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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 02
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03 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Executive Summary
India's defence spending has grown manifold since the country announced its
first defence budget in 1950, to INR 1,420 Bn in 2009-10. Of this, approximately
40 percent relates to capital expenditure which is currently driven by equipment
modernisation programmes in each of the three Services. India currently procures
approximately 70 percent of it equipment needs from abroad, but Government's
aim is to reverse this balance and manufacture 70 percent or more of its defence
equipment needs in India. 1
The Defence Procurement Procedure public and private sector defence The key theme of industry’s views on
was issued in 2002 to streamline the industries in India offsets is that offset investment requires
acquisition process and transform the greater direction by Government and
Further
? changes to taxation regime
efficiency and transparency of defence targeting to help ensure that its full
and incentives.
acquisitions. It has been revised and potential benefit is realised. There is
amended in several iterations since, the strong support for extending the use of
Defence procurement process
most recent being DPP Amendment offset credit banking, allowing offset
Throughout the evolution of the defence
20082. In concert with the opening up of credit trading, and introducing the use of
procurement process, Government has
the defence industry to the private multipliers. Industry is upbeat on the
indicated its willingness to improve
sector and foreign investment, the aim introduction of offsets but cautious
policy and its desire to create an
is to bring about a major restructuring about the extent of the opportunity.
effective and efficient procurement
and development of the defence
process. The DPP has evolved
industry in India. Transfer of foreign technologies to India
significantly since its first edition and
is essential for realising the goal of self-
further iterations are expected in 2010.
The Defence industry in India is poised sufficiency. Receipt of technology
The key initiatives now sought by
at an inflection point in its expansion assets under major procurements is
industry relate to:
cycle driven by the modernisation plans, currently the exclusive remit of the
the increased focus on homeland Improving
? visibility of Government’s DPSUs. Industry would like, instead, to
security, and India’s growing defence order book see private sector companies competing
attractiveness as a ‘home market’ Increasing
? industry’s input and with the DPSUs for technology assets.
defence sourcing hub. Government has feedback into the RFP process Technology assets should also be
put in place the building blocks to Improving
? the predictably and eligible for discharging offset
incentivise the growth of a domestic flexibility of the procurement process obligations.
defence industry. A CII-KPMG survey Taking
? steps to reduce bidders’ costs.
identified several factors that are likely The case for a higher Foreign Direct
to influence its future growth trajectory: Investment cap in Indian defence
Defence industrialisation strategy
industry is one of the most hotly
For India of to realise its objective of
? Further development of the defence debated issues amongst defence
building the military capabilities it
procurement process industry players. Opinion on a higher FDI
requires, the Government needs to
cap appears to be divided. The case for
? The forming and actioning of a develop a comprehensive
raising the cap primarily rests on
defence industrialisation strategy to industrialisation strategy for defence.
increasing investment and the transfer
coordinate the use of offsets, The use of offsets will be a critical part
of foreign technologies. The case for
transfer of technology, FDI and the of this strategy.
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 04
maintaining the FDI cap is founded on class of defence company. Companies With skilled intensive manufacturing
sovereignty and security of supply are also critical of the RUR selection capabilities and a world class IT base,
issues and promoting organic industry criteria as being too narrow and believe India has the right ingredients to become
development. Whatever the arguments, that RUR entitlements should be a key link in the global defence supply
the clear expectation of industry is that extended to all. chain. The outlook is bright, but will
the FDI cap will be increased above its require Government’s on-going active
current level of 26 percent. Taxation regime and incentives management and fine tuning of policy,
The fiscal regime plays a critical role in regulations, process and fiscal
The DPSUs continue to dominate any defence market in creating an environment to help ensure strong
domestic defence production and environment that incentivises and domestic growth and achievement of
Research & Development facilities in supports the long term risk taking, self-sufficiency.
India. Their role and that of Raksha investment and R&D required by the
Udyog Ratnas and other private sector industry. The view generally given by
companies needs on-going appraisal and the global defence industry is that India
alignment to ensure their respective currently has a comparatively aggressive
strengths and capabilities are best and complex tax regime. Whilst tax
optimised. Government needs to ensure laws provide various exemptions and
a level playing field between the DPSUs concessions applicable in the defence
and private sector players, and DPSUs sector, these are restrictive and seldom
should be encouraged to focus on their defence sector specific. Given the
core capabilities and strengths and strategic importance of the defence
increase the quantum of ancillary sector, Government is urged to consider
business they outsource to the private further exemptions or concessions to
sector, possibly divesting of non-core the defence sector as detailed in this
capabilities. The private sector should report, for example, the establishment of
also be allowed a larger role in defence dedicated defence specific SEZs,
R&D. establishment of a tax equalization
subsidy linked to value of goods and
RURs were conceived as private sector
services supplied to the Defence Sector,
defence champions which would be
and exemptions to offset JVs from R&D
‘treated at par’ with DPSUs. Industry
Cess, etc.
players are sceptical about the
advantages of introducing an additional
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05 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 06
TABLE
03 T HE DEFENCE PROCUREMENT PROCESS | 35
O
F
04 D
CO
| 39
NTEN
06 F UTURE OUTLOOK | 59
07 GLOSSARY OF TERMS | 69
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07 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
01 Accelerating
the growth of the Indian defence industry
One thing is clear from our research; the CII’s Defence and Aerospace Division and
Government needs Indian industry to KPMG have sought the views of CII’s
respond to this opportunity in a rapid and members and the major players in the
well structured manner, making best use Indian defence industry, both foreign and
of the skills, capabilities and resources domestic, on the challenges that face the
available to it; and Indian industry needs development of the industry in India. This
the Government to provide a defence report sets out the context, both domestic
industrialisation strategy and appropriate and global, for the development of an
planning, procurement, legal, regulatory indigenous defence industry in India, the
and tax environments. factors currently affecting the growth of
the industry in India, and suggests
changes which could be made to defence
acquisition policy and procedures, foreign
direct investment (FDI) regulations and the
tax regime in India which would facilitate
the continued growth of the defence
industry in India, but at an accelerated
pace.
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 08
© 2010
2009 KPMG,
KPMG, an an Indian
Indian Partnership
registered partnership
and a member
and firm
a member
of the firm
KPMG of network
the KPMG of network
independent
of independent
member firms
member
affiliated with
firms affiliated
KPMG with KPMG
International International,
Cooperative (“KPMGa Swiss cooperative.
International”), All rights
a Swiss reserved.
entity. Printed
All rights in India.
reserved.
09 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 10
The Global Context: Global defence expenditure is on an upwards trend, increasing 45 percent since 1998,
with the highest growth in Eastern Europe and North America1
800
600
400
200
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
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11 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
The United States continues to dominate global military spending, with India as the
10th largest defence spender worldwide
India
3%
Russia Rest of the world
3% 28%
Italy
3% US
Germany 44%
3%
Japan
3%
UK
4%
France
5%
China
5%
The United States has historically India is currently the 10th largest defence
accounted for the majority of global spender in the world with an estimated 2
defence spending and the trend continued percent share of global defence
in 2007 with US accounting for close to expenditure, but with the third highest
half of the global total, followed by UK, growth rate.3
China, France and Japan, each
representing between 3 to 5 percent
share of the world’s total defence
expenditure. The 27 European Union (EU)
member states collectively accounted for
21 percent of the global defence
expenditure. The member states of North
Atlantic Treaty Organisation (NATO) on the
other hand account for 71 percent of the
total military expenditure worldwide.3
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 12
Russia has the highest annual growth rate with India third
25%
21.7%
20%
15% 13.0%
9.3%
10% 8.6%
5.4%
4.7%
5% 2.7%
2.1%
0.3%
0%
-0.3%
-5%
Russia China India US Saudi UK Italy France Germany Japan
Arabia
Note: Growth rates calculated on the basis of defence expenditures in local currencies
Source: CIA World Factbook 2008, SIPRI Military Database, KPMG Analysis
Over the previous decade, US military Indian defence expenditure has grown at a
expenditure has more than doubled in real relatively high rate of 9.3 percent
terms, principally because of large compared to many other countries,
spending on military operations in South emphasising the increasing prioritisation of
East Asia and Iraq, but also because of this sector by the Indian Government.
increases in the ‘base’ defence budget.
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13 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Japan 0.8%
Canada 1.1%
Spain 1.2%
China 1.4%
Germany 1.5%
Italy 1.8%
Australia 2.4%
UK 2.4%
India 2.5%
Brazil 2.6%
France 2.6%
South Korea 2.7%
Russia 3.9%
US 4.1%
Saudi Arabia 10%
0% 2% 4% 6% 8% 10%
Amongst the largest global defence Not surprisingly, the Middle Eastern
spenders, Saudi Arabia has the highest countries tend to show the highest focus
military spend as a percentage of GDP (10 on military spending partly driven by the
percent). Other large spenders typically perceived levels of threats in the region.
have had military budgets in the range of 1 Oman’s military budget is the highest as a
– 4 percent of the country’s GDP. Although percentage of GDP at 11 percent, followed
US defence spending in 2007 has been by Qatar, Saudi Arabia, Jordan and Israel5.
higher than at any time since World War II,
its share of GDP is much lower at 4
percent in 2008 as compared to
approximately 40 percent during the war5.
