 3 to 5 year ECB maturity and
500 points for over 5 years. Further, relaxation
of ECB norms to allow intermediaries and less
established firms to access foreign funds would
be a significant step forward.
Topics from Tax &
Regulatory Environment
page 23 - 56 >>
23
Foreign Direct Investment Regulations for
investment in Building, Infrastructure and Energy Sectors
Governing law
FDI Routes
The objective of the FDI policy issued by the
A diagrammatic representation of the FDI routes is
Government is to invite and encourage foreign
given below:
investments in India. Since 1991, the guidelines and
the regulatory processes have been substantially
Foreign Investment
liberalized to facilitate foreign investment in India.
The Government issued a consolidated FDI Policy
vide Circular 2 of 2011 dated 30 September 2011
Automatic Route
Prior Approval Route (FIPB)
effective from 1 October 2011. This Circular
consolidates and subsumes all Press Notes, Press
Releases, Clarifications issued on FDI policy as
on 30 September 2011. The Government has also
Investment in sectors requiring prior
Government approval
announced that it will issue a consolidated circular
Previous venture in India in the same field
as stipulated
every six months to update the FDI policy.
The administrative and compliance aspects of
FDI including the modes/instruments of Foreign
Investments in an Indian Company (e.g. Equity,
Compulsorily
Convertible
Preference
FDI in excess of 24% for manufacturing
items reserved for small scale sector
Shares,
Compulsorily Convertible Debentures, American
Depository Receipt (ADR)/Global Depository Receipt
Investment excedding sectoral caps for
Automatic Route to the excelent permitted
(GDR), etc) are embedded in the Foreign Exchange
Regulations prescribed and monitored by the RBI.
Categories that assume relevance:
The Foreign Exchange Regulation also contains
• Sectors in which FDI is prohibited;
beneficial schemes/provisions for investments by
• Sectors in which FDI is permitted;
Non-Resident Indians (NRI)/Person of Indian Origin
(PIOs) within the overall framework/policy.
- Investment under Automatic Route; and
- Investment under Prior Approval Route i.e. with
Apart from fresh investments in an Indian company,
prior approval of the Government through the
the FDI and Foreign Exchange Policy is also
Foreign Investment Promotion Board (FIPB).
relevant for the transfer of shares in an Indian
Company between residents and non-residents.
These are subject to detailed guidelines, valuation
norms, compliances and approval requirements as
stipulated.
24
Automatic Route
Under Automatic Route there is no requirement for
any prior regulatory approval but only post facto
filing by the Indian Company to the RBI through
Authorized dealer (Bankers) are required asunder:
Sectoral guidelines
Annexure I provides an illustrative list relevant to the
• Filing an intimation, in the prescribed format,
sectors discussed in this paper for FDI falling under
within 30 days of receipt of FDI in India including
the Automatic Route, Prior Approval Route and
KYC norms; and
prohibited list. The Government depending upon the
• Filing prescribed form and documents within 30
industry needs to revise these on a regular basis.
days of issue of equity shares/equity convertible
Apart from the above, for stipulated manufacturing/
instruments to foreign investors.
industrial activities by an Indian Company, the
The equity shares/equity convertible instruments
are required to be issued within 180 days from
the receipt of application money. FDI by a nonresident entity in an Indian Company in most of the
business or commercial sectors now falls under the
applicability and need for availing an industrial
license under the Industrial Licensing Policy needs
to be examined and complied with.
FDI in Limited Liability Partnership (LLP)
Automatic Route and very few cases require prior
The Government has now recognized the LLP form
Government approval.
of business under FDI policy. FDI in LLP is allowed
through the approval route only. Permitted sectors
Prior Approval Route
FDI in the following activities or sectors generally
requires prior approval of the Government/FIPB:
for such investments would be those where 100
percent FDI is permitted through the automatic
route and there are no FDI linked performance
conditions. An Indian company having FDI will be
• Proposals where the foreign collaborator has
permitted to make downstream investments in an
an existing financial or technical collaboration
LLP only if both the company and the LLP operate
in India in the ‘same field’ prior to or as on 12
in sectors where 100 percent FDI is allowed through
January 2005;
the automatic route and there are no FDI-linked
• Proposals falling outside notified sectoral caps
for Automatic Route but within the ceilings
permitted under the Approval Route;
• Proposals for FDI in sectors / activities in which
FDI is permitted only under the Prior Approval
performance conditions. Additionally, LLPs with
FDI cannot operate in agriculture/plantation activity,
print media or real estate business. Further, LLPs
with FDI are not eligible to make any downstream
investments. Conversion of a company with FDI into
LLP will be allowed subject to certain conditions.
Route.
Approval is granted by the FIPB on a case to case
basis after examining the proposal for investment.
Issue and transfer of instruments and
pricing guidelines
Post FIPB approval, prescribed filings as applicable
The Indian companies can issue the following equity
under the Automatic Route are also required to be
shares/equity
carried out by the Indian Company under the Prior
to sectoral caps, timelines and pricing norms as
Approval Route.
prescribed as under:
convertible
instruments
subject
• Equity shares;
25
Foreign Direct Investment Regulations for investment in Building, Infrastructure and Energy Sectors
• Fully compulsorily and mandatorily convertible
debentures;
is considered as ECB from a foreign exchange
regulation perspective and needs to complywith
• Fully, compulsorily and mandatorily convertible
preference shares;
ECB guidelines.
An Indian company can also raise funds by issuing
• Foreign Currency Convertible Bonds (FCCB);
FCCBs. FCCB means a bond issued by an Indian
company to non-residents in foreign currency, the
• Depository Receipts (ADR and GDR);
principal and interest of which is payable in foreign
Foreign investors can also invest in Indian companies
currency. The FCCB are convertible into ordinary
by
shares of the issuing company in any manner, either
purchasing
or
acquiring
existing
shares/
convertible instruments from Indian shareholders or
in whole, or in part.
from other non-resident shareholders.
Similarly, an Indian company can also raise funds
Pricing guidelines
Any issue or transfer of equity shares/equity
convertible instruments is subject to pricing or
valuation norms. The pricing of the convertible
capital instruments is required to be determined
upfront at the time of issue/transfer of the
instruments. In general, for listed companies,
the pricing guidelines stipulate recourse to the
Securities and Exchange Board of India (SEBI)
Guidelines and for unlisted companies, as per the
discounted free cash flow method except for rights
issue and preferential allotment.
External commercial borrowing/foreign
currency convertible bonds/foreign
currency exchangeable bonds
through Foreign Currency Exchangeable Bonds
(FCEBs). FCEB are similar to FCCBs except that in
this case equity shares of another Indian Company
(Offered Company – being a listed company, which
is engaged in a sector eligible to receive FDI and
eligible to issue or avail of FCCB or ECB) are issued
on conversion. The issuer company should be part
of the promoter group of the Offered company. The
policy for ECB is also applicable to FCCBs and FCEBs
and accordingly all norms applicable for ECBs also
apply to them as well. LLPs are not permitted to
avail ECBs.
American depositary receipts or global
depositary receipts
A company can issue ADRs or GDRs if it is eligible
Overseas loans in foreign currency by Indian
to issue shares to a person resident outside India
companies/entities from foreign lenders are governed
under the FDI Policy subject to compliance with
by the guidelines on External Commercial Borrowings
the framework stipulated in this regard. In general,
(ECB) issued by the RBI under Foreign Exchange
unlisted companies, which have not yet accessed
Regulations. The ECB Policy stipulates detailed
the ADR or GDR route for raising capital, would require
guidelines for eligible borrowers, recognized lenders,
prior or simultaneous listing in the domestic market.
amount and maturity period, all-in-cost interest
Unlisted companies which have already issued ADR/
ceilings, end-use stipulations, compliances, etc.
GDR in the international market, have to list in the
Issue of any non-convertible, optionally convertible or
partially convertible preference shares or debentures
26
domestic market on making profit or within three
years of such issue whichever is earlier.
Calculation of total foreign investment
The FDI Policy also provides the methodology for
calculation of Total Foreign Investment in an Indian
company or one that does not have any operation
prior Government approval is required followed by
notification has been stipulated.
Company for the purpose of sectoral cap and
For all cases of transfer of ownership or control of
approval requirements. For this purpose all types
Indian companies in specified or controlled sectors
of foreign investments i.e. FDI; FII holding as
from resident Indian citizens orentities to non-resident
on 31 March; NRIs; ADRs; GDRs; FCCB; FCEB;
entities prior Government approval will be required.
fully, compulsorily and mandatorily convertible
For downstream investment by an operating-
preferences shares; and fully, compulsorily and
cum-holding company with foreign investment
mandatorily convertible preferences shares are to
as stipulated, a notification to the Government is
be considered.
stipulated within the prescribed timeframe and
Total foreign investment is equal to Direct foreign
parameters.
investment plus indirect foreign investments in an
The investing companies cannot leverage funds from
Indian company.
the domestic market for the purpose of downstream
• Direct investments are all specified types of
foreign investments made directly by a non-
investment.
resident entity into the Indian company;
• Indirect foreign investments in an Indian
company are made through investing entities
that are ‘owned or controlled’ by non-resident
entities to be calculated as per the prescribed
methodology.
