Taxing Taxes

With a market size of around $16 billion, the Indian aviation industry, which is the ninth largest civil aviation market in the world, is forecast to be the third largest by 2020. There is much discussion and debate in the industry regarding the steps that the government can and must take to realise this potential and ensure robust growth. More often than not, infrastructure development and a clear and defined policy are cited as key levers to provide the desired impetus to the civil aviation industry. However, in order to develop infrastructure and fund other public development work, it is crucial for any government to levy tax in various forms. But it is equally important to take into account the impact of the tax structure could have on the industry.

The tax structure formulated by the government not only directly affects the bottom line of any company, but also can make the domestic industry segment attractive or unattractive when compared to international economies. This article highlights some of the key tax issues with respect to the Indian civil aviation industry that can enable it to soar to even greater levels.

Tax on Aviation Turbine Fuel (ATF)

Fuel cost constitutes the largest component of operating costs for airlines and any revision to taxes levied on ATF directly impacts their financial performance. Presently, all the states charge value added tax (VAT) on ATF which ranges from one to 30 per cent making operations for the domestic carriers more expensive as compared to airlines that have the facility to pick up ATF internationally. Thus, the Indian domestic carriers are at a tremendous disadvantage when compared to carriers operating on the international segment. This is reflected in the weak margins for airlines and rationalising this policy can alleviate this pressure for airlines. For instance, an airline such as IndiGo stands to save almost Rs. 4,00,000 to 4,50,000 each year for every Indian rupee reduction in the per litre price of ATF. Rationalising the tax structure for ATF can serve as a driver of profitability for airlines which then flows to all elements of the value chain.

Tax on ‘Sale and Lease Back’

With the increasing popularity of ‘Sale and Lease Back’ of airplanes, lease rental payments by airlines that are linked with the operating leases are now commonplace. Until 2007, the airlines were exempt from income tax levied on lease rental payments made to foreign lessors. However, after the withdrawal of exemption from income tax levied on these payments since this date, all payments to foreign lessors are now taxable. In a cash-strapped industry, withdrawal of this exemption has substantially increased the pressure on the cash outflow of airlines.

Restrictions on Foreign Borrowing

The airline industry is a capital-intensive industry and requires large amounts of funds for acquiring assets as well as to sustain working capital. A majority of this funding requirement is met through foreign borrowings thereby making the liability of payment of interest a major financial burden for the airlines. Till 2001, interest payable on foreign borrowings was exempt from taxation. However, this was then withdrawn making competitive foreign borrowings unattractive to the Indian airlines. Easing of or eliminating the tax on foreign currency loans will provide the airlines an access to cheaper funding, thereby reducing their interest burden and help them improve their overall financial performance.

Rationalising the tax structure on MRO can help promote this segment of the civil aviation industry in India

Service Tax on Air Tickets

In addition to the taxes listed above, since 2012, service tax is charged on the full amount of the air ticket with an abatement of 60 per cent. This component of tax levied is ultimately passed on to the passengers and drives up the price of tickets. The Indian market is extremely price-sensitive and thus this has a detrimental effect on the flying public. Often the decision between modes of transport, especially rail and air, boils down to price and with this, several travellers choose the cheaper option, in most cases rail travel. An increment in the available abatement or easing the tax rates would not only help bring down ticket prices but also stimulate demand.

Airport Fees

To top it all, several airport taxes in the form of user development fee (UDF) and/or airport development fee (ADF) are levied at present. UDFs and ADFs are imposed with the view of helping an airport operator recover the cost pertaining to development and maintenance of an airport as a part of their guaranteed return on equity. However, there is a large difference between the intent and impact of these taxes. While the intent is to spur the growth of aviation through speedy infrastructure development, the impact in many cases is that these taxes being somewhat exorbitant are inclined to dampen demand. Often, the UDF, ADF and related taxes constitute 20 per cent or more of the price of the ticket and these costs are passed on directly to the passengers, driving up the ticket prices. Rationalising these would lower air ticket prices, enabling more people to fly.

The airline industry is a capitalintensive industry and requires large amounts of funds for acquiring assets

Taxes on MRO

With all airlines adding capacity and expanding their fleets, the requirement to maintain this fleet is growing as well. Currently, a VAT of 12.5 to 15 per cent is levied on aircraft parts imported by maintenance, repair and operations (MRO) service providers. Furthermore, the tax is levied on the selling price and not on the cost price. When clubbed with service tax, it brings the total tax component to be around 20 to 22 per cent. Additionally, in case an MRO activity is undertaken in India, a service tax of 12.36 per cent is levied, whereas, in case such repairs are undertaken outside India, no such tax is charged which makes Indian MRO industry uncompetitive as compared to neighbouring countries. Indian carriers are already using facilities at Dubai, Sri Lanka, and Singapore for their MRO requirements. Rationalising the tax structure on MRO can help promote this segment of the civil aviation industry in India as well as attract foreign airlines, consequently leading to additional economic output and employment.

The Final Word

These key elements of tax policy as highlighted above are currently acting as a detriment to India realising its full potential in the civil aviation industry. With passenger traffic growing at six to eight per cent and is forecast to reach 100 million passengers by 2020, it is all the more important for the government to give a deliberate and definite focus on tax policy. The macroeconomic factors including a young population, a growing economy, declining deficit and a surge in demand are all aligning in India’s favour. Accordingly, this is the time for the Indian civil aviation industry to ascend to greater heights. A more enlightened and effective taxation policy can enable the Indian civil aviation industry soar to greater heights.

The writer is a certified financial analyst (CFA) and currently an independent consultant. A technology enthusiast, she has worked as Aviation Consultant and Advisor with CAPA where her work involved extensive financial analysis, benchmarking and pre-IPO research.