India Law News - Rogers, Joseph O'Donnell

India Law News 1 Civil Aviation Issue Part II 2014

India Law NewsA quarterly newsletter of the India Committee

VOLUME 5, ISSUE 1, WINTER ISSUE 2014

The Opening in the Clouds

Cash and capital must be “checked-in” before anaviation player can take off. Aircraft, aviation fuel,employees, training, airport charges and maintenanceare only some of the many factors that swell costs,while delaying difficult-to-earn returnsfor airlines theworld over. India is no different. The recent debtburden of domestic airlines in India stands at U.S.$14.5 billion. The finances of the airline sector havebeen reeling. Financial and private equity investorshave shown minimal interest in this sector in the pastgiven that India’s regulatory framework did not evenpermit strategic investment.

Foreign airlines were not allowed to hold an equitystake in an Indian air transport undertaking engaged inoperating scheduled and non-scheduled air transportservices, except cargo airlines. Foreign DirectInvestment (FDI) up to 49% was allowed under the“Automatic Route” (i.e., without obtaining priorapproval from the Foreign Investment PromotionBoard, Ministry of Finance [FIPB]) in scheduled air

transport service/domestic scheduled passengerairlines. In the non-scheduled air transport service, FDIup to 74% was allowed (under the Automatic Route upto 49% and with prior FIPB approval for FDI above49%).

All this changed on September 20, 2012, when theDepartment of Industrial Policy & Promotion (DIPP) ofthe Ministry of Commerce and Industry issued newregulations. DIPP’s “Press Note 6” changed businessfor good. It allowed foreign airlines to hold capital inIndian companies operating scheduled and non-scheduled air transport services up to 49% of their paidup capital under the Approval Route (i.e., with priorFIPB approval). The Press Note infused fresh breath inthe Indian airline space and raised the hopes ofdomestic carriers that the policy change would revivetheir sector.

The Government had long delayed this stepbecause of security concerns as well as the fear ofacquisition of small players by foreign airlines.

continued on page 6

FOREIGN DIRECT INVESTMENT IN INDIA’S AIR CARRIERS: A NEW CASE FOR EFFICIENCY?By Sundeep Dudeja and Vaibhav Kakkar


he Indian civil aviation sector continues to face a paradox. While on the onehand Indian carriers continue to lose large amounts of money and are undertremendous pressure to improve their yields, there have been positive

developments in the recent past with the Jet Airways-Etihad Airways deal, the AirAsia-Tata venture and the Tata-Singapore Airlines venture, alllooking for theopportune time to start operations.

In the environment that the Indian carriers find themselves, a continuous re-examination of the regulatory and tax regimes has become imperative. The regulatoryand tax regime needs to keep changing by carrying out a balancing act between thestakeholder interest and the profitability of the carriers.

The legal fraternity in India and those who have been closely associated with theaviation sector have consistently assisted industry in analysing various implications ofthe regulatory and tax regime and suggesting ways of improving the regulatoryenvironment for encouraging growth of the industry.

In this background, this issue of the India Law News of the India Committee of theAmerican Bar Association’s Section of International Law assumes greater significance.India Law News in this issue has been fortunate to have valuable contributions fromexpert lawyers practicing in the field of foreign direct investment (FDI), mergers andacquisitions, private equity, tax, civil aviation, and infrastructure, who discuss many ofthe aspects pertaining to the regulatory and tax regime. Sundeep Dudeja and VaibhavKakkar of Luthra & Luthra Law Offices give their perspective on the FDI norms whichenable foreign airlines to hold capital in Indian companies operating scheduled andnon-scheduled air transport services. Keeping the recent Jet-Etihad deal in mind, VikasKumar of DH Law Associates, Advocates and Solicitors, analyses FDI norms applicableto foreign investments and the government policy pertaining to “bilateral air serviceagreements.”Pawan Khatter and Jayanta Kalita, of EY India and Vikas Srivastava andSanjeev Sachdeva of Luthra & Luthra Law Offices provide their respective views on theindirect and direct tax issues impacting the aviation industry. Aseem Chawla, AnujMathur, and Shashank Goel of MPC Legal touch upon certain direct and indirect taxaspects of cross border leasing and highlight deliberation between the stakeholders ofthis industry and the tax authorities. Co-Guest Editor, Robert S. Metzger, of RogersJoseph O'Donnell, P.C., makes the case for a national program to develop a nextgeneration turboprop aircraft to meet India’s regional transport needs. He suggests sucha program can be used to address India’s national technology and manufacturingobjectives.

We hope you find the above articles interesting and useful.

Atul Sharma and Robert S. MetzgerGuest Editors, Winter Issue 2014

Atul Sharma is the Managing Partner of Link Legal India Law Services, a fullservice law firm. He has over 30 years of experience in civil and commerciallitigation and arbitration in various sectors, including aviation, infrastructure,

ABOUT THIS ISSUE

CONTENTSOVERVIEW

2 About This Issue

4 Co-Chairs’ Column

________ ________

COMMITTEE NEWS

34 Submission Requests35 Join the India Committee

________ ________

SPECIAL FOCUS

1 Foreign Direct Investment inIndia’s Air Carriers: A NewCase For Efficiency?

11 Foreign Direct Investment IssuesIn The Backdrop Of The JetAirways – Etihad AirwaysStrategic Acquisition

15 The Impact of Direct andIndirect Taxes on ForeignCarriers Operating in India

19 Tax Turbulence for IndianAviation

25 Cross-Border Aircraft Leasing:An Indian Tax Perspective

29 A Next Generation RegionalTurboprop Transport: ANational Aerospace Project ForIndia

________ ________

36 Threading the Needle inU.S./India Deals: SafePassage throughFormidable Legal Risk


real estate, telecom and banking. He has wide experience in dispute resolutionprocedures and domestic and international arbitration. Atul has advised andrepresented clients in shareholder disputes arising out of the acquisition and saleof companies, as well as contentious regulatory matters, insolvency proceedings,and real estate and tender-related disputes. He also specializes in theinfrastructure sector and has advised developers and contractors. In the last fiveyears, Atul has advised on projects at airports in Istanbul, Turkey, Male, Maldives,and on four major airports in India - Delhi, Mumbai, Bangalore and Hyderabad, inaddition to other infrastructure projects like ports, transportation, power andwater. Atul can be reached at [email protected]

Robert S. Metzger is a shareholder at the law firm of Rogers Joseph O'Donnell, P.C.,and is based in Washington, D.C. Mr. Metzger counsels leading U.S. andinternational companies in aviation and defense matters. He is a member of theDefense Executive Committee of the U.S.-India Business Council and has publishedseveral articles in international journals on the subject of the U.S.-India aerospaceand defense industrial relationship. Mr. Metzger was a Research Fellow at theCenter for Science & International Affairs, Harvard University Kennedy School ofgovernment, and is a member of the International Institute of StrategicStudies(London). He can be reached at [email protected].

Editorial Boar


n behalf of the India Committee we wish all our readers a veryHappy New Year.

India’s general election takes place between March and April2014.Once the elections are over, whichever party or combination ofparties prevails, it is expected that the new government will focus ontaking effective measures to get India’s struggling economy back on track.An anemic 4.6 percent annualized growth rate in GDP in the middle of2013 shows the extent to which the Planning Commission’s ambitiousannual target of 8 percent has been derailed.

We can expect that after the elections India is likely to explore allgrowth options, including putting major infrastructure projects back ontrack. Some steps have already been taken. For example, a CabinetCommittee on Investment has been created to find ways to streamlineregulatory clearance of major projects. The new government will also needto explore ways to address supply-side constraints, double digit inflation—caused in large part by higher food and energy prices—an increasingcurrent account deficit, fall in aggregate investment, and a decrease incollection of tax and non-tax revenues with the consequent risk of higherfiscal deficits.

The India Committee, through its programs and this newsletter willcontinue to endeavor to keep our readers, members and programparticipants informed of significant legislative, regulatory and judicialdevelopments in India in the coming months particularly to the extent thatsuch developments may affect investor and business confidence.

This issue of the India Law News continues from our previous issuewith a special focus on civil aviation. The articles, written by distinguishedlegal practitioners, explain the reasons behind India’s slow start in layingthe foundation for what is potentially one of the largest civil aviationmarkets in the world. This issue of India Law News, along with theprevious one, gives insight into India’s revenue, regulatory, environmentaland social policy spheres that often have overlapping jurisdictions anddifferent perspectives. This can make it hard for the aviation industry toplan for growth, especially when conflicting decisions by regulatory bodiesinevitably leads to litigation. Our special thanks go to co-Guest Editors,Atul Sharma and Robert Metzger for putting together both parts of ourtwo-part series on civil aviation in India. We have been particularlyfortunate in having as authors for these two editions among the best legaland tax practitioners in India to guide us through the complexities of theIndian civil aviation industry today. As always we wish to express aregratitude to our editorial board for producing another timely issue on animportant topic and to LawQuest for providing desktop publishing for theIndia Law News.

The India Committee has also chosen this critical time to discussforeign investment and trade, especially between India and the U.S., at aconference in New Delhi from February 13 to 15, 2014. The India

India Law News

EDITORIAL BOARD (2013-2014)

Editor-in-ChiefBhalinder L. RikhyeBartlett, McDonough & Monaghan, LLP, New York, NY

Co-EditorsPoorvi ChothaniLawQuest, Mumbai, India

Aseem ChawlaMohinder, Puri & Company, New Delhi, India

Antonia GiulianaKelley Drye & Warren LLP, New York, NY

Julia LuysterBogert & Rembold, PL, Coral Gables, FL

Sylvana Q. Sinha

Desktop PublishingLawQuest, Mumbai, India

India Law Newsis published quarterly by theIndia Committee of the American BarAssociation’s Section of International Law, 74015th Street, N.W., Washington, DC 20005. Nopart of this publication may be reproduced, storedin a retrieval system (except a copy may be storedfor your limited personal use), or transmitted in anyform or by any means (electronic, mechanical,photocopying, recording, or otherwise) without theprior written permission of the publisher. Torequest permission, contact the Co-Chairs of theIndia Committee.

India Law News endeavors to provideinformation concerning current, importantdevelopments pertaining to law in India,Committee news, and other information ofprofessional interest to its readers. Articles reflectthe views of the individuals who prepared themand do not necessarily represent the position of theAmerican Bar Association, the Section ofInternational Law, the India Committee, or theeditors of India Law News. Unless stated otherwise,views and opinions are those of the authors andnot of the organizations with which they areaffiliated. This newsletter is intended to provideonly general information and should not be reliedupon in the absence of advice from competentlocal counsel.

SUBMISSION DEADLINESFall Issue August 1stWinter Issue November 1stSpring Issue February 1stSummer Issue May 1st

Potential authors should review the AuthorGuidelines and send manuscripts via email to theEditorial Board.

© 2014 American Bar AssociationAll rights reserved

Produced by India Committee

CO-CHAIR’S COLUMN


Committee has been extremely fortunate to have as conference organizingpartners the Society of Indian Law Firms (SILF) and the Indian ServicesExport Promotion Council, and other supporters including the U.S IndiaBusiness Council, for the presentation of this three-day program in NewDelhi on trade and investment between the U.S. and India, entitled“Threading the Needle in U.S./India Deals: Safe Passage throughFormidable Legal Risk.”

With senior lawyers from India and the U.S. expected to present andattend, this conference promises to be a thought-provoking event and aninvaluable networking opportunity. Registration is open and fast fillingup, at http://www.events.iceindia.in/threadingtheneedle/registration.html.We hope you will register for this event at the Hyatt Regency Hotel, NewDelhi, from February 13 through 15, 2014. The panels will cover topicssuch as India’s new Companies Act, 2013, the mergers and acquisitionsregime under the new Companies Act, including cross-border mergers, theever evolving Indian tax landscape affecting cross border transactions, thecompelling logic behind corporate governance, ethical behavior andeffective corporate compliance, how India has enabled class actionlawsuits, and the lessons India can learn from the U.S., the legalrequirement of corporate investment in corporate social responsibility andindustry’s response, navigating India's defense procurement policy, civilaviation, issues related to cross-border franchising, key legal aspects oflisting Indian companies in the U.S., the future of international arbitrationin India, immigration issues especially as they relate to the conduct ofIndia-U.S. business, a look at U.S. and Indian trade regulations, dealingwith cyber attacks that disrupt the nation’s power grid for months, theevolving intellectual property rights regime in India and U.S., movingwealth between India and the U.S. and back, in the context of tax and legalstructures affecting persons and families with ties to both India and theU.S., and increasing opportunities for young lawyers in India.

