Defense Manufacturing

OUTLINE

  • India has the third largest armed forces in the world
  • The allocation of Defense in the India’s union budget is approx. USD 34.53 billion and 31.1% of the defense budget is spent on capital acquisitions
  • 60% of defense-related requirements are met by imports, offering a huge opportunity for import substitution
  • The opening of the defense sector for private sector participation will help foreign original equipment manufacturers to enter into strategic partnerships with Indian companies and leverage the domestic markets as well as aim at global markets. Besides helping in building domestic capabilities, this will also bolster exports in the long term
  • Contractual offset obligations worth approximately USD 4.53 billion in next 5-6 years
  • The offset policy (which stipulates the mandatory offset requirement of a minimum 30% for procurement of defense equipment in excess of USD 306.69 million) has been introduced in the capital purchase agreements with foreign defense players. It would also ensure that an eco-system of suppliers is built domestically
  • Favorable government policy promotes self-reliance, indigenization, technology upgradation and achieving economies of scale including the development of capabilities for exports in the defense sector
  • The country’s extensive modernization plan has an increased focus on homeland security and India’s growing attractiveness as a defense sourcing hub
  • Defense Production Policy, 2011 has encouraged indigenous manufacturing of defense equipment. Defense Procurement Procedure (DPP) has been amended in 2016 to provide for the following:
    • A new category of capital procurement – Buy Indian — IDDM (Indigenously Designed, Developed and Manufactured) introduced to encourage indigenous design, development, and manufacturing of defense equipment
    • Preference to ‘Buy (Indian-IDDM)’, ‘Buy (Indian)’ and ‘Buy and Make (Indian)’ over ‘Buy (Global)’ categories of capital acquisition
    • Clear and unambiguous definition of indigenous content
    • Provision for Maintenance TOT (Transfer of Technology) to Indian Industry partners
    • Provisions to allow foreign OEM (Original Equipment Manufacturer) to select Indian Production agency
    • The requirement of minimum indigenous content has been enhanced/rationalized
    • Services’ as an avenue for discharging offsets have been re-introduced
      1. Defense products list for industrial licensing has been articulated in June 2014, wherein large numbers of parts/components, castings/forgings, etc., have been excluded from the purview of industrial licensing
      2. The defense security manual for the private sector defense manufacturing units has been finalized and put in public domain by the Department of Defense Production. The manual clarifies the security architecture required to be put in place by the industry while undertaking sensitive defense equipment.
      3. The MAKE procedure, which aims to promote research & development in the industry with support from the government and the placement of orders, has been promulgated with provision for 90% funding by Government and preference to MSMEs in certain category of projects

FDI POLICY

  • 100% FDI in defense sector: Up to 49% under automatic route; FDI above 49% through Government route where it is likely to result in access to modern technology
  • The defence industry is subject to industrial licenses under the Industries (Development and Regulation) Act, 1951 and manufacturing of small arms ammunition under Arms Act, 1959
  • The requirement of single largest Indian ownership of 51% of equity removed
  • A lock-in period of three years on equity transfer has been done-away with in FDI for defence
  • FDI in the defence sector is subject to other security conditions

SECTOR POLICY

  1. Procurement Policy:

    • The defense procurement is governed by the Defense Procurement Procedure (DPP 2016)
    • Latest revision of DPP was released in March 2016
  2. Offset Policy:

    • The key objectives of the defense offset policy is to leverage capital acquisitions to develop the domestic defense industry. Mandatory offset requirements of a minimum of 30% for procurement of defense equipment in excess of USD 307.69 million have been envisaged
  3. Procedures for the Grant of Industrial Licenses have been streamlined:

    • The initial validity period of industrial licenses has been increased from 3 years to 15 years with a provision to grant extension for a period of 3 years
    • Guidelines for the extension of validity of industrial licenses have been issued
    • Partial commencement of production is treated as commencement of production of all the items included in the license

FINANCIAL SUPPORT

Key Provisions of the Union Budget 2016-17:

  • Provision of USD 34.53 billion for defense services in the FY 2016-17 Union Budget
  • Capital outlay for Defence in 2016-17 is kept at USD 12.09 billion
  • Out of this, USD 10.75 billion has been allocated for Capital Acquisition of the Defense Services
  • USD 1.33 billion has been provided under “Other than Capital Acquisition” segment for capital expenditure to Army, Navy, Joint staff and Air Force
  • Either of the following two deductions can be availed:
    • Investment allowance (additional depreciation) at the rate of 15% to manufacturing companies that invest more than USD 15.38 million in plants and machinery acquired and installed between 01.04.2013 to 31.03.2015 provided the aggregate amount of investment in the new plants and machinery during the said period exceeds USD 15.38 million
    • In order to provide a further fillip to companies engaged in the manufacture of an article or thing, the said benefit of additional deduction of 15% of the cost of new plants and machinery, exceeding USD 3.84 million, acquired and installed during any previous year until 31.o3.2017

Tax Incentives:

R&D Incentives – Industry/private sponsored research programmes.

  • A weighted tax deduction is given under Section 35 (2AA) of the Income Tax Act
  • A weighted deduction of 200% is granted to assess for any sums paid to a national laboratory, university or institute of technology, or specified persons with a specific direction that the said sum would be used for scientific research within a programme approved by the prescribed authority

For companies engaged in the manufacture of an in-house R&D centre, a weighted tax deduction of 200% under Section 35 (2AB) of the Income Tax Act for both capital and revenue expenditure incurred on scientific research and development. Expenditure on land and buildings are not eligible for deduction

State Incentives:

  • Apart from the above, each state in India offers additional incentives for industrial projects. Incentives are in areas like subsidised land cost, relaxation in stamp duty exemption on sale/lease of land, power tariff incentives, concessional rates of interest on loans, investment subsidies/tax incentives, backward areas subsidies, special incentive packages for mega projects.

Export Incentives:

  • Export promotion capital goods scheme
  • Duty remission scheme
  • Focus product scheme, special focus product scheme, focus market scheme
  • Incentives as per ‘merchandise Exports from India Scheme (MEIS)’ under new Foreign Trade Policy

Area based Incentives:

  • Incentives for units in Special Economic Zones (SEZs) / National Investment & Manufacturing Zones (NIMZs) as specified in respective Acts or for the setting up of projects in special areas such as the North-East, Jammu & Kashmir, Himachal Pradesh and Uttarakhand
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