Ernst & Young India's in-depth analysis of the Defence budget announced on 28th February, 2015.

1. Budget Connect 2015+
EY Tax Alert
Impact of budget on Aerospace and Defence Sector

2. Budget Connect+ 2015 2
Executive Summary
► Union Budget for the financial year
2015-16 has been presented before the
Parliament on 28 February 2015. This
was the first full budget of the Narendra
Modi led government. The Budget
primarily based on the theme of ‘Make
in India and ease of doing business was
presented by the Hon’ble’ Finance
Minister (‘FM’).
► With a view to meet industry
expectations, the FM unveiled a
pragmatic Budget with key focus on
providing impetus to manufacturing
sector and devising an investor friendly
economic climate in the country. To that
extent, the Budget has been able to
meet broad expectations of the
economy.
► The Government has increased
allocation for defence expenditure to
US$ 41.12 billion as compared to last
year’s figure of US$ 38.17 billion, an
increase of 7.74%. The Finance Minister
mentioned in his speech that it is the
intent of the government to promote
transparency, and Make in India in
defence manufacturing.
► While no specific incentives have been
granted to Defence & Aerospace
industry, however proposals introduced
in pursuance of the ‘Make in India’
dream will have a positive impact on the
Aerospace and Defence sector and may
provide it some boost.
► On balance, the Budget looks to
establish a modern tax system which
would provide impetus to growth,
investments and creation of jobs. The
industry only wished that the FM would
have included specific proposals
focused on revival of the Aerospace and
Defence sector.
► This alert captures the key changes
proposed by the Union Budget 2015
which has a potential impact on the
Aerospace and Defence sector.
Capital Expenditure
► The budgetary allocation towards
capital expenditure, which caters mostly
towards fresh procurement
programmes of military hardware and
platforms, has been kept at US$15.76
billion. The capital allocation has not
increased as compared to the budgetary
estimate of the last fiscal year 2014-15.
However, when compared with the
revised estimate of 2014-15, there has
been an increase of 15.4%. This is
because about INR 122,000 million
(US$ 2 billion) out of the capital
expenditure was taken back (a portion
was transferred to the revenue
account). We have witnessed a similar
trend in the previous years as well.
► The increase in capital budget from the
revised budget for 2014-15 is
accounted for by increase in budget
38.17
37.05
41.12
2014-15 (Budget) 2014-15 (Revised) 2015-16 (Budget)
Total Defense Expenditure
(US$ billion)
15.76
13.66
15.76
2014-15 (Budget) 2014-15 (Revised) 2015-16 (Budget)
Capital expenditure (US$ billion)
% increase from 2014-15 (Budget): 7.74%
% increase from 2014-15 (Revised): 10.98%
% increase from 2014-15 (Budget): 0.00%
% increase from 2014-15 (Revised): 15.40%

3. Budget Connect+ 2015 3
allocation for the Army and the Navy.
There has been an increase under the
allocation for ‘Make’ procedures from
INR 5 million in the revised estimate to
INR 1,442.1 million. This change is
critical as the government will have to
cater for payments for two key Make
programs - TCS and the BMS within this
fiscal year.
► The share of Air Force has remained
constant compared with the revised
defence budget.
Breakdown of capital expenditure
(In US$ billions)
► A major portion of this allocation is
committed towards contracts such as
for C-17, C-130J, Basic Trainer, LCA,
SU-30MKi signed in previous years. The
Air Force has a long list of acquisitions
to undertake this year and with the
limited ability to deploy additional
funds, the Air Force will have to
prioritize its acquisitions which include
procurement of attack and transport
helicopters from Boeing, Re engine
program of Jaguar aircraft with
Honeywell, MMRCA with Dassault
(Rafale), AEWACS from Israel and Aerial
Refuelers Tankers from Airbus Military
among others. The MoD will have to
make a down-payment of up to 15% of
the contract value on signing of the
programs.
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 growth of
13.19% from the estimated budget and
that of 8.39% from the revised budget
of 2013-14. This increase may be
attributed mainly to the increase in pay
and allowances of soldiers.
► Last year the revenue expenditure
overshot its allocation and this shortfall
was made good by transferring money
from the Capital Budget account to the
revenue account.
0.00
1.00
2.00
3.00
4.00
5.00
6.00
2014-15
(Budget)
2014-15
(Revised)
2015-16
(Budget)
Army
Navy
Airforce
Defence
Ordnance
Factories
R&D
Other
22.40
23.39
25.36
2014-15 (Budget) 2014-15 (Revised) 2015-16 (Budget)
Revenue expenditure (US$ billion)
0
5
10
15
20
2014-15 (Budget) 2014-15 (Revised) 2015-16 (Budget)
Army
Navy
Air Force
Defence
Ordnance
Factories
R&D
% increase from 2014-15 (Budget): 13.19%
% increase from 2014-15 (Revised): 8.39%
Breakup of revenue expenditure
(In US$ billions)