These provisions are far-reaching in terms of scope,
coverage, computation and go beyond the pro-rata
methodology which washitherto being applied in
most cases.
There are detailed guidelines with respect to
investment in ‘operating-cum-investing companies’
and ‘investment companies’. The entry level
guidelines or conditions for FDI in an Indian
Company have been expressly clarified to extend to
indirect foreign investment as well, i.e. downstream
investments by Indian entities owned and controlled
by non-resident entities.
For foreign investments in an Indian Investment
27
Investment Vehicles for Foreign Investors
Choice of vehicle
Depending upon its business needs, a foreign company can choose between setting-up a Liaison Office (LO),
a Branch Office (BO) or a Project Office (PO), Limited Liability Partnership (‘LLP’) instead of incorporating/
investing in an Indian company under FDI guidelines.
Liaison
Office
Limited
Branch
Liability
Office
Partnership
Forms
of entity
Wholly Owned
Subsidiary
Project
(‘WOS’) / Joint
Office
Venture (‘JV’)
Particulars
Liaison Office
Branch Office
Project Office
Subsidiary / Joint
Venture
1. Setting up
requirements
(General)
Prior approval of
RBI required.
Prior approval of
RBI required.
Prior RBI
approval
not required
if certain
conditions
are fulfilled.
If activities/sectors
Approval
fall under Automatic
required.
Route, no prior
approval but only
post facto filings with
the RBI is obligated.
Otherwise obtain
Government/ FIPB
approval and then
comply with post facto
filings.
28
Limited
Liability
Partnership
(‘LLP’)
2. Permitted
Activities
Only liaison,
representation,
communication
role is permitted.
No commercial or
business activities
or otherwise
giving rise to
any business
income can be
undertaken.
Activities listed /
permitted
by RBI can only
be undertaken.
Local
manufacturing
and domestic
/ retail trading
are not
permitted.
Permitted if
the foreign
company has
a secured
contract from
an Indian
company to
execute a
project in India.
Any activity specified
in the Memorandum
of Association (MOA)
of the company. Wide
range of activities
permissible subject
to FDI guidelines /
framework.
Independent
legal presence,
Limited liability
for Indian
operations,
Management
/ organisation
flexible.
3. Funding
for local
Operations
Local expenses
can be met only
out of inward
remittances
received from
abroad from Head
Office through
normal banking
channels.
Local expenses
can be met
through inward
remittances
from Head Office
or from earnings
from permitted
operations.
Local expenses
can be met
through inward
remittances
from Head
Office or from
earnings from
permitted
operations.
Funding may be
through equity or other
forms of permitted
capital infusion or
borrowings (local as
well as overseas per
prescribed norms) or
internal accruals.
Capital
infusion or
borrowings
(local as well
as overseas),
FDI in LLP
permitted now
under approval
route
4. Limitation of
Liability
Unlimited liability
(limited to the
extent of capital
of Foreign
Company).
Unlimited liability
(limited to
the extent of
capital of
Foreign
Company).
Unlimited
liability (limited
to the extent
of capital
of Foreign
Company).
Liability limited to the
extent of capital
of Indian Company.
Limited for
partners
except
designated
partner.
5. Compliance
requirements
under
Companies Act
Requires
registration and
periodical filing of
accounts / other
documents.
Requires
registration
and periodical
filing of
accounts / other
documents.
Requires
registration
and periodical
filing of
accounts / other
documents.
Required to comply
with substantial
higher statutory
compliance and filings
requirements as
compared to LO / BO.
Required to
comply with
substantial
higher
statutory
compliance
and filings
requirements
as compared
to LO / BO.
6. Compliance
Requirements
under Foreign
Exchange
Management
Regulations
Required to obtain
and file an Annual
Activity Certificate
from the Auditors
in India with the
Authorized Dealer
/ Bankers with a
copy to the
Income Tax
Authorities.
Required to
obtain and file an
Annual Activity
Certificate from
the Auditors
in India with
the Authorized
Dealer/ Bankers
with a copy to
the Income Tax
Authorities.
Compliance
certificates
stipulated
for various
purposes.
Required to file
Periodic and Annual
filings relating to
receipt of capital and
issue of shares to
foreign investors.
Certain
compliance
requirements
to be met.
29
7. Permanent
Establishment
(PE)/taxable
presence
LO generally do
not constitute PE /
taxable presence
under Double
Taxation
Avoidance
Agreements
(DTAA) due to
limited scope of
activities in India.
Generally
constitute a
PE and are a
taxable presence
under DTAA as
well domestic
income-tax
provisions.
Generally
constitute a
PE and are
a taxable
presence
under DTAA as
well domestic
income-tax
provisions.
It is an independent
taxable entity and does
not constitute a PE of
the Foreign Company
per se unless deeming
provisions of the DTAA
are attracted.
It is an
independent
taxable entity
and does not
constitute a
PE of an LLP
per se unless
deeming
provisions of
the DTAA are
attracted.
8. Compliance
Requirements
under Income
Tax Act
No tax liability as
generally it
cannot/ does
not carry out any
commercial or
income earning
activities.
Obliged to pay
tax on income
earned and
required to file
return of income
in India.
No further tax on
repatriation
of profits.
Obliged to pay
tax on income
earned and
required to
file return of
income in India.
No further tax
on repatriation
of profits.
Liable to tax on global
income on net
basis.
Dividend declared is
freely remittable but
subject to Dividend
Distribution Tax (DDT)
of 16.225 percent on
Dividends declared/
distributed/paid by the
Indian Company.
Liable to tax
on global
income on net
basis.
Repatriation Of Foreign Exchange
The Foreign Exchange Management Act, 1999 (FEMA), forms the statutory basis of foreign exchange
management in India. The RBI which is the apex banking authority administers the foreign exchange
management regulations jointly with the Government of India.
India does not have full capital account convertibility as yet. However, there have been significant relaxations
in the recent past for drawal of foreign exchange for both current account as well as capital account
transactions.The payments due in connection with foreign trade, other current business, services, etc. are
regarded as Current Account transactions. As per the Current Account Transaction Rules, the withdrawal of
foreign exchange for current account transactions is regulated as under:
Prescribed schedule of
Current account rules
Drawal of foreign exchange for
Approving authority
Schedule I
Transactions which are prohibited
N.A.
Schedule II
Transactions which require prior
Concerned Ministry or Department
approval of the Central Government: of Government
Schedule III
Transactions which require prior
approval of the RBI:
30
RBI
In case of certain transactions listed in Schedule II and III, prior approval is not required if the payment is made
out of foreign exchange funds held in Exchange Earner’s Foreign Currency EEFC account of the Remitter.
Remittances for all other current Account transactions can generally be made directly through the Authorized
Dealers (Bankers) without any specific prior approval. Some of the relevant Current Account payments are
discussed hereunder.
Illustrative sector-wise regulation for FDI
Sectors prohibited for FDI (Illustrative)
• Real estate business and construction of farm houses
• Atomic energy
• Trading in transferable development rights
Sectors falling under the Automatic Route for FDI (Illustrative) (100 percent unless specified)
• Mining
Coal and lignite mining for captive consumption by power projects; iron and steel, and cement units,
and other specified activities
Setting up coal processing plants like washeries subject to conditions
Mining and exploration of metal, non-metal ores including diamonds, precious stones, gold, silver and
minerals
• Power
Power including generation (except atomic energy), transmission, distribution and power trading
• Service Sector
Construction and maintenance of roads, bridges, etc.; Ports and harbors related activities; Mass
Rapid Transport Systems in metropolitan cities; etc.
Development of Township, Housing, Built-up Infrastructure and construction development projects
Development of Special Economic Zones
Health and medical services
Hotel and Tourism related industry
Industrial parks
Storage and warehouse services
Transport and transport support services
31
Sectors falling under either Automatic Route and / or Approval Route (also refer Notes below)
Sector heading
Sector sub-heading
Airports
Air transport services
Automatic
Route (%)
Approval
Route (%)
• Greenfield
100
---
• Existing
74
up to 100
49 (NRIs – 100%)
---
49
up to 74
• Scheduled
• Non-scheduled / chartered and
cargo airlines
• Helicopter services / seaplane
100
services (specified)
Civil aviation services
---
• Ground Handling services
49
up to 74
• Maintenance and repair
100
---
---
100
100
---
---
49
49
up to 74
49
up to 74
49
up to 100
organisations, flying training
institutes, and technical training
institutions
Mining and mineral separation of titanium bearing minerals
and ores, its value addition and integrated activities
Petroleum and natural • Private sector (Exploration / Refining)
gas
• Public Sector Undertakings
(Refining)
Telecommunication
• Basic, cellular services unified
access services, value added and
other specified services
• ISP with or without gateways, radio
paging, end to end bandwidth
• Infrastructure provider (specified),
electronic mail and voice mail
Note:
1 Certain sectoral caps include investments by NRI, FII, FVCI investments having underlying cap on FDI
investments and NRI, FII, FVCI investments.