In December 2013, the India Committee also ran a teleconference, “TheElephant Trots Again: Further Liberalizations and Initiatives BoostInvestments in India.” The panel addressed India’s recent Companies Act,2013, the improvement in credit growth, the Cabinet Committee onInvestments, the easing of regulations on financing through equity anddebt offerings, reforms in the companies law, land acquisition and foreigninvestment policy, developments in taxation, and contract enforcement.More teleconferences are planned for 2014.

We hope you enjoy this issue of India Law News, and hope to see youat the Hyatt Regency in New Delhi between February 13 and 15, 2014!

We hope you find the above articles interesting and useful.

Sajai SinghSanjay TailorRicha Naujoks


continued from page 1

The present government’s dependence on support ofallied political parties may also have been a factor.While long overdue, this was a welcome move becauseas strategic alliances were required for achievingconsolidation, efficiency and reduction of costs. Suchalliances were seen as helping to usher expertise andglobal practices and standards into India.

The decision paved the way for airlines suchasGoAir, SpiceJet, Jet and Kingfisher to explorerecapitalisation, restructuring and partnerships withglobal operators. Further, this bold move, along withthe opening of multi-brand retail trade for FDI, helpedbolster investor confidence. Before September 2012, theterm “policy paralysis” was being associated with theGovernment. Even Prime Minister Manmohan Singhhimself had come under criticism. The new rulescheered global airlines as new opportunities opened upin what they began seeing as India’s huge market.

Some of the important conditions for acquisition ofa stake by foreign airlines in Indian carriers, was that a“scheduled operator’s permit can be granted only to acompany (i) that is registered and has its principalplace of business within India, (ii) whose Chairmanand at least two-thirds of the directors are citizens ofIndia and (iii) the substantial ownership and effectivecontrol of which is vested in Indian nationals.” Therevised policy was not made applicable to Air Indiawhich is still owned by the government.

Air Asia Flies Into Turbulent Weather

After Press Note 6 was issued, Malaysia-basedbudget carrier AirAsia was the first airline to announcea collaboration with the Tatas and Telstra Group to

launch a new low-fare airline in India. AirAsia was tohave a 49% stake in AirAsia India, and the Tatas andTelstra 30% and 21% respectively. The FIPB gave itsapproval to the venture in March 2013; but theproposal almost immediately hit turbulence when theMinistry for Civil Aviation pointed out that thelanguage of Press Note 6 only allowed foreign airlinesto acquire a stake in existing carriers, not in greenfieldairline projects such as AirAsia India. DIPP at theMinistry of Commerce and Industry, however took theposition that the policy change envisaged stakes ingreenfield projects as well as existing carriers.

According to paragraph 2.1 of Press Note 6 the“Government of India has reviewed the position in thisregard and decided to also permit foreign airlines toinvest, in the capital of Indian companies, operatingscheduled and non-scheduled air transport services, upto the limit of 49% of their paid-up capital.” The FIPB’sinterpretation that the rule applied to Greenfieldprojects was based on the comma placed after the word“companies,” arguing that there is no distinction madein the said language between existing and newlycreated companies. The Ministry of Civil Aviation,however, insisted on clarification of the language of thePress Note. The differing viewpoints of these twogovernment departments were widely reported.

The issue could have been avoided by constructivedialogue between government departments prior to themeeting of the FIPB in which AirAsia’s proposal wasconsidered. While ultimately, it did not have a bearingon the approval of the proposal by the FIPB, thedisagreement showed an inefficient and confusing lackof co-ordination between Government departmentsand jeopardized investor confidence. Technically, the

FOREIGN DIRECT INVESTMENT IN INDIA’S AIR CARRIERS: A NEW CASE FOR EFFICIENCY?

By Sundeep Dudeja and Vaibhav Kakkar


DIPP is the policy formulator and its view should havesettled the issue.

In support of the argument that Press Note 6 didnot permit foreign airlines to invest in greenfieldcarriers, senior BJP politician Subramanian Swamyfiled a public interest litigation (PIL) against the dealbefore the High Court of Delhi. The case is presentlybeing litigated. However, a fundamental aspect whichshould not be lost sight of here is that under the settledprinciples of Indian administrative law, Governmentpolicy and its interpretation are the executive’sprerogative, which limits judicial review of policymatters. In the context of FDI policy itself, in thejudicial decisions of Federation of Associations ofMaharashtra v. Union of India ([2005] 63 SCL 77 (Delhi))and Radio House and Ors. v. Union of India (2008 (2)KarLJ 695), it has been held that the Governmentdecides and interprets the implications of policy.Therefore, it is unlikely that the Delhi High Court willgrant Mr. Swamy’s petition given that the FIPB hasalready cleared the AirAsia India investment, and theDIPP has stated that Press Note 6 is not restricted toinvestment in existing carriers only.

Jet Airways & Etihad Airways – The Not–So-Smooth Runway for The Big Players

Another deal which lit up the Indian sky in 2013was Abu Dhabi-based Etihad Airways’ 24% investmentin Naresh Goyal - owned Jet Airways forapproximately $350 million. The investment deal washuge and the first in an existing domestic airline,amongst the existing Indian operators and was at thesame time as India and UAE had signed amemorandum of understanding (MoU) on air servicesfor enhancing seat capacity. The deal in whole couldlead Jet Airways being able to reduce its debt burdenfrom $2.1 billion to $1.5 billion.

Allegations were made by several politicians,including Subramanian Swamy, that the Governmentunduly influenced the deal. This transaction, too, is sub-judice on a plea filed by him to the Supreme Court ofIndia. The MoU entered into between India and UAE

for an increase in the number of seats per week for theirairlines, was alleged to have been formulated tospecifically facilitate the Jet-Etihad deal. The MoU hasbeen said to impact domestic carriers (other than Jet)and domestic airports, as it would lead to Abu Dhabibecoming a hub for in-bound and out-bound Indiaflights. Nevertheless, the MoU was given ex post factoclearance by the Cabinet in September, 2013.

The Matter of “Effective Control”

While Press Note 6 mentions that a scheduledoperator’s permit may be granted only when thecompany’s “effective control” is vested in Indiannationals, it does not define “effective control.” Theprevalent FDI policy outlined “control” as the power toappoint a majority of directors. Control as stipulatedby the Securities and Exchange Board of India (SEBI)Takeover Code includes the right to appoint a majorityof directors or to control management or policydecisions, directly or indirectly, including by virtue ofshareholding or management rights or shareholdersagreements or voting agreements or in any othermanner.

As soon as the Etihad investment in Jet was firstannounced in April 2013, the proposed structure facedscrutiny of the FIPB, SEBI, the CompetitionCommission of India (CCI) and the Ministry ofCorporate Affairs, on the grounds that the proposeddocumentation appeared to show a shift in effectivecontrol of the airline into Etihad’s hands. Theregulatory authorities perceived that Etihad wasattaining much more than the law permitted, eventhough the stake proposed to be acquired was aminority 24%. As initially proposed, Etihad was to getthree directors on the board, while Jet was to have four,with seven directors being independent. The dealenvisaged, among other things, that Etihad couldsource candidates for senior management positions,network and revenue management functions could beshifted to Abu Dhabi, and the nominations committeecould exclusively recommend appointment/removal ofindependent directors and chief executive officers.


The then existing FDI Policy defined control assimply the power to appoint majority of directors,which was a narrower definition than the definition ofcontrol under the SEBI Takeover Code. Practically,however, in the context of FDI also, the Governmentwas applying similar parameters as those envisagedunder the SEBI Takeover Code for assessment ofcontrol of an entity. FIPB’s assessment of theinvestment in Tata Sky Ltd. is an example of wherevarious governance rights proposed in the transactiondocuments were directed to be reduced.

Further, the deal was facing examination by SEBIunder the requirements of the Takeover Code itself,which mandates that if an acquisition leads to changein control of an entity listed on any stock exchange—Jetis a listed entity—an open offer is required to be madeby the acquirer to the public shareholders of the entityfor tendering their shares to the acquirer. SEBI wasapprehensive that certain clauses in the proposedstructure would give control to Etihad over Jet. SEBI’sconcerns, when echoed in the media and otherplatforms, led, for the first time, to the FIPB seekingspecific comments from SEBI and the Ministry ofCorporate Affairs on the deal structure beforeapproving it.

These various regulators worked closely amongthemselves as well as with Jet-Etihad, to identify thoseclauses of the proposed shareholders’ agreement,commercial cooperation agreement, etc., that could beinterpreted as handing control to Etihad. When finallyFIPB cleared the deal in July it did so conditionally. JetAirways Chairman, Naresh Goyal, was to remainexecutive chairman with a casting vote. Any futurechanges in the shareholding pattern or shareholdersagreement were made subject to prior Governmentapproval. Most importantly, Etihad agreed to twoboard seats, as opposed to three discussed earlier, withsix seats for independent directors. Under the revisedterms of the agreement Etihad could only recommendappointments to management. Also, Etihad would nothave the right to appoint independent members on thenomination and audit committees and such members

could be appointed only if nominated by the board ofdirectors.

The proposal for shifting of revenue managementand the network operations office to Abu Dhabi wasalso dropped. (Source:http://m.financialexpress.com/news/jet-flight-plan-gets-green-signal-after-control-shift/1148298/). Importantly,however, SEBI stated in its assessment that if any otherregulator differed in its analysis of the change in JetAirways’ control, SEBI reserved the option of re-examining the issue of open offers to be made to publicshareholders.

The clearance of the investment by the FIPB andsubsequently by Cabinet Committee on EconomicAffairs was a bright spot, even though it took over sixmonths. There were many authorities involved and thedeal can be seen as an example of constructive andproductive dialogue between a willing investor andIndian regulators, who are usually perceived by theglobal community as stringent and reluctant to approvethese kinds of complex transactions.

The Jet-Etihad transaction also glided through thescrutiny of the Competition Commission of Indiawhich did not see the combination as having anappreciable adverse effect on competition in India.However, in its order of November, 2013, based on itsassessment of the investment agreement, theshareholders agreement and commercial co-operationagreement, the Commission concluded that Etihadwould be in joint control over Jet under the deal. Giventhis, SEBI has recently been mulling re-examining thedeal to determine whether it is indeed a change ofcontrol, which could trigger an open offer. Therefore,the last word on this issue is yet to be heard.

Controlling The “Control”

Around the same time that the Jet-Etihad deal wasunder consideration, the DIPP revised the FDI policy(in August 2013) to bring the definition of “control” inline with that prevalent under the SEBI Takeover Code.The (Indian) Companies Act, 2013, which has been


recently enacted to replace the half-a-century oldcompany law embodied in the (Indian) Companies Act,1956, also encapsulates a new definition of controlwhich conforms to the one contained in the SEBITakeover Code.

This is a positive development in the sense thatdifferent regulations/guidelines now do not carrycontrasting definitions of control. However, certainaspects still remain unresolved. The definition ofcontrol under the SEBI Takeover Code has itself been asubject of intense judicial debate and varyinginterpretation historically, as the same has beeninterpreted in light of the particular facts of individualcases. As the FDI Policy (post amendment) now carriesmore or less the same definition of control as in theSEBI Takeover Code, the remaining uncertainty andfluctuations travel here as well.