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 14
The roles of state and the private sector in the global defence industry differ
from country to country
Government continues to play an Some countries have integrated their Russian defence industry, for both exports
important role in various countries defence industry into one state/jointly and domestic procurements, such as the
Various governments worldwide have controlled industry Sukhoi/ MiG’s candidature in the Indian
adopted different strategies to determine Some major defence spenders have 126-plane Medium Multi-Role Combat
the role of the private sector in the decided to integrate their large defence Aircraft (MMRCA) competitive bid.
defence industry. In many countries, the companies in to a single entity jointly
government continues to dominate the controlled by the State and the private The private sector has played a major
sector primarily driven by the sensitive sector. An example of this is provided by role in the development of the defence
nature of the industry. the European Aeronautic Defence and sector in some countries
Space Company (EADS), currently the The private sector plays a significant role
For example, despite liberalisation, the world’s sixth largest defence company in in the United States defence sector, with
Chinese government controls a major terms of revenue from defence operations contracted troops employed in the
stake in the country’s defence sector (see table below). EADS was developed as ongoing conflicts in Iraq and Afghanistan.
viewing the industry to be too critical to a trans-European organisation in 2000 with The extent of participation of the private
national security for it to be privatised and the merger of DaimlerChrysler Aerospace sector is exemplified by the 140,0009
keeping the Defence Industry Enterprise AG of Germany, Aérospatiale-Matra of contracted troops outnumbering the US
Groups (DIEGs) under much stricter France and Construcciones Aeronáuticas military personnel in Iraq in 200710. Even in
supervision than other types of reformed SA of Spain. According to the latest Japan, the defence industry is heavily
state-owned enterprises. shareholding pattern of the company, 10 dominated by a few large players (Toshiba,
percent is owned by the French State7 and Mitsubishi etc.). According to recent
Nonetheless, the private sector has statistics released by the US Department
5.5 percent by the Spanish State8.
shown its eagerness to be part of the of Commerce, 95 percent of the Japanese
opportunity to develop and produce arms The Russian government also decided to Ministry of Defence’s acquisition budget is
for the People’s Liberation Army as well as integrate its defence companies into one spent within a concentration of just 12
for exports. The government has partly government controlled company - the companies. Further, it is estimated that
acceded to demands from the private United Aircraft Corporation (UAC). The about 70 percent of the procurement of
sector, allowing non-state enterprises to Russian government holds a controlling 91 defence systems is done through a no-bid
enter the defence market – for example in percent stake in UAC and the company is system to these companies11. However,
2005 it was announced that the State was headed by the defence minister of Russia. there exists a ban on these companies
prepared to subsidise private sector arms The UAC has become the realisation portal exporting their products and this limits
production6. for various projects undertaken by the their dependency on domestic markets.
6. “Rising China”, Strategic and Defence Studies Centre, 2005 8. Holding through state owned company SEPI 10. LA Times, July 04, 2007, “Contractors outnumber troops in
Australian National University 9. www.nolanchart.com, “Obama warned not to take peace for Iraq…”
7. Holding through partially state owned company SOGEADE granted” 11. BMI Industry Reports, Japan Defence and Security Report, Q1
2009
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15 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 16
S.No Company Country of origin Annual Defence Revenue, Defence Related Businesses
2008 (USD Bn)
4 BAE Systems UK 30.5 Delivers a range of systems and services for all three
forces, as well as advanced electronics and Information
Technology (IT)
6 Eurocopter and Typhoon EU 23.4 A trans European organisation and makers of the
Eurocopter and Typhoon fighter jets, the company has a
significant presence in North America as well
10 L3 Communications US 14.9 The sixth largest defence company in the US, and a prime
defence contractor in Intelligence, Surveillance and
Reconnaissance (ISR), secure communications, training,
simulation and aircraft modernisation
Note: Only revenues from defence subsidiaries taken into account; revenues for the year ending December 31st, 2008
Source: SIPRI Yearbook 2008, Company Annual Reports, OneSource
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17 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Overview of Defence India’s defence spending has grown manifold since the country announced its first
defence budget in 1950.
Spending in India India’s Growing Annual Defence Expenditure
Defence Expenditure
160
142
140
t
rcen
120 R1 2 pe
CAG 105
100 93
86
INR billion
77 81
80
60
54 56
60 50
40
20
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 18
18%
9th Defence Plan 10th Defence Plan 11th Defence Plan
16%
avg. = 15%
14%
12%
10%
8%
6%
4%
avg. = 2.5%
2%
0%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
% GDP % CGE
As a percentage of GDP, India has been economy to date. The Government, as the
able to maintain defence expenditure to a sole purchaser of defence equipment,
range of 2 to 3 percent, in line with other spends heavily with defence expenditure
major developed nations, signifying a fairly accounting for close to 15 percent of the
steady focus on defence within the Central Government Expenditure.
Revenue, i.e. operating, expenditure, Split between Revenue and Capital Expenditure
accounts for the majority of the
expenditure Changed in Defination
At the macro level, defence expenditure is 24% 25% 25% 25% 30% 27% 28% 42% 40% 39% 41% 46% 39%
100%
divided into two categories: ‘Revenue’ and
‘Capital’. ‘Revenue’ expenditure includes
80%
expenditure on pay and allowances,
maintenance, transportation and all stores
60%
expenditures on utilities, whereas the
‘Capital’ expenditure includes creation of
40% 76% 75% 75% 75% 70% 73% 72% 58% 60% 61% 59% 54% 61%
assets and expenditure on procurement of
new equipment.
20%
0%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Revenue Capital
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19 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
RESTRUCTURING BUDGET
With effect from FY 2004-05, all issues from the Ordnance Factories are accounted
in the capital budget as against previous accounting in the revenue budget. The
committee headed by former Secretary-Defence Finance, PR Sivasubramanian,
redefined the classification of the expenditure under the two categories, thereby
causing a change of the capital to revenue ratio in favour of capital14
Whilst the Army accounts for a majority capital budget has been close to 30 General of Quality Assurance (DGQA)
of the budget, the Air Force has the percent16. However, when seen as a account for a small portion of the Indian
largest procurement programme percentage of the total military spend, the military budget; typically close to 5
The Indian Army is the third largest in the Navy still accounts for about 20 percent of percent17. However, there has been
world with over 1.1 Mn soldiers in active the total budget.17 greater demand from the defence industry
service. Being personnel heavy in nature, to increase this spending and also to direct
Other defence organisations such as the some of it towards the private sector.
it accounts for a majority of the defence
Defence Research and Development
budget typically accounting for over 50
Organisation (DRDO) and Directorate
percent of the entire defence budget.15
However, within the Army only
approximately 25 percent16 of the
expenditure is incurred under the capital Distribution of Military Expenditure 2008 - 2009
head, with the remaining being spent on
the maintenance of equipment and
personnel.
Others
Others
Unlike the Army, the Air Force and the 6%
7%
Navy spend the majority of their budgets
Air Force Air Force
on capital expenditure. 29% 40%
14. Defence Service Estimates of respective years 16. Defence Service Estimate 2008-09
15. www.janes.com 17. Economic Survey
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 20
development (R&D) support. Today, India account for more than 65 percent of the
maintains an extensive defence industrial total industrial output of all defence public
base with 40 Ordnance Factories and sector entities in India18. During 2007-08,
eight DPSUs which are engaged in the the value of production by DPSUs totaled
and systems for the armed forces18. Over 20 percent as compared to the previous
Hindustan Aeronautics 86,250 Design, development, manufacture, repair and overhaul of aircraft, helicopters, engines and their accessories
Limited (HAL)
Bharat Electronics Limited 41,025 Design, development and manufacture of sophisticated state-or-the-art electronic equipment components for
(BEL) the use of the defence services, para-military organisations and other government users
Bharat Earth Movers Ltd 27,133 Multi-product company engaged in the design and manufacture of a wide range of equipment including
(BEML) specialised heavy vehicles for defence and re-engineering solutions in automotive and aeronautics
Mazagon Dock Limited 23,217 Submarines, missile boats, destroyers, frigates and corvettes for the Indian Navy
(MDL)
Garden Reach Shipbuilders 5,566 Builds and repairs warships and auxiliary vessels for the Indian Navy and the Coast Guard
& Engineers Ltd (GRSE)
Bharat Dynamics Limited 4,543 Missiles, torpedo counter measure system, counter measures dispensing system
(BDL)
Mishra Dhatu Nigam 2,550 Aeronautics, space, armaments, atomic energy, navy special products like molybdenum wires and plates,
Limited (MIDHANI) titanium and stainless steel tubes, alloys etc.
Goa Shipyard Ltd (GSL) 269 Builds a variety of medium size, special purpose ships for the defence , Indian Coast Gaurd (ICG) and civil
sectors
18. MoD Website and CII Website 19. Keynote Address by Shri A.K.Antony, January 23-24, 2009,
National Seminar on Defence Industry
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21 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
The private sector in the Indian defence factories, and were able to become overall market. Currently, the defence
industry is still evolving manufacturers of more advanced defence market for private sector firms in India,
The production of defence equipment equipments and systems. which includes outsourcing from DPSUs
was, until relatively recently entirely a and ordnance factories is estimated to be
In terms of market share, the Indian worth USD 700 million9. This spend is
government function. The Industrial Policy
private sector is still at a nascent stage expected to increase steadily with the
Resolution, 1948, restricted the entry of
compared to the private sector in other growing participation of private players in
the private sector into this industry.
developed nations. Foreign companies the Indian defence industry that the
However, in May 2001, the sector was
account for the majority of procurement Government is keen to encourage.
opened for private sector participation,
from the private sector in India, with
with 100 percent private sector ownership
approximately 70 percent of Indian Major Indian industrial houses like the
permissible and FDI of up to 26 percent.
defence procurement coming from TATA Group, Mahindra Group, the Kirloskar
Under this policy all defence related items
overseas sources. Of the 30 percent of Brothers and Larsen and Toubro have
were removed from the reserved category
orders placed in India, only an estimated 9 diversified in to the defence sector,
and transferred to the licensed category.
percent is attributed directly to the private forming joint ventures with foreign
This led to a paradigm shift in the structure
sector. Along with this, the private sector companies on both strategic and product
of the defence industry as private players
also accounts for 25 percent of the specific bases.
were no longer restricted to supplying raw
components provided to the DPSUs,
materials, semi-finished products, parts
giving them a 14 percent share in the
and components to DPSUs and ordnance
Tata Advanced Systems 2007 Design, manufacture and supply of composite components, sub-assemblies for applications in
Limited (TAS) aerospace division and solutions for personal armour, vehicle armour and special applications.
Larsen and Toubro - Design, development and manufacture of integrated land based /naval combat/missile systems,
defence electronics & control systems and integrated naval engineering systems
Kirloskar Brothers - Infrastructure projects (water supply, power plants, irrigation), project and engineered pumps,
industrial pumps
Mahindra Defence Systems 2001 Total solutions for the range of light combat/armoured vehicles, simulators for weapons &
weapon systems, sea mines, small arms, variants and associated ammunition.