2 Sectoral caps are subject to detailed guidelines, other conditions, sectoral laws, licensing and other
requirements (e.g. divestment) hence readers are requested to refer to detailed policy guidelines before
acting upon.
Source: Circular 2 of 2011 issued by the Department of Industrial Policy and Promotion, Ministry of Finance,
Government of India on 30 September 2011
32
An Overview of Direct Taxes in India
In India, under the constitution taxes can be levied
Generally, the global income of domestic companies,
by Central and the State Governments, and by the
partnerships and local authorities is subject to tax at
local government bodies. Principal taxes, including
flat rates, whereas individuals and other specified
Income-tax, Custom Duties, Central Excise Duty and
taxpayers are subject to progressive tax rates.
Service Tax are levied by the Central Government.
Foreign companies and nonresident individuals
States levy taxes like State Excise Duties, Value-Added
are also subject to tax at varying rates on specified
Tax, Sales Tax and Stamp Duties. Local government
incomes which are received/accrued or deemed to
bodies levy Octroi Duties and other taxes of local
be received /accrued in India.
nature like Water Tax, Property Tax, etc. Income is
taxed in India in accordance with the provisions of
Agricultural income is exempted from Income-tax at
the Income-tax Act, 1961 (the Act). The Ministry of
the central level but is taken into account for rate
Finance (Department of Revenue) through the Central
purposes. Income earned by specified organisations,
Board of Direct Taxes (CBDT), an apex tax authority,
for e.g. trusts, hospitals, universities, mutual funds,
implements and administers direct tax laws.
etc., is exempted from Income-tax, subject to the
fulfillment of certain conditions. India adopts the
India has embarked on a series of tax reforms since
self-assessment tax system. Taxpayers are required
the early 1990s. The focus of reforms has been
to file their tax returns by specified dates. The Tax
on rationalisation of tax rates and simplification
Officer may choose to make a scrutiny assessment
of procedures. India follows a ‘residence’ based
to assess the correct amount of tax by calling for
taxation system. Broadly, taxpayers may be classified
further details. Generally, taxpayers are liable to
as ‘residents’ or ‘non-residents’. Individual taxpayers
make Income-tax payments as advance tax, in three
may also be classified as ’residents but not ordinary
or four installments, depending on the category they
residents’. The ‘tax year’ (known as the financial year)
belong to, during the year in which the income is
in I runs from 1 April to 31 March, of the following
earned. Balance tax payable, if any, can be paid by
calendar year for all taxpayers in India. The ‘previous
way of self-assessment tax at the time of filing the
year’ basis of assessment is used that is any income
return of income. Employed individuals are subject
pertaining to the ‘tax year’ is offered to tax in the
to tax withholding by the employer on a ‘pay-as-you-
following year (known as the assessment year).
earn’ basis. Certain other specified incomes are also
Taxable income has to be ascertained separately
subject to tax withholding at specified rates.
for different classes of income (called as heads of
income) and is then aggregated to determine the
total taxable income. Income tax is levied on ‘taxable
income’, comprising of income under the following
categories, referred to as heads of income:
• Salaries
• Income from house property
• Profits and gains of business or profession
Residential status
Individual
Depending upon the period of physical stay in India
during a given tax year (and preceding 10 tax years),
an individual may be classified as a resident or a
non-resident or a ‘not ordinarily resident’ in India.
• Capital gains
• Income from other sources.
33
Company
A resident company (also referred to as an Indian
Company) is a company formed and registered under
the Companies Act, 1956 or one whose control and
management is situated wholly in India. An Indian
company by definition is always a resident.
A non-resident company is one, whose control and
management are situated wholly outside India.
Consequently, an Indian company that is wholly
owned by a foreign entity but managed from India
by foreign individuals/companies is also considered
a resident Indian company.
Tax Categories
Corporate Income tax
and education cess) of the adjusted book profits
of companies where the income tax payable is less
than 18 percent of their book profits. Education cess
is applicable at 3 percent on income-tax (inclusive of
surcharge, if any).
A tax credit is available being the difference of the tax
liability under MAT provisions and regular provisions,
to be carried forward to set off in the year in which
tax is payable under the regular provisions. However,
no carry forward shall be allowed beyond the tenth
assessment year succeeding the assessment year
in which the tax credit became allowable.
Dividend Distribution Tax
Dividends paid by an Indian company are currently
exempt from Income-tax in the hands of the recipient
Income-tax to 30 percent is levied on income earned
shareholders. However, the company paying the
during a tax year as per the rates declared by the
dividends is required to pay DDT on the amount of
annual Finance Act. A surcharge of 5 percent is
dividends declared. The rate of tax is 16.22 percent
chargeable, in case of companies other than a
(inclusive of surcharge and educational cess). DDT
foreign company, if the total income exceeds INR 10
is a tax payable on the dividend declared, distributed
million. Education cess is applicable at 3 percent on
or paid. An exemption from this tax has been granted
income-tax (inclusive of surcharge, if any).
in case of dividends distributed out of profits of SEZ
Minimum Alternate Tax (MAT)
developers.
With a view to bring zero tax paying companies
Domestic companies will not have to pay DDT on
having book profits under the tax net, the domestic
dividend distributed to its shareholders to the extent
tax law requires companies to pay MAT in lieu of the
of dividend received from its subsidiary if:
regular corporate tax, in a case where the regular
• The subsidiary has paid DDT on such dividend
corporate tax is lower than the MAT. However, MAT
is not applicable in respect of:
• Income exempt from tax (excluding exempt long-
received; and
• Such a domestic company is not a subsidiary of
any other company.
term capital gains);
• Income from units in specified zones including
SEZs or specified backward districts; and
• Income of certain sick industrial companies.
As per the Finance Act 2011 MAT is applicable at
the rate of 18 percent (plus applicable surcharge
34
A company would be subsidiary of another company
if such a company holds more than half in nominal
value of equity share capital of the company.
Tonnage tax scheme for Indian shipping
companies
Tax rates
Tax is levied on the notional income of the shipping
Personal taxes
company arising from the operations of ships at
Individuals (excluding women and senior citizen) are
normal corporate tax rates. The notional income is
liable to tax in India at progressive rates of tax as
determined in a prescribed manner on the basis
under:
of the tonnage of the ship. Tax is payable even
in the case of loss. The scheme is applicable to
shipping companies that are incorporated under
Individual
Income Slab
Effective Tax rate
(including educational
cess of 3 percent)
(in percent)
Upto INR 180,000
NIL
INR 180,001 to 500,000
10.3
INR 500,000 to 800,000
20.6
800,001 and above
30.9
the Indian Companies Act (with its effective place
of management in India) with at least 1 ship with
minimum tonnage of 15 tonnes and holding a valid
certificate under the Merchant Shipping Act, 1959.
Shipping companies have an option to opt for the
scheme or taxation under normal provisions. Once
the scheme has been opted for, it would apply
for a mandatory period of 10 years and other tax
Basic exemption limit for Women, Senior Citizens and
provisions would not apply.
Super Senior Citizens is higher than INR 180,000.
Securities Transaction Tax (STT)
Capital gains tax
STT is levied on the value of taxable securities
The profits arising from the transfer of capital assets
transactions at specified rates. The taxable securities
are liable to be taxed as capital gains. Capital assets
transactions are:
include all kinds of property except stock-in-trade,
• Purchase/Sale of equity shares in a company or
a derivative or a unit of an equity-oriented fund
entered into in a recognised stock exchange; and
• Sale of unit of an equity-oriented fund to the
mutual fund.
Wealth Tax
raw materials and consumables used in businesses
or professions, personal effects (except jewellery),
agricultural land and notified gold bonds.
The length of time of holding of an asset determines
whether the gain is short term or long term.
Long term capital gains arise from assets held for 36
months or more (12 months for shares, units, etc).
Wealth tax is levied on specified assets at 1 percent
on the value of the net assets as held by the assessee
Gains arising from transfer of long-term capital
(net of debts incurred in respect of such assets) in
assets are taxed at special rates / eligible for certain
excess of the basic exemption of INR 3 million.
exemptions (including exemption from tax where
Dividend Distribution Tax
the sale transaction is chargeable to STT). Short
term capital gains arising on transfer of assets other
than certain specified assets are taxable at normal
rates.
35
The following figure shows the rates of capital gains
the Act. The tax rates for the tax year 2011-12 are
tax (excluding the effect of cess and surcharge that
given in the table below:
may apply):
Type of gain
Type of Company
Tax rate in case
Tax rate in case
of transfer of
of transfer of
assets subject to other assets
payment of STT
Long-term
capital gains
NIL
20 percent
Short-term
capital gains
15 percent
Normal
Tax Rates
applicable to
corporates/
individuals
Effective tax rate (including
surcharge and educational
cess)
Domestic company 32.45 percent*
Foreign company
42.02 percent**
* Income-tax 30 percent plus surcharge of 5 percent
(if the total income exceeds INR 10 million) thereon
plus education cess of 3 percent on Income-tax
including surcharge.
**Income-tax 40 percent plus surcharge of 2
percent thereon plus education cess of 3 percent
Taxability of Non Resident Indians
NRIs are also be liable to tax in India on a gross basis
depending upon the type of income received.
