Vikas Srivastava and Sanjeev Sachdeva
The aviation and aircraft maintenance industry encapsulates the overall operation, management and upkeep of aircraft. Globally, there has been a gradual shift in the industry, with airlines acquiringand leasingaircraft, and outsource Maintenance, Repair and Overhaul (MRO) services to third-parties. In India, due to liberalisation policies of the Government over the last two decades, tremendous growth has been observed in the civil aviation sector. Many private airlines and corporations in India today are operating with high operating revenues. Given this, the sheer numbers and players involved result in magnification of the impact of even small changes in tax laws, which can change at a rate of more than once year!
The Impact Of The Indirect Tax Regime On Civil Aviation
The indirect tax regime in India is characterised by multiple levies, which are administered by governmental agencies at three levels (central, state and local). Principal indirect taxes include service tax on provision of services, customs duty on import of goods, excise duty on manufacture of goods, and Value Added Tax (VAT)/Central Sales Tax (CST) on sale of goods. Service tax, customs duty and excise duty are administered by the Central Government, while VAT and CST are administered by the State Governments. A Research & Development(R&D)cess (tax) is levied on import of technology under foreign collaboration agreements.
The aviation industry encompasses a whole gamut of activities carried out by airlines, airports and agents. The main activities carried out by airlines in India—whichinclude passenger and goods transportation by air, ground handling services, repair and maintenance services—areprimarily subject to service tax.
The aviation sector in India comprises two broad segments, namely, civil aviation and defence. Customs duty exemptions are available for goods imported in relation to defence, subject to certain conditions. As regards civil aviation, indirect tax incentives are available for R&D, and for entities located in Special Economic Zones (SEZ). (There are currently over 140 SEZs in India with another 630 approved for future development.) The tax incentives for SEZ units have the potential to make India a preferred destination for outsourcing manufacturing and services, particularly since there is no attendant export obligation. The only obligation is to achieve a positive net foreign exchange inflow over a cumulative period of five years. Thus, there is great potential for development of aerospace and MRO units in SEZs.
Prior to July 2012, the service tax regime in India was based on a “positive list” of specified services, which attracted service tax. Since July 2012, the service tax regime has been based on a “negative list,” under which all services attract service tax, other than those which are specified in a “negative list” and those which are specifically exempted from the levy. With respect to services provided by a service provider located outside India, the service recipient in India is liable to pay service tax to the government, under the “reverse charge” mechanism.
Thus, all services provided by airlines for a consideration are now subject to service tax in India, except services covered under the negative list or exempted under an exemption notification. Goods transportation services provided by air from outside India are covered in the negative list of services, and are hence not liable to service tax. In the case of passenger air transportation services (domestic and international routes), service tax is presently applicable at the rate of 12.36 percent of the consideration. An abatement of 60 percent is provided for, subject to the condition that no input tax credit is taken on inputs and capital goods.
Tax Issues Relating To Aviation Turbine Fuel
One major problem is in terms of input tax credits, since cross-utilization of credits between service tax and VAT is not permitted. As a result, VAT on goods procured by the airline industry is a cost which is often a dead loss, since it cannot be offset against service tax payable by the airlines on their output services. Another long-standing complaint of the aviation sector is the non-admissibility of input tax credit (Central VAT [CENVAT] credit) on Aviation Turbine Fuel (ATF).
Airlines in India incur high costson domestic procurement of ATF(40-to-50 percent of operating costs, by some estimates). The cost of ATF for domestic operators is 60-to-70 percent higher than international benchmarks. ATF is subject to multiple taxes, including customs duties (basic duty, as well as additional duty equivalent to excise duty leviable on domestic manufacture) and VAT, and other levies such as throughput fees charged by airport operators and marketing margins charged by oil marketing companies (OMCs) which are typically owned by the Central Government. The rate of VAT levied on ATF for domestic air carriers is quite high, averaging 23 percent across States according to the Federation of Indian Airlines. The high rate of VAT levied by most States on ATF results in escalating the overall procurement costs of airlines, the burden of which has to be passed on to passengers. An added complication is the fact that VAT rates on ATF vary between States, ranging from 20 percent to as high as 30 percent on the one hand, and from 5 to 12 percent on the other hand. As a fall-out of varying VAT rates, airplanes often have to carry extra fuel, which results in additional costs by way of increased fuel consumption.