Ashok Leyland 1970s Design, development and manufacture of special vehicles, serving Indian Armed Forces and
international customers such as US army
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 22
Micro, Small and Medium Enterprises are large private players. DPSUs and ordnance
dependent on outsourcing factories outsource 20-25 percent of their
A large number of micro, small and requirements to the private sector20. Out
medium-size enterprises (MSMEs) also of this outsourcing, approximately 25
operate within the Indian defence industry, percent requirement is met by the small-
providing components to the DPSUs and scale sector.
Due to the need for updated equipment, also highlights the need for modernisation
Procurement India is set to undertake one of the with ‘obsolete’ equipment currently
Objectives, Structure, largest procurement cycles in the world accounting for 50 percent of equipment
(see graphic below), whereas the Ministry
and Regulations India’s Procurement Objectives of Defence’s required profile would have
The last major ammunition procurement this at 30 percent. The proportion of state
undertaken by the Indian military was for of the art equipment also needs to grow
the Bofors Howitzers in 198621. The Kargil from its current level of 15 percent to 30
conflict of 1999 highlighted the percent. Hence, during the last decade,
shortcomings of equipment held by the the Indian defence industry has been in
Indian Armed Forces, highlighting the the process of undertaking one of the
need to modernise the equipment largest procurement cycles in the world.
portfolio. As previously illustrated, a The current cycle, which includes the
significant share of the current annual acquisitions drafted under the Long Term
defence budget supports the maintenance Integrated Perspective Plan (LTIPP), is
of current equipment, rather than the expected to include procurements worth
procurement of new equipment. The USD 100 Bn by 2022.
current profile of the equipment held
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23 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
The Indian Armed Forces have announced aircraft procurement deal worldwide since KPMG, approximately 62 percent of the
some significant forthcoming the 1990s’22. There are several other billion companies believe that Indian market is an
procurements in recent years. The largest dollar plus deals that are making India’s attractive proposition for foreign defence
announced to-date procurement is the current procurement cycle one of the companies owing to India’s large
USD 10.5 Bn MMRCA procurement for most attractive markets for defence procurement plan.
126 combat aircraft, which will be India’s companies worldwide. In the survey of CII
largest procurement and the ‘largest Defence Division members conducted by
Air Force
Deal Size in USD Offset Size Deal Status RFP Type Bidders/ Expected Bidders
127 Multi Mission 10,000 MN 50% Field trial being conducted Buy & Make Lockheed Martin , Boeing,
Role Combat Aircrafts (Global) Dassault, UAC, EADS, Saab Gripen
6 Transport Aircrafts 1,000 MN 30% Nomination Based.Trials is expected to take Buy Global NA
place in 2012, prior to formal induction.
12 Heavy lift 700 MN 30% Tender released on 26 May 2009 Buy & Make Boeing, Sikorsky, Bell, Augusta
Helicopter (Global) Westland, Eurocopter, Mil-MI
Design bureau.
Army
Deal Size in USD Offset Size Deal Status RFP Type Bidders/ Expected Bidders
197 Light 3,000 MN 50% Tender released in 2008 after cancellation Buy & Make Elbit, Thales, Marconi, Motorola,
Observations/Utility of previous tender of 2004. (Global) Ericsson, Raytheon, Honeywell
Helicopters
Future Infantry Soldier 1,100 MN 30% Tender released by DRDO. Buy Global Elbit, Thales, Marconi, Motorola,
as a System Global tender issued by MoD in April 2008 Ericsson, Raytheon, Honeywell
(F-INSAS)
Howitzers 2,170 MN 30% The Army at this stage has plans to phase Buy & Make NA
the 105 MM field gun (Global)
Navy
Deal Size in USD Offset Size Deal Status RFP Type Bidders/ Expected Bidders
7 Scorpene 3,500 MN 30% Tender to be issued Buy & Make Companies engaged in electronics,
Submarines (Global) weapon control, fire control,
navigation systems, turbine engine
manufacturing, generators, standoff
weapon systems.
12 Stealth Frigates 7,600 MN 30% RFP to be issued Buy & Make Similar to above
(Global)
16 Multi Role 1,000 MN 30% Issue of tender- 10 Aug 2008 Buy & Make Finmeccanica & others
Helicopter (MRH) (Global)
22. Mark Kronenburg, Boeing ASPAC, Defence Industry Daily, April 19th, 2009
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 24
Ministry of Defence has restructured implementation to the Service the Ministry of Defence has been
itself in order to improve efficiency Headquarters, Inter-Service Organisations, categorised in to four departments based
The principal task of the Ministry of Production Establishments and Research on areas of functions:
Defence is to create policy framework for and Development Organisations. In India,
MINISTRY OF DEFENCE
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25 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
The structures and processes for long prioritising equipment requirements from
term planning and procurement have the services. Long term plans are drafted
also been revised to provide greater under the LTIPP the first edition of which
transparency is currently two years delayed and will
The Integrated Defence Staff (IDS) is cover the requirements under the 11th,
responsible for preparation of both short 12th and the 13th five year plans. The
term and long term perspective planning LTIPP is further broken down into shorter
documents for the requirements of the
23 plans, namely the 5 years Services Capital
armed forces, receiving and Acquisition Plan (SCAP) and Annual
23 Acquisition Plan (AAP)23.
‘BUY’ PROCEDURE
Following the Kargil conflict of 1999, a
number of shortcomings in the
Buy would mean an outright purchase of equipment. Based on the source of procurement procedures in the country
procurement, this category would be classified as ‘Buy (Indian)’ and ‘Buy (Global)’. were highlighted, showcasing the need for
‘Indian’ would mean Indian vendors only and ‘Global’ would mean foreign as well as a revision. Hence, the roles of three
Indian vendors. ‘Buy Indian’ must have minimum 30 percent indigenous content if organisations were redefined in order to
the systems are being integrated by an Indian vendor assist the armed forces to acquire new
equipments:
23. DPP 2008 and MoD Website 24. DPP Amendment 2009
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 26
25
Special Secretary (Acquisition) to the ‘MAKE’ PROCEDURE
DPB. Once the DPB clears the
proposal the approval of the Defence
Acquisitions covered under the ‘Make’ decision would include high technology
Minister, Finance Minister and the
complex systems to be designed, developed and produced indigenously
Cabinet Committee for Security is
taken.
Once an acquisition has been approved by and tenders are floated for the approved technical/commercial evaluations of their
the above mentioned personnel, a acquisition. This is followed by a bidding bids before the granting of the contracts
Request for Information (RFI) is issued, process by respective companies and (see graphic below).
followed by a Request for Proposal (RFP),
Procurement Timeline
Contract Signing Thus the cumulative process takes around 20-34 months
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27 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 28
Increased information
?
provided during issue of
RFPs
…During the development of the DPP 2006, it was decided to review the policy every two Indian prime in ‘Buy (Global)’
years in order to keep up to date with the demands of the industry; as per latest press tenders
reports it has been announced by the MoD that the DPP will be revised on an annual basis
The Ministry of Defence has made clear period by issuing amendments to DPP
its intent that the DPP will continue to 2008 coming into effect on November 1,
evolve in response to the needs of the 2009. The amendments have been issued
Services and equipment vendors, both with the twin objectives of facilitating
foreign and domestic. It was until recently wider participation of Indian industry in
envisaged that a review of the defence procurement and to ensure
procurement procedure would be increased transparency.
undertaken every two years. However, the
MoD has narrowed down the review
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29 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
The Indian offset policies have undergone incorporated in DPP 2008. Also in 2008,
major evolutionary changes since their offsets were no longer required where the
inception in 2006. Offsets were relevant products which contained at least
introduced at 30 percent of the contract 30 percent of indigenously-developed
value; however a clause increasing offsets content27.
to 50 percent on a per case basis was
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 30
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31 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Country MTV (USD Mn) Offset Range Multipliers Penalties Areas of Focus
Austria 1.1 100 – 300 None N.A. Direct Investment, R&D, technology transfer and sub
percent contracting
Hungary 5.0 100 percent 1.0 - 2.5 6 percent Defence, biotech, nanotech, environment, renewable
energy, electronics, IT, telecom
Italy 7.5 70 percent Up to 3.0 10 percent Provide export opportunity for Italian companies
Kuwait 10.0 35 percent 1.0 - 5.5 Upto 6 percent Transfer of technology, job creation, provision of
educational and training opportunities
Spain - 100 percent 2.0 - 5.0 5-10 percent Technology similar to the product purchased, improving
the armed forces, increasing R&D
UK 17.0 100 percent None None Sovereign capability, competitive and leading edge
domestic industry and added overseas business
Although the benefits of offsets have been Although the licencing eligibilty licensing conditions constrained possible
recognised internationally, certain conditions for Indian JV offset partners offset partners for foreign vendors to
developed nations have decided to do were dispensed with in DPP 2008, the established Indian defence manufacturers.
without offsets as they believe that offsets licencing norms of DIPP for defence They were dispensed with in DPP 2008
are against ‘free market policies’. Major production still apply providing the foreign vendor with
examples of such countries include US, In 2002, the Department of Industrial increased flexibility in choosing their offset
Japan, Germany and France. A report Policy & Promotion (DIPP), in consultation partner. However, licensing norms of the
published by the European Defence with the MoD, issued guidelines through Department of Industrial Policy and
Agency in 2007 claims that “offsets should Press Note No2 (2002 Series) for licensing Promotion (DIPP) still remain applicable,
ideally by phased out eventually” and that the production of arms and ammunitions. so whilst licenses are no longer required
it is “generally difficult to justify any type Licensing requirements in DPP 2006 for the forming of offset businesses per
of offset on the basis of Article 296 [of the made it binding for any Indian offset se, they are still required by any business
Treaty of the European Union]”30. partner to have a license in order to be involved in the production of arms and
eligible to partner a foreign vendor in its ammunitions.
offset obligations discharge. These
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 32
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33 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
In India few private players have started industry participation still remains at a
formed strategic alliances with global nascent stage as compared to other
players to fulfill current requirements and developed nations:
ISRO - Indian space Raytheon Installation of GPS system at 100 airports across the country; total cost of project was USD 22 MN
Research Orgnaisation
Wipro Technologies Lockheed Martin Opened up a Network Centric Operations Centre in India providing net enabled capabilities and
solutions for potential civil and military applications.