For instance, in the order in Subhkam Ventures v.SEBI, dated January 15, 2010, of the SecuritiesAppellate Tribunal, it was held that control has to bepositive control. Certain rights to prevent a companyfrom taking certain actions (such as affirmative/protective right of the investor), however, would notamount to control. However, later, the Supreme Courtruled that this order cannot be treated as a precedent,thus leaving open the contours of the definition ofcontrol. Another aspect of this issue is that since thedefinition of control is now similar in the FDI Policy,the SEBI Takeover Code and the Companies Act, 2013,the interpretation given by regulatory and judicialauthorities to “control” under one framework, willnecessarily affect the interpretation to be given inanother.

Better co-ordination among various Governmentand regulatory wings will be required. Entrusting oneagency with the responsibility of assessment of controlin a transaction and the determination made by suchagency serving as a parameter for other Governmentdepartments, would enhance consistency and clarity.

Press Note 6 was a bold step forward. In barely ayear, the civil aviation sector has seen three major

ventures: Jet-Etihad, Air Asia India and SingaporeAirlines-Tata. Clearly, long-overdue policy changeshave provided these companies broad avenues andpossibilities for structuring and consolidation. Theobligation is on the Government now to keep up theliberalization process, eliminate inconsistencies andsimplify procedures. This will allow domestic airlinesin India to receive a much needed impetus to recoverand flourish. Ultimately, the impact of the reforms, ifapplied consistently and in a coordinated manner willbenefit airlines in terms of increased capitalization, andpassengers in terms of competitive fares, more routesand a greater choice of airline.

Sundeep Dudeja is a Partner in the Corporate andRegulatory Practices Team of Luthra & Luthra LawOffices, New Delhi. Sundeep specializes in foreigninvestment/exchange laws, securities laws andgeneral corporate laws. He has extensive experiencein structuring transactions and advising clients oncorporate, regulatory and contractual mattersincluding, cross border mergers & acquisitions, jointventures and private equity. Sundeep has advisedclients from across industry sectors such asinfrastructure, pharma and health, retail, realestate, oil and gas, financial services, insurance,information technology, e-commerce, broad castingand telecom. He has also advised various reputedmultinational clients on significant and complexcorporate matters including setting up theirpresence in India. Sundeep is a qualified CharteredAccountant and Company Secretary. He also hasvarious notable publications in several leadingjournals. Sundeep can be reached [email protected]

Vaibhav Kakkar is a Partner in the Corporate andRegulatory Practices Team of Luthra & Luthra LawOffices, New Delhi. Having more than seven years ofexperience, he has a unique mix of extensiveregulatory and transactional expertise, andspecializes in structuring transactions, and advisingon foreign investment/exchange laws, company lawand securities laws. He has advised several global


corporates on appropriate strategies in relation toinvestments in India and domestic andmultinational clients on significant and complexcorporate matters including cross border mergers& acquisitions, joint ventures, private equity. He hasin-depth experience with industry-specific legal andregulatory issues in sectors including retail, realestate, telecommunications, gaming, hospitals,pharma, education mutual funds, education and thefinancial sector (banking and non-banking). He hasvarious notable publications in several leadingjournals and newspapers. Vaibhav can be reachedat [email protected].


If the Wright brothers were alive today Wilbur would have tofire Orville to reduce costs.

- Herb Kelleher, CEO, Southwest Airlines

ndia’s regime for foreign direct investment (FDI)in the civil aviation sector has been progressively

liberalized. This article examines the new FDI regimeapplicable to air transport services and passengerairlines (“Indian Carriers”) in the context of the recentpartial strategic acquisition of India’s Jet Airways bythe Abu Dhabi based Etihad Airways.

The fettle of the civil aviation industry is a goodbarometer of the prevailing economic mood in India.The airlines segment is a disproportionately visiblesubset of the civil aviation sector due to its glamourwhich makes it a source of national pride. However,the flight path of the Indian civil aviation industry hasmostly been turbulent and marked with intense air-pockets.

Plotting the trajectory of India’s airline industryfrom 2006 tells the whole story. Deccan Airlines hadbarely managed its initial public offering when it wasswiftly folded into Kingfisher Airlines in 2008.Kingfisher Airlines itself, along with its chairman VijayMallya, the “King of Good Times,” soon thereafterunglamorously collapsed in tough conditions. AirIndia had its tryst with mounting losses. Saharamerged with Jet Airways. And finally Jet Airways hasfound itself in a blockbuster foreign direct investment(FDI) deal with Abu Dhabi’s Etihad Airways thatcontinues to attract immense scrutiny. India’s civilaviation industry rarely engenders a dull moment!

Notwithstanding its reputation as an industry thatcan only incur losses and destroy wealth, the airlinecarrier segment has witnessed extraordinary growth inIndia over the last decade and has the potential tobecome one of the largest aviation markets in theworld. Examples of this potential include WilburRoss’s profitable exit from SpiceJet after a short two-year term and late entrant IndiGo Airlines’ confidentglide to a fifth straight year of profits.

The fortunes of Indian carriers ride with those ofthe external business environment. But they are alsogreatly impacted by government policy. Overall policydirectives notifying changes in foreign directinvestment (FDI) regulations, generally also affect thecivil aviation industry. The Department of IndustrialPolicy and Promotion (DIPP) of the Ministry ofCommerce and Industry heralds policy changes, andthen, in deference to DIPP’s policy, the DirectorateGeneral of Civil Aviation (DGCA) of the Ministry ofCivil Aviation amends its foreign equity participationguidelines for airlines.

In June 2008, FDI upto 49% was allowed under theautomatic route (i.e. no prior approval from theReserve Bank of India is required) subject to some verysignificant restrictions. Only foreign financialinstitutions are permitted to invest in Indian Carriers.Foreign airlines are expressly prohibited from having –

(i) any direct or indirect shareholding interest,financial or commercial tie-up with, or havingany interest, in management of Indian Carriers;and

(ii) loan arrangements, lease-finance and similar tie-ups with Indian Carriers, except for marketingarrangements such as ground handling and code-sharing etc.

FOREIGN DIRECT INVESTMENT ISSUES IN THE BACKDROP OF THE JET AIRWAYS – ETIHADAIRWAYS STRATEGIC ACQUISITION

By Vikas Kumar


Predictably, financial investors with the expertiseand finesse in distressed assets investment have taken achance on Indian carriers. Also not surprisingly, latelythere has been a significant surge of interest amonginternational carriers in acquiring strategic stakes inIndian Carriers. Here we get introduced to anothergame changer – bilateral “Air Services Agreements”(ASAs) that two nations sign to allow internationalcommercial air transport services between theirterritories. The Ministry of Civil Aviation negotiatesASAs with its bilateral counterpart. Since ASAsdramatically influence volume of air services betweentwo nations, they have an exponential impact onstrategic collaborations between airlines. ASAs alsoovertly signify warming of bilateral trade relationsbetween two nations. Hence, the overall policy impactpurportedly travels much beyond the civil aviationsector.

The Jet-Etihad deal makes an interesting case studyin the backdrop of the new FDI regulations and ASAs.On September 2, 2012 the DIPP allowed foreign airlinesto acquire up to 49% in Indian Carriers under theapproval route (Government’s approval is required)and subject to security clearances. The turnstile ofevents thereafter has attracted a lot of debate, as well asmedia and judicial scrutiny. Thereafter, on March 1,2013 the DGCA issued its operational guidelines forFDI in the airline sector. Thus the earlier policyobstacles preventing foreign airlines from acquiringstrategic ownership interest in Indian carriers wereconclusively removed.

Thereafter, on April 24, 2013, the Ministry of CivilAviation announced its revised ASA with the UnitedArab Emirates (UAE) that enhanced seat capacitynearly threefold to 36,670 seats per week, and code-share facilities between designated airlines of bothnations spread over 3 years. The Ministry of CivilAviation has stated that the objective of the revisedASA is to allow carriers of both nations to plan futureoperations and promote Indian and internationalconnectivity.

Curiously enough, on the same date as when thebar against ownership by foreign airlines was removed,Jet Airways and Etihad Airways jointly announcedtheir ambitious strategic deal whereby Jet Airwayswould issue 24% of its paid-up equity to Etihad for US$380 million. Coincidentally, the 24% acquisition stakealso ensured that the deal fell below the Securities andExchange Board of India’s 25% threshold for publicoffers. Other highlights of the Jet-Etihad deal included– (i) a US$ 150 million investment by Etihad in Jet’sfrequent flyer program; (ii) a US$ 70 million purchaseof Jet’s three slots at Heathrow under ‘sale and lease-back’ agreement; and (iii) co-operation on purchasingopportunities for fuel, spare parts, training andmaintenance of aircraft.

The policy changes, which seemed to have beensynchronized with what appeared to be an overnightJet-Etihad strategic deal, predictably invited allegationsthat India’s national interest was being compromised inorder to benefit a particular Indian carrier—in this case,Jet Airways. Given the airline industry’s almostoligopolistic nature, such insinuations are oftenpresumed to be true. The presumption appeared all themore convincing since Etihad agreed to pay a 32%premium over the market-quoted price of Jet’s shares.Questions were raised as to why Etihad would buy intoa debt-ridden company in the struggling Indianaviation sector? An inference was drawn that theGovernment might have engineered or set the stage forthe Jet-Etihad deal by agreeing to policy changesbeforehand in the form of ASA sweeteners. Given theincumbent Government unenviable record of facingmultiple allegations of irregularities in ministerialpolicy making, the presumption of the governmentchanging the regulations to pave the way for the Jet-Etihad deal got added to its rather bad report card.Since the Jet-Etihad strategic deal was in any caseunder the “approval route,” the entire proposalinvariably had to come up before the ForeignInvestment Promotion Board (FIPB) and the CabinetCommittee on Economic Affairs (CCEA) for approval.

In July 2013, FIPB approved the deal subject tocertain conditions – (i) Jet shall seek FIPB’s approval


before making any changes in the Shareholders’Agreement with Etihad; (ii) all shareholder disputesunder the Shareholders’ Agreement shall beadjudicated under Indian laws; (iii) Jet Airways’Articles of Association shall be submitted for approvalbefore the CCEA. It was also reported that prior tosubmission before the FIPB – (i) Etihad’s representationon Jet’s Board of Directors was to be reduced fromthree to two; and (ii) Mr. Naresh Goyal, Jet’s chairmanwould have the right to deliver the “casting vote onany matter;” and (iii) an earlier proposal of shiftingrevenue management to Abu Dhabi was also dropped.This was purportedly done in deference to FIPB’swishes that it required details on who would controlthe management of Jet before arriving at any decision.

In October 2013, after studying the revisedstructure, SEBI also conveyed its prima-facie opinionthat the deal would not trigger “change in control”provisions which absolved Etihad from making anopen offer to public shareholders of Jet. However, SEBIhas left it open to the Government to construe theimplications of the revised Commercial Co-operationAgreement proposed by Jet and Etihad. It is notablethat SEBI also advised Mr. Goyal to divest a 6% stakebefore allotting shares to Etihad, in the interest ofcorporate governance and to ensure well-dispersedpublic shareholding.

On October 4, 2013 the CCEA approved the Jet-Etihad deal, expressing satisfaction that Jet and Etihadhad complied with regulations relating to “ownershipand effective control” issues. On November 12, 2013,the Competition Commission of India (CCI) alsoapproved the Jet-Etihad deal, albeit with a minoritydissenting order, stating that the proposed combinationwas not likely to have appreciable adverse effect oncompetition in India. The CCI though made asignificant observation that the governance structureenvisaged in the Commercial Co-operation Agreementdid establish “joint control” over Jet’s operations andassets.

Meanwhile, simultaneously with the deal lurchingforward before market regulators, the Supreme Court

also admitted a public interest litigation (PIL) andbegan hearings. The PIL was on alleged grounds thatthe ASA with the UAE was devised to facilitate onlythis deal and that it would put the national carrier, AirIndia to disadvantage. In October 2013, though theSupreme Court refused to grant an interim stay on thedeal, it continued its hearings and issued notices to theGovernment and regulatory agencies.