The aviation industry has been trying for many years to persuade the government to grant the status of “declared goods” to ATF, which would ensure a uniform VAT rate of 4 percent across the country. Some States have recently reduced the rate of VAT on ATF, as an incentive to bring down the burden of VAT on airlines and to encourage them to frequently fly to that State for refuelling, thereby increasing air connectivity. Earlier, only certain OMCs were allowed to import ATF. The Central Government has recently allowed Indian carriers to directly import ATF as actual users, which would enable them to avoid the burden of VAT on the domestic sale of ATF by OMCs to the carriers. However, to take advantage of this benefit carrierswill need to incur investment and operational costs in terms of storage and logistics infrastructure. To reduce the burden of taxes on ATF, the Central Government has also reduced the effective customs duty chargeable on import of ATF.
Taxability Of MRO Services
The surge in demand for aviation services in recent years has also fuelled demand for support services, including ground-handling, and MRO services. These services play a critical role in contributing to the efficiency standards of the sector. The Government has recognised the potential for India to establish itself as a hub for MRO services, which would reduce operating costs for domestic carriers and enable other carriers in the vicinity to fly to India for MRO of aircrafts. India has certain advantages for establishment of MRO services, in terms of expertise in design and development, and availability of a low-cost pool of trained engineers and technical personnel. To incentivise MRO operations in India, customs duty exemption has been provided on import of aircraft parts and testing equipment for maintenance, repair and overhauling of aircraft used for operating scheduled and non-scheduled passenger air transport services, scheduled air cargo services, and charter services. However, the customs duty exemption is not available on parts and testing equipment imported for use on aircraft which do not operate in India i.e. “non-India operators.” Further, the exemption is not available for import of consumables such as lubricants, oils, grease and similar goods.
The competiveness of the MRO sector in India is adversely impacted by service tax, which is levied on the provision of services. The Indian aviation sector contends that neighbouring countries (including Middle Eastern and South East Asian countries and Sri Lanka) do not levy service tax on similar services. Another complaint is the lack of clarity regarding “export of services,”as MRO services provided to overseas carriers are not considered by the tax authorities as “exported” from India given that these are performed in India.
Goods And Services Tax
In many countries, international passenger travel is exempt from levy of Goods and Services Tax (GST) / VAT, while domestic travel is taxed. However, in India service tax is levied on international as well as domestic routes, thereby making airlines a highly taxed means of transportation. The aviation sector has been petitioningfor reduction of indirect tax rates, rationalisation of the indirect tax structure, relief in the service tax burden, and the smooth flow of input tax credits across all indirect taxes, to catalyse growth of the aviation sector. Industry bodies often point out that the indirect tax structure acts as a disincentive for final assembly in India.
The proposed introduction of GST in India presents a great opportunity to undo the inequitable and onerous burden on taxation on the airline industry. Under the GST regime, it is proposed that there will be a single levy on goods and services, consisting of a Central and a State component. It is hoped that appropriate provisions are made for allowing GST paid on goods to be set-off against GST applicable on provision of services, and vice versa. The cross-utilization of credits across the principal indirect taxes will present an opportunity to airlines to mitigate the effects of cascading of taxes. If the government chooses to follow international GST practices, international passenger transportation would be zero-rated. This would mean zero-rating of any passenger transportation service that begins or ends at a point outside India, including round-trip international transportation services. Such a move would directly benefit passengers and the airline industry, and will generate indirect benefits for the economy.
Direct Tax Regime
Unlike indirect taxes, income-taxes are levied based on the residential status of the taxpayer. Companies resident in India, whether owned by Indians or by non-residents, are taxed on their worldwide income.Non-resident companies, on the other hand, are taxed only on the Indian-sourced income. A company is deemed to be resident in India if it is incorporated in India or if its control and management is wholly situated in India.
If there is a double taxation avoidance agreement (tax treaty) between India and the country of residence of the taxpayer, the provisions of the domestic tax law or the tax treaty, whichever is more beneficial will apply. In order to be eligible for tax treaty benefits, the non-resident taxpayer will be required to obtain a valid tax residency certificate (TRC) with prescribed particulars issued by the Revenue authorities of the country of residence of the non-resident taxpayer.
While resident companies are subject to a basic corporate tax rate of 30 percent, non-resident companies are subject to a basic corporate tax rate of 40 percent. In addition, a surcharge and education cess applies to the basic corporate tax rate taking the effective corporate tax rate to 43.26 percent for foreign companies and 33.99 percent for Indian companies.
India is in the process of implementing anti-avoidance measures called General Anti-Avoidance Rules (GAAR). GAAR provisions were earlier introduced in the domestic tax law in 2012 to deal with aggressive tax planning and to codify the doctrine of “substance over form;”however, its implementation date was postponed absent sufficient clarity and these are now made effective from April 1, 2015.
India is also in the process of revamping the existing tax legislation with a more reformed Direct Tax Code. However, there is no clarity as yet on the date of its enactment.
