Indian Aerospace & Defence Budget 2016-17 analysis

Budget Connect 2016 2
Executive summary
Union Budget for the financial year 2016-17 has
been presented before the Parliament on 29
February 2016. The Budget is primarily based on
transformative agenda with nine distinct pillars.
Keeping in line with the current Government’s
commitments, the Budget hinges on three tenets
of introducing tax incentives to provide the much
needed fillip to domestic manufacturing and the
start-up industry; simplification and
rationalization of tax regime and an endeavour to
promote the non-adversarial tax regime.
Further, with the objective of incentivizing
domestic value addition towards Make in India
campaign, it has been proposed to make suitable
changes in customs and excise duty rates on
certain inputs, raw materials, intermediaries and
components and simplify procedures so as to
reduce cost and improve competitiveness of
domestic industry in defence production,
maintenance repair and overhauling (MRO) of
aircrafts and ship repair etc.
This alert captures the key changes proposed by
the Union Budget 2016 which impact the
aerospace and defence sector.
(1USD=INR62 for FY 2015-16)
(1USD=INR69 for FY 2016-17)

Defence Budget Proposals
► The Government’s allocation in USD terms
for the overall defence budget has reduced
by 9.28% as compared to the Budgetary
Estimate (BE) of 2015-16 and reduced by
0.36% as compared to the Revised Estimate
(RE) of 2015-16. For the first time ever, the
budgetary allocation for the defence sector
did not find a mention in the budget speech
either.
Brief on Capital Expenditure
► The budgetary allocation towards capital
expenditure, which caters mostly towards
fresh procurement programmes of military
hardware; both platforms as well as
infrastructure, as well as the development
and modernization effort of the DRDO and
the OFB’s has been kept at USD 12.51
billion. The capital allocation has decreased
significantly (17.98%) as compared to the
BE of 2015-16 and there has been a minor
reduction as compared to the RE of the
same period. This can be attributed to the
fact that in excess of USD 2 billion was un-
spent from last year’s BE.
► The decrease in Capital budget when
compared to the BE of the previous year is
most significant for the Navy; Air Force and
the DRDO.
► When we compare the Capital budget BE for
2016-17 with the RE for the previous year,
the Army and the Navy actually have more
or less remained flat whereas there is a
double digit decrease for the Air Force.
► The decline in the Air Force’s budget could
lead to delays for some of the programs that
are anticipated to be signed this year. These
include, the Rafale (Dassault Aviation),
Aerial Re-fueler (Airbus is L1); Repeat order
for AWACS from Israel and the Jaguar Re-
engine program (Honeywell). On the other
hand, the Army’s budget has managed to
remain constant and this could bode well for
the M777 (FMS- BAE); and the RSH (Ka-
226) programs.
Breakdown of capital expenditure
(USD billions)
39.79
36.23 36.10
2015-16 (Budget) 2015-16 (Revised) 2016-17 (Budget)
Total Defense Expenditure
(USD billion)
15.26
13.13 12.51
Capital expenditure
(USD billion)
0.00
1.00
2.00
3.00
4.00
5.00
6.00
2015-16
(Budget)
2015-16
(Revised)
2016-17
(Budget)
Army
Navy
Airforce
Defence
Ordnance
Factories
R&D
Other
% decrease from 2015-16 (Budget): 9.28%
% decrease from 2015-16 (Revised): 0.36%
% decrease from 2015-16 (Revised): 4.69%

Brief on Revenue Expenditure
► Revenue expenditure includes budget for
pay and allowances, rations, clothing,
stocking of spares, petrol, oil and lubricants,
maintenance works, etc. In the budget it has
shown a decrease of 3.87% when compared
to the BE and an increase of 2.10% when
compared to the RE of 2015-16.
► This increase when compared to the RE of
the previous year is due to the fact that
approximately USD 1.5 billion remained
unspent from the revenue budget.
► The Air Force has seen the largest (single
digit) fall in its Revenue budget when
compared to the BE of last year. The NAVY
has seen the largest (single digit) increase in
its Revenue budget when compared to the
RE of the previous year.
Breakdown of capital expenditure
(USD billions)
Notes & Explanations
► In INR terms there has been an increase of
1% over the BE of last year and the
increase is in excess of 10% over the RE of
the same period.
► The USD has appreciated from ~INR 62 to
~INR 69 during the last year. This increase
of ~11% is the main reason why the
defence budget is showing an overall
decrease. The figures for 2015-16 have
been calculated at INR 62 whereas the
figures for 2016-17 have been calculated
at INR 69.
► The MoD has made an accounting change
this year which complicates the analysis.
The previous demand for grants numbers
21 to 28 have been consolidated and stand
reduced to four - 20 to 23 in the FY16
budget.
► In order to maintain parity we have used
the previous break-up for this year’s
analysis as well. However starting next
year, we will be using the new head’s for
analysis.
24.54
23.10
23.59
Revenue expenditure
(USD billion)
0
2
4
6
8
10
12
14
16
18
2015-16
(Budget)
2015-16
(Revised)
2016-17
(Budget)
Army
Navy
Air Force
Defence
Ordnance
Factories
R&D
% increase from 2015-16 (Revised): 2.10%