Tata Real Estate Changi Airports Intl. Formed a consortium (Tata group holds a 51 percent stake and Singapore's Changi the remaining 49
percent) to modernise Kolkata and Chennai airports
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 34
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35 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
03 The Defence
Procurement Process
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 36
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37 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
used to provide sufficient rationalisation of DPP Amendment 2009 includes preferred. It was felt that SHQ, which is
requirements. RFPs continue to be amendments enabling improvements in responsible for drafting SQRs, should be
overspecified, input rather than output the formulation of SQRs. The new allowed to decide at the outset whether it
based, and without sufficient mandatory requirement for issue of an RFI is targeting specific products or
determination being made as to what has been made mandatory for all technologies or whether there is genuine
requirements are genuinely mandatory procurement cases provides advance scope for competition. In the case of the
and which could preferably be classed as information to the industry about the former, there should be procurement
desirable. As a consequence, there are a procurement and also helps SHQ to procedures which allow for and dictate the
high number of retractions of RFPs due to formulate SQRs based on readily available circumstances wherein a single source
specifications not being aligned to what is technology in the world. procurement can be made. Currently, only
available in the market. Companies the FTP is available for such
recognised that there is balance to be Procurement procedures should allow circumstances and this is reserved for
struck between specifying RFPs only in single source competition where expediting procurements for urgent
terms of currently available technologies appropriate operational requirements.
as opposed to yet-to-be-developed Industry also felt that on certain occasions
technologies which should be achievable avoidable expenses are incurred through
given current rates of technology the use of competition where a particular
development and change and, therefore, product or technology was clearly
preferable in terms of capability.
Process predictability A second major source of concern for industry over the procurement process, once
commenced, is the lack of predictability and flexibility. A consequence of this is the
annual defence underspends.
and flexibility
Defence Expenditure and Underspends
160 20%
18% 142
140 17%
16%
120
14% 105
INR billion
100 93 12%
86
81
80 77
9%
60 56 60 8%
54
50 7%
40
TH
9 DEFENCE PLAN 4% 4% 4%
3%
TH 20 3%
10 DEFENCE PLAN
India has significant annual defence (MoF). Although, the percentage of funds
underspends returned witnessed a decline between
Over the last decade, every year, sizeable 2003 and 2006, it has been increasing
funds have been surrendered as ‘unspent’ ever since leading to significant amounts
and returned to the Ministry of Finance being returned each year.
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 38
”
- Private Defence Contractor,
SME
been a demand from the industry to
introduce the concept of rolling budgets,
allotting the under spends from prior years
to the following year’s annual budget in
order to ensure that on-going
the L-1 approach to tender evaluation
which requires the selection of the lowest
cost bidder to qualify against minimum
laid-down criteria. The absence of a cost-
benefit trade-off analysis in evaluations
procurements are not stopped for lack of where superior technical performance is
funds. given due credit is a source of concern
Defence underspends could be both for bidders and for the ultimate end-
The need for transparency, probity and users.
addressed through rolling budgets
public accountability should not be at
A major reason for the under spends is the
the expense of efficiency and the proper Other jurisdictions do allow the use of
time frame allotted to the Services for the
use of discretion and cost-benefit trade- cost-benefit analysis, generally with an
expenditure. Currently, the procurements
off judgements overall cost limit set by reference to
undertaken by the Ministry of Defence are
A concern voiced by CII members is that budgets and affordability. The limited and
done according to the Annual Acquisition
in the interests of transparency, probity highly regulated use of discretion is also
Plans (AAP) and the Services Capital
and public accountability, the correct and allowed in modifying procurement
Acquisition Plan (SCAP) etc. Given the
regulated use of discretion has been specifications where this can maintain or
estimated length of a typical acquisition, it
eliminated from the procurement process. expedite a procurement.
is sometimes difficult to plan in which
Process cost
A third major source of concern over the procurement process is
its cost to bidders
‘No cost, no commitment’ trials are does, on occasions, allow trials to take
noted by foreign and domestic vendors place in the country of manufacture or
alike as a barrier to entry to the Indian current use this is not a usual concession.
defence industry
In other jurisdictions, the government
The costs of major procurements may run
procurement authorities will on occasions
into many millions of dollars and represent
pay bid costs in the event of a halted
a major barrier to entry to many
procurement or in order to de-risk and
companies. A persistent message from
secure properly developed bids for unique
across industry is that ‘no cost, no
or complex requirements. In return, the
commitment’ trials are a particular
bidders are sometimes required to
constraint on bidding, especially where
transfer relevant R&D, technologies, or
equipment is required to be brought to
other knowledge developed during the
India and often trialled in more than one
bidding process.
location. While the Ministry of Defence
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39 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
04 Defence
industrialisation strategy
”
comprehensive industrialisation strategy for defence.
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 40
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41 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
valid discharge of offset obligations as will remain valid for two financial years
specified in DPP 2008 after the conclusion of the contract
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 42
Hence, where a foreign vendor earns The consequence of the various sectors. Under the multiplier system,
offsets credits through offset transactions constraints and uncertainties regarding weighted credits would be attached to
in anticipation of a future offset obligation, offset credit banking is that offset credit certain prioritised capabilities and
they shall be valid against any future banking in the present form is unlikely to technologies to incentivise offset
obligations on the vendor under new RFPs be a major driver in a foreign vendor’s investment into core capabilities (defence
issued within the next two financial years. decision as to whether to source from or or otherwise) targeted by the Indian
They would alternatively be valid against invest in India or a competitor country. As Government.
the offset obligations of a prime contractor things stand, there are likely to be
where the vendor concerned is its sub- considerable uncertainties as to whether Many foreign vendors feel that an effective
contractor within the same programme. offset credits banked by a foreign vendor application of offset multipliers in Indian
will be lost before they can be validly defence procurement would allow a
Although the industry has welcomed this discharged against an offset obligation. greater and fairer recognition of their
addition in DPP 2008, there is currently investments in India. It would provide a
very little detail concerning the A defence industrialisation strategy much increased incentive to transfer
requirements and timescales of the would allow greater direction and technologies, to build complementary
banking and discharge processes (the targeting of offset investment capabilities within a prioritised sector, and
banking process is contained within seven Commentators suggest that Offsets are develop businesses rather than simply to
paragraphs of the DPP) and there has most effective where they form part of source supplies. At the same time, it
been little or no experience of its wider economic strategy and direct would lead to a faster development of the
application to date. This lack of clarity is investment to specific areas of need. The home production of systems and
coupled with a concern that the limit of Ministry of Defence has set broad equipment required by the Services.
two financial years as the period for objectives for offset investment by
discharge is relatively short given the A key challenge to the introduction of
requiring direct offsets and listing thirteen
average time taken for an acquisition multipliers is the greater scrutiny and
applicable categories of defence products.
targeted by a vendor to reach the RFP evaluation of offset technical and
stage. Separately, the Ministry of Defence has commercial submissions, coupled with the
published a list of critical spares required potential need for valuations of transferred
On this second point regarding the time by the Services and has also identified a technologies. To date, no such evaluation
limit for discharge, the Ministry of Defence long list of defence technology needs. procedures have been used by the Indian
has pointed out that the mechanics of the However, while there are areas of overlap government and only once such
process actually allow this period to between these three sources, there is procedures are in place can the concept of
extend for up to two and half calendar currently no ranking of the spares and multipliers be implemented effectively.
years between banking approval and RFP technology needs, and, importantly, no
issue. It also points out that given that the strategy or routemap to show how India Offset Trading would also encourage
discharge trigger is the RFP issue rather will develop its current industrial base in earlier investment by foreign vendors
than, say, the award of contract, and the order to build self-sufficiency in these Coupled with the offset banking
time between the RFP issue and award spares and technologies. Furthermore, provisions, vendors suggest that free
may extend a further one to two years or within the DPP, there is no mechanism as trading of credits could also be introduced
more, banked offsets may actually be yet to enable Government actively to thereby encouraging firms to invest in
applied against on-going defence contracts manage offset investment in accordance India without fear of losing unutilised
several years after the original offset with a defence industrialisation strategy. credits where they are unsuccessful in
transaction. This, of course, assumes that getting the contract they may have
the vendor is successful in winning the Multipliers in offsets are awaited competed for.
tender, and the mechanism currently does The concept of multipliers in offsets is
not allow any form of offset trading or used by many countries around the world
deferral against later RFPs for to encourage the inward investment of
unsuccessful vendors with banked offset sought-after technologies into targeted
credits.