It has been reported that recently the CCI hasrejected Jet-Etihad’s plea to rectify that part of CCI’sorder which observed that (i) with a 24% stake andright to nominate 2 directors, Etihad has “significant”ability to participate in management of Jet Airways;and (ii) Etihad has effective “joint control” over Jet. It ispertinent to note that such observations of the CCIappear at variance with SEBI’s observations on “changein control.” As a consequence, SEBI has also clarifiedits stance stating that if any other regulator (i.e., CCI)raises an issue on the deal, SEBI may also re-considerits order. Based on recent news reports, SEBI hasalready started its preliminary work for reopening thematter. The next roll of the turnstile took place asrecently as December 2013, when the CCI imposed amonetary fine on Etihad for “consummating parts ofthe deal without CCI’s approval.” This relates to Jet’slanding slots at Heathrow for US$ 70 million under thesale and lease-back agreement.

While the Jet-Etihad saga continues, and time willtell how it influences the course of strategic tie-upsbetween international and Indian Carriers, the blemishon FDI reforms cannot be denied. The overnightopening of the India-UAE ASA just hours before theJet-Etihad deal was announced, lends itself to anegative perception of how the aviation sector ismanaged in India.

Herb Kelleher’s quote aptly describes the dilemmaof the airlines industry. It is an industry that isintensely competitive, needs massive capital injectionsto survive because of excessively high elasticity withrespect to fuel prices and the external businessenvironment. Survival in India also means dealingwith competitors who are seen as being able to benefit


from sovereign pacts that are concluded with highopacity to facilitate strategic tie-ups.

Vikas Kumar is a Partner with DH Law Associates,Advocates and Solicitors and advises clients onM&A, private equity and FDI issues. He can bereached at [email protected]


ith increasing globalization and expandingmarkets, it is now commonfor domesticairlines in India to tie-up with international

airlines. India is becoming an attractive aviationindustry destination, given increasing domestic andinternational traffic, a rising addressable market androbust projected economic growth.The recent openingof this sector by allowing foreign airlines foreign directinvestment (FDI) of upto 49% in Indian airlines hasresulted in a considerable increase in activity in thisspace.Businesses world over are making long-termplans of investing and doing business in the India. Thesame is true of the Indian aviation industry.

According to the latest statistics released by AirportAuthorities of India for fiscal year 2013, India iscurrently the ninth largest civil aviation market,handling 121 million domestic and 41 millioninternational passengers. Today, more than 85international airlines operate to India and five Indiancarriers connect to over 40 countries.The Indian civilaviation market has only a tenth of the passenger trafficof United States even though only one per cent of theIndian population hasso far opted for the skies as amedium of transportation.

A special report released by the International AirTransport Association in October 2012 states that ifIndians begin to travel with the same frequency asAmericans, the years ahead could see the Indianmarket boom beyond the two billion passengers peryear mark.The growth potential of the Indian civilaviation market is clearly enormous.

However, the industry faces various challenges;foremost among them is the impact of taxes. There areseveral types of taxes (both direct and indirect)applicable on the aviation industry.

Taxes on Profits

The domestic tax laws of India provide for adeemed basis of taxation (as opposed to actual basis)where 5% of the amount received by a foreign carrierfrom passenger fares and freight receiptsby way of airtransport from any place in India shall be deemedincome of such foreign carrier.Internationaltransportation has been regulated by agreements as amatter of international co-operation between countriespermitting aircraft of other countries tofly in theirrespective jurisdictions on a basis of mutuality.

The Indian government has entered into doubletaxation avoidance agreements(DTAA) with variouscountries to provide bilateral relief to taxpayersbetween the country of residence and country of sourceof income. Where a specific provision has been made ina DTAA entered into by the Government of India withthe Government of a foreign state,that provision shallprevail over the general provisions made in thedomestic tax law.Article 8 of a typical DTAAprovidesfor taxation of profit from the operation of aircraft ininternational traffic and grants the taxing rights to thecountry in which place of effective management ofairline is situated i.e. the place of residence.

Ancillary Revenue

Foreign carriers earn revenues in relation to theirinternational air traffic to and from India derived fromticket sales and cargo traffic. Also, a few foreignairlines, having significant international traffic to andfrom India have, over the years, establishedappropriate infrastructure in India for maintenance andrepair of its aircraft. These airlines make certainrecoveries from other international airlines that, fromtime to time, use the infrastructure facilities in India,

THE IMPACT OF DIRECT AND INDIRECT TAXES ON FOREIGN CARRIERS OPERATING ININDIABy Pawan Khatter and JayantaKalita


either because these airlines do not have similarresources or to augment their existing facilities.

These facilities are generally related to groundhandling and engineering services (repairs,maintenance etc.) provided in pursuance of a reciprocalpooling arrangement envisaged by the InternationalAirlines Technical Pool (IATP) which has been enteredinto by most airlines worldwide. These activities areancillary, incidental and supplemental to the airlinebusiness of operating aircraft in international traffic toand from India.As member of the IATP, any foreignairline providing ancillary services in India to otherIATP member airlines receives similar services fromother airlines worldwide.

The issue arises, whether all income from operationof aircraft in international traffic, including incomefrom ancillary, incidental and supplemental servicessuch as provision of engineering and ground handlingservices under a pooling arrangement to IATPmembers are exempt from tax in India under Article 8of the DTAA. This issue is unfortunately a subjectmatter of long standing dispute with the Indianrevenue authorities, with contradictory decisions of taxcourts in India. The matter is currently pendingadjudication by the High Court of Delhi and has not yetreached finality.

Profits covered under Article 8 should consist in thefirst place of profits directly arising from transportationof passengers or cargo by airlines in internationaltraffic. However, as international transport hasevolved, air transport enterprises invariably carry on alarge variety of activities to permit, facilitate or supporttheir international traffic operations. The article alsocovers profits from activities which are not directlyconnected with the operation of the enterprise's aircraftin international traffic as long as they are ancillary tosuch operation.

Contemporary tax treaty interpretation is to includeancillary, auxiliary, closely related, supplementary andincidental activities, which is applied by taxingauthorities in general.

VAT on Sale of Ticket – Taxation of Ticket Saleson International Travel

An ad valorem (fixed percentage on value) tax onsale of tickets for air travel of passengers is levied onthe airline operator. Such a tax is internationally knownas a ticket tax. Such taxes may be levied either as a VAT(Value Added Tax, which works on the principle of taxon value added in the supply chain) or GST (Goods &Service Tax, a comprehensive tax on supply of goods orservices).

In India, a tax by the name of Service Tax is leviedon airline operators providing services of passengertravel. Service Tax was initially levied in May 2006 oninternational air travel of passengers on an ad valorembasis (rates varying between 10% - 12% since 2006).This was later extended to domestic travel from July2010, albeit at nominal fixed value rate per ticket. Todate both international and domestic civil aviationattract Service Tax at an abated rate.

Levy of GST/VAT on international passenger travelis converse from that of India. Globally, the majority ofthe countries (including European nations, Australiaand Canada) either exempt or levy VAT/GST oninternational passenger travel at zero rates. Manyemerging markets like Argentina, China, Korea, SouthAfrica etc. also do not levy VAT/GST on internationaltravel. Thus, many countries have recognized thepotential of civil aviation and taxing international airtravel as zero rated so as to also avoid tax cascading (acascading tax is a turnover tax applied at every stage inthe supply chain without any deduction for the taxpaid at earlier stages).

In 2012, the Ministry of Civil Aviation in Indiamade a proposal to the Ministry of Finance for removalof Service Tax on air tickets on the ground that thepolicy change would result in economic benefits of tentimes the revenue generated by the exchequer. Theproposal has been considered to the extent thatabatements have been granted to airline operators thusreducing the effective rate of Service Tax. However, the


need is for a complete waiver as was envisaged by theInternational Civil Aviation Organization (ICAO) so asnot to tax international air transport services given thatsuch services are provided outside the boundaries ofany tax authority.

The Tax-On-Tax Conundrum

Levy of tax on aad valorem basis creates issuesregarding the valuation of services. A Service Tax hasbeen sought to be levied by the revenue authorities onthe total fare i.e., basic fare, surcharge as well as taxesand the fees component of the ticket. The Indianrevenue authorities have been aggressively litigatingwith carriers demanding Service Tax on the taxes andfees portion of the ticket fare (i.e., departure and othertrip charges) which are levied by the governments,government departments and airport authorities ofother countries, clearly transcending jurisdictionalboundaries. For example, the Indian revenueauthorities are seeking to subject to service tax theCustoms User Fee levied on arrival of passengers in theUnited States.

The airlines are contending that they have beendesignated by governmentsauthorities to collect suchtaxes and fees from the passengers for administrativeconvenience only. Such taxes and fees do not form partof the revenue of the airlines. Hence, levy of tax onsuch amounts is preposterous to say the least.

Tax-on-tax is technically known as the cascadingeffect which defeats the principle of value added basisof taxation. Moreover, the demand of Service Tax ontax-on-tax is post facto which literally means that theairline would not be in a position to collect it from thepassengers and which, in all probability, may not havebeen accounted as a cost at the time of budgeting ticketfares.

Significant Taxes on Aviation Turbine Fuel (ATF)

Aviation fuel constitutes a staggering 50-60 per centof the total operating cost of airlines in India. TheAssociation of European Airlines (AEA) members

indicate that their fuel constitutes 33 per cent ofoperating cost.

The pricing and tax regime of the Union and StateGovernments in India have made ATF significantlymore expensive compared to international standards.The pricing of ATF in India is based on internationalimport parity prices. Excise duty is levied by theCentral Government on such prices at 8 per cent. Inaddition, VAT is levied by State Governments whichcan range anywhere between 4-30 per cent (dependingupon the State from where ATF is sold). The resultantincidence of tax on ATF could be in the range of 30 percent (assuming a VAT rate of approximately 20 percent). Thus, the price of ATF in India works out to be60-70 per cent higher than international benchmarks.

The Government has accorded a lower rate of VATof 5 per cent on the sale of ATF, but that is onlyapplicable on ATF sold to aircraft having a maximumtake-off mass of less than 40 tonnes. In effect, thisconcession is only available to smaller aircraft andturbo-props. The industry has been lobbying with theMinistry of Finance for extendingthis concessional rateof tax on supply of ATF to all aircraft, but has so farbeen unsuccessful.

Given that the India lacks a comprehensive indirecttax regime (the move towards a comprehensive GSTregime has been sluggish), airlines do not have theability to set off VAT on ATF against their service taxliability.

Even on international travel, the levy of certaintaxes is clearly contradictory to the resolutions agreedunder the Chicago Convention of 1944 (to which Indiais a signatory) which requires the signatories to exempttaxes/duties applicable on fuel and lubricants used inthe aircraft of other signatory nations. Though theMinistry of Civil Aviation has issued notificationsproviding for such exemptions, we understand thattaxes such as ATF are still levied by many States evenon aircraft for international travel.


Other Tax Issues

There are various other tax issues plaguing theaviation industry. Some of these issues includeapplication of a service tax on excess baggage chargesand import cargo, and application of VAT or servicetax on on-board sale of food and other goods.

Taxes are levied on virtually all facets of theaviation sector. Given the growth potential of the

Indian aviation market, particularly internationaltravel, the Government should view this sector as arevenue generator and rationalize the tax regine toprovide a much needed impetus to this industry.

Pawan Khatter and Jayanta Kalita are Senior TaxProfessionals at EY India. They can be [email protected]@in.ey.com.


he aviation and aircraft maintenance industryencapsulates the overall operation, managementand upkeep of aircraft. Globally, there has been a

gradual shift in the industry, with airlines acquiringand leasing aircraft, and outsource Maintenance,Repair and Overhaul (MRO) services to third-parties.In India, due to liberalisation policies of theGovernment over the last two decades, tremendousgrowth has been observed in the civil aviation sector.Many private airlines and corporations in India todayare operating with high operating revenues. Giventhis, the sheer numbers and players involved result inmagnification of the impact of even small changes intax laws, which can change at a rate of more than onceyear!