Direct Tax Proposals
Tax Rates
► It has been proposed to reduce corporate
tax rate from 30% to 29% in case of
domestic company whose total turnover or
gross receipts in the financial year (FY)
2014-15 does not exceed INR 5 crore.
► Newly setup domestic companies (engaged
in manufacturing business) have been given
option to be taxed at the rate of 25%
(applicable for FY 2016-17 onwards). The
key conditions for availing above are as
under:
- Company has been registered on or
after 01 March 2016;
- Company does not claim any specified
deduction such as Accelerated /
Additional Depreciation, Investment
Allowance, Expenditure on Scientific
Research, Deduction under Section
10AA or under Part C of Chapter VI-A;
- The intention of claiming such option is
furnished to tax authorities in
prescribed manner before due date of
furnishing return of income.
► No change in corporate tax rate is proposed
for existing tax-payers who are not covered
by the above provisions.
► Minimum Alternate Tax (‘MAT’), Surcharge
and Education cess to continue at existing
rates for all corporate tax payers.
Phasing out of deductions and exemptions
► In line with the stated objective of reducing
the tax rates together with reducing the
exemptions available, the phase out plan
has been proposed for certain profit linked/
weighted deductions, such as:
a. Section 35(2AB) – Weighted deduction
of 200% available for in-house scientific
R&D – Limited to 150% from FY 2017-
18 to FY 2019-20 and 100% thereafter.
Restrictions also imposed on other
deductions available for expenditure on
scientific research from FY 2016-17
onwards.
b. Section 35AC – Expenditure on certain
eligible social development projects and
schemes – Limited to 100% from FY
2016-17.
c. Section 35CCD – Expenditure on skill
development project – Limited to 100%
from FY 2020-21.
d. Section 10AA – Special provisions in
respect of newly established SEZ – No
deduction when activities commence
from FY 2020-21 or later.
e. Accelerated depreciation would be
reduced to 40% of assets from FY
2017-18 onwards.
Taxation of income from Patents
► In order to encourage indigenous research &
development activities and to make India a
global R & D hub, the Government has
proposed concessional taxation regime for
royalty income from patents.
► It has been proposed that any income by
way of royalty in respect of a patent
developed and registered in India, shall be
taxable @ 10% (plus applicable surcharge
and cess) on gross basis.
► For the purpose of availing benefit, an
assessee should be a person resident in
India and should be true and first inventor of
the invention, whose name is entered on the
patent register as the patentee in
accordance with Indian Patent Act.
► The proposal will be effective from FY 2016-
17.
Tax incentives for start-ups
► Deduction of 100% of profits and gains for
eligible start-ups has been proposed for a
period of 3 consecutive years.
a) The consecutive 3 year period may be
chosen out of a 5 year block beginning
with the year of incorporation.
b) Benefit of the tax holiday would not be
available where the start-up is formed