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43 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
” transferable to the defence sector, which all sectors where offset requirement may
would also contribute to the development be warranted and to which offset
of skills and capabilities required for investment may be directed. In this way,
- Private Defence Contractor,
defence production in India. They also offsets should be used not only to expand
SME the Indian defence industry but also to fuel
noted that broadening the scope of offsets
still further, to infrastructure for example, growth in other targeted sectors of the
would less directly but nonetheless economy.
effectively contribute to the country’s
security and economic advantage. Industry is upbeat but cautious about
the offset opportunity
Offset policy across all sectors (defence The survey conducted by KPMG in India
and other) would benefit from central questioned the Indian defence industry on
coordination, possibly through the the perceived benefits of the current
creation of a central policy body offset policy in the form of joint ventures,
The issues and possible solutions technology, know-how, human resource
discussed above, and similar issues in development, foreign direct investment
respect of aerospace offsets, point etc. The following graph depicts industry
towards gaps in the policies for offsets as sentiment in this context.
they exist today. Interviews conducted
15
14
12
10
8
6
4
2
0
Subcontracting
Co-production
License
production
Others
Human resource
development
Foreign Direct
Investment
Up grade plant
& machinery
Joint Ventures/
Collaboration
Technology Up
gradation/ Know-how
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 44
The results reveal that Indian industry percent of respondents, are of the view
clearly expects the offset policy to result in that it requires improvement and, feel that
technology transfer, joint venture its success will depend on how the policy
collaborations, and subcontracts. They is implemented.
have lower expectations for human
resource development and the upgrading Nonetheless, the opportunity created by
of plant and machinery, both critical offsets is undoubted by Indian industry as
requirements for building India’s defence more than 93 percent of the participating
industry capabilities. FDI is also lowly companies, expect to be a part of the
rated, though this is likely to be driven by opportunities generated by the offsets
the cap on FDI discussed later. programme. On an overall basis, the offset
policy has been received with caution by
The overall industry perspective of offsets the industry, with 84 percent of the
policy seems to be that of cautious companies questioned rating the policy as
optimism. While more than 53 percent of ‘satisfactory’ or ‘needs improvement’,
the respondents to the KPMG survey indicating that significant regulatory
believe that the offset provisions advances may have to be made in order to
contained in DPP 2008 will provide key realise Government’s target of achieving
growth opportunities and support the 70 percent and, eventually 90 percent,
indigenisation of the defence industry, 47 defence production indigenisation.
Satisfactory
29%
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45 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Transfer of Technology
Transfer of Technology (ToT) is an essential aspect towards
realising the goal of self-sufficiency.
ToT related to ‘Buy & Make’ which would be responsible for providing
programmes is currently the exclusive base repairs and the requisite spares for
remit of the Defence Public Sector Units the entire life cycle of the equipment. In
(DPSUs), Industry respondents see a this case, the vendor makes the
strong case for broadening this to nomination and it may select from among
private sector players DPSUs, OFBs, RURs or any other entity
The DPP 2006 and DPP 2008 identify ToT specially selected for this purpose.
under the “Buy & Make” category, i.e.
purchase from a foreign vendor followed DPSUs and private sector companies
by licensed production in India. When should be able to compete for ToT
technology is procured under this assets
category, the Ministry of Defence A critical part of a defence industrialisation
designates in the RFP the production strategy would be to broaden the defence
agency(s) to the technology is to be technology base. This is envisaged by
transferred. In the past this agency was a DPP 2008 and DPP Amendment 2008, but
designated DPSU. DPP 2008 introduced is yet to be put into action. A key
the concept of RURs, one of the key additional consideration is also, where
intentions being that RURs should be appropriate, to allow this broader base to
‘treated at par’ with DPSUs for the compete for ToT assets rather than the
selection of receiving technology and current nomination approach taken by
undertaking licenced production of Ministry of Defence. This is likely to allow
technology received from foreign vendors. the DPSU and Indian private sector
Since DPP 2008, the RUR selection bidders for technology assets to
process has yet to be completed. In a demonstrate how they are likely to
recent move, DPP Amendment 2008 has maximise the efficient and effective use of
introduced a new category "Buy and Make the technology and its further
(Indian)", as distinguished from the development.
previous "Buy and Make (Global)" category.
This new category is intended to provide a ToT is currently excluded from offsets
further mechanism for incentivising ToT to Although 35 percent of all offsets
the domestic industry, However, it is too worldwide relate to technology transfer3,
early to access its effectiveness in this ToT as a means of discharging offset
regard and hence, for the time being, the obligations has yet to be implemented in
receipt of ToT remains the exclusive remit India due to concerns regarding
of the DPSUs. determining the true significance and
hence the value of technology being
A different procedure is used for ToT proposed. Foreign vendors argue that this
related to maintenance infrastructure. and the lack of multipliers in Indian
When equipment is purchased from a defence offset policy act as a brake on
foreign vendor requiring maintenance and countries and vendors which may
lifetime support, the foreign vendor needs otherwise be willing to transfer critical
to identify in its tender an Indian entity technologies to India.
3. KPMG Research
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 46
FDI
The case for a higher FDI cap in Indian defence industry than the
current 26 percent is one of the most hotly-debated issues amongst
defence industry players.
Opinion on a higher FDI cap appears to acquire more advanced technologies; the
be divided assistance foreign players can provide to
In the Indian scenario, the FDI issue is MSMEs; and the concerns of the larger
driven by a number of factors comprising: players, both private and DPSUs, that
sovereignty concerns in respect to the greater foreign involvement would be at
ownership of core strategic industries like the expense of their own businesses.
defence; Government’s desire rapidly to
POSITIONS
PRO
Y
FO
G
OLO
RE
IGN
N
TECH
PLAYERS
FDI 26%
FDI IN DEFENCE
In May 2001, the Ministry of Commerce allowed the participation of the private sector
in the defence industry permitting 100 percent equity with a maximum of 26 percent of
FDI, subject to licensing. The ministry at various public forums has acknowledged the
need to relax the FDi norms for the Defence sector to 49 percent from existing 26
percent on a case to case basis4
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47 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
The industry view on the case for increasing the FDI limit appears to be divided:
”
development centres…
- Foreign Company,
Maybe
Defence Contractor 26%
The case for raising the FDI cap production. They believe that increasing security and secrecy. Regulations such as
primarily rests on increasing investment FDI limits would help to secure the physical and electronic access controls to
and the transfer of foreign technologies transfer of key technologies to India, and sensitive information and manufacturing
Restricting the limit of FDI to 26 percent would boost the foreign capital investment processes, limiting access only to
has been challenged by certain foreign available to them. employees who are domestic security-
companies as they believe that it acts as cleared nationals, restricting the number
an inhibiting factor towards their entry into The case for maintaining the FDI cap is of foreign nationals on the company board,
the Indian defence market. Despite the founded on sovereignty and security of and strict controls over end-use of
attractive pipeline of procurements issuing supply issues and promoting organic products and export sales have allowed
from the Ministry of Defence, certain industry development governments to ensure that, except for
foreign vendors feel that, where ToT is The case against increasing the limits for foreign ownership and investment, the
involved, the returns likely to be generated FDI is founded primarily in Indian company is essentially a domestic entity
on the basis of current FDI regulations, sovereignty. It is believed that allowing serving the domestic military
coupled with the lack of control they greater levels of FDI, even below 49 requirements with absolute security and
would have over the technologies and percent level, might increase the amount secrecy where required.
know-how they are being asked to of control exercised by foreign partners
provide, makes entry in to the Indian and this in turn would reduce the actual If the FDI cap is to be increased, then to
market an unattractive proposition. level of indigenisation and maintain the what level?
Furthermore, a number of foreign reliance on foreign suppliers. Also, it is One of the arguments put forward for
companies have stated their intention of believed that that the level of technology increasing the FDI cap from 26 percent to
developing India as a ‘home market’, e.g. required by the country can be achieved 49 percent is that there is no significant
both a major domestic sales market and a within the existing FDI limits and it is for difference in the control over a business
gobal manufacturing hub, but comment the domestic industry players to rise to between these levels. Opponents argue
that the current FDI restrictions constrain the challenge and ensure that they capture that a company’s board with 49 percent
their ambitions in this regard. The result the “know-why” along with the “know- foreign members is significantly different
has been limited FDI inflows to India, with how” of manufacturing techniques, in terms of influence, culture and
a total of only INR 7 Mn between April technology and efficiency. management approach to one with 26
2000 and February 2009 . 5 percent.
To counter sovereignty and national
The major proponents for increasing the control concerns, foreign companies have Policy makers argue that an increase to 49
FDI cap, apart from the foreign vendors, cited examples of other countries which percent would be largely ineffectual in
are the MSMEs and larger organisations have allowed up to 100 percent FDI in the achieving India’s main aim of technology
seeking to diversify into defence sector without comprising on control,
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 48
enhancement, as foreign vendors will not The clear expectation is that the FDI cap A growing number of JVs between foreign
transfer critical technologies without will be increased above 26 percent and domestic defence companies (both
ownership and management control of the Despite the on-going uncertainty as to public and private companies) have been
Indian venture6. Several foreign vendors whether the permissible FDI levels will be announced with a view both to short term
have themselves pointed out that an raised, many of the large foreign OEMs aims of responding jointly to specific
increase in FDI levels to 49 percent will are already setting up joint ventures (JVs) RFPs, and to develop over time broader
not be a panacea. The debate, they argue, in India, within the existing investment defence relationships involving the Indian
should focus whether the FDI cap should limits, but in the stated expectation that partner as part of the foreign partner’s
remain at 26 percent or be increased to 51 FDI limits will soon be increased. global supply chain. Some of these tie-ups
percent or above7. are set out in the table below:
Mahindra Defence BAE Systems Formed JV in order to assist in the manufacture of land combat vehicles based on BAE’s successful RG-31 mine
Systems protected vehicles
Seabird Aviation Secured exclusive marketing and support agreement to supply the Seabird SEEKER range of aircraft into India in
February, 2007. The strategic intent of this partnership is to assemble, supply and support sales to both the India market
and elsewhere
Larsen and Toubro EADS Formed a JV for defence electronics in India. Will set up a facility at Pune, at a cost of INR 1 bn focusing on design,
development, manufacture and related services in electronic warfare, radar, military avionics and mobile systems
Raytheon, Boeing Signed an MoUs with these companies for joint exploration of business opportunities in India’s defence sector
RAC MiG, SAAB Gripen, Is manufacturing structures or frames on which the MMRC aircrafts are built. Offsets for the deal will come in areas of
LMCO manufacturing or sub-systems for which there will have to be vendor development at different tiers
TATA Advanced Sikorsky Aircraft Signed a deal to manufacture cabins for their S-92 helicopter
Systems Corporation
Boeing Formed a JV for USD 500 Mn to manufacture military components for the F-18 Super Hornet fighter, the CH-47 Chinook
helicopter and the P-8 Maritime Patrol Aircraft
Israel Aerospace To develop and manufacture missiles, unmanned aerial vehicles (UAVs), radars, electronic warfare systems, and
Industries Ltd (IAI) homeland security systems
HCL Boeing Entered into an agreement with Boeing and IISc to develop wireless and other network technologies for aerospace
related applications
Circor Aerospace Inc Announced a strategic partnership to design and develop software for fluid controls, landing gear for aerospace and
defence applications
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49 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Government needs to ensure a level relatively small share of the market in the
playing field between the DPSUs and last eight years. The majority of private
private sector players players believe that there is a lack of a
Despite the opening up of the defence level-playing field between them and the
industry to the private sector in 2001, DPSUs (see chart below).