Foreign Airlines Operating In India
Non-resident entities engaged in the business of operation of aircraft in India are taxed on a presumptive basis. A specified tax rate of 5 percent is applied to (a) amounts received by non-residents (whether in India or outside) for the carriage of passengers, livestock, mail or goods from any place in India; and (b) amounts received in India by non-residents for carriage of passengers, livestock, mail or goods from any place outside India.
Most tax treaties provide that profits derived by an entity from the operation of aircraft in international traffic are taxable only in the country in which the place of effective management of the enterprise is situated. Given this and based on the provisions contained in the applicable tax treaty, profits derived by foreign airline companies from operating aircraft in India would not be taxable in India, provided the effective place of management of such airlines is located outside India. Depending upon the facts and the circumstances of each case, foreign airline companies may approach the Indian Revenue authorities to seek a specific dispensation to claim this exemption. Such dispensation may also be utilized by the foreign airline companies for receiving payments without a withholding tax.
In the current tough times for the Indian airline industry, with increasing fuel costs, buying an aircraft may not necessarily be a preferable option considering the huge cash outlays, delivery time involved and rapid technological improvements. Leasing an aircraft therefore has emerged as a viable solution as it helps increase the fleet size to fulfill growing demand and is less capital intensive.
Generally, there are two types of aircraft lease: (a) Dry Lease, and (b) Wet Lease. A Dry Lease entails a plain vanilla aircraft lease, without any additional service components; whereas a Wet Lease means leasing the aircraft along with insurance, crew, maintenance, etc.The Dry Lease appears to be the preferred lease method in India.
Tax considerations vary depending upon the type of lease.The majority of lease contracts with foreign airlines are “net of tax” arrangements, which means that withholding tax (if any) on lease payments is to be borne by the Indian company taking the aircraft on lease. Given this, the tax consideration and the attached costs assume significant importance.
The domestic tax law used to provide tax exemption to foreign companies on lease payments made by Indian companies. The exemption applied to agreements entered into on or before March 31, 2007, subject to obtaining approval of the Central Government.Payments under any lease agreement entered into after March 31, 2007, are not eligible for such exemption under the domestic tax law.Absent tax exemption, payment of such lease rental by an Indian company to foreign company may qualify as “royalty”as payment for use of or the right to use any industrial, commercial or scientific equipment. Such royalty income is taxable at the current tax rate of 27.0375 percent (inclusive of applicable surcharge and education cess) on a gross basis; this higher rate is made effective from April 1, 2013. In a situation where the lease agreement provides that the tax is to be borne by the Indian company, this could significantly increase the cost for the Indian company leasing the aircraft. The tax rate could however be lowered depending upon the rate prescribed in the relevant tax treaty (if any) where the foreign company is resident.
Where the relevant tax treaty does not contain a clause dealing with “royalty” income or does not cover lease of aircraft within the scope of royalty income,taxability would need to be examined based on whether such income could qualify as “Business Income” or “other income” under the respective tax treaty.
Typically, Business Income of a foreign entity can be taxed in India, if the foreign company is construed to have a Permanent Establishment (PE) in India.
The existence of a PE of the foreign lessor in India would largely depend on the nature of activities carried out by such foreign companies in India. Typically in a Dry Lease scenario, where the lessee in India will remain responsible for all aspects of operation, maintenance, insurance and inspection of the aircrafts, mere leasing of the aircraft should not create any PE exposure to the foreign lessor companies. This issue has been tested in the Indian courts, where the Tax Tribunal and Courts have held that the mere presence of equipment (aircraft) in India should not create PE of the foreign company in India.However, certain tax treaties that India has entered into even provide that the presence of substantial equipment itself can be translated into a PE of the foreign lessor in India.
On the other hand, in a Wet Lease scenario, where along with aircraft, the foreign lessor also takes responsibility of insurance, crew, maintenance, etc., there may be a potential PE exposure in India for the foreign lessor company, in which case income would be taxed as Business Income, taxable at the rate of 43.26 percent on a net basis.
While the decision to lease an aircraft is purely commercial, the attached tax cost needs to be considered when leasingfrom a foreign jurisdiction. An unplanned transaction can result in increased tax cost.
Maintenance, Repair and OperationsServices
Costs incurred by airline companies for MRO services being rendered by MRO operators in India, either by stand-alone foreign companies or even joint ventures (JVs) involving big foreign companies, also forms a significant chunk of the overall cost base. Any withholding tax on payment for such MRO services not only increases the burden of compliance but could potentially create cash flow constraints for the operators working on thin margins against stiff competition.
