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: [email protected] Hemal Zobalia Partner Tax and Regulatory T: +91 22 3090 2706 E: [email protected] Anand Jain Associate Director Energy and Natural Resources T: +91 22 3090 2479 E: [email protected] Graphics Sunshine Creations Printed by Omkar Arts The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. KPMG International’s Trademarks are the sole property of KPMG International and their use here does not imply auditing by or endorsement of KPMG International or any of its member firms. Printed in the month of October 2011 How to do Business in the Indian Infrastructure Industry 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 How to do Business in the Indian Infrastructure Industry 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 Concessioning Authority Regulatory Body Concessioning Authority 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 How to do Business in the Indian Infrastructure Industry 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 How to do Business in the Indian Infrastructure Industry 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 How to do Business in the Indian Infrastructure Industry 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 How to do Business in the Indian Infrastructure Industry 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 How to do Business in the Indian Infrastructure Industry 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. How to do Business in the Indian Infrastructure Industry 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 How to do Business in the Indian Infrastructure Industry 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. How to do Business in the Indian Infrastructure Industry 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’) How to do Business in the Indian Infrastructure Industry 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 Investment Vehicles for Foreign Investors 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 How to do Business in the Indian Infrastructure Industry 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 Investment Vehicles for Foreign Investors 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 An Overview of Direct Taxes in India 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. How to do Business in the Indian Infrastructure Industry 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 An Overview of Direct Taxes in India 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 How to do Business in the Indian Infrastructure Industry 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 An Overview of Direct Taxes in India 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, How to do Business in the Indian Infrastructure Industry 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 An Overview of Direct Taxes in India • 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 An Overview of the Transfer Pricing Regulations in India • 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 How to do Business in the Indian Infrastructure Industry 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 An Overview of the Transfer Pricing Regulations in India 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 Important Changes in the Direct Taxes Code 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 How to do Business in the Indian Infrastructure Industry 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 Important Changes in the Direct Taxes Code 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 Important Changes in the Direct Taxes Code 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 How to do Business in the Indian Infrastructure Industry 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 Important Changes in the Direct Taxes Code 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 How to do Business in the Indian Infrastructure Industry 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 Important Changes in the Direct Taxes Code 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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