private players have been able to secure a
Do you believe Public Sector Units (PSUs) have an advantage over private companies
in procuring defence contracts
Yes Maybe
85% 10%
No
5%
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 50
The DPSUs enjoy significant tax and There is an exemption from Excise
? The DPSUs should be encouraged to
funding advantages duty on all goods supplied by notified focus on their core capabilities and
Currently, Indian Customs and Central DPSUs to the Ministry of Defence for strengths and increase the quantum of
Excise regimes prescribe significant official purposes, whereas the benefits ancillary business they outsource to the
exemptions or concessions from payment provided to the private sector are private sector, possibly divesting of non-
of Customs and Excise duties on supplies restricted to those which are provided core capabilities
made to the defence sector (discussed in specifically vide notifications. As the receivers of major government
detail in the next section). investment over many years and their
Such distinctions in grant of benefits to
consequent position as market leaders in
Such benefits are generally confined to DPSUs vis-à-vis the private sector could
the Indian defence industry, the DPSUs
supplies of specific items (as notified by significantly erode the competitiveness of
share both advantage and responsibility in
the Government from time to time) or private sector firms at the time of bidding
the development of the defence industry
confined to supplies meant for specified for projects pursuant to offset clauses in
in India.
programmes under the Ministry of major defence acquisitions such as
Defence (such as the All Terrain Vehicle combat aircraft, and other weaponry.
(ATV) project or the Light Combat Aircraft
(LCA) project).
certain key areas, in terms of the grant of and private sectors in the form of joint
such benefits, over the private sector, as projects and increased outsourcing to the
illustrated below: MSMEs, including divestments of non-
”
vendors...
exemption from Customs duty, when allowed a larger role in defence R&D
such imports are undertaken by - Defence Consultant Private sector participation in R&D was
DPSUs as well as by private sector considerably advanced following the May
firms which are contractors of the 1998 nuclear tests when the imposition of
Indian industry commentators suggest
Government, subject to fulfilment of sanctions on India prompted the DRDO to
that greater access to these latest
specified conditions. Crucially, open up eight labs in non-strategic areas
technologies would allow private players
however, the benefits are also to private participation. The DRDO states it
to compete not only with the DPSUs but
extended to vendors/sub-contractors has 'various levels of partnership' with 250
also to complete more effectively with
of DPSUs whereas they have not been private sector industries8.
foreign private vendors, thus helping the
extended to those of private sector
government towards its target of self-
firms supplying such goods to the However, DPSUs continue to hold an
sufficiency. This should also lead to
Government. This results in major inherent advantage over private sector
enhanced design, engineering and
savings on the input costs of DPSUs players as Government regularly invests in
developmental efficiencies within the
while the private sector manufacturers developing DPSU manufacturing
sector.
do not have the same advantages; capabilities and in-house research and
development facilities.
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51 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
At frequent industry forums, it has been would be increased competition for R&D
acknowledged that the private sector funding encouraging a more results driven
should be allowed to play a larger role in approach, and the ability tap into and
defence R&D thereby complementing the expand the private sector’s leading
role of the DRDO. As well as allocating capabilities in specific sectors, for example
funding to private sector companies information technology.
engaged in defence research, a critical
enabler would be the further opening up At present, expenditure incurred for
of DPSU R&D facilities to the private scientific research enjoys a weighted
sector. The benefits for Government deduction under section 35 of the Income
tax Act. 1961. However, it has been the
demand of the industry to introduce
DEFENCE R&D additional incentives in this area so that
the there is a reduction in the burden of
research costs on the private players.
While DPP 2008 encourages the private sector to enter into defence production,
However interactions with tax policy
government continues to retain its own defence research and development through
experts indicate that the general
the DRDO. DRDO was formed in 1958 from the amalgamation of the then already
framework of weighted deduction for R&D
functioning Technical Development Establishment of the Indian Army and the
expenditure is considered adequate and
Directorate of Technical Development & Production with the Defence Science
special sector specific provisions may
Organisation.9
introduce distortions and be
counterproductive from tax policy
perspective.
9. MoD Website
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 52
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53 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
05 Taxation
regime and incentives
The view generally given by the global concessions applicable to the defence
defence industry is that India currently has industry and suggests additional indirect
a comparatively aggressive and and direct tax concessions that could be
demanding tax regime. This section applied.
examines the existing exemptions and
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 54
Indirect tax regime Indirect tax laws provide various exemptions and concessions
An overview of the indirect tax applicable in the defence sector
regime governing the defence
sector is provided in Appendix I.
Indirect tax laws provide various Apart from the above, there are certain
exemptions and concessions from area-based and incentive based
payment of Customs duty (on imports) exemptions provided under Excise and
and Excise duty (on domestic VAT laws. However, at present, no
manufacture) of capital goods, machinery, exemptions have been provided from
equipment, spares, tools etc. for use by payment of Service tax or VAT (except for
the armed forces and defence sector. certain exemptions on notified products
Such benefits are specific in nature and when supplies are made to specific bodies
have been restricted to certain types of such as the armed forces canteens etc.)
equipment, machinery etc. or to various on inputs and input services used in
programmes or development projects manufacture or development of
undertaken by the Ministry of Defence. equipment for the defence sector. Thus, in
the absence of any output tax liabilities,
this Service tax and VAT usually
constitutes a cost.
ToT, already mentioned in the previous In this context, following points merit
section, is subject to a number of consideration from an indirect tax
indirect taxes which add cost to perspective:
transactions involving ToT Equipment, including capital goods as
?
ToT is a typical clause under many defence well as drawings, designs, plans etc.,
procurement contracts especially where imported into India as part of the ToT
licensed production of capital goods, agreement would attract Customs
equipment and machinery etc. is involved. duty at applicable rates unless these
are covered under any of the specific
exemptions
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55 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 56
Further, repair and maintenance services Service tax concessions on supplies The establishment of dedicated defence
would attract Service tax under the taxable made to armed forces and defence SEZs:
category ‘Management, maintenance or establishments: India’s first SEZ for aerospace in
?
repair services’. Supplies of equipment, machinery,
? Belgaum, Karnataka was inaugurated
spares, tools etc. meant for armed in November 2009. The Government
JVs formed for Offset purposes incur a forces or defence establishments may consider establishment of
number of indirect tax obligations should be exempted from applicable dedicated Special Economic Zones
JVs formed in India, (whether in the public duties, thereby significantly reducing (SEZs) on similar lines catering
or private sector) in pursuance of offset the acquisitions costs for such specifically to the defence sector along
clauses in defence procurement contracts, supplies the lines of numerous IT, automobile
would be governed by the same indirect and other specialized SEZs which
tax regime as applicable to Indian As mentioned earlier, Service tax
? already exist in the country. This would
companies. would constitute a major cost to the provide defence manufacturers and
defence sector. It is suggested that in service providers (especially foreign
Such JVs would have to discharge any light of its strategic importance and its companies) a suitably tax friendly
applicable indirect tax obligations/liabilities potential to emerge as a major driver environment and also aid in promoting
in the same manner as other companies. in the economy, the defence sector exports of products and services to
This would entail; should be granted significant other countries
Obtaining registrations under Central
? concessions under Service tax
Excise, Service tax and VAT laws analogous to those envisaged under Clearance of goods and services from
?
Customs and Central Excise laws SEZs units to the Indian defence
Obtaining an Importer-Exporter Code
? sector should be treated as Deemed
(‘IEC’) from the Director General of Deemed Export benefits for supplies Exports and revenue from such
Foreign Trade (‘DGFT’) which is a pre- made to manufacturers in defence domestic sales should be counted
requisite for import/export of goods sector: towards fulfilment of their export
Currently, the Government provides major obligation/net foreign exchange
Filing periodic returns as specified
?
Indirect tax concessions, such as Deemed requirements
under Service tax laws and VAT laws
Export benefits as a tool to boost
of the particular state Exemptions to offset JVs from R&D
investment in various sectors which are
considered vital to the growth and Cess:
Payment of applicable Customs duty
?
economic interests of the country (such as Government should consider
?
on import of goods
energy sector, power sector etc.) Similar exempting JVs formed under offsets
status should be accorded to the defence as well as those formed to undertake
sector and the Government should provide significant research and development
Suggested indirect tax a similar tax friendly regime to attract work in the defence sector from the
exemptions and concessions investment; levy of R & D Cess
Supplies of goods and services to
?
manufacturers in the defence sector Provision of additional incentives under
should be granted Deemed Export the VAT laws regime:
Due to the strategic importance of the
status and declared zero-rated so as to The Industrial Policies prevalent in
?
defence sector, the following exemptions
reduce input costs and increase various states provide customized
or concessions are suggested for
competitiveness of domestic packages (including exemptions and
consideration:
manufacturers concessions from VAT) on a case-to-
It is suggested that due to the strategic case basis depending on the nature of
importance of the sector and in light of This would also enable the vendors,
? industry (such as manufacturing or
exemptions already granted by Central and service providers or contractors of infrastructure etc.) as well as providing
State Governments under Excise, Customs defence to claim refund of any input numerous incentive schemes to
and VAT respectively, the Government taxes paid by them on supplies made encourage investments. Further, the
should consider the following exemptions to manufacturers in the defence sector states have shown their willingness to
or concessions to the defence sector:
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57 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 58
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59 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
06 Future outlook
India has witnessed a resurgence of its desert, mountains, swampy land and
manufacturing sector over the last two coastline etc. with consistent integrity.
decades on the backdrop of robust India must aim to derive synergistic
domestic demand and increasing private benefits from the wide ranging IT
participation. Amongst the emerging infrastructure it already has in place to
economies, India’s manufacturing sector cement its place as the global IT sourcing
has established its name for better quality, destination for defence and increasingly
design and innovation. The country has homeland security equipment.
already made its mark in the automobile
and automotive components sectors with The defence opportunity is a win-win
a number of auto giants around the world situation for the country. With stronger
sourcing from India. Further, the domestic focus on IT, high tech engineering and
heavy and light engineering sectors have research and design capabilities, India can
come a long way with high end leverage its IT infrastructure and
innovations and capabilities. manufacturing potential to be one of the
key global sourcing destinations for
The role of IT in shaping the face of future defence systems and equipment. This
warfare cannot be over emphasised. The should, in turn, catalyse both the
term "information warfare" is widely used development and the influx of high end
and is a testimony to the impending technologies and efficiencies into the
changes at all levels - macro or micro. In country which can be used to pioneer
times to come, warfare is likely to become innovations across multiple sectors. The
far more complex in which outlook is bright, but will require
communications and informatics would Government’s on-going active
play a greater role1. Further, defence management and fine tuning of policy,
informatics are crucial to protect India’s regulations, process and fiscal
15,000 km long border running, as it does, environment to ensure strong domestic
across a variety of terrains including growth and the achievement of self-
sufficiency.