The Impact of the Indirect Tax Regime on CivilAviation

The indirect tax regime in India is characterised bymultiple levies, which are administered bygovernmental agencies at three levels (central, state andlocal). Principal indirect taxes include service tax onprovision of services, customs duty on import of goods,excise duty on manufacture of goods, and ValueAdded Tax (VAT)/Central Sales Tax (CST) on sale ofgoods. Service tax, customs duty and excise duty areadministered by the Central Government, while VATand CST are administered by the State Governments. AResearch & Development (R&D) cess (tax) is levied onimport of technology under foreign collaborationagreements.

The aviation industry encompasses a whole gamutof activities carried out by airlines, airports and agents.The main activities carried out by airlines in India—which include passenger and goods transportation by

air, ground handling services, repair and maintenanceservices—are primarily subject to service tax.

The aviation sector in India comprises two broadsegments, namely, civil aviation and defence. Customsduty exemptions are available for goods imported inrelation to defence, subject to certain conditions. Asregards civil aviation, indirect tax incentives areavailable for R&D, and for entities located in SpecialEconomic Zones (SEZ). (There are currently over 140SEZs in India with another 630 approved for futuredevelopment.) The tax incentives for SEZ units havethe potential to make India a preferred destination foroutsourcing manufacturing and services, particularlysince there is no attendant export obligation. The onlyobligation is to achieve a positive net foreign exchangeinflow over a cumulative period of five years. Thus,there is great potential for development of aerospaceand MRO units in SEZs.

Prior to July 2012, the service tax regime in Indiawas based on a “positive list” of specified services,which attracted service tax. Since July 2012, the servicetax regime has been based on a “negative list,” underwhich all services attract service tax, other than thosewhich are specified in a “negative list” and those whichare specifically exempted from the levy. With respect toservices provided by a service provider located outsideIndia, the service recipient in India is liable to payservice tax to the government, under the “reversecharge” mechanism.

Thus, all services provided by airlines for aconsideration are now subject to service tax in India,except services covered under the negative list orexempted under an exemption notification. Goodstransportation services provided by air from outsideIndia are covered in the negative list of services, andare hence not liable to service tax. In the case of

TAX TURBULENCE FOR INDIAN AVIATION

By Vikas Srivastava and Sanjeev Sachdeva


passenger air transportation services (domestic andinternational routes), service tax is presently applicableat the rate of 12.36 percent of the consideration. Anabatement of 60 percent is provided for, subject to thecondition that no input tax credit is taken on inputs andcapital 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 taxand VAT is not permitted. As a result, VAT on goodsprocured by the airline industry is a cost which is oftena dead loss, since it cannot be offset against service taxpayable by the airlines on their output services.Another long-standing complaint of the aviation sectoris the non-admissibility of input tax credit (CentralVAT [CENVAT] credit) on Aviation Turbine Fuel(ATF).

Airlines in India incur high costs on domesticprocurement of ATF (40-to-50 percent of operatingcosts, by some estimates). The cost of ATF for domesticoperators is 60-to-70 percent higher than internationalbenchmarks. ATF is subject to multiple taxes, includingcustoms duties (basic duty, as well as additional dutyequivalent to excise duty leviable on domesticmanufacture) and VAT, and other levies such asthroughput fees charged by airport operators andmarketing margins charged by oil marketingcompanies (OMCs) which are typically owned by theCentral Government. The rate of VAT levied on ATFfor domestic air carriers is quite high, averaging 23percent across States according to the Federation ofIndian Airlines. The high rate of VAT levied by mostStates on ATF results in escalating the overallprocurement costs of airlines, the burden of which hasto be passed on to passengers. An added complicationis the fact that VAT rates on ATF vary between States,ranging from 20 percent to as high as 30 percent on theone hand, and from 5 to 12 percent on the other hand.As a fall-out of varying VAT rates, airplanes often haveto carry extra fuel, which results in additional costs byway of increased fuel consumption.

The aviation industry has been trying for manyyears to persuade the government to grant the status of“declared goods” to ATF, which would ensure auniform VAT rate of 4 percent across the country. SomeStates have recently reduced the rate of VAT on ATF,as an incentive to bring down the burden of VAT onairlines and to encourage them to frequently fly to thatState for refuelling, thereby increasing air connectivity.Earlier, only certain OMCs were allowed to importATF. The Central Government has recently allowedIndian carriers to directly import ATF as actual users,which would enable them to avoid the burden of VATon the domestic sale of ATF by OMCs to the carriers.However, to take advantage of this benefit carriers willneed to incur investment and operational costs in termsof storage and logistics infrastructure. To reduce theburden of taxes on ATF, the Central Government hasalso reduced the effective customs duty chargeable onimport of ATF.

Taxability of MRO Services

The surge in demand for aviation services in recentyears has also fuelled demand for support services,including ground-handling, and MRO services. Theseservices play a critical role in contributing to theefficiency standards of the sector. The Government hasrecognised the potential for India to establish itself as ahub for MRO services, which would reduce operatingcosts for domestic carriers and enable other carriers inthe vicinity to fly to India for MRO of aircrafts. Indiahas certain advantages for establishment of MROservices, in terms of expertise in design anddevelopment, and availability of a low-cost pool oftrained engineers and technical personnel. Toincentivise MRO operations in India, customs dutyexemption has been provided on import of aircraftparts and testing equipment for maintenance, repairand overhauling of aircraft used for operatingscheduled and non-scheduled passenger air transportservices, scheduled air cargo services, and charterservices. However, the customs duty exemption is notavailable on parts and testing equipment imported foruse 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 isadversely impacted by service tax, which is levied onthe provision of services. The Indian aviation sectorcontends that neighbouring countries (includingMiddle Eastern and South East Asian countries and SriLanka) do not levy service tax on similar services.Another complaint is the lack of clarity regarding“export of services,” as MRO services provided tooverseas carriers are not considered by the taxauthorities as “exported” from India given that theseare performed in India.

Goods and Services Tax

In many countries, international passenger travel isexempt from levy of Goods and Services Tax (GST) /VAT, while domestic travel is taxed. However, in Indiaservice tax is levied on international as well as domesticroutes, thereby making airlines a highly taxed means oftransportation. The aviation sector has been petitioningfor reduction of indirect tax rates, rationalisation of theindirect tax structure, relief in the service tax burden,and the smooth flow of input tax credits across allindirect taxes, to catalyse growth of the aviation sector.Industry bodies often point out that the indirect taxstructure acts as a disincentive for final assembly inIndia.

The proposed introduction of GST in India presentsa great opportunity to undo the inequitable andonerous burden on taxation on the airline industry.Under the GST regime, it is proposed that there will bea single levy on goods and services, consisting of aCentral and a State component. It is hoped thatappropriate provisions are made for allowing GST paidon goods to be set-off against GST applicable onprovision of services, and vice versa. The cross-utilization of credits across the principal indirect taxeswill present an opportunity to airlines to mitigate theeffects of cascading of taxes. If the government choosesto follow international GST practices, internationalpassenger transportation would be zero-rated. This

would mean zero-rating of any passengertransportation service that begins or ends at a pointoutside India, including round-trip internationaltransportation services. Such a move would directlybenefit passengers and the airline industry, and willgenerate indirect benefits for the economy.

Direct Tax Regime

Unlike indirect taxes, income-taxes are levied basedon the residential status of the taxpayer. Companiesresident 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 onlyon the Indian-sourced income. A company is deemedto be resident in India if it is incorporated in India or ifits control and management is wholly situated in India.

If there is a double taxation avoidance agreement(tax treaty) between India and the country of residenceof the taxpayer, the provisions of the domestic tax lawor the tax treaty, whichever is more beneficial willapply. In order to be eligible for tax treaty benefits, thenon-resident taxpayer will be required to obtain a validtax residency certificate (TRC) with prescribedparticulars issued by the Revenue authorities of thecountry of residence of the non-resident taxpayer.

While resident companies are subject to a basiccorporate tax rate of 30 percent, non-residentcompanies are subject to a basic corporate tax rate of 40percent. In addition, a surcharge and education cessapplies to the basic corporate tax rate taking theeffective corporate tax rate to 43.26 percent for foreigncompanies and 33.99 percent for Indian companies.

India is in the process of implementing anti-avoidance measures called General Anti-AvoidanceRules (GAAR). GAAR provisions were earlierintroduced in the domestic tax law in 2012 to deal withaggressive tax planning and to codify the doctrine of“substance over form;”however, its implementationdate was postponed absent sufficient clarity and theseare now made effective from April 1, 2015.


India is also in the process of revamping theexisting tax legislation with a more reformed Direct TaxCode. However, there is no clarity as yet on the date ofits enactment.

Foreign Airlines Operating in India

Non-resident entities engaged in the business ofoperation of aircraft in India are taxed on apresumptive basis. A specified tax rate of 5 percent isapplied to (a) amounts received by non-residents(whether in India or outside) for the carriage ofpassengers, livestock, mail or goods from any place inIndia; and (b) amounts received in India by non-residents for carriage of passengers, livestock, mail orgoods from any place outside India.

Most tax treaties provide that profits derived by anentity from the operation of aircraft in internationaltraffic are taxable only in the country in which the placeof effective management of the enterprise is situated.Given this and based on the provisions contained in theapplicable tax treaty, profits derived by foreign airlinecompanies from operating aircraft in India would notbe taxable in India, provided the effective place ofmanagement of such airlines is located outside India.Depending upon the facts and the circumstances ofeach case, foreign airline companies may approach theIndian Revenue authorities to seek a specificdispensation to claim this exemption. Suchdispensation may also be utilized by the foreign airlinecompanies for receiving payments without awithholding tax.

Aircraft Lease

In the current tough times for the Indian airlineindustry, with increasing fuel costs, buying an aircraftmay not necessarily be a preferable option consideringthe huge cash outlays, delivery time involved andrapid technological improvements. Leasing an aircrafttherefore has emerged as a viable solution as it helpsincrease the fleet size to fulfill growing demand and isless capital intensive.

Generally, there are two types of aircraft lease: (a)Dry Lease, and (b) Wet Lease. A Dry Lease entails aplain vanilla aircraft lease, without any additionalservice components; whereas a Wet Lease meansleasing the aircraft along with insurance, crew,maintenance, etc. The Dry Lease appears to be thepreferred lease method in India.

Tax considerations vary depending upon the typeof lease. The majority of lease contracts with foreignairlines are “net of tax” arrangements, which meansthat withholding tax (if any) on lease payments is to beborne by the Indian company taking the aircraft onlease. Given this, the tax consideration and theattached costs assume significant importance.

The domestic tax law used to provide taxexemption to foreign companies on lease paymentsmade by Indian companies. The exemption applied toagreements entered into on or before March 31, 2007,subject to obtaining approval of the CentralGovernment. Payments under any lease agreemententered into after March 31, 2007, are not eligible forsuch exemption under the domestic tax law. Absent taxexemption, payment of such lease rental by an Indiancompany to foreign company may qualify as “royalty”as payment for use of or the right to use any industrial,commercial or scientific equipment. Such royaltyincome is taxable at the current tax rate of 27.0375percent (inclusive of applicable surcharge andeducation cess) on a gross basis; this higher rate ismade effective from April 1, 2013. In a situation wherethe lease agreement provides that the tax is to be borneby the Indian company, this could significantlyincrease the cost for the Indian company leasing theaircraft. The tax rate could however be lowereddepending upon the rate prescribed in the relevant taxtreaty (if any) where the foreign company is resident.

Where the relevant tax treaty does not contain aclause dealing with “royalty” income or does not coverlease of aircraft within the scope of royalty income,taxability would need to be examined based onwhether such income could qualify as “Business


Income” or “other income” under the respective taxtreaty.

Typically, Business Income of a foreign entity canbe taxed in India, if the foreign company is construedto have a Permanent Establishment (PE) in India.

The existence of a PE of the foreign lessor in Indiawould largely depend on the nature of activities carriedout by such foreign companies in India. Typically in aDry Lease scenario, where the lessee in India willremain responsible for all aspects of operation,maintenance, insurance and inspection of the aircrafts,mere leasing of the aircraft should not create any PEexposure to the foreign lessor companies. This issuehas been tested in the Indian courts, where the TaxTribunal and Courts have held that the mere presenceof equipment (aircraft) in India should not create PE ofthe foreign company in India. However, certain taxtreaties that India has entered into even provide thatthe presence of substantial equipment itself can betranslated into a PE of the foreign lessor in India.