Foreign nationals
on Income-tax including surcharge. A company
may be required to pay the other taxes, e.g., MAT,
Wealth tax, DDT.
Modes of taxation
Indian tax law provides for exemption of income
Gross basis of taxation
earned by foreign nationals for services rendered
Certain specific income streams earned by non-
in India, subject to prescribed conditions. For
residents are liable to tax on gross basis in certain
example:
cases, that is a specified rate of tax is applied on the
gross basis and no deduction of expenses is allowed.
• Remuneration from a foreign enterprise not
conducting any business in India provided the
The details of nature of income and applicable rate
of tax are as below:
individual’s stay in India does not exceed 90
days and the payment made is not deducted in
Income stream
Rate of tax
computing the income of the employer
Interest
21.01 percent
Royalty
10.51 percent
Fees for technical services
10.51 percent
• Remuneration received by a person employed on
a foreign ship provided his stay in India does not
exceed 90 days.
Companies
The rates are in the case of a foreign company
and are inclusive of surcharge of 2 percent and
education cess of 3 percent on tax and surcharge
A resident company is taxed on its global income.
in respect of agreements made on or after 1 June
A non-resident company is taxed on income which
2005 respectively.
is received / accrued or deemed to accrue / arise in
India. The scope of Indian income is defined under
36
Presumptive basis of taxation
Foreign companies engaged in certain specified
business activities are subject to tax on a
presumptive basis i.e. income is recognized at a
specific percentage of gross revenue and thereafter
tax liability is determined by applying the normal tax
on deemed income.
with the basis of taxation are set out below:
Basis of taxation
deduction. Depreciation on specified capital assets
at prescribed rates is also deductible.
Expenditure incurred on taxes (excluding Incometax) and duties, bonus or commission to employees,
fees under any law, interest on loans or borrowings
from public financial institutions and interest on
Certain activities taxed on a presumptive basis along
Activity
deductible. Income tax paid is not allowable as a
loans and advances from scheduled banks is
deductible only if it is paid during the previous year,
or on or before the due date for furnishing the return
Effective tax
of income. However, interest on capital borrowed
rate (including
for acquisition of assets acquired for extension of
surcharge of 2%
and education
cess of 3%)
(in percent)
4. 202
existing business is not allowed as a deduction until
the time such assets are actually put to use.
Employee’s contributions to specified staff welfare
Oil and gas
Deemed profit
services
of 10 percent of
funds – that is, provident funds, gratuity funds, etc.
revenues
are allowed only if actually paid on or before the
4. 202
specified/ applicable due date. Salaries, interest,
Execution of
Deemed profit
certain turnkey
of 10 percent of
royalties fees for technical service, commission or
contracts
revenues
any other amount payable outside India or in India to
Air transport
Deemed profit
2. 101
non-residents or a resident on which the tax has not
of 5 percent of
been withheld or after deduction has not been paid
revenues
within the prescribed time are not deductible.
Shipping
Deemed profit
operations
of 7.5 percent of
3.152
freight revenues
Deductions allowable from business
income
Such amounts are deductible in the year in which
the withholding tax is paid.
Similarly, any payment made to residents for
interest, commission or brokerage, rent, royalty,
fees for professional or technical services, contract/
Generally, all revenue expenses incurred for business
sub-contract payments, where taxes have not been
purposes are deductible from the taxable income.
withheld or after withholding have not been paid
The requirement for deductibility of expenses is
within the prescribed time limit, will be disallowed
that the expenses must be wholly and exclusively
in the hands of the payer.
incurred for business purposes; that the expenses
must be incurred or paid during the previous year
and supported by relevant papers and records.
The deduction of such a sum will be allowed in the
year in which the withholding taxes are paid.
Expenses of a personal or a capital nature are not
37
Grouping/consolidation
* Effective tax rate including surcharge of 2 percent
and education cess of 3 percent
No provisions currently exist for the grouping /
consolidation of losses of entities within the same
group.
** Effective tax rate including education cess of 3
percent.
Carry forward of losses and unabsorbed
depreciation
Withholding of taxes
residents are liable to withholding tax by the payer
Subject to the fulfillment of prescribed
conditions
(in most cases individuals are not obliged to withhold
• Business loss can be carried forward for eight
tax on payments made by them). The rates in case of
consecutive financial years and can be set off
residents would vary depending on the income and
against the profits of subsequent years. Losses
the payee involved for e.g. in case of rent the rate
from a speculation business can be set off only
is 2 percent for the use of any machinery or plant
against gains from speculation business for a
or equipment, 10 percent for other kind of rental
maximum of four years.
Generally, incomes payable to residents or non-
payments.
• Unabsorbed depreciation may be carried forward
Except where preferential tax rates are provided for
for set-off indefinitely.
under DTAA, payments to foreign companies/nonresidents are subject to the following withholding
• Capital losses may also be carried forward for setoff for eight subsequent financial years subject to
tax rates:
fulfillment of certain conditions. Long-term capital
Type of income
Foreign
companies*
Other non
residents**
losses can be set off only against long-term
Interest on foreign
currency loan
21.01 percent
20.60
percent
can be set off against short-term as well as long-
Winnings from
horse races
31.52 percent
30.90
percent
Royalties and
10.51 percent
technical services
fee approved by
the Government or
in accordance with
the industrial policy
10.30
percent
Winnings from
lotteries and
crossword puzzles
31.52 percent
30.90
percent
Long term capital
gains
21.01percent
Any other income
42.02 percent
38
capital gains, whereas short- term capital losses
term capital gains. These losses cannot be set off
against income under any other head.
• Carry back of losses or depreciation is not
permitted.
Corporate reorganizations
Corporate
re-organisations,
such
as
mergers,
demergers and slump sales are either tax neutral or
taxed at concessional rates subject to the fulfillment
of prescribed conditions.
20.60
percent
30.60
percent
Tax neutrality in restructuring
If the transferee company is an Indian company, then,
subject to the fulfillment of prescribed conditions,
transactions pursuant to merger/demerger are
technical services which should be applied if the
entitled to various other tax concessions, including
rates prescribed in the Act are higher. Business
the following:
income of a non-resident may not be taxable in India
- No capital gains to the shareholders of transferor
or company
if the non-resident does not have a PE in India.
For countries with no DTAA with India, a foreign tax
credit is available under Indian domestic tax law
- No capital gains to the transferor company
to a resident taxpayer in respect of foreign taxes
- Merger/demerger expenses shall be allowed to
paid. The amount of credit allowable should be the
be amortised 1/5th every year for a period of five
lower of the tax suffered in the foreign country or
years
the Indian tax attributable to the foreign income.
- Pursuant to restructuring, various tax incentives
hitherto available to the transferor company will
ordinarily be available to the transferee company
Currently, there is no carry forward/carry back of
excess tax credits. Also, there are no detailed rules
for availment of foreign tax credit but is governed
by the DTAA’s clauses. With effect from 1 June
2006, a statutory recognition has also been given to
The Limited Liability Partnerships
agreements entered into between specified Indian
The Finance Act 2009 introduced the tax treatment
association and a non-resident specified association
for
which
for grant of double taxation relief, for avoidance of
are recently introduced by the Limited Liability
double taxation, for exchange of information for the
Partnership Act, 2008 in India. The terms ‘Firm’,
prevention of evasion or avoidance of income tax or
‘Partner’ and ‘Partnership’ were amended and LLP,
for recovery of income tax. It is also clarified that a
as defined under the LLP Act, has been put on par
higher charge of tax on the foreign entity will not be
with a partnership firm under the Indian Partnership
considered as discrimination against such an entity.
the
Limited
Liability
Partnerships
Act, 1932 (General Partnership) for the purpose of
income-tax. Consequently, provisions relating to
The Central Government may enter into agreements
interest and remuneration to partners would apply
with the Government of any specified territory
to a LLP, while provisions applicable to companies
outside India for the purpose of double tax relief and
such as MAT, DDT, etc. will not apply to an LLP.
specified purposes in the same manner as with the
Government of any country outside India.
Relief from Double Taxation
For countries that have DTAAs with India, bilateral
Authority for Advance Ruling (AAR)
relief is available to a resident in respect of foreign
• A scheme of advance rulings is available to an
taxes paid. Generally, provisions of DTAAs prevail
applicant (who may be either a non-resident or
over the domestic tax provisions. However, the
a resident who has entered a transaction with a
domestic tax provisions may apply to the extent
non-resident) with respect to any question of law
that they are more beneficial to the taxpayer. The
or fact in relation to the tax liability of the non-
DTAAs would also prescribe rates of tax in the case
resident, arising out of a transaction undertaken
of dividend income, interest, royalties and fees for
or proposed to be undertaken.
39
• The advance rulings are binding on the tax
same with the DRP within 30 days. The DRP upon
authorities as well as the applicant. Further, an
hearing both sides shall issue necessary directions
appeal can be filed before the High Court against
to the AO for completing the assessment, within a
the AAR order.
period of 9 months from the end of the month in
which the draft order is forwarded to the taxpayer.