It is currently debatable whether the payment for MRO services qualifies as “Fees for Technical Services” (FTS) subject to a withholding tax. Characterization of such payment would significantly depend on the nature of the services and the definition contained in the applicable tax treaty where the MRO operator is a foreign company.
Indian courtshave generally treated payment for basic services as not qualifying as FTS, while payment for special technical services forming part of MRO services do qualify for FTS, and hence are subject to withholding tax obligations.
Landing And Parking Charges
Also unsettled is the questions of whether whethercharges paid by foreign airlines on landing and parking charges to the Airport Authorities of India represent “rent” payments subject to a withholding tax. The present rate for Indian tax residents is 10 percent.
The Airports Authority provides various facilities to aircraft for a fee. The services provided typically include charges for landing and take-off facilities, taxiways with necessary draining and fencing of airport, parking route, navigation and terminal navigation. These charges are based on a weight formula and maximum permissible take-off weight and length of the stay of the aircraft.
The airlines contend that such payments,being contractual payments, should, at best, be subject to a withholding tax at the rate of 2 percent.The Indian Revenue authorities, however, have taken the view that such payment are not mere contractual payments but “rent” and should be subject to a withholding tax at the rate of 10 percent.
There are contradictory rulings on this point from different courts—the Madras High Court, in an action brought by Singapore Airlines, has ruled landing and parking fees to be a contractual payment, while the Delhi High Court, in a case brought by United Airlines has held it to be rent. The issue should attain finality in a much followed case brought by Japan Airlines pending before the Supreme Court of India.
The domestic tax law prescribes that any payment to non-residents, which is chargeable to tax in India, should be subject to a withholding tax at appropriate rates. Certain prescribed payments to residents, are also required to be subject to a withholding tax.Payment streams between foreign and Indian companies, such as for lease of aircraft, MRO services, ground handling charges, etc, need to be thoroughly examined to determine appropriate withholding tax.
The withholding tax obligationsunder the domestic law of India is quite onerous, and failure to withhold appropriate taxattracts various penal consequences, such as disallowance of expenses, penal interest at the prescribed rate payable until the taxes are ultimately deposited, and penalty equivalent to the amount of tax required to be withheld. Considering this, the payor typically adopts a conservative approach and applies withholding tax, unless the tax position is very clear that the underlying payment is not chargeable to tax.
The Need For Clarity
Aviation and aircraft maintenance is a burgeoning industry in India, and holds great promise for growth. The most prominent example in this regard is the MRO sector, which the Indian Government has been attempting to incentivize. However, the airline industry continues to be saddled with many issues, particularly from a tax perspective, which are inhibiting its development and adversely impacting its competitiveness.
Greater clarity and certainty surrounding tax issues and relief from multiple levies of taxes will provide adequate impetus to the aviation industry to realize its true potential.
Vikas Srivastava is a Senior Partner at Luthra&Luthra Law Offices. He heads the Direct Tax Practice of the Firm, and has over 29 years of experience inCorporate Taxation, both domestic as well as international tax. He specializes in international taxation and transfer pricing. Vikas has represented several large multinationals and corporates before the tax authorities and courts for complex corporate tax and transfer pricing matters.He has advised several multinationals on their cross border group structuring and entry/exit strategies. He has particular expertise in the impact of tax treaties, inbound & outbound investments, transfer pricing regulations, corporate and expatriate taxation. Clients have been from diverse fields including auto components, aviation, banking, consumer goods, construction, defence, food, hospitality, information technology, infrastructure, insurance, luxury goods, media, oil and gas, pharmaceuticals, power, private equity, real estate, retail, steel, telecom and travel. He also has significant experience and expertise in the various facets of conceptualization, structuring, constitution and formulation of entry and exit strategies for private equity funds and venture capital funds. Vikas can be reached at firstname.lastname@example.org.
Sanjeev Sachdeva is a Partner at Luthra&Luthra Law Offices. He specializes in Indirect Taxes, Foreign Trade Laws and the Foreign Exchange Management Act and has over 30 years of relevant experience. He has been a member of the Indian Revenue Service, and was conferred with the Presidential Award of Appreciation Certificate for “Specially Distinguished Record of Service” on the occasion of Republic Day, 1999. Sanjeev has extensive experience in advising clients across industry sectors ranging from hospitality and hospitals to airlines, infra-structure, oil & gas, retail and BPO. He also regularly appears before departmental adjudicating authorities, the Customs, Excise and Service Tax Appellate Tribunal (CESTAT), FEMA authorities, Settlement Commission and the Authority on Advance Rulings. Sanjeev can be reached at email@example.com