On the other hand, in a Wet Lease scenario, wherealong with aircraft, the foreign lessor also takesresponsibility of insurance, crew, maintenance, etc.,there may be a potential PE exposure in India for theforeign lessor company, in which case income wouldbe taxed as Business Income, taxable at the rate of 43.26percent on a net basis.

While the decision to lease an aircraft is purelycommercial, the attached tax cost needs to beconsidered when leasing from a foreign jurisdiction.An unplanned transaction can result in increased taxcost.

Maintenance, Repair and Operations Services

Costs incurred by airline companies for MROservices being rendered by MRO operators in India,either by stand-alone foreign companies or even jointventures (JVs) involving big foreign companies, alsoforms a significant chunk of the overall cost base. Anywithholding tax on payment for such MRO services not

only increases the burden of compliance but couldpotentially create cash flow constraints for theoperators working on thin margins against stiffcompetition.

It is currently debatable whether the payment forMRO services qualifies as “Fees for Technical Services”(FTS) subject to a withholding tax. Characterization ofsuch payment would significantly depend on thenature of the services and the definition contained inthe applicable tax treaty where the MRO operator is aforeign company.

Indian courts have generally treated payment forbasic services as not qualifying as FTS, while paymentfor special technical services forming part of MROservices do qualify for FTS, and hence are subject towithholding tax obligations.

Landing and Parking Charges

Also unsettled is the questions of whether chargespaid by foreign airlines on landing and parking chargesto the Airport Authorities of India represent “rent”payments subject to a withholding tax. The presentrate for Indian tax residents is 10 percent.

The Airports Authority provides various facilitiesto aircraft for a fee. The services provided typicallyinclude charges for landing and take-off facilities,taxiways with necessary draining and fencing ofairport, parking route, navigation and terminalnavigation. These charges are based on a weightformula and maximum permissible take-off weight andlength of the stay of the aircraft.

The airlines contend that such payments, beingcontractual payments, should, at best, be subject to awithholding tax at the rate of 2 percent. The IndianRevenue authorities, however, have taken the view thatsuch payment are not mere contractual payments but“rent” and should be subject to a withholding tax at therate of 10 percent.


There are contradictory rulings on this point fromdifferent courts—the Madras High Court, in an actionbrought by Singapore Airlines, has ruled landing andparking fees to be a contractual payment, while theDelhi High Court, in a case brought by United Airlineshas held it to be rent. The issue should attain finality ina much followed case brought by Japan Airlinespending before the Supreme Court of India.

Withholding Tax

The domestic tax law prescribes that any paymentto non-residents, which is chargeable to tax in India,should be subject to a withholding tax at appropriaterates. Certain prescribed payments to residents, arealso required to be subject to a withholding tax.Payment streams between foreign and Indiancompanies, such as for lease of aircraft, MRO services,ground handling charges, etc, need to be thoroughlyexamined to determine appropriate withholding tax.

The withholding tax obligations under thedomestic law of India is quite onerous, and failure towithhold appropriate tax attracts various penalconsequences, such as disallowance of expenses, penalinterest at the prescribed rate payable until the taxesare ultimately deposited, and penalty equivalent to theamount of tax required to be withheld. Consideringthis, the payor typically adopts a conservativeapproach and applies withholding tax, unless the taxposition is very clear that the underlying payment isnot chargeable to tax.

The Need for Clarity

Aviation and aircraft maintenance is a burgeoningindustry in India, and holds great promise for growth.The most prominent example in this regard is the MROsector, which the Indian Government has beenattempting to incentivize. However, the airlineindustry continues to be saddled with many issues,particularly from a tax perspective, which areinhibiting its development and adversely impacting itscompetitiveness.

Greater clarity and certainty surrounding tax issuesand relief from multiple levies of taxes will provideadequate impetus to the aviation industry to realize itstrue potential.

Vikas Srivastava is a Senior Partner at Luthra&LuthraLaw Offices. He heads the Direct Tax Practice of theFirm, and has over 29 years of experience inCorporateTaxation, both domestic as well as international tax. Hespecializes in international taxation and transferpricing. Vikas has represented several largemultinationals and corporates before the tax authoritiesand courts for complex corporate tax and transferpricing matters.He has advised several multinationalson their cross border group structuring and entry/exitstrategies. He has particular expertise in the impact oftax treaties, inbound & outbound investments, transferpricing regulations, corporate and expatriate taxation.Clients have been from diverse fields including autocomponents, aviation, banking, consumer goods,construction, defence, food, hospitality, informationtechnology, infrastructure, insurance, luxury goods,media, oil and gas, pharmaceuticals, power, privateequity, real estate, retail, steel, telecom and travel. Healso has significant experience and expertise in thevarious facets of conceptualization, structuring,constitution and formulation of entry and exit strategiesfor private equity funds and venture capital funds. Vikascan be reached at [email protected].

Sanjeev Sachdeva is a Partner at Luthra & Luthra LawOffices. He specializes in Indirect Taxes, Foreign TradeLaws and the Foreign Exchange Management Act andhas over 30 years of relevant experience. He has been amember of the Indian Revenue Service, and wasconferred with the Presidential Award of AppreciationCertificate for “Specially Distinguished Record ofService” on the occasion of Republic Day, 1999. Sanjeevhas extensive experience in advising clients acrossindustry sectors ranging from hospitality and hospitalsto airlines, infra-structure, oil & gas, retail and BPO. Healso regularly appears before departmentaladjudicating authorities, the Customs, Excise and ServiceTax Appellate Tribunal (CESTAT), FEMA authorities,Settlement Commission and the Authority on AdvanceRulings. Sanjeev can be reached [email protected].


hen the Government of India opened India’sskies by deregulating the aviation sector, Indiawas widely expected to become a dominant

global player in aviation by 2020. This sector, however,which was once considered a sunrise industry, is nowviewed with circumspection because of continuinginadequate infrastructure, escalating fuel prices anduncertain tax policies.

As an alternative to outright purchase of aircraft(which has the potential of adversely affecting abalance sheet), leasing has emerged as a preferredmode of meeting the requirements of increasing fleetsize. The option of leasing not only leverages onoperational efficiency, but also saves considerableamounts of outflows for the cash-strapped aviationsector.

The aviation industry usually adopts twomechanisms of leasing, i.e. the wet lease and the drylease. Under a wet lease the aircraft is provided onlease along with complete crew, maintenance andinsurance. Under a dry lease (also known as a”bareboat arrangement”), aircraft are leased withoutany accompaniments.

Taxation of cross border leasing of civil aircraft,from a direct as well as indirect tax perspective hasbeen a contentious affair and has multi-foldimplications. This article touches upon certain indirecttax and direct tax aspects of cross border leasing andhighlights matters currently being deliberated betweenindustry stakeholders and the tax authorities.

Value Added Tax Considerations

India has not yet adopted the Goods & Service TaxModel, which is otherwise prevalent across the globe.

India’s indirect tax regime is based on a Federalsystem wherein, goods are subject to a state levy that isValue Added Tax (VAT) is levied on transactionsinvolving sale of goods. Services are subject to servicetax which is a Central (Federal) levy. Due to theexisting federal tax system, equipment leasing in Indiahas been extremely litigious because it has been subjectto double taxation in the form of VAT and service tax.

An equipment leasing transaction is considered asa sale of goods under the VAT laws and Constitutionof India, if the right to use the equipment has beentransferred to the lessee. However, case law andamendments of service tax laws carve out an exceptionunder which a transaction is characterised as a“service” subject to service tax if the right to use hasbeen transferred without control, custody andpossession of the equipment.

The tax structure in India also provides thatmovement of goods from one state to another,pursuant to a contract of sale, or the transfer of theright to use of goods (i.e., a lease), are not subject tostates’ sales tax laws and shall be taxable only underthe Central Sales Tax Act, 1956, which is a federalstatute.

Therefore, when the right to use an aircraft istransferred from one state to another it is characterisedas an inter-state transaction. On the other hand, whenthere is a transfer of the right to use an aircraft outsidethe taxable territories of India, or vice versa, thetransaction is characterised as an import/export. Given,however that Article 286(1) of the Constitution of Indiaprohibits imposition of Central Sales Tax (CST) on theimport and export of goods, it can be argued thatairline leases to or from parties in another country falloutside the ambit of the CST. There is a school ofthought that holds that leases qualify as import/export

CROSS-BORDER AIRCRAFT LEASING: AN INDIAN TAX PERSPECTIVE

By Aseem Chawla


only if the agreement for transfer of right to use hasbeen executed outside India. In the absence of anyauthoritative judicial decisions on this aspect andgiven high taxes and litigation costs, the aviationindustry has adopted a practice of executing suchcontracts outside India, as a matter of abundantcaution.

Service Tax Considerations

At the outset, imposition of service tax may occurwhere aircraft are leased without transfer of thecorresponding right to use, i.e., where aircraft areleased without transfer of effective control, custodyand possession.

Under the new service tax regime effective July2012, service transactions are exigible (leviable) toservice tax only if the place of provision of services isin India. In cases of service transactions, where theduration of the lease of an aircraft to be used as ameans of transport does not exceed a month, thelocation of the service provider is considered to be the“place of provision of service.” Conversely, where theduration of the lease of an aircraft to be used as ameans of transport exceeds a month, or where theaircraft is not used as a means of transport, the locationof the recipient of the service shall be regarded as the“place of provision of service.”

To illustrate this legal proposition, where the lessorof an aircraft situated outside India provides theaircraft on lease to the lessee located in India for aperiod less than one month, for the purpose of use asmeans of transport, the place of lessor i.e., a countryoutside India, is regarded as the “place of provision”and accordingly, imposition of service tax would notarise. However, where the aircraft is being leased for aperiod more than one month or is being leased forpurpose other than a means of transport, then theplace of provision of service would be the location oflessee, i.e., India, and hence the provisions of theservice tax law would be applicable.

Customs Laws

Broadly speaking, import of aircraft is subject tocustoms duty at the applicable rate. However,exemptions in the applicable rate of tax have been

issued from time to time by the Central Board of Exciseand Customs (India’s highest indirect taxadministrative body [CBEC]), in certain specifiedsituations, such as:

(i) where the aircraft is imported by an operatoror on behalf of an operator, for operatingscheduled air transport service or scheduled aircargo service; or

(ii) where the aircraft is imported by the Aero Clubof India, New Delhi or a flying traininginstitute approved by the competent authority,for imparting training; or

(iii) where the aircraft is imported by an operatorwho has been granted approval by thecompetent authority in the Ministry of CivilAviation to import aircraft for providing non-scheduled (passenger) services or non-scheduled (charter) services.

Under these scenarios there is an exemption fromdifferential customs duty or a complete exemptiondepending upon the applicable scenario. Despite this,the procedural aspects and clearance formalities foraircraft are rather elaborate. The importer is requiredto seek various approvals from Ministry of CivilAviation, thereby, protracting the entire process ofcustoms clearance.

Direct Tax Considerations

Cross border leasing of aircraft also enjoys aspecial exemption under Section 10(15A) of the IncomeTax Act, 1961 (ITA). However, a sunset clause wasintroduced by the Finance Act, 2005, to provide thatthe exemption shall not be available for agreementsentered after April 1, 2007.

In the aftermath of the withdrawal of theexemption, direct tax is largely governed by the ITA orbilateral tax treaties entered into by India and variouscountries. The extent to which a direct tax liabilityarises depends on the nature of the lease agreement.The foremost consideration is whether a non-residentlessor has a taxable presence in India by way of aPermanent Establishment (PE) as defined by Article 5of those tax treaties. Where a PE is found to exist underArticle 5, the profits that are attributable to such PE arechargeable to tax in India as defined in Article 7(business profits).