Dispute resolution mechanism
Such directions of the DRP would be binding on the
In order to facilitate expeditious resolutions of
AO. Any appeal against the order passed by the AO
transfer pricing disputes and disputes relating to
in pursuance of the directions issued by the DRP
taxation of foreign companies, an alternate dispute
shall be filed by the taxpayer only with the Income -
resolution mechanism has been provided in the
tax Appellate Tribunal. It has also been clarified that
form of Dispute Resolution Panel (DRP) effective
the DRP is an alternate remedy for taxpayers; the
from 1 October 2009 [a collegium comprising of
traditional route of appeal through normal appellate
three Commissioners of Income - tax (CIT). Under
proceedings, i.e. the Commissioner of Income Tax
the proposed mechanism, the Assessing Officer
(Appeals) is still available.
(AO) is required to forward the draft of the proposed
assessment order to the taxpayer, which the taxpayer
may accept; or instead file an application against the
40
Tax incentives relevant to the Building,
Infrastructure and Energy Sectors
Special Economic Zones
Units set up in SEZs
Commercial production or refining of
mineral oil
A unit which sets up its operations in SEZ is entitled
A 100 percent tax holiday for the first seven
to claim Income-tax holiday for a period of 15 years
consecutive
commencing from the year in which such unit begins
undertakings located in the North eastern region)
to manufacture or produce articles or things or
engaged in refining of mineral oil or engaged in
provide services. The benefits are available against
commercial production of natural gas in blocks
export profits, as under:
licensed under the VIII Round of bidding for award
• Deduction of 100 percent for the first five years
• Deduction of 50 percent for the next five years
• Deduction of 50 percent for the next five years
(subject to conditions for creation of specified
reserves).
MAT has been made applicable to SEZ units.
years
to
undertakings
(excluding
of exploration contracts under the New Exploration
Licencing Policy announced by the Government
of India vide Resolution No. O-19018/22/95-ONG.
DO.VL, dated 10 February 1999 or engaged in
commercial production of natural gas in blocks
licensed under the IV Round of bidding for award of
exploration contracts for Coal Bed Methane blocks.
The tax holiday for refining of mineral oil would be
available only if such activity begins no later than 31
SEZ developer
March 2012.
A 100 percent tax holiday (on profits and gains
derived from any business of developing an SEZ) for
any 10 consecutive years out of15 years has been
extended to undertakings involved in developing
SEZs notified on or after 1 April 2005 under the SEZ
Act, 2005. MAT and DDT have been made applicable
to SEZ Developers
Business of collecting and processing
biodegradable waste
A 100 percent tax holiday to undertakings from the
business of collecting and processing or treating
Capital expenditure incurred in specified
industries
A deduction in respect of entire capital expenditure
(excluding expenditure on cost of land or goodwill
or financial instrument) is allowed to the taxpayer
engaged in following business on or after 1 April
2010:
• Setting up and operating cold chain facilities for
specified products
• Warehousing facilities for storage of agricultural
produce
of bio-degradable waste for generating power or
• Laying and operating cross-country natural gas
producing bio-fertilisers, bio pesticides or other
or crude or petroleum oil pipeline network for
biological agents or for producing bio-gas or making
distribution including storage facilities
pellets or briquettes for fuel or organic manure, for
the first five consecutive years.
• Building and operating a new hospital with at least
100 patient beds
• Developing and building a housing project under a
scheme for slum redevelopment or rehabilitation
41
Tax incentives relevant to the Building, Infrastructure and Energy Sectors
framed by the Central Government or a State
waterways, inland ports or navigational channels
Government which is notified by the CBDT
in the sea.
• Building and operating a new hotel of two stars or
above category anywhere in India
• Developing and building a housing project under
a notified scheme for affordable housing on or
after 1 April 2011
• Production of fertilisers in India on or after 1 April
2011
Tax holiday in respect of power projects
Undertakings engaged in prescribed power projects
are eligible for a consecutive 10 year tax holiday as
set out below:
• A tax holiday of 10 years in a block of 15 years
has also been extended to the undertakings set
up before 31 March 2012 with respect to the
Deduction to the expenditure incurred prior to the
commencement of operation of the above specified
business, will be allowed if the expenditure was
capitalised in the books of the taxpayer on the date
of commencement of operation. The deduction
will be allowed to the taxpayer in the year of
commencement of operation.
Tax holiday in respect of infrastructure
projects
Undertakings engaged in a prescribed infrastructure
projects are eligible for a consecutive 10 year tax
holiday as set out below:
following:
- generation/generation and distribution of power,
laying the network of new lines for transmission or
distribution, undertaking a substantial renovation
(more than 50 percent)and modernisation of the
existing network of transmission or distribution
lines.
Tax holiday in respect of hospitals/hotels/
convention centres’
• A 100 percent tax holiday for the first five
consecutive years to an undertaking deriving
profits from the business of operating and
• A 10 year tax holiday in a block of 20 years has been
maintaining a hospital located anywhere in India
extended to undertakings engaged in developing/
(subject to exclusions), provided the hospital is
operating and maintaining/developing, operating
constructed and has started or starts functioning
and maintaining any infrastructure facility such
at anytime before 31 March 2013.
as roads, bridges, rail systems, highway projects
including housing or other activities being an
integral part of the project, water supply projects,
water treatment systems, irrigation projects,
sanitation and sewerage systems or solid waste
management system; and
• A 10 year tax holiday in a block of 15 years has also
been extended to undertakings involved in the
developing/operating and maintaining/developing,
operating and maintaining, ports, airports, inland
42
• A 100 percent tax holiday for the first five
consecutive years to an undertaking deriving
profit from the business of a hotel located in the
specified district having a World Heritage Site,
if such a hotel is constructed and has started or
starts functioning before 31 March, 2013.
There are certain conditions which need to be
satisfied before claiming the tax holiday.
An Overview of the Transfer Pricing Regulations in India
Background
Taking into account the increased participation of
Multinational groups involved in economic activities
either or both of whom are non resident for Indian
income tax purposes, shall be computed having
regard to the arm’s length price.
in India, Transfer Pricing regulations were introduced
• Two enterprises are considered to be “associated”
in 2001 to ensure that fair and equitable proportion of
if there is direct/indirect participation in the
profits and tax arising from cross border transactions
management or control or capital of an enterprise
between related entities are duly received in India.
by another enterprise or by same persons in
both the enterprises. Further, the Transfer Pricing
India today is experiencing an evolving transfer pricing
regulations prescribe certain other conditions
regulation with issues relating to interpretation and
that could trigger an “associated enterprise”
effective implementation mechanism that have
relationship. Significant conditions among these
surfaced in the course of sustained transfer pricing
include:
audits. India now ranks among the top 50 countries
that have enacted comprehensive Transfer Pricing
regulations to protect the erosion of its tax base.
- Direct/indirect shareholding giving rise to 26
percent or more of voting power;
Since its introduction in April 2001, the Indian
- Substantial purchase of raw materials/sale of
transfer pricing regulations have come of age– both
manufactured goods by an enterprise from/to
in terms of quality of audits as well as the revenue
the other enterprise at prices and conditions
generated for the Indian Government. It is estimated
influenced by the latter;
that till date, the Directorate of Transfer Pricing has
made adjustments of approximately INR 230 billion,
which is a considerable achievement in a relatively
small period of time - this being due to the focused
efforts of the Indian Revenue Authorities on transfer
pricing matters.
- Authority to appoint more than 50 percent of
the board of directors or one or more of the
executive directors;
- Dependency in relation to intellectual property
rights
(know
-how,
patents,
trademarks,
copyrights, trademarks, licenses, franchises
The Indian transfer pricing regulations are broadly
based on the Transfer Pricing Guidelines for
Multinational Enterprises and Tax Administrations
issued by Organization for Economic Co-operation
and Development (OECD Guidelines), albeit with
some adaptations. The regulations prescribe detailed
mandatory documentation requirements along with
disclosure of international transactions and impose
steep penalties for non-compliance.
etc) owned by either party; and
- Dependency
relating
to
borrowings
i.e.
advancing of loans amounting to not less
than 51 percent of total assets or provision
of guarantee amounting to not less than 10
percent of the total borrowings.
Determination of arm’s length price
The Indian transfer pricing regulations require the
Scope and Applicability
• Section 92 of the Act provides that the price of any
transaction between “associated enterprises”,
arm’s length price in relation to an international
transaction to be determined any one of the following
methods, being the most appropriate method.