1. http://mod.nic.in/Samachar/1feb01/html/trish.htm
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 60
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61 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Appendix I:
Overview of Indirect Taxes 1
Due to the strategic nature of the defence Central Excise Laws Most notably services in the nature of
industry, various Customs duty and ‘Consulting engineer’s services’,
At present, benefit of exemption from
Central Excise exemptions & concessions ‘Information Technology software services’
payment of Excise duty is restricted to
have been provided to the sector. In this (‘IT services’), ‘Management, maintenance
notified institutions such as DPSUs and
section we have examined the indirect tax or repair services’, ‘Management
OFBs. Such exemptions include;
regime relevant to the defence industry in consultancy services’, ‘Intellectual
India. Any goods produced by the OFBs for
? property services’ (‘IPR services’),
use by the armed forces, or for use by Scientific or technical consultancy service,
the OFBs themselves, have been fully Technical inspection and certification
Customs Laws
exempted from Excise duty service, Technical testing and analysis
Customs laws provide for exemption from
Any goods manufactured by specified
? service etc. would be relevant for the
payment of Customs duty on goods
institutions (such as BEL, BDL, NAL, sector.
imported into India for use by the defence
forces. These exemptions are provided to HAL etc.) and meant for supply to the
Since it is unlikely that the manufacturers
several categories of imports including ; Ministry of Defence for official
would have any output Excise
purposes have been fully exempted
Specified capital goods, supplies,
? duty/Service tax liability, Service tax paid
from payment of Excise duty
stores and consumables etc. which are by them on input services would become
imported directly for use by the armed Corresponding to exemptions provided
? a cost.
forces on imports as mentioned earlier,
In addition to the above services, the
Central Excise laws provide full
Import of capital goods/consumables
? armed forces/DPSUs/OFBs etc. would
exemption from Excise duty on
required for manufacture of specified also contract with various onshore as well
domestic manufacture of capital
equipment for the defence forces viz. as offshore parties for such services on a
goods/consumables/spares etc. for
ships, aircraft, weaponry, stand alone basis. These services may,
specified purposes.
communication equipment, spare inter alia, include
parts etc.
maintenance and repair services for
?
Import of capital goods/instruments/
? Service Tax equipment, machinery etc.
tools/machinery etc. required in setting Unlike Central Excise and Customs laws,
consulting engineer’s services
?
up specified facilities such as presently there are no
regarding weapons development
assembly lines, production or exemptions/concessions which have been
programmes or in setting up facilities
maintenance facilities etc. provided under the Service tax laws to the
defence sector. Therefore, any incidence training of armed forces personnel in
?
Import of goods required in connection
?
of Service tax on services used in use of equipment, maintenance etc.
with various specified programmes of
manufacture of products meant for management consultancy services or
?
DRDO, HAL etc. including projects
defence sector, technology transfer, etc design services etc. in relation to
such as ATV project, LCA project,
would become a cost to the transaction. various programmes being executed
IGMDP etc.
by the armed forces or DPSUs
1. Customs duty- Customs Tariff Act, 1975 read with Notification No. 39/96 – Cus dated 23 July 1996 (as amended from time to time)
Excise duty - Central Excise Tariff Act, 1985 read with Notification No. 63/95 dated 16 March 1995 – C.E (as amended from time to time);
Notification No. 63/95 dated 16 March 1995 – C.E (as amended from time to time); Notification No. 64/95 dated 16 March 1995 – C.E (as
amended from time to time)
Service tax – Chapter V of the Finance Act, 1994
VAT- State VAT legislations of various states
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 62
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63 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Appendix II:
Overview of Direct Taxes
Forms of entities in India: Choice and subject to guidelines issued in this Post approval of RBI and set-up in India,
regard. The RBI also monitors its activities various registrations and compliance
of Vehicle
on an ongoing basis primarily by seeking obligations are required to be carried out
A foreign company engaged in the
an annual compliance/activity certificate by the LO.
production of defence equipments
for the LOs operation from its Auditors in
typically enters into India through any of Joint Venture Company
India.
the following vehicles:
Recently, the Reserve Bank of India (RBI) Subject to Foreign Direct Investment
Liaison Office; or
? placed in the public domain (through a Guidelines (currently pegged at 26
draft circular) the eligibility criteria and percent) and Foreign Exchange
Joint Ventures
?
procedural guidelines for establishment of Regulations, a foreign company can set-up
Liaison Office liaison offices by foreign entities in India. a joint venture company in India along with
As per the draft guidelines the foreign an Indian partner.
A large number of foreign players wish to
first study the Indian markets and obtain entity needs to have a successful profit
A joint venture company can be formed
relevant information before they expand making track record during immediately
either as a private limited company or a
their operations in India. Some foreign preceding 3 years in the home country.
public limited company. A private limited
companies establish a Liaison Office Further, a net worth of not less than USD
company is obliged to restrict the right of
(“LO”) as an intermediate step before 50,000 is also required.
its members to transfer the shares, can
entering into a Joint Venture (“JV”) with
Further, defence sector related requests have only 50 shareholders and is not
an Indian partner.
for LO/BO/PO need government’s inter- allowed to have access to deposits from
ministerial consultation. Consequently the public directly. It is also subject to less
A LO is permitted to act as a channel of
process becomes time-consuming and is corporate compliance requirements as
communication/carry out a
subject to uncertainties as a MoD compared to a public company which is
liaison/representation role between the
clearance is also required. eligible for listing on stock exchanges.
head office/group companies and parties
in India. It is not permitted to undertake
any commercial/trading/industrial activity,
directly or indirectly. LO is obliged to Particulars Private Public
maintain itself and meet its expenditure
through inward remittances from the Head Minimum number of shareholders 2 7
Office. LO is generally approved only for a
specified period which is subject to Maximum number of shareholders 50 Unlimited
renewal and in certain sectors, the LO is
obliged to upgrade into a company (wholly Minimum number of directors 2 3
Establishing an LO requires the prior Minimum paid–up capital INR 1,00,000 INR 5,00,000 (Approx. USD 10,000)
approval of RBI which is location specific requirement in general (Approx. USD 2,000)
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 64
A private company can commence Withholding tax obligations under the Further, the non resident recipient is under
business immediately on obtaining a Act an obligation to file a tax return for almost
Certificate of Incorporation from the Under the domestic tax laws, every all types of cross border income arising
Registrar of Companies (ROC). A public person responsible for paying to a non- from India (even if full taxes are withheld
company is required to obtain a resident, any sum chargeable to tax in at source).
“Certificate of Commencement of India, is obligated to withhold taxes from
Business” by filing additional documents such payments. Taxes need to be
with the ROC. withheld “at the rates in force” at the time Dividend Pay Out
Further, a substantially higher degree of of credit or payment, whichever is earlier. Exchange Control guidelines
flexibility in operations is available to a JV In case a non resident has a business Dividends are freely repatriable under
as compared to a LO. The activities that a connection/ fixed place of business/ exchange control regulations. Dividends
LO can perform are limited and set out as permanent establishment, the appropriate on shares are repatriable provided proof of
above. On the other hand, a JV once rate of withholding would need to be payment of DDT is submitted to the
incorporated, is allowed to perform determined based on an application made authorised dealer (i.e., the banker) along
activities set out by its Memorandum of to the tax administration in India. with an undertaking from the remitter and
Association (“MOA”) provided the
activities fall under the automatic route or
a prior FIPB approval has been obtained in
this regard.
Interest payments;
?
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 66
Withholding Tax Implications as equity capital of the JV cannot be cost on account of DDT on buying back its
Royalties or fees for technical services
? withdrawn until the operations of the JV own shares.
(received from GOI or from an Indian are shut down and the JV is liquidated.
Capital Reduction
company under agreements that are
If for any reasons, the JV is not in a
approved by the GOI or which are in
Buyback position to comply with all the stipulated
accordance with the Industrial Policy)
conditions of buyback, then the JV can
are taxable in the hands of the non- Tax implications on buyback of shares
under take a capital reduction through a
residents (including foreign The Act provides that the difference
Court process. Consequently the JV will
companies) as follows: between the cost of acquisition of shares
be able to distribute assets/cash in lieu of
and the value of consideration received by
Royalties and fees for technical
? the capital reduction. However, to the
the shareholders is deemed to be capital
services earned from agreements extent of reserves in the books of the JV,
gains arising to the shareholder in the year
executed between 31 May 1997 and the distribution would attract DDT.
of buyback and is liable to capital gains
31 March 2003 are taxed at the rate of
tax. The excess consideration (reduced by the
20 percent on a gross basis
According depending on whether a DTAA cost plus deemed dividend) would be liable
Royalties and fees for technical
? to capital gains tax in the hands of the
has been executed between India and the
services earned from agreements shareholders, whether in India or in the
country of the shareholder, capital gains
executed after 31 March 2003 that are shareholder’s country or both, depends on
arising in the hands of a foreign
effectively connected with the foreign the relevant provisions of the DTAA
shareholder on sale of shares in the Indian
company’s Indian permanent between such country and India, if any.
company may be subject to tax in India or
establishment are taxed at the rate of
in that foreign country or in both the
40 percent after allowing for certain
countries.
specified deductions Capital Structuring
As per the Indian laws, ‘transfer’ of shares
Royalties and fees for technical
? To understand and make an entry into the
typically attracts capital gains tax in the
services earned from agreements Indian defence market, a foreign investor
hands of the seller if the consideration for
executed after 1 June 2005 are taxed may propose setting up a subsidiary
the transfer exceeds its cost of
at the rate of 10 percent on a gross company in India. The investment in such
acquisition. Such capital gains are taxed in
basis provided such services are not proposed Indian subsidiary could be in the
India at the rate of 42.23 percent/21.115
rendered through the permanent form of:
percent (including surcharge of 2.5
establishment of the foreign enterprise
percent, if income exceeds INR 1000,000 Equity share capital; or
?
in India.
and an education cess of 3 percent),
Preference/quasi equity share capital; or
?