Generally speaking, mere leasing of an aircraftwhich is located in India ought not to result in findingthe existence of a PE. The Organisation for EconomicDevelopment and Cooperation has expressly statedthat where an enterprise leases equipment in anothercontracting state without maintaining a fixed place ofbusiness in that other state, the leased equipment shallnot constitute a PE in that other state. This should alsobe so where the lessor supplies personnel to operatethe equipment, as long as its responsibility is limitedsolely to the operation and maintenance of theequipment under the direction, control andresponsibility of the lessee.

A departure from this general principle iscontained in the India-Australia tax treaty, the peculiarprovisions of which stipulate that presence ofequipment in the other state may lead to a finding ofthe existence of a PE in that other state. A detailedexamination of the facts of each case is essential toevaluate whether a PE will be found to exist on thebasis of leasing activities.

There are other considerations regarding thecharacterisation of lease income. Depending on thenature of the lease arrangement, i.e., whether the leaseis an operating lease or finance lease, the lease rentalsaccruing to the lessor may also be characterised as“royalty” or “interest.”

The definition of royalty under the ITA and certaintax treaties, includes consideration for the use or rightto use any commercial, scientific and industrialequipment. Aircraft do arguably fall within thiscategory of equipment (although the equally oppositeargument is also made) and therefore, thecorresponding lease rentals may be characterised asroyalty. However, certain tax treaties which India has,notably with Ireland and Singapore, have explicitlyexcluded aircraft from the scope of this provision.While under the ITA royalty attracts a withholding taxrate of 25 percent (subject to surcharges where incomeexceeds INR 10 million to INR 1 billion), the tax payermay be entitled to the beneficial provisions of the taxtreaty which requires a tax ranging from 10-to-20percent.

The characterisation of lease rentals as royalty maybe appropriate only where the lease arrangement is ofthe nature of an operating lease. Moreover, it isessential that the lessor be in “control” and“possession” of the aircraft, which is usual for a drylease.

In contrast, a finance lease arrangement has certaincharacteristics of a loan for purchase of an asset, ratherthan mere use of an asset. The consideration in afinance lease comprises the selling price along with anembedded interest component. Under the ITA, thisinterest element is taxable at the rate of 20 percent(subject to the same surcharge as a royalty). However,the tax treaties entered into by India do prescribe abeneficial rate of tax for interest, which ranges from 10-to-15 percent.

Most of the tax treaties entered into by Indiaincorporate a separate provision (Article 8) on profitsfrom shipping and air transport. Although, in broaderterms, this Article deals with allocation of taxing rightson profits from operations of ships and aircraft ininternational traffic, certain tax treaties, also includewithin the ambit of this provision, rental of ships andaircraft. For instance, under the tax treaty with Ireland,profits derived by an enterprise of a contracting statefrom rentals of aircraft are taxable “only” in suchcountry.

Another aspect is the entitlement tax depreciationon leased aircrafts. The issue of eligibility of taxdepreciation is often contentious, especially withfinance lease arrangements. However, the SupremeCourt of India has held that the claim of depreciationin the case of a finance lease lies with the lessor,because the lessor fulfils the twin test of “ownership”and “usage for the purpose of business.”

The debate is far from settled. First, the Direct TaxCode, 2010 (which will replace the ITA but whoseeffective date has not yet been announced), grants taxdepreciation to the lessee, rather than the lessor.Second, the Central Board of Direct Taxes— the apexdirect tax administrative body—recently rolled outdraft “Tax Accounting Standards” (TAS) and invitedpublic comment. Among other things the draft TASprovides that in a finance lease transaction, the lessorshall be eligible to receive the benefit of tax


depreciation. It remains to be seen whether these draftprovisions will withstand future judicial scrutiny.Transactions involving the sale and lease of fixedassets have always been viewed with circumspection.

Lease Versus Purchase

In light of the prevailing legal, tax and regulatoryenvironment in India and the recent head winds beingfaced by the aviation industry, the efficacy ofimporting aircraft is a matter of doubt. This isespecially due to the fact that outright importing ofaircraft does have a considerable impact on thefinancial position and liquidity of an enterprise.However, given the lack of clarity surrounding the taxtreatment of transactions involving cross borderleasing of aircraft—including consequential tax andlitigation costs—the cost/ benefit of a leasingtransaction has to some extent withered away.

Aseem Chawla is the founding partner of MPC Legalin New Delhi and leads the firm’s tax practicegroup. He is currently Vice Chair of India Committeeof ABA Section of International Law & is Co-editorof India Law News. He can be reached [email protected]. The author wishes toacknowledge the contributions of Anuj Mathur andShashank Goel, senior associates in the tax practicegroup at MPC Legal.


third "U.S.-India Aviation Summit" was heldin October 2013 in Washington, D.C. Indiasent a distinguished delegation, led by Ajit

Singh, Minster of Civil Aviation, Arun Mishra, DirectorGeneral of Civil Aviation, Y.S. Bave, Chairman of theAirports Economic Regulatory Authority of India andV.P. Agrawal, Chairman of the Airports Authority ofIndia. The U.S. responded with Cabinet officers fromthe Departments of Transportation and of Commerce,and the heads of the Federal Aviation Administrationand the Transportation Security administration.

This impressive gathering spoke to the enormouspromise as well as the daunting challenges of civilaviation in India. India is seen as a huge untappedmarket for both domestic and international air travel,as well as for cargo and private aviation. Manyforecasts anticipate continued growth in civil air trafficand expected demand for many hundreds of newaircraft worth tens of billions of dollars. Alsorecognized are the serious restraints on India's aviationinfrastructure. There are not enough airports and notenough carrier capacity to service growing demand forair travel to non-metro, "Tier II" and "Tier III" cities.

Even if one submits to optimism, and postulates theachievement of new airports and improvedinfrastructure, how are domestic carriers to addnecessary capacity tailored for these emerging markets?How can India participate in the supply of thehundreds of new airplanes and in maintenance andsupport of its growing domestic fleet?

Today there is neither a coherent nor a realisticnational program to answer either of these multi-billiondollar questions. Yet there is so much at stake. Acommercially viable domestic aviation industry canoffer long-term technical and manufacturing

employment for thousands. If India can contribute tothe supply chain for the new aircraft its carriers willacquire in coming years, it will help India to managebalance of trade and current account deficit risks andpromote national economic growth.

Viewing Government pronouncements over recentyears, many airplane initiatives have been touted. Fewhave made real progress. Among this field, however,one prospect shines with opportunity.

A decade ago, Government sources announcedintent to develop the "RTA-70," a Regional TransportAircraft. Then, it was to be powered by turbopropengines, designed by the National AerospaceLaboratory with Hindustan Aeronautics Limited(HAL) envisioned for the production role. As of now,it is only a “paper airplane.”

In December 2006, HAL announced a $700 millionjoint venture with a Russian company to manufacture aMulti-Role Transport Aircraft (MRTA). Intendedprimarily for military purposes, the MRTA was to bejet-powered, carry 18-20 tons of payload or 100+soldiers, and have a range approaching 3,000 miles. A"framework" agreement reportedly was signed inOctober 2012 between HAL and the Russian partner.Supposedly, 150 designers are working on the plane'sdesign. A first flight in 2017 has been promised. Butseasoned observers of aerospace in India know to limittrust to what is verified by observation anddemonstration. Evidence of actual progress on theMRTA is scant. In any case, it never was realistic topropose to develop a "heavy" military transportaircraft, using advanced technology, for $700 million.Embraer is reported to expect to spend nearly $2.5billion to complete development of its KC-390 militarytransport. Moreover, if the MRTA aircraft somehowwere brought to market, it would compete against

A NEXT GENERATION REGIONAL TURBOPROP TRANSPORT: A NATIONAL AEROSPACEPROJECT FOR INDIA

By Robert S. Metzger


established alternatives, such as the Lockheed MartinC-130J, the Airbus A-400M and Embraer’s KC-390.

Another collaboration with Russia also figures intothe equation. India has announced a partnership withRussia to share design, development and production ofa Fifth Generation Fighter Aircraft (FGFA). If thisproject proceeds, its forecast cost of $35 billion, for 200fighters, would be much greater than the $15+ billionthat has been publicly identified as the price India hasagreed to pay Dassault to buy 126 Rafale fourthgeneration “medium” fighters.

India announced the award to Dassault in January2012 but the parties have yet to agree upon thecommercial terms of the deal. The problems may bemore than contractual. One question is whether Indiahas sufficient funds, given the slowing economy andadverse effects of the rupee’s decline in value. Anotheris the present sufficiency of India’s aerospace industrialbase. India has demanded that Dassault satisfy a huge“offset” requirement set at 50% of the Rafale’s purchasevalue. Questions have been raised whether there isenough relevant and competent indigenous industrialcapacity for Dassault to meet this obligation.Reportedly, Dassault and HAL have been unable toreach an understanding on “workshare” division.

Last summer, the Ministry of Defence put out a $3billion tender to replace 56 aging Avro transportaircraft, inviting eight foreign airframe makers topropose partnerships with the Indian private sector.The first 16 aircraft would be purchased off-the-shelf,while the remaining 40 would be manufactured inIndia.

But this solicitation has proven controversial. Theinvited foreign sources may decline to participatebecause the quantities are too small and co-productionin India, on the terms required, may not be realistic.Moreover, Minister of Heavy Industry Praful Patel hasopenly questioned the exclusion of the PSUs,suggesting a political push to move the project to HAL.While it is only public sector unit possessing therelevant competencies, other Government officials haveconceded HAL’s order book is full. As a matter ofhistory, HAL has had trouble finishing and fieldingaircraft. Not until late December 2013 was the IndianAir Force able to induct the Tejas Light Combat Aircraft

into operational service – nearly 30 years after programinception.

In July 2012, the Prime Minister's office announceda commitment of $2 billion for the development of anew Regional Transport Aircraft (RTA), to be designedand built in India. It would carry 70-90 passengers.Should the RTA proceeds as a jet-powered aircraft, itwill find itself squarely in a very crowded market inwhich competition is presented by Bombardier(Canada), Embraer (Brazil), Comac (China), Mitsubishi(Japan), and Sukhoi (Russia). As a jet, the RTA willhave no commercial credibility, if only because of thesurfeit of competition. For India’s specific needs, it haslimited utility, since a jet is most unlikely to be capableof operation from short runways as needed to workroutes to India’s under-served cities.

Yet – if properly executed – the RTA holds greatpromise. As a national initiative, India shouldchampion a long-term program to design, develop,build and support a civil aircraft focused on India’sparticular transport needs. Such an aircraft need notfly fast, but it must be able to operate economically onroutes under 1,000 km and from unimproved airfieldswith short runways. This points to a next generationturboprop-powered transport aircraft.

Turboprops are undergoing something of arenaissance elsewhere in the world, largely as afunction of continuing high prices for aviation fuel thatreward the lower cost of operation (versus a jet) of aturboprop. Indian carriers, the bulk of whom are “lowcost carriers” operating with thin margins, no doubtshare the motivation to employ next generation aircraftthat are miserly in fuel use, as India has among thehighest jet fuel costs in the world. Today, the fuel usedfor turboprops enjoys a favorable advantage undernational and State tax regimes. And turboprops arecomparatively miserly in the use of fuel.

But the dominant reason to look to a nextgeneration turboprop is to answer the infrastructureproblem. However positive the Government’sintentions, it will take many years to add airports andimprove infrastructure. And the costs will be great.India has announced a national imperative to improveair service beyond the key metro areas to provide moreconnectivity to Tier II and Tier III cities. A modern


turboprop does a better job to answer this demand thanconventional jet transports. With a suitably optimizeddesign, this aircraft type can operate from shorterrunways with less improved ground infrastructure,and can handle high altitude destinations well. Thiscomports with the Government’s new plans to expandairport connectivity by emphasizing, initially, newairports for lesser served communities that haverunways too short for typical jets. The lower operatingcosts and potentially reduced maintenance demandsfor turboprops also can translate into economies thatwill translate into lower ticket prices as budget carrierswill seek to introduce air travel to more passengers.