4. Budget Connect+ 2015 4
Key Direct Tax Proposals
Most direct tax proposals in the Finance Bill
are effective from the assessment year
commencing from 1 April 2016, unless
otherwise specified.
A. Income Tax Rates
► Corporate tax rates are proposed to be
reduced from 30% to 25% over the next
four years. Simultaneously, there is a
proposal to eliminate exemptions
available to corporate tax payers in a
phased manner.
► Surcharge in case of a domestic company
has been increased to 7% where income
is between INR 10 million to INR 100
million; surcharge has been increased to
12% where income of domestic company
exceeds INR 100 million.
► Surcharge on dividend distribution tax
(‘DDT’) and Buy-back tax proposed to be
increased from 10% to 12%.
Particulars Tax rate
Where income of the
company is equal to or
less than INR 10 million
30.9%
Where income of the
company is
greater than INR 10
million but less than INR
100 million
33.063%
Where income of the
company is
greater than INR 100
million
34.608%
Dividend Distribution Tax 20.35%
Buy-back tax 23.072%
► No change in tax rates, surcharge or cess
for foreign companies.
B. Wealth Tax
► It is proposed to abolish the Wealth-tax
Act,
1957; in lieu of this it is proposed to
increase the surcharge by 2% in case of
domestic taxpayers earning income in
excess of INR 10 million.
C. Reduction of rate of tax for ‘Royalty’
and ‘Fee for Technical services’
► Presently, the rate of tax on income
earned by non-residents by way of
Royalty or Fees for Technical Services
(received through an Indian concern or
Government of India) which is not
effectively connected with a Permanent
Establishment in India is 25% (excluding
applicable surcharge and education
cess). This higher rate of tax on royalty/
Fees for Technical Services to be
reduced to 10% (excluding applicable
surcharge and education cess). This will
however, not impact the tax rate
applicable under the relevant tax treaty.
This amendment will take effect from
1st April 2016.
D. Area based incentives for the
manufacturing sector
► Additional investment allowance of 15%
and additional depreciation of 35% (from
existing 20%) of cost of new assets
(other than a ship and aircraft) is now
available for tax payers setting up of
industrial undertakings in the notified
backward areas in the States of Andhra
Pradesh and the State of Telangana
subject to satisfaction of prescribed
conditions:
a. The tax payer sets up an undertaking
or enterprise for manufacture or
production of any article or thing on
or after 1st April 2015 in any
notified backward areas in the State

5. Budget Connect+ 2015 5
of Andhra Pradesh and the State of
Telangana; and
b. The new assets are acquired and
installed for the purposes of the said
undertaking or enterprise during the
period beginning from the 1st April
2015 to 31st March 2020.
► Additional investment allowance is over
and above the existing investment
allowance available to taxpayers under
section 32AC of the Income Tax Law
(ITL).
E. Deduction in respect of employment of
new workmen
► 30% additional deduction is allowed for
wages paid to new workmen engaged in
manufacture of goods in a factory for a
period of 3 years.
► The deduction has been proposed to be
extended to non-corporate
manufacturing taxpayers.
► Further, the threshold for availing this
benefit has been reduced to 50 new
regular work men from 100 as per the
present provisions of the ITL.
F. Allowance of balance 50% additional
depreciation
► The current provisions of the ITL
restricted allowance of additional
depreciation on new plant and machinery
to 50% (of additional depreciation
allowance) in the year of acquisition, if
the newly acquired assets were put to
use for a period of less than 180 days in
a financial year.
► It has been proposed in the current
budget that the remaining 50% of the
additional depreciation shall be allowed
in the immediately succeeding year to
the year of acquisition.
G. Domestic transfer Pricing
► As per the existing provisions of the ITL,
a threshold limit of INR 50 million is
specified for a transaction to qualify as
“specified domestic transaction” for
applicability of transfer pricing on
domestic transactions. It has been
proposed to amend the provisions of the
ITL to increase such threshold to limit to
INR 200 million.
H. General Anti Avoidance Rules (‘GAAR’)
and indirect transfer
► GAAR deferred by two years i.e.,
applicable from financial year April 1,
2017. Grandfathering benefits extended
to investments made till 31 March
2017.
► Clarifications introduced on taxability of
indirect transfer of shares deriving
substantial value from assets in India.
‘Substantial’ value clarified to mean 50%
Indian assets vis a vis global assets and
minimum Indian assets of INR 100
million.
I. Rules for claiming foreign-tax credit
► The ITL provides a relief in respect of
income which is doubly taxed in India as
well as in another jurisdiction by way of
a credit in respect of foreign taxes paid
on income which is taxed in India. An
amendment is proposed in the ITL to
empower the Indian tax administration
to prescribe rules regarding the
procedure for granting FTC under the
ITL.
J. Residential Status of a foreign
company
► Presently under the ITL, a company is
said to be resident in India, inter alia, if
during the year, the control and
management of its affairs is entirely
situated in India. It is proposed that a
company shall be a resident in India if its

