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The year 2013 was an eventful one for the Indian defence sector in terms of witnessing substantial policy amendments with the use of the new defence procurement procedure (DPP) which aims to balance the competing requirements of expediting capital procurement, developing a robust indigenous defence sector, and promoting transparency and accountability.
The key change in DPP 2013 has been the stipulation of a hierarchy of categorisation of any new defence procurement under ‘Buy (Indian)’ and ‘Buy and Make (Indian)’ categories.
The new policy aims at creating a level playing field for Indian industry while laying a strong emphasis on promoting indigenisation.
Consequently, the majority of the ‘request for proposals’ (RFPs) are expected to be preferred to Indian vendors.
As India does not have the capability to manufacture high-end defence equipment, Indian vendors will be compelled to enter into joint ventures or technical collaboration arrangements or co-production arrangements with foreign original equipment manufacturers (OEMs).
On the one hand, the new DPP opens up greater opportunities for Indian vendors to imbibe technical capabilities to manufacture defence equipment; on the other hand, such arrangements will expose foreign OEMs and Indian vendors to a high level of direct taxes and related tax compliances.
How it works
Let’s try and understand this with the help of an example. An Indian vendor enters into a contract with the MoD for the supply of defence equipment. The Indian vendor also enters into a technical collaboration agreement with foreign suppliers for manufacturing critical components for which the know-how is not available in India.
The technical collaboration agreement will generally entail provision of know-how, training, designs and drawings and so on to enable transfer of technology from foreign supplier to Indian vendor. The arrangement may also involve flying down personnel of the foreign supplier to India for imparting technical knowledge, training the personnel of Indian companies, supervision and control, and so on.
All these transaction flows are bound to have income tax implications for the foreign suppliers. They can range from the remuneration received by the foreign supplier being considered as royalty or fee for technical services, to foreign suppliers being exposed to permanent establishment exposure in India.
The deputation of employees from foreign companies to India must also be regularly monitored as their consistent presence can expose the employees as well as the foreign companies to tax liability in India.
It is also important to note that certain exemptions that were available to foreign companies when they were directly supplying the technology to the Ministry of Defence may not be available when the technology transfer agreement is with the Indian companies.
The Income-tax Act, 1961, allows exemption from taxability to the foreign companies in relation to royalty or fee for technical services where the same is received in pursuance to an agreement with the government in projects connected with India’s security.
Sensitive issue
A high-level review of recent controversial tax issues reveals that withholding tax obligation is one of the most sensitive areas where revenue authorities are most aggressive.
The tax liability for foreign companies emerging out of these contracts or arrangements casts significant ‘withholding tax obligations’ on their Indian counterparts and accordingly, the Indian companies must ensure that related compliances are adequately discharged to insulate themselves from payment of high taxes, interest and penalty.
The new DPP will pave the way for fresh cross-border partnering arrangements. To optimise tax and regulatory compliances, it will be important to evaluate the supply chain and its component transactions from the perspective of multiple regulatory regimes: the DPP and its offset policy, industrial licensing, FDI policy, the foreign trade policy and tax — corporate, indirect and transfer pricing.
In defence of optimisation | Business Line
The key change in DPP 2013 has been the stipulation of a hierarchy of categorisation of any new defence procurement under ‘Buy (Indian)’ and ‘Buy and Make (Indian)’ categories.
The new policy aims at creating a level playing field for Indian industry while laying a strong emphasis on promoting indigenisation.
Consequently, the majority of the ‘request for proposals’ (RFPs) are expected to be preferred to Indian vendors.
As India does not have the capability to manufacture high-end defence equipment, Indian vendors will be compelled to enter into joint ventures or technical collaboration arrangements or co-production arrangements with foreign original equipment manufacturers (OEMs).
On the one hand, the new DPP opens up greater opportunities for Indian vendors to imbibe technical capabilities to manufacture defence equipment; on the other hand, such arrangements will expose foreign OEMs and Indian vendors to a high level of direct taxes and related tax compliances.
How it works
Let’s try and understand this with the help of an example. An Indian vendor enters into a contract with the MoD for the supply of defence equipment. The Indian vendor also enters into a technical collaboration agreement with foreign suppliers for manufacturing critical components for which the know-how is not available in India.
The technical collaboration agreement will generally entail provision of know-how, training, designs and drawings and so on to enable transfer of technology from foreign supplier to Indian vendor. The arrangement may also involve flying down personnel of the foreign supplier to India for imparting technical knowledge, training the personnel of Indian companies, supervision and control, and so on.
All these transaction flows are bound to have income tax implications for the foreign suppliers. They can range from the remuneration received by the foreign supplier being considered as royalty or fee for technical services, to foreign suppliers being exposed to permanent establishment exposure in India.
The deputation of employees from foreign companies to India must also be regularly monitored as their consistent presence can expose the employees as well as the foreign companies to tax liability in India.
It is also important to note that certain exemptions that were available to foreign companies when they were directly supplying the technology to the Ministry of Defence may not be available when the technology transfer agreement is with the Indian companies.
The Income-tax Act, 1961, allows exemption from taxability to the foreign companies in relation to royalty or fee for technical services where the same is received in pursuance to an agreement with the government in projects connected with India’s security.
Sensitive issue
A high-level review of recent controversial tax issues reveals that withholding tax obligation is one of the most sensitive areas where revenue authorities are most aggressive.
The tax liability for foreign companies emerging out of these contracts or arrangements casts significant ‘withholding tax obligations’ on their Indian counterparts and accordingly, the Indian companies must ensure that related compliances are adequately discharged to insulate themselves from payment of high taxes, interest and penalty.
The new DPP will pave the way for fresh cross-border partnering arrangements. To optimise tax and regulatory compliances, it will be important to evaluate the supply chain and its component transactions from the perspective of multiple regulatory regimes: the DPP and its offset policy, industrial licensing, FDI policy, the foreign trade policy and tax — corporate, indirect and transfer pricing.
In defence of optimisation | Business Line