Today, the Government is contemplating variousregulatory and subsidy schemes to compel orencourage domestic air carriers to increase service tothe Tier II and III cities. These have their place, but arenot long-term solutions, because such policies do notanswer airport infrastructure constraints. A nationalprogram to develop a new airplane optimized for Indiamay prove the right answer to India’s need to offer aircarriage to more of its population – and to improve thebalance sheets of domestic carriers.

Many considerations figure into the optimumaircraft. Ability to operate from short runways at highaltitude airports is critical. This will present a designchallenge since a high lift wing can produce higherdrag that works against range and fuel efficiency. Butlow cost of operation and high fuel efficiency are amust, as is reliability and ease of support andmaintenance. Emissions should be minimized. Alsoimportant is the number of passengers that can becarried, comfortably and safely, and passenger flightexperience must appeal to the public (including thosenew to air travel). Cargo handling is another keyconsideration. These factors suggest that a regionalaircraft best suited for India will be one that can holdmore than 75 passengers. It should be planned forgrowth versions that can carry 100 passengers, or more.India should pursue a new “clean sheet” aircraft ratherthan a derivative of some existing design. The aircraftshould employ new generation gas turbine engines toachieve double digit reductions in fuel utilization,produce greater power and improve on emissions.These goals appear achievable, based on variousannouncements of the world’s leading engine suppliers– but they will require a new powerplant (a

“centerline” program, in the parlance of the industry)rather than a derivation of an existing engine.

There are existing turboprops in the market.Bombardier’s Q-400 and the ATR 72 both carry about75 passengers and are optimized for short-haul routes.But neither employs “next generation” advances inmaterials, propulsion, aerodynamics and flightcontrols. Both are at the practical limits of their existingdesign. There is room in the market for a newturboprop that can carry more passengers and operateefficiently from small airports over regional routes.Powerful advances have occurred in many areas ofaviation design over the past decade, but few havebeen realized in turboprop-powered aircraft, thus far.

If it pursues a “clean sheet” advanced turbopropregional aircraft as a national project, rather than acceptan existing design and accommodate its limitations,India can design to its unique requirements and thebusiness needs of its carriers. This may mean that theprogram takes a decade to reach fruition – but that ispar for the course, considering the experience of Chinaand Brazil, for example. And India can “aim high.”The long-term objective is to build hundreds ofairplanes that will be relied upon by Indian flag carriersfor hundreds of domestic routes. The Government canencourage domestic adoption by tax benefits or othersubsidy or preference.

Outside of India, a next generation regionalturboprop can find markets in other countries, such asthe Philippines or the Indonesian archipelago, withsimilar tension between growing demand for domesticair travel and infrastructure limitations. These marketssimilarly will favor airplanes that are inexpensive tooperate and relatively easy to service.

India cannot achieve this promise by going it alone.Nor will it get done by reliance upon the DPSUs.Rather, to succeed such a project virtually “demands”the active commitment of foreign airframe and engineprime contractors. To get that commitment, with allthat it implies as to transfer of technology and sharingof IP and know-how, India must end its pattern ofactive and passive frustration of foreign investmentand ownership in aerospace industries.


In fact, this national aerospace project would be agreat vehicle for India to “pilot” reforms which, oncedemonstrated, could be employed in other areas wherenational industrial base growth is sought and foreignassistance is needed. India could create a specially-chartered national agency to champion this airplaneproject. Suitably empowered, this agency wouldresolve permits and licenses, clarify disputes amongagencies and serve as a “single window” for permits.Corruption risks could be greatly reduced byconcentrating the decision making authority in a fewofficials and using modern information systems thatassure high transparency and efficient decision-making. It would act as the accountable nationalauthority to oversee the private sector partners whomanage the design, development, test and productionof the aircraft.

For such a project, India must involve its leadingprivate sector industrial firms and resist the politicaldemands of the DPSUs to dominate the project. Indiaalso must welcome new foreign investment andactively encourage the participation of existing foreign-owned companies already doing business in India. Inaddition, participation should be open to Indiancompanies whose products are “dual use,” suitable formilitary or civil application. Offset obligations, owedby foreign sellers of military equipment, can beleveraged by awarding “multipliers” on credits earnedthough investments or technology transferred to thenew national aerospace program.

The national aerospace program must becommercially viable. That presents some hard decisionsup-front. The development expense likely will beseveral billion dollars. The market is too uncertain forprivate companies to shoulder that expense and risk.Accordingly, the Government must be prepared tounderwrite the development and perhaps initialproduction as well. This may mean abbreviation orearly termination of other projects, such as several citedabove, that are not producing results sufficient tojustify their costs. The national benefits of a successfuladvanced regional turboprop aircraft project areenormous. The Government’s investment can berecouped in a number of ways, such as manufacturerpayment of license fees or use of debt financing forlater project stages.

Of fundamental importance, a national aerospaceproject to field an Indian advanced regional turbopropaircraft would be a civil project intended forcommercial application. This will greatly reduce thedevelopment cost and time to flight, and will focusdesign and development attention on the low operatingcosts and passenger safety and comfort that are key toprofitable operation by commercial air carriers.Foreign participation will be facilitated as technologyrelease and export are much less problematic when theproduct is civil in character. It is fine to anticipatemilitary derivatives, and the design should recognizeeventual military applications, but the project shouldnot be driven by military requirements. The market istoo small, the costs are too high and a military programwill take too long. Moreover, for near-term militaryairlift needs, India has many choices, as evidenced bythe recent decision to purchase additional C-130Jaircraft from Lockheed Martin.

A national aerospace project, as here described,requires a long-term vision, an investment mentalityand a business-like approach. These may be differentfrom the norm of Government-sponsored projects inIndia, but they can be accomplished with the will andthe necessary organizational and financialcommitment. As the project proceeds, even before afirst aircraft taxis out to test, it will help India todevelop an indigenous aerospace industrial base. Asthat base matures, its benefits to India’s economy areself-evident. It also will assist India in realizing thelong-held national goals of achieving genuine, world-class indigenous aerospace and defence capabilities.More Indian companies can occupy roles as trustedsuppliers in the global aerospace supply chain. Asuccessful advanced turboprop aircraft, once certifiedunder international standards, could position India toexploit international markets with a product that isdistinguished from of other rivals. India can become,at last, an aerospace leader and aviation exporter.

Robert S. Metzger is a lawyer with Rogers JosephO'Donnell, P.C., based in Washington, D.C. Headvises U.S. and international companies onaerospace and defense matters, and has writtenfrequently about the U.S.-India defense industrialrelationship and aviation matters. He is a memberof the International Institute of Strategic Studies(London) and was a Research Fellow at the


Harvard Kennedy School Center for Science &International Affairs. He can be reached [email protected].

An earlier and shorter version of this article waspreviously published in the Economic Times onNovember 13, 2013.


Annual Year-in-Review

Each year, ABA International requests each of itscommittees to submit an overview of significant legaldevelopments of that year within each committee’sjurisdiction. These submissions are then compiled asrespective committee’s Year-in-Review articles andtypically published in the Spring Issue of the Section’saward-winning quarterly scholarly journal, TheInternational Lawyer. Submissions are typically due inthe first week of November with final manuscripts dueat the end of November. Potential authors may submitarticles and case notes for the India Committee’s Year-in-Review by emailing the Co-Chairs and requestingsubmission guidelines.

India Law News

India Law News is looking for articles and recent Indiancase notes on significant legal or businessdevelopments in India that would be of interest tointernational practitioners. The Spring 2014 issue willhave a special focus on the Companies Act, 2013.Please read the Author Guidelines available on theIndia Committee website. The deadline for submissionshas been extended to March 15, 2014. Note that, IndiaLaw News does not publish any footnotes,bibliographies or lengthy citations. Submissions will beaccepted and published at the sole discretion of theEditorial Board.

SUBMISSION REQUESTS


The India Committee is a forum for ABA International members whohave an interest in Indian legal, regulatory and policy matters, both inthe private and public international law spheres. The Committeefacilitates information sharing, analysis, and review on these matters,with a focus on the evolving Indo-U.S. relationship. Key objectivesinclude facilitation of trade and investment in the private domain,while concurrently supporting democratic institutions in the publicdomain. The Committee believes in creating links and understandingbetween the legal fraternity and law students in India and the U.S., aswell as other countries, in an effort to support the global Rule of Law.

BECOME A MEMBER!

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Membership in the India Committee will enable you to participate inan online “members only” listserv to exchange news, views orcomments regarding any legal or business developments in orconcerning India that may be of interest to Committee members.

We hope you will consider joining the India Committee!

UPCOMING SECTION EVENTS (India Committee)

Conference

Threading the Needle in U.S./India Deals:Safe Passage through Formidable Legal RiskHyatt Regency Hotel, New DelhiFebruary 13 - 15, 2014

INDIA COMMITTEE

LEADERSHIP (2013-2014)

Senior Advisors

Aaron SchildhausLaw Offices of Aaron Schildhaus, Washington, D.C.

Erik B. WulffDLA Piper, Washington DC

Immediate Past Co-Chairs

Priti SuriPSA Legal Counsellors, New Delhi, India

Co-Chairs

Sajai SinghJ Sagar Associates, Bangalore, India

Hon. Sanjay T. TailorCircuit Court of Cook County, Illinois

Richa NaujoksNixon Peabody LLP, New York, NY

Vice Chairs

Aseem ChawlaMohinder, Puri & Company, New Delhi, India

Bhalinder L. RikhyeBartlett, McDonough & Monaghan, LLP, New York, NY

Douglas Ochs AdlerVedder Price, Washington, DC

Hanishi Thanawalla AliMithras Law Group, Woodville, MA

Kavita MohanGrunfeld, Desiderio, Lebowitz, Silverman, & Klestadt,Washington, DC

Kaviraj SinghTrustman & Co, New Delhi, India

Vishal GandhiGandhi & Associates, Mumbai, India

Vijaya SampathLakshmi Kumaran &Sridharan Attorneys, New Delhi,India

Shikhil SuriSuri & Suri, New Delhi, India


THREADING THE NEEDLE IN U.S. INDIA DEALS:SAFE PASSAGE THROUGH FORMIDABLE LEGAL RISK

Presented byAmerican Bar Association

Society of Indian Law FirmsServices Export Promotion Council

Hyatt RegencyFebruary 13-15, 2014

Bhikaji Cama Place, Ring Road, New Delhi 110607, India

CONFERENCE CONVENORS

Dr. Lalit BhasinPresident SILF

James P. Duffy, IIIBerg and Duffy

Erik B. WulffDLA Piper

SUPPORTING ORGANIZATIONS

Indian National Bar Association

International Section of the New York State Bar Association

South Asian Bar Association of North America

US-India Business CouncilNew York City Bar

Bar & Bench

THE FOLLOWING ABA SECTION OF INTERNATIONAL LAW COMMITTEES

Asia Pacific Committee


Middle East Committee

International Energy and Natural Resources Committee

International M&A and JV Committee

Aerospace & Defense Industries Committee

Privacy, E-Commerce & Data Security Committee

Export Controls & Economic Sanctions Committee

Young Lawyer's Interest Network

International Arbitration Committee

CSR Committee

Immigration & Naturalization Committee

International Employment CommitteeInternational Legal Education and Specialist Certification Committee

ABA SECTION OF INTERNATIONAL LAW, INDIA COMMITTEE CO-CHAIRS

Richa Naujoks Sajai Singh Hon. Sanjay T. Tailor

CONFERENCE STEERING COMMITTEE

Priti Suri, Rajiv Luthra, and Sajai Singh, Co-chairs

Hanishi Ali Richa Naujoks Kaviraj Singh

Aseem Chawla Ashish Jejurkar Shikhil Suri

Poorvi Chothani Robert Metzger Roland Trope

Vishal Gandhi Kavita Mohan Ramesh Vaidyanathan

Shubha Ghosh JLN Murthy Vikas Varma

Bhali Rikhye

India Law News - Rogers, Joseph O'Donnell

Documents

Transcript of India Law News - Rogers, Joseph O'Donnell