by reorganization of an existing
business.
c) The benefit would be available to start-
ups set up between 1 April 2016 and 31
March 2019.
d) The following additional conditions
would need to be met by the start-up.
► The business of the start-up
involves innovation, development,
deployment or commercialization of
new products, processes or services
driven by technology or intellectual
property and is certified as such by
the Inter-Ministerial Board of
Certification, as notified by the
Government.
► Annual turnover does not exceed
INR 250 million in any of the
financial years between 2016-17
and 2020-21.
17.
Rationalisation of scope of investment
allowance under section 32AC
► The existing provision of section 32AC of
the Act provides for investment allowance
for a company engaged in manufacturing or
production of any article or thing subject to
the condition that the acquisition and
installation has to be done in the same
financial year.
► The dual condition of acquisition and
installation causes genuine hardship in
cases in which assets having been acquired
could not be installed in same financial year.
► It is proposed to amend the sub-section (1A)
of section 32AC to extend the benefit of the
said section in a case where acquisition of
the plant & machinery (of the specified
value) has been made in preceding year,
however, installation is done on or before
31.03.2017. Also, it is provided that in such
a case deduction under this sub-section shall
be allowed in the year of installation.
► These amendments will take effect
retrospectively from 01 April 2016 and will,
accordingly, apply in relation to the FY
2015-16 and 2016-17.
Tax incentive for employment generation
► The existing provision of Section 80JJAA is
now extended to all tax payers to whom the
provision of section 44AB (i.e. tax audit)
applies.
► It is proposed to relax the norms for
minimum number of days of employment in
a financial year from 300 days to 240 days
and the condition of 10% increase in number
of employees every year has been done
away.
► It is further proposed to provide that the
deduction under the said provisions shall be
available in respect of cost incurred on any
employee whose total emoluments are less
than or equal to INR 25,000 per month. No
deduction, however, shall be allowed in
respect of cost incurred on those
employees, for whom the entire
contribution under Employees' Pension
Scheme notified in accordance with
Employees' Provident Fund and
Miscellaneous Provisions Act, 1952, is paid
by the Government or who does not
participate in recognised provident funds.
Exemptions from requirement of furnishing
PAN to certain non-resident
► It is proposed to amend the said section
206AA so as to provide that the provisions
of this section shall also not apply to a non-
resident, not being a company, or to a
foreign company, in respect of any other
payment, other than interest on bonds,
subject to such conditions as may be
prescribed.
► This amendment will take effect from 01
June 2016.
Clarification regarding the definition of the
term 'unlisted securities'
► It has been proposed to amend the
provisions of clause (c) of sub-section (1) of
section 112 of the Income- tax Act, so as to
provide that long-term capital gains arising
from the transfer of a capital asset being
shares of a company not being a company in

which the public are substantially interested
(i.e. Private Company), shall be chargeable
to tax at the rate of 10%.
17.
Transfer pricing proposal – country by
country reporting
► On 5 October 2015 the Organisation of
Economic Cooperation and Development
(OECD) released its Final Report on Action
13 (Transfer Pricing Documentation and
Country-by-Country Reporting) of the
Action Plan on Base Erosion of Profit
Shifting (BEPS).
► In order to meet India’s commitment to
BEPS initiative of OECD, the Government
has proposed requirement of filing country-
by-country reporting (CbCR).
► The CbCR requires multinational enterprises
(MNEs) to report annually and for each tax
jurisdiction in which they do business
- report the amount of revenue, profit
before income tax and income tax paid
and accrued.
- report their total employment, capital,
accumulated earnings and tangible
assets in each tax jurisdiction.
- identify each entity within the group
doing business in a particular tax
jurisdiction and to provide an indication
of the business activities each entity is
engaged.
► Reporting provision shall apply to an
international group having an Indian parent
with consolidated revenue greater than
€750m (currently, approximately INR 53.95
billion).
► Indian constituent entities that are a part of
foreign group/ parent would generally be
only required to intimate to the Indian tax
authorities about country of residence of
foreign parent. However, such constituent
entities would also be required to file CbCR
in India if foreign parent company is
resident of countries with which India does
not have arrangement for exchange of CbCR
or India does not receive information even
though arrangement exists.
► The reporting requirement shall be effective
from FY 2016-17 and non-furnishing of the
report would attract penal consequences.
Other Proposals
► Apart from above, there are certain other
proposals made vide Finance Bill 2016
mainly to reduce litigation, promote
investor friendly environment, ensure
automation etc. Such proposals are
mentioned below:
- General Anti Avoidance Rules
implementation date continues to be 01
April 2017.
- Tax residency test for foreign
companies based on Place of Effective
Management (POEM) which was
introduced from FY 2015-16 deferred
by 1 year to FY 2016-17.
- In order to reduce pending litigation
cases, dispute resolution scheme is
introduced wherein taxpayer whose
appeal is pending with first appellate
authority (pursuant to appeal against
assessment order or a penalty order)
will be liable to pay tax arrears (i.e. tax,
interest and penalty) and the appeal will
stand withdrawn. Immunity from
prosecution and further penalty to be
granted. Certain other conditions also to
be satisfied.
- Similar scheme applicable for appeals
pending with appellate authorities up to
Supreme Court arising from
retrospective amendments also
introduced.
- New penalty regime being introduced
wherein the penalty will be levied on
underreported and misreported income.
Rate of penalty to be 50% of tax payable
on underreported income and 200% of
tax payable on misreported income.
- Introduction of additional conditions for
tax neutrality on conversion of a
company into Limited Liability
Partnership.