43
• Comparable uncontrolled price (CUP) method
• Resale price method (RPM)
• Cost plus method (CPLM)
The information and documents specified, should,
as far as possible, be contemporaneous and should
exist latest by the specified date and should be
maintained for a period of nine years from the
• Profit split method (PSM)
end of the relevant financial year. The prescribed
• Transactional Net Margin Method (TNMM).
documentation
include
details
of
ownership
structure, description of functions performed, risks
The regulations also permit the CBDT to prescribe any
undertaken and assets used by respective parties,
other method - however, no other method has been
discussion on the selection of most appropriate
prescribed to date. Further, there is no hierarchy of
method and economic analysis resulting into
methods prescribed. The most appropriate method
determination of arm’s length price, etc.
shall be the method which is best suited to the facts
and circumstances of each particular international
transaction, and which provides the most reliable
measure of an arm’s length price in relation to an
international transaction. In a case where more than
one price is determined by the most appropriate
method, the arm’s length price shall be taken to be
the arithmetical mean of such prices. Further the
Transfer Pricing regulations also incorporate the
In
addition
to
maintaining
the
prescribed
documentation, tax payers are also required to
obtain a certificate / report (detailing the particulars
of international transactions) from an accountant
and file the same with the Revenue Authorities on
or before the specified date (currently the due date
of filing the corporate tax return i.e. 30 November) in
the prescribed form and manner.
option of a 5 percent variation in the arithmetic mean,
The Act has prescribed penal provisions for default
in determining the arm’s length price. However, the
in compliance with the aforesaid transfer pricing
recent amendment now restricts the adjustment
regulations, which are summarized below.
only to those cases which fall within a 5 percent
range variance range. Those cases falling outside
Nature of default
Penalty prescribed
the range shall no longer be eligible for the benefit
Failure to maintain
2 percent of value
as the option clause has now been omitted.
prescribed
of international
information/ documents
transaction
Failure to furnish
2 percent of value
information/ documents
of international
during audit
transaction
documents required to maintain by tax payers
Adjustment to
100 percent to 300
entering into an international transaction. Currently,
taxpayer’s income
percent of tax on
Compliance Requirements
The Transfer Pricing regulations have prescribed
an illustrative list of information and supporting
adjustment amount
the mandatory documentation requirements are
applicable only incases where the aggregate value
Failure to furnish
of the international transactions entered into by the
accountant’s report
taxpayer as recorded in the books of account exceed
INR 10 million.
44
INR 100,000
Transfer Pricing Audits
the Revenue authorities on its transfer prices. If the
taxpayer meets the criteria agreed in the APA, the
Transfer pricing matters are dealt with by specialized
taxpayer will not be subject to a transfer pricing
Transfer Pricing Officers duly guided by Directors of
adjustment and such an arrangement would remain
International Taxation, being part of the Indian tax
valid for a period of five years. This would help in
administration. In the course of a Transfer Pricing
minimizing risk of a transfer pricing adjustment;
audit, incase any adjustments are made by the
providing certainty through a negotiation process
Revenue authorities to the taxable income reported,
and avoiding tax risk by preventing double taxation.
taxpayers cannot avail of any tax exemption to
which they may be otherwise entitled to. Further, the
Mutual Agreement Procedure
penalties as stated above may also be levied.
The taxpayers can choose Mutual Agreement
Recent Developments
Procedure (MAP) to resolve bilateral transfer pricing
issues with certain foreign jurisdictions depending
Safe Harbor Rules
on the provisions in the relevant DTAAs. The Revenue
The CBDT has been empowered to introduce Safe
Authorities have issued notifications whereby
Harbor provisions aimed at minimizing disputes
subject to the satisfaction of certain conditions and
relating to transfer pricing matters. ‘Safe Harbor’ has
depending on the relevant foreign jurisdiction, the
been defined to mean ‘circumstances’ in which the
taxpayers choosing the MAP process may not need
Revenue authorities shall accept the transfer prices
to pay the tax demand until the closure of the MAP
declared by the taxpayers - i.e. such taxpayers
proceedings.
would not be subject to transfer pricing scrutiny.
The primary objective seems to be reduction of
Judicial Guidance
judgmental errors in determination of transfer price
Since the introduction of Transfer Pricing regulations
relating to international transactions. Safe harbor
in India, litigation on Transfer Pricing matters has
provisions are expected to offer three main benefits
consistently been on the increase. Five rounds of
to taxpayers and tax administrators: i) compliance
transfer pricing audits have been completed. Each
relief ii) administrative simplicity and iii) certainty.
year has seen a steep increase in the quantum of
Detailed rules to operationalize the safe harbor
adjustments.
provisions are awaited and with the establishment
The numerous judicial precedents available on
of Committee constituted by BDT, it is anticipated
Transfer Pricing matters to date provide guidance on
that the same shall be introduced soon.
the interpretation and application of Indian transfer
pricing laws. Though some of them may have varied
Advance Pricing Agreements
interpretations on contentious issues, many of them
Currently, the Indian transfer pricing provisions
acknowledge certain fundamental Transfer Pricing
do not provide any facility for Advance Pricing
principles and, in a way, have supported that the
Agreements (APAs), however this is proposed to
following are an integral part of an objective Transfer
be introduced in the DTC. An APA is a mechanism
Pricing analysis
whereby a taxpayer enters into an agreement with
• Detailed FAR analysis for tested party and
45
comparable companies is crucial - taxpayers
must have robust documentation with sound FAR
analysis and well developed economic analysis to
justify their transfer prices.
• International
transactions
Transfer Pricing and Customs Valuation
There is a lack of consistency between customs
valuation procedure and transfer pricing regulations
under tax laws. Both departments work at divergent
should
not
be
aggregated unless they are inextricably linked.
purposes in relation to the same transactions.
Suitable methods for valuation of imported goods
• Greater need to build adequate “cost-benefit”
should be established which are acceptable to
documentation to substantiate management and
both customs law and the Indian transfer pricing
technical fee payouts.
regulations. Towards this end, the Indian Revenue
• Least complex entity to be selected as the tested
party.
• Adjustments
Authorities set up a Joint Working Group, comprising
of transfer pricing and customs officers. This
initiative was undertaken by the Revenue Authorities
may
be
made
to
improve
in order to bring greater harmonization, coordination
comparability between the results of taxpayer and
and communication between the two departments
the comparable.
as regards to the valuation of imported goods.
• Transfer Pricing provisions being specific in nature;
override other general provisions as contained in
the Act.
While the transfer pricing compliance requirements
and audits are stringent, there is good hope for the
taxpayers that the objectivity witnessed through
• The business case and the economic environment
recent developments and in particular on the dispute
of the taxpayer must be taken into account while
resolution mechanism, is expected to overhaul for
testing the arm’s length criterion.
better the Indian transfer pricing administration.
46
Important Changes in the Direct Taxes Code
The Direct Taxes Code, 2010 (‘the Bill’), has been laid
before the Parliament for discussion. The Bill would
now need to be approved by both the Houses of the
Parliament of India and the President of India before
it becomes law. Some of the salient features of the
Bill have been discussed below.
• Income has been proposed to be classified into
two broad groups:
Income from Ordinary Sources and income from
Special Sources
• Income from Ordinary Sources refers to:
- Income from employment
Preface
The DTC aims to replace the Act and the Wealth-tax
Act, 1957. Several proposals of the DTC are path-
- Income from house property
- Income from business
breaking and aim to bring changes to the ways we
- Capital Gains
have traditionally understood tax issues in India.
- Income from Residuary Sources
General provisions
• Income from Special Sources to include specified
• The DTC 2010 would come into force on 1 April
income of non-residents, winning from lotteries,
horse races, etc. However, if such income is
2012, if enacted.
attributable to the PE of the non-resident it would
• The concept of previous year has been replaced
not be considered as Special Source income.
with a new concept of financial year which inter
Accordingly, such income would be liable to tax
alia means a period of 12 months commencing
on net income basis
from the 1st day of April.
Corporate Tax
Tax rates for domestic companies
Category
Existing rate*
As per draft DTC**
Income Tax
30 percent
30 percent
MAT
Levied at 18 percent of the adjusted
book profits in case of companies
where income-tax payable on
taxable income according to the
normal provisions of the Act is
lower than the tax @ 18 percent on
book profits
Levied at 20 percent of the
adjusted book profits in case
of companies where income
tax payable on taxable income
according to normal provisions
of the DTC is lower than the tax
@ 20 percent on book profits
DDT
15 percent
15 percent
Income distributed by mutual fund to
unit holders of equity-oriented funds
Not applicable
5 percent of income
distributed
Income distributed by life insurance
Not applicable
companies to policy holders of equity
oriented life insurance schemes
5 percent of income
distributed
47
Notes:
Any other person is considered to be a resident in
* Exclusive of surcharge and education cess
India if its place of control and management at any
** There is no surcharge and education cess under
time in the year is situated wholly or partly in India 1
April 2000. The provisions of the DTC or the relevant
DTC
• MAT credit is allowed to be carried forward for
tax treaty, whichever are more beneficial shall apply
except where provisions relating to (a) General Anti-
15 years
• In the case of a Company, its liability to pay
income-tax is to be the higher of the two:
- The amount of income-tax liability computed
at normal rates of tax on its Total Income
- The amount of income-tax liability calculated
at the specified rates on ‘Book profits’
- Provision pertaining to non-residents
Avoidance Rules (GAAR), (b) levy of Branch Profits
Tax, or (c) Controlled Foreign Companies (CFC) shall
apply in preference to the beneficial provisions of
the relevant tax treaty.
