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Simplify service tax, VAT to make aviation sector investor-friendly
February, 19th 2013

The Indian aviation industry has evolved steadily from the days of the erstwhile Tata Airlines (then India's national carrier) with single aircraft operations to a phase that has not only been witnessing a multitude of airlines and airports, but also a gamut of service offerings. These integrated services include passenger and freight movements and aviation allied services, including maintenance, repair, ground handling and general aviation.

The entry of low-cost carriers, higher household incomes, strong economic growth, the opening up of the aviation sector to allow foreign airlines to invest in Indian peers, and surging tourist inflows are the major drivers of growth in the sector.

Having said that, rising fuel prices and the global economic uncertainty, coupled with intense competition, are adversely affecting the financial performance of Indian airlines. There are multiple and cascading incidence of taxes throughout the sector. It appears that the sector is seen as a revenue source rather than a revenue and employment generator for the economy. Although the government has allowed airlines to import fuel, the sector is grappling with high service tax on air travel, airport charges, fuel surcharge, etc..

Generally, aircraft lease arrangements are entered on a net of tax basis (i.e. Indian income tax is borne by the lessee). This increases the cost in the hands of Indian airlines which have to bear the additional tax cost on aircraft lease. Till a few years back, withholding tax on aircraft lease rentals was exempt subject to approval from the central government. This exemption should be restored to ease the tax burden on Indian airlines.

The maintenance, repair and overhaul (MRO) sector is affected by the tax differential in domestic and foreign MROs, which is rendering the sector unattractive. The government needs to rationalize the customs duty on the import of spare parts and simplify the service tax and the value added tax (VAT) regime to ensure a more investor-friendly tax environment.

According to the International Air Transport Association (IATA), fuel accounts for about 45 per cent (as published in business daily on February 14, 2012) of Indian airlines' cost base. There is an urgent need to rationalize VAT on the aviation turbine fuel (ATF) which ranges from 4 per cent to 30 per cent across India. It is a long-standing demand of the industry that ATF be classified under the 'Declared Goods' category with a uniform VAT rate of 4 per cent.

The government has revised the service tax on air tickets and removed the upper limit on taxes. Accordingly, all international and domestic air tickets are subject to 4.95 per cent service tax on the gross fare. This has brought about an upswing in prices, negatively impacting general consumers, making a case for a reduction in the service tax on all classes of air travel.

In the last Budget, overseas borrowing for working capital requirements of airlines was permitted for one year subject to an overall ceiling of $1 billion. This should continue to bring in a long-term respite for bleeding airlines. Further, the government could consider allowing private airport operators to issue long-term infrastructure bonds to raise funds from the market.

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