- Providing legal framework for
automation of various processes and
paperless assessment.
- Change in timelines related to filing of
belated return and completion of
assessment.
- No right for revenue authorities to
appeal against DRP direction.
- Withholding tax provisions amended -
threshold and rate revised.
- Introduction of Income Declaration
Scheme, 2016 for tax defaulter.
Indirect Tax Proposals
Excise duty
► Median excise duty retained at 12.50%.
► Exemption from Excise duty provided on
tools and tools kits procured for
maintenance, repair of aircraft subject to
certifications by DGCA.
► Excise duty on Aviation turbine fuel other
than for supply to scheduled commuter
airlines from the regional connectivity
schemes airports increased from 8% to 14%.
► Interest rate on delayed payment of duty
reduced from 18% to 15%.
► Period of limitation increased from 1 year to
2 years in cases not involving fraud,
suppression of facts, willful misstatement
etc.
► Provision to file revised returns by the end
of the calendar month in which the return is
filed is introduced; to be applicable from the
date to be notified.
► Indirect tax Dispute Resolution Scheme
introduced for disputes pending before
Commissioner (Appeals).
Service tax
► Introduction of Krishi Kalyan Cess, proposed
to be levied on all or any taxable services at
the rate of 0.5%; the said Cess would be
applicable with effect from 1 June 2016 and
would be creditable against output liability
of Krishi Kalyan Cess.
► Services provided by foreign shipping lines
to business entities made liable to Service
Tax on a reverse charge basis; applicable
from 1 March 2016.
► Restoration of exemption to construction,
erection etc. of airport upto March 2020,
where the contract contracts were entered
prior to 1 March 2015.
► Annual returns under Service Tax required
to be filed by 30th November of the
succeeding year.
► Normal period of limitation for issuance of
the show cause notice increased from 18
months to 30 months.
► Rationalization of interest rates from 18% -
30% to 15% in general cases and 24% in case
of collection and non-payment of tax into
the government exchequer.
► The power to arrest has been proposed to
be restricted only to the cases where tax
has been collected but has not been
deposited and amount of such tax exceeds
INR 2 Crore.
Customs duty
► Median rate of BCD retained and effective
peak rate of customs duty retained at 10%
and 29.44% respectively.
► BCD/ CVD exemption withdrawn for certain
defence machinery and equipment required
for construction of or fitment to ships of
Indian Navy or Coast Guard.
► BCD/ CVD exemption withdrawn on import
of aircrafts, aircraft parts, aircraft engines
arms, ammunitions, radars, torpedoes,
spares and other related products.

► BCD on tools and tools kit for maintenance,
repair and overhauling of aircraft exempted.
Procedure for availment of exemption
simplified and restriction of 1 year for
utilisation of duty free parts done away
with.
► Specified aircrafts imported for
maintenance, repair and overhaul exempt
from BCD, CVD, subject to conditions.
► The existing condition of stay of foreign
aircraft, for maintenance repair and
overhaul, upto 60 days is being relaxed and
extended to 6 months (which can be further
extended DGCA as deemed fit).
► Import of air craft parts (which are not new
parts) for repair and overhaul is now
permitted under the Standard Exchange
Scheme.
► The existing Customs (Import of Goods at
Concessional Rate of Duty for Manufacture
of Excisable Goods) Rules, 1996 are being
substituted with the Customs (Import of
Goods at Concessional Rate of Duty for
Manufacture of Excisable Goods) Rules,
2016 with a view to simplify the rules,
including allowing duty exemptions to
importer/ manufacturer based on self-
declaration instead of obtaining permissions
from the Central Excise authorities. Need
for additional registration is also being done
away with.
► Interest rate on delayed payment of
Customs duty under Section 28AA has been
reduced to 15% from the current 18%.
► Normal period of limitation for issuance of
the show cause notice increased from 1
year to 2 years.
CENVAT Credit
► Time limit of filing refund claim under Rule 5
of the CENVAT Credit Rules, 2004 in case of
export of services to be 1 year from the
date of:
- Receipt of payment in convertible
foreign exchange where provision of
service has been completed prior to
receipt of payment; or
- Date of issue of invoice where payment
for service has been received in advance
prior to date of issuance of the invoice.
► Rationalization of provisions relating to
availability of CENVAT credit under CENVAT
Credit Rules, 2004 in case of a service
provider engaged in providing taxable as
well as exempt services.
► Manufacturer of final products allowed to
take CENVAT credit on tools sent to a job
worker.
► Permission given to a manufacturer for
sending inputs/ partially processed inputs to
a job-worker and clearance of final products
therefrom extended from 1 financial year to
3 financial years.

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Indian Aerospace & Defence Budget 2016-17 analysis

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