All tax rates mentioned above,
? depending upon the period of holding such
excluding the rates prescribed under shares in the hand of the seller. Debentures; or
?
the relevant treaty, must be enhanced
If the shareholder in the Indian entity is Convertible instruments; or
?
by a surcharge of 2.5 percent (if total
based out of a jurisdiction such as Debt in form of ECB or domestic debt; or
?
income is in excess of INR
Netherlands, Mauritius etc., any capital
10,000,000) and then an education Any combination of the above options
?
gains arising in the hands of a resident of
cess of 3 percent.
these countries on sale of shares in an
Indian company may be exempt from tax
in India, subject to certain conditions.
Withdrawal of Equity Share
However, the foreign investor shall have to
Capital demonstrate ‘substance’ to avail of such
As per present company law provisions, treaty benefits.
equity capital cannot be withdrawn during Further, the Act specifically excludes the
the life span of the company except consideration received by the
through buyback or a scheme of reduction shareholders on account of buyback from
duly approved by the jurisdictional High being taxed as deemed dividend.
Court. Thus, ordinarily the funds invested Accordingly, the JV does not incur any
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67 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Glossary of Terms
Personnel: Capital expenditure helps create assets and includes expenditure on aircraft and
?
covers the salaries, allowances, transportation, food, all stores such as rations, aero engines, heavy and medium vehicles, all other equipments of the naval fleet
petroleum, oil, lubricant, veterinary stores, IT, vehicles, spares, revenue works, and expenditure on the purchase of land, construction, plant and machinery
maintenance of buildings, water, electricity, bedding and clothing, insurance and
Since, 2004 – 05 all issues from ordnance factories like tanks, guns, heavy and
?
welfare benefits and miscellaneous expenditures pertaining to all unit allowances for
medium vehicles are being accounted for in the capital budget.
training, contingency and other grants for officers, non – commissioned officers,
enlisted men and contracted civilians as well as pensions for the disabled or the
family of the deceased.
Note: The above definition refers to the Indian industry and may vary by country
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 68
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69 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
CII Defence
and Aerospace Division
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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 70
Defence on the international best the global defence industries towards emerged as a significant field of activity
practices and ways and means by which India. CII also conducts various of the committee. CII has constituted
India’s Defence Offset policy could be workshops/ interactions with various three sub-groups to focus on Policy
streamlined. It is planning to bring out a national and international think-tanks Advocacy, Spreading awareness of the
reference guide on Defence offsets with an aim to promote an technologies and drawing guidelines for
shortly. understanding about the policy issues in the Industries for maintaining adequate
the defence sector. security environment within their
Promoting Public-Private partnership
premises, and identifying ways and
is viewed as a priority agenda by the CII offers advisory services such as means by which industry could
committee. CII organises activities DTAAS – Defence Technical synergize the efforts of the industry in
workshops/ Seminars/ Exhibitions with Assessment & Advisory Service to the this regard. The committee has carved
an aim bring Armed Forces and Industry industry. Such service include out a comprehensive long-term action
together on one platform. To enable assessment of the Current plan on Internal Security through which
business development for its member manufacturing capabilities, Products and it seeks to support the governmental
companies, CII organise sectoral services offered by a company. On the initiatives to modernize the state and
programmes. The objective of these bases of such an assessment, CII paramilitary forces.
programmes is the dissemination of suggest products that can be developed
information to Indian Industry on the / manufactured by a company. CII also CII promotes Joint ventures and
requirements of the Armed Forces and advice industry on doing business with technological partnerships between the
also the policy reforms, which have defence - policy and procedures. It also Indian and global defence industry. With
taken place as well as to update the end formally introduce the company and its an aim to provide international exposure
user about the emerging technologies / capabilities to the Defence procurement to Indian Defence Industry, CII organise
products and the capabilities of the agencies and prospective partners. regular interactive sessions and visits
Indian Industry in defence production. between the industry members of its
CII also facilitated many RFI (Request for With an aim to spreading awareness MOU partners such as US-India Business
Information) / project briefings for the among the companies and helping them Council (USIBC) US, Defence
armed forces to enable them to identify understand the procurement procedures Manufacturers Association of UK
potential Indian companies as their adopted by the Ministry of Defence and (DMA/SBAC); Polish Chamber of
suppliers. CII works very closely with its aligned organisations, CII organise National Defence Manufacturers,
DPSUs / OFB and DRDO to promote "Defence Acquisition Management Association of the Defence Industry of
Public – Private Partnership in Defence Courses". Such courses are designed in the Slovak Republish (ADISR),
Production and organise Public Private a manner to help the participants to Association of Italian Defence and
Partnership Meets with almost all the understand various aspects of defence Aerospace (AIDA), GIFAS, GICAT and
PSUs. To enable the Ministry of Defence procurement and also to seek technical GICAN of France and the Korean
and potential OEMs to identify Indian clarification on the policies and Defence Industry Association (KDIA).
suppliers, the Committee has launched procedures. The Defence Committee has been active
an online directory of defence and in creating international linkages. CII
Internal security products and services. The mandate of the committee has
facilitates defence industry delegations
continuously evolved and enlarged. As
CII conducts regular studies on different to and from various countries.
of date, the scope of activities
aspects of the defence and aerospace
incorporates Space and Internal Security
industry. These have been able to
too. In consideration of the increased
project the trends, competencies and
involvement of Indian armed forces in
opportunities within the defence market
the management of internal security
in India. These studies have been able to
within the country, Internal Security has
generate considerable interest among
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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
71 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
The Confederation of Indian Industry has been actively partnering with the
Ministry of Defence, Armed Forces and DRDO in promoting Industry
participation in Defence Production. CII Defence Division has been committed to
working in the areas of steering policy formulation, defence market development
/ trade promotion and formulation of international joint ventures / technology
transfers.
CII formed the Defence Division in 1993 to catalyse change in the Defence
sector by pursuing the Government to liberalise Defence Production and by
initiating the process of partnership with the Defence establishments in
organising interactive meetings with end users, i.e. the Armed Forces. Realising
the importance of harnessing the technologies developed within the country, CII
has also been a pioneer in organising interactive sessions with the Defence
Research and Development Organisation to enlarge the role of Private sector in
Defence R&D. A major partnership with Ministry of Defence has been the
organisation of the Defexpo India (Asia’s largest Land and Naval Systems
exhibition) in 1999, 2002, 2004, 2006 & 2008 and the Aero India exhibition in
2009.
CII Defence Division strives to forge industry initiatives to strengthen the Indian
Defence Sector. The objective of this division is to “Establish a strong
partnership between Defence Services & Industry and enlarge the role and
scope of Indian Industry in Defence Production for mutual benefit and enhance
the National Security”.
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 72
The Indian member firms affiliated with KPMG International were established in
September 1993. As members of a cohesive business unit they respond to a
client service environment by leveraging the resources of a global network of
firms, providing detailed knowledge of local laws, regulations, markets and
competition. We provide services to over 2,000 international and national clients,
in India. KPMG has offices in India in Mumbai, Delhi, Bangalore, Chennai,
Hyderabad, Kolkata, Pune and Kochi. The firms in India have access to more than
2000 Indian and expatriate professionals, many of whom are internationally
trained. We strive to provide rapid, performance-based, industry-focused and
technology-enabled services, which reflect a shared knowledge of global and
local industries and our experience of the Indian business environment.
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with
KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
73 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
Our professionals have extensive direct industry experience across the defence
and aerospace markets having worked with the Indian Air Force, defence
procurement and defence programmes. Our partners and management
personnel are regular speakers at defence industry events, and frequently
contribute to leading business publications.
We have a well defined and robust approach that we adopt to support clients
when they are looking at the defence sector including experience in market
opportunity assessment, options analysis, feasibility studies, strategy
formulation, market assessment, operations/process advisory, partner search,
valuations and other advisory services. This breadth of experience leaves us
strongly placed to advise clients effectively across the spectrum of projects.
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 74
Acknowledgements
In order to provide a comprehensive industry view in the study, we have
interacted with various representatives from private companies (both Indian and
Foreign), DPSUs, independent defence consultants, ex-officials from the
Ministry of Defence and other relevant governmental organisations. We would
like to thank the various industry participants, whose invaluable contributions
have made this study possible.
We would also like to thank the companies which replied to the questionnaire,
circulated by CII on behalf of KPMG, as part of the study.
This document has been drafted by Defence Advisory, Direct Tax and Indirect Tax
team within KPMG. The Defence Advisory Team consisted of Richard Rekhy, Jai
Mavani, Charles Pybus, Gaurav Mehndiratta, Amit Mookim, Amber Dubey,
Deepak Wadhawan, Rashi Prasad, Wg Cdr (Retd) Neelu Khatri, Hemu Narang,
Rajat Sharma and Rajat Duggal.
Inputs on the Tax structure were provided by Ajay Sud, Pratik Jain, Ravi Kumar
Shingari, Krishnan Arora, Kabir Bogra, Rahul Jena, Jayant Bakshi and Katherine
Markova.
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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
75 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
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