6. Budget Connect+ 2015 6
Place of Effective Management (‘POEM’)
is in India, at any time in that year.
POEM is defined to mean a place where
key management and commercial
decisions that are necessary for the
conduct of the business of an entity as a
whole are in substance made.
K. Individual Tax proposals
► Income tax rates for individuals remain
unchanged.
► However, surcharge has been increased
from 10% to 12% on income-tax for
income exceeding INR 10 million.
► Limit of deduction from total income
enhanced in relation to investment/
contribution/ payment for health
insurance, Pension fund, medical
expenditure etc
Key Indirect Tax Proposals
A. Excise duty
► Basic Excise duty rate increased from
12% to 12.5%.
► Education cess/ Higher Education cess
exempted on all goods.
► Application for registration available
online – approval within 2 days (pending
post –facto verification).
► Manufacturers can issue digitally signed
invoices and maintain records in
electronic form.
► Rationalisation of penalty provisions.
► Specific Rules to be introduced for
recovery of Excise duty where the non-
payment or short payment of duty is
reflected in the periodic returns.
► Limited liability partnerships, sole
proprietorships and One Person
Company can seek advance ruling.
► The time limit for availing Cenvat credit
on inputs and input services has been
increased from six months to one year
to facilitate businesses.
B. Service tax
► Service tax rate increased from 12% to
14%.
► Education cess and Secondary and
Higher Education cess shall be
subsumed in the revised rate of Service
tax.
► Thus, effective increase in the Service
tax rate will be from the existing rate of
12.36% to 14%.
► Central Government empowered to
impose a Swachh Bharat Cess on all or
any of the taxable services at a rate of
2% of the value of such taxable services.
► Presently, services provided by the
Government or a local authority,
excluding certain services are specified
in the Negative list. An enabling
provision is being made so as to exclude
all services provided by the Government
or local authority to a business entity
from the Negative list. Accordingly, all
services provided by the Government or
local authority to a business entity,
except the services that are specifically
exempted or covered in the Negative list
shall be liable to Service tax.
► Exemption to construction, erection,
commissioning or installation of original
works pertaining to an airport or port is
being withdrawn
► Goods transport agency service
provided for transport of export goods
by road from the place of removal to an
inland container depot, a container
freight station, a port or airport is
exempt from Service. The scope of the
said exemption is being widened to
exempt such services when provided for

7. Budget Connect+ 2015 7
transport of export goods by road from
the place of removal to a land customs
station.
► Manpower supply and security services
when provided by an individual, HUF or
partnership firm to a body corporate are
being brought to full reverse charge as
opposed to partial reverse charge
mechanism.
► Definition of the term ‘Government’ has
been included in the Finance Act, 1994
so as to address interpretational issues
on availment of exemptions.
► Finance Act specifically amended to
state that valuation of services shall
include reimbursable expenses.
► Cenvat credit of Service tax paid under
partial reverse charge by the service
receiver shall be allowed without linking
it to the payment to the service
provider.
► Consequent to the upward revision in
the Service tax rate, the composition
rate on specified services, namely, life
insurance services, services of sir travel
agent, money changing service provided
by banks or authorised dealers and
service provided by lottery distributor
and selling agent, is proposed to be
revised accordingly.
► A uniform abatement is being prescribed
for transport of rail, road and vessel to
bring parity in these sectors. Service tax
shall be payable on 30% of the value of
such service subject to a uniform
condition of non-availment of Cenvat
credit on inputs, capital goods and input
services.
► The abatement for executive (business /
first class) air travel, wherein the service
element is higher, is being reduced from
60% to 40%. Consequently, Service tax
would be payable on 60% of the value of
fare of business class.
C. Customs duty
► Peak rate of effective Customs Duty
increased from 28.85% to 29.44% due
to change in peak Excise duty rate.
► SAD exemption extended to all goods
used for manufacture of ITA bound
products (except PCB) subject to actual
user condition.
► Basic Customs duty exemption extended
to certain inputs for consumer products
industry.
► Penalty provisions rationalised.

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