• Income shall be deemed to accrue in India, if it
accrues, whether directly or indirectly, through
or from the transfer of a capital asset situated in
India
Category
Existing rate As per DTC
Foreign com-
40 percent
pany
• Income from transfer of share or interest in a
• 30 percent
foreign company by a non resident outside India
• Additional
will not be deemed to accrue in India if the fair
branch profits tax
market value of the assets in India owned (directly
of 15 percent (on
or indirectly) by that company is greater than or
post tax
equal to 50 percent of the fair market value of
income)
the total assets owned by that company. Further,
• A foreign company is considered to be a resident
in India if its ‘place of effective management’ is
situated in India.
Place of effective management of the company
means:
- the place where the board of directors of the
company or its executive directors, as the case
may be, make their decisions; or
- In a case where the board of directors routinely
approve the commercial and strategic decisions
made by the executive directors or officers of
it is provided that proportionate gains would be
taxable in India where any income is deemed to
accrue to a non-resident by way of transfer of
share or interest in a foreign company
• PE defined in the same way as in treaties and
includes the concept of one day Service PE,
(substantial) equipment PE and insurance agent
PE
• In relation to availability of Foreign Tax Credit, it
has been clarified that:
- Foreign Tax Credit to be available to a person
resident in India; and
the company, the place where such executive
- Foreign Tax Credit to be restricted to the
directors or officers of the company perform
amount of Indian income tax payable on
their functions.
(a) income taxed outside India and (b) total
income of the assessee.
48
The Central Government may prescribe methods
for computing the foreign tax credit, the manner
of claiming credit and such other particulars as are
necessary for providing the relief or avoidance of
double taxation :
• Income of FIIs from transfer of any security will
be taxable as capital gains
• For non-residents, head office expenditure shall
be restricted to one-half percent of the total
sales, turnover or gross receipts
Controlled Foreign Companies
The concept of Controlled Foreign Companies has
been introduced in the proposed DTC. However,
it is more relevant for Indian companies investing
outside and therefore, has not been discussed in
detail in this booklet.
employed for bona fide business purposes
• An arrangement would be presumed to be
for obtaining tax benefit unless the tax payer
demonstrates that obtaining tax benefit was not
the main objective of the arrangement
• IT to determine the tax consequences on
invoking GAAR by reallocating the income etc or
is regarding / recharacterising the whole or part
of the arrangement
• GAAR provisions to be applicable as per
the guidelines to be framed by the Central
Government
• GAAR to override Tax Treaty provisions.
Capital gains
• The definition of capital assets has been modified
and replaced with the term investment asset.
General anti-avoidance rules
• The DTC contains GAAR provisions which
provide sweeping powers to the tax authorities.
The same are applicable to domestic as well as
international arrangements
Investment asset does not include business
assets like self generated assets, right to
manufacture and other capital asset connected
with the business. Further, Investment Asset is
defined to include any securities held by FII and
any undertaking or division of a business.
• GAAR provisions empower the CIT to declare
any arrangement as “impermissible avoidance
arrangement” provided the same has been
entered into with the objective of obtaining tax
benefit and satisfies any one of the following
conditions:
- It is not at arm’s length
- It represents misuse or abuse of the provisions
of the DTC
- It lacks commercial substance
- It is carried out in a manner not normally
Personal taxation
• New beneficial tax slabs are proposed to be
introduced which will reduce the tax burden
for individuals. The peak rate of 30 percent is
applicable on income exceeding INR 1 million.
• The category of ‘Not Ordinarily Resident’
abolished and only two categories of taxpayers
proposed viz. residents and nonresidents.
• The additional condition of stay in India of 729
49
days during the 7 preceding financial years is
retained only to ascertain taxability of overseas
income earned during a financial year.
• A citizen of India or person of Indian origin
- Archaeological
collections,
drawings,
paintings, sculptures or any other work of art
- Watches with a value in excess of INR
50,000
living outside India and visiting India will trigger
- Bank deposits outside India, in case of
residency by staying in India for more than 59
individuals and HUFs, and in the case of other
days in a financial year proposed earlier.
persons, any such deposit not recorded in the
books of account
Wealth tax
• Every person, other than a NPO, would be liable
to pay wealth tax at the rate of 1 percent on net
wealth exceeding INR 10 million
• The specified assets for computing ‘net wealth’
have been retained in line with existing taxable
assets, with additional items as under:
50
- Any interest in a foreign trust or any other body
located outside India (whether incorporated
or not) other than a foreign company
- Any equity or preference shares held by a
resident in a CFC
- Cash in hand in excess of INR 200,000 in the
case of an individual and HUF.
An overview of Indirect Taxes
India has a combination of a federal as well as
a decentralized system of levying taxes. The
Central Government of India, the Governments of
each individual state and the local authorities are
empowered to impose various indirect taxes. The
key indirect taxes include:
A. The Central taxes, which are levied by the Central
Government, such as:
• Customs Duty
• Education Cess (E-cess);
• Secondary and Higher Education cess (SHEC);
and
• Special Additional duty (SAD)
The applicable customs duty rate on the import
of any goods into India is based on the universally
accepted Harmonized System of Nomenclature
(HSN) code assigned to the said goods. In India, the
Customs Tariff Act, 1975 outlines the HSN codes
• CENVAT (or excise duty)
assigned to various goods determining the duty rate
• Service Tax
on the import of such goods. The generic BCD rate
• Central Sales Tax
is 10 percent at present and the effective customs
• Research and Development Cess.
B. The State taxes, which are levied by the
respective State Governments, such as:
• Value Added Tax (VAT)
• Entry Tax
• Octroi
• Other Local Taxes
duty rate (i.e. the aggregate of the abovementioned
components, i.e. BCD, ACD, SAD and cesses) with
BCD at 10 percent is 26.85 percent (with ACD at 10
percent, SAD at 4 percent and cesses at 3 percent).
The ACD paid as part of customs duty would be
available as credit (set-off) to the manufacturers /
service providers using the imported goods as inputs
in their manufacturing / service provision activity.
The SAD paid as part of customs duty would be
C. The Government of India is planning to introduce
available as credit to the manufacturer, whereas
a single uniform Goods and Services Tax (GST)
for a trader, the same would be available as refund
in the financial year 2011-12 which would
(subject to the prescribed procedure). This refund
subsume many of the above taxes.
of SAD is available to a trader subject to VAT being
paid on the subsequent sale of the imported goods.
1. Customs duty
Further, an exemption from SAD has been provided
to importers trading in pre-packaged and other
Customs duty is applicable on import of goods into
specified goods.
India. It is payable by the importer of goods into
India. Customs duty comprises of the following
elements:
• Basic Customs Duty (BCD);
• Additional customs duty (ACD) (this is in lieu
of CENVAT, i.e. excise duty, levied on goods
manufactured in India);
2. Foreign Trade Policy (FTP)
The FTP provides a broad policy framework for the
import and export of goods and services outlined by
the Ministry of Commerce.
The objective of the FTP is to promote the exports
and to regulate the imports of the country. The FTP
51
outlines export promotion schemes for enterprises
3. Research and development Cess (R&D Cess)
in designated areas such as Software Technology
Parks, Export Oriented Units and Units in SEZs. Such
R&D Cess is leviable at the rate of 5 percent on
enterprises are inter alia granted exemptions from
import of technology under a foreign collaboration.
customs duty and CENVAT on the procurement.
The term ‘foreign collaboration’ has been defined
to include Joint ventures, partnerships, etc. Import
Export Promotion Capital Goods (EPCG)
of any designs/ specifications from outside India or
Under the EPCG Scheme, capital goods (including
deputation of foreign technical personnel, under a
second hand capital goods) can be imported at a
foreign collaboration, would also be liable to R&D
concessional customs duty rate of 0 percent and 3
Cess. R&D Cess paid is available as deduction
percent (depending on the goods imported). This
with respect to service tax payable for Consulting
concession is available subject to fulfillment of the
Engineer’s services and Intellectual Property Right
export obligation of 8 times the duty saved (owing to
related services.
the concessional duty rate) over a period of 8 years.
Served From India Scheme (SFIS)
4. CENVAT
CENVAT, also known as Excise duty, applies on goods
exporting
manufactured in India. It is payable by the person
specified services are allowed to import goods
undertaking manufacturing activity and the point of
without payment of duty up to 10 percent of the
payment is when manufactured goods are removed
realisations from such service exports in the current/
out of the factory of manufacture. Further, certain
previous financial year. Services exported means
prescribed processes undertaken would also qualify
specified services rendered to any other country
as manufacture, commonly known as ‘deemed
or to a consumer of any other country or through
manufacture’ and would be chargeable to CENVAT.
presence in any other country. The consideration
It can be recovered from the buyer of the goods.
received for such export services can be received
The applicable CENVAT rate on the manufacture
in foreign exchange or in Indian rupees, which are
of any goods into India is based on the universally
otherwise considered by the RBI to be paid in foreign
accepted HSN code assigned to the said goods. In
exchange.
India, the Central Excise Tariff Act, 1985 outlines the
Under
the
SFIS,
service
providers
HSN codes assigned to various goods determining
Duty Free Import Authorization (‘DFIA’)
the rate on the manufacture of such goods. The
Under the DFIA Scheme, the raw materials for
generic CENVAT rate is 10.30 (including 2 percent
manufacture of goods meant for export are
E-Cess and 1 percent SHEC).
allowed to be imported without payment of duty.
This exemption from duty is available subject to
prescribed Standard Input Output Norms depending
on the quantity and value of imported and exported
goods. Further, there is an additional requirement of
achieving a minimum value addition of 20 percent.
52
The CENVAT paid on inputs used in the manufacture
of final goods, is available for set-off against the
tax liability on such finished goods manufactured,
subject to satisfaction of prescribed conditions
under the CENVAT Credit Rules, 2004. Certain duty
incentives are presently available to manufacturers
having units in notified areas (such as J&K & North
Eastern states etc). Such incentives are in the nature
of complete exemption from duty (in which case no
CENVAT would be charged by the manufacturer) or
in the nature of remission of CENVAT charged (in
which case CENVAT would be charged, collected and
deposited by the manufacturer and subsequently
refunded by the Government).
5. Service tax
6. Central Sales Tax (CST)
This is a form of transaction tax applicable on sale
transactions involving movement of goods from one
state to another. Presently it is levied and collected
by the seller’s state (though levied under and
governed by the Central Government’s legislation)
and is payable by the seller. The seller can recover it
from the buyer. Under the CST legislation, the buyer
can issue declaration in Form C, subject to fulfillment
of conditions, to be able to claim concessional CST
Service tax was introduced in India in 1994. The levy
rate of 2 percent (at present). Form C can be issued
of service tax is governed by the Finance Act, 1994
by the purchasing dealer provided he is registered
(‘the Finance Act’) and is applicable to the whole
with the VAT authorities of the relevant state and
of India, except the state of Jammu and Kashmir.
has procured the goods for any of the following
Currently, it seeks to levy tax on more than hundred
purposes:
categories of services specifically defined under the
• Resale;
Finance Act. Service tax is generally imposed at the
• Use in manufacture or processing of goods for
rate of 10 percent (plus 2 percent education cess and
1 percent SHEC on service tax) (i.e.10.30 percent) on
the gross taxable value of specified services.
Service tax is generally paid by the service provider.
However, in certain cases like goods transport
agency, sponsorship services or services received
from outside India, the service recipient would be
liable to discharge the service tax liability on the
services received by him on a reverse charge basis.
sale;
• Use in telecommunication network;
• Use in mining;
• Use in generation or distribution of electricity or
any other form of power.
In the absence of issuance of Form C by the
purchaser, the applicable tax rate would be the VAT
rate applicable to the goods in the selling state. CST
paid to vendors while procuring inputs is not available
Further, the Export of Service Rules, 2005 have
as set-off for payment of VAT or CST liability at the
provided an option to service providers for exporting
time of sale of finished goods and hence increases
services without levy of service tax, subject to
the cost of procurement.
satisfaction of prescribed rules and conditions.
Thus, the concept of ‘export’ is based on zero-rating
Interstate stock transfers
principles adopted by several countries around the
Goods can be transferred by a branch of a company
world.
in one state to another branch of the company in
another state without payment of CST by collecting
The service tax paid on the services received can
declaration in Form F from the recipient branch.
be used as set-off while payment of service tax
In case of failure to issue Form F by the recipient
on provision of services or CENVAT on removal of
branch, the VAT rate applicable in the dispatching
goods manufactured.
state would be payable.
53
7. VAT
9. Octroi
This is a form of transaction tax applicable on sale
Octroi is levied on the entry of specified goods into a
transactions involving movements of goods within
specified municipal limit / local areas (e.g., Mumbai)
the same state, i.e. buyer and seller located within
for use, consumption or sale therein. Presently,
the same state. The levy of VAT is state specific. Each
Octroi is levied only in certain areas of the state of
state has prescribed the schedule of rates applicable
Maharashtra.
to goods sold within the state. The generic VAT rates
The Octroi rates vary from municipal limit to
in the states are as follows:
municipal limit depending on the type of goods. It
Goods
Rate
(in percent)
Essential commodities – fruits,
0
may be noted that the set-off ofOctroi paid is not
available against the VAT payable and hence is a
cost to the business.
vegetables, staples, etc
Precious goods – jewellery,
1
bullion, etc
Capital goods and Industrial
4-5
Inputs
Residuary category – consumer
12.50 – 15
durables
Liquor, tobacco, fuel, etc
Specific rates
10. Other Local Taxes
Besides the abovementioned taxes, there are
certain local taxes applicable within specific areas
of certain identified cities, towns, villages, etc, for
e.g.: Agricultural Produce Market Cess (APMC) and
Mandi Tax.
Such taxes are generally levied on the removal of
It is pertinent to note that the VAT is paid to
goods from the specified locations. No set-off of
vendors for procurement of goods cans leases
the taxes paid is available and hence such taxes
and mortgages, transfers of property, insurance
would form part of the cost of procurement. Further,
policies, hire purchase agreements, motor vehicle
another tax known as stamp duty is applicable on
registrations and transfers, etc. The rates of stamp
documents. The State Governments impose the
duty vary from state to state.
stamp duty on a range of instruments such as leases
8. Entry tax
and mortgages, transfers of property, insurance
policies, hire purchase agreements, motor vehicle
Entry tax is levied on the entry of specified goods
registrations and transfers, etc. The rates of stamp
into a state for use, consumption or sale therein. The
duty vary from state to state.
entry tax rates vary from state to state depending on
the type of goods. It may be noted that, in certain
Goods and service tax
states, the set-off of entry tax paid is available
The Indian indirect tax system as mentioned above
against the VAT payable on the sale of goods in the
is complicated and multi-layered with levies both at
state, subject to state prescribed laws.
the Central and State levels.
There has been a constant evolution of the indirect
tax laws over a period of time such as allowing
54
cross credits between goods and services and
Some of the features of the proposed GST as outlined
introduction of VAT in all states. Despite such efforts,
by the discussion paper and the Honorable Finance
the existing structure and mechanism for indirect
Minister’s speech to the Empowered Committee on
taxes in India is fraught with various inefficiencies
21 July 2010 are as follows:
such as multiplicity of taxes at the Central and State
levels, cascading effect of taxes, non availability of
VAT credit against CENVAT liability, non availability
of CST credit, multiplicity of tax rates, etc. With an
attempt to integrate the multiple indirect taxes on
goods and services into a single levy, the Finance
Minister in the Central Budget for the year 2006-07
announced the proposed implementation of the GST
for the first time from 1 April 2010.
A model of dual GST is proposed to be introduced
comprising of the Central GST (CGST) levied by the
Centre and the State GST (SGST) to be levied by the
States. The dual GST would replace a number of
existing central and state level taxes such as excise
duty, service tax, additional duty of customs, State
level VAT, Entertainment tax ,Central Sales Tax, etc.
The said GST would operate as a VAT whereby
• GST is a broad based and a single unified
consumption tax on supply of goods and
services
• GST would be levied on the value addition at
each stage of supply chain
• GST proposes to subsume the following taxes:
- Central taxes – CENVAT, CVD, SAD, Service
Tax, Surcharges, and Cesses
- State taxes – VAT, Entertainment tax; Luxury
tax; Taxes on lottery, betting and gambling;
State Cesses and Surcharges, Entry Tax.
No decision has been taken yet on whether
purchase tax would be subsumed in GST
• Petroleum products and alcoholic beverages
have been proposed to be kept out of GST
credit of all taxes paid on the procurements would
• It has been proposed that there should be a two-
be available for discharging the GST liabilities on
tier rate structure for goods and different rates for
supplies. The GST will not make a distinction between
goods and services, which would converge into a
goods and services and there would be free flow
single rate for goods and services after two years
of credits between goods and services. This will
of GST implementation as tabulated below:
have the effect of removing the distortions in the
existing tax regime, wherein cross credits between
Year
Goods
Services
goods and services is not available. An Empowered
Lower
Standard
Committee of State Finance Ministers has been
rate
rate
formed to lay out the plan for the implementation
Year 1
6
10
8
of GST. The Empowered Committee had published
Year 2
6
9
8
a Discussion Paper outlining the proposed features
Year 3
8
8
8
of the dual GST in November 2009 for views of the
industry and trade. In furtherance to the Discussion
Paper, the Honorable Finance Minister made a
speech to the Empowered Committee outlining the
broad contours of the proposed GST.
• The CGST and SGST rates are proposed to be
kept same as mentioned above.
• CGST and SGST would be applicable to all
55
transactions of goods and services except:
- Small list of exempted goods and services
- Goods which are outside the purview of
GST
(petroleum
products
and
alcoholic
of CGST and SGST would be applicable on all
inter-state transactions of goods and services
and would be levied by Central Government.
Interstate stock transfers would be treated at par
with interstate sales for the levy of GST
beverages)
- Transactions which are below the prescribed
threshold limits.
• Presently a threshold limit of INR 10 million has
been prescribed under CGST and INR 1 million for
SGST (no threshold limit prescribed for services)
• Integrated GST (IGST) which is combination
56
• Exports would be zero rated, whereas GST would
be levied on imports
• Full input credit of the taxes paid in the supply
chain would be available. However, there would
be no cross credit available between CGST and
SGST.

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