Budget Impact on Indian Automotive Sector

Keval Doshi, Mayur Shah and Sarika Goel, Sr Tax Professionals, Ernst & Young India

The overall sentiment in the automotive sector post-budget 2011 has been relatively positive. However, the finer details of the budget makes one ponder whether outlook for the Indian automotive sector is really positive?

To start with the proposals directly affecting auto sector -major positive developments have been on policy front, which are expected to pan out in the longer term and would depend on actual implementation.

The green-themed budget 2011 provides special emphasis on hybrid and electric vehicles by granting concessions in indirect taxes and duties on their components. This should help in bringing down the cost of ownership for such vehicles and help in conservation of environment. However, this being recent technology, the immediate effect on the sales volumes needs to be seen.

Launch of a national mission for hybrid and electric vehicles and increased weighted deduction of 200% for contribution to approved scientific research programmes is expected to bring in development of new and better technologies in the longer run.

Considering that the economy is in the recovery mode and the general mood in public at large is upbeat, it was expected that the Government would provide support to the auto sector that has grown at 30% for last two years. However, nothing has been done to fuel domestic demand for auto products. Further, the corporate tax incentives available to the EOUs have not been extended. This will affect the entire auto value chain - especially the OEMs and component suppliers. No measures have been taken to drive up exports by the domestic auto players. Levy of MAT at 20% on SEZ units will also significantly affect the auto players operating in SEZs.

No tax or duty concessions were announced for increasing demand of existing vehicles. Maintaining status quo on peak rates of customs and excise duties may not be enough to help the auto industry to grow at the same pace.

Other policy initiatives such as permitting mutual funds to accept foreign subscription are likely to help capital flows and ease liquidity. However, this will help capital infusion only by way of equity and will not help leveraging capabilities of the auto industry.

Indian auto players having overseas subsidiaries can heave sigh of relief, as dividends received from their overseas subsidiaries shall now be taxed at 15% instead of 33%. However, there is a catch wherein such dividends shall be taxed at 15% on a gross basis vis-à-vis existing regime of taxing the same at 33.22% on a net basis. This move may not benefit highly-leveraged Indian auto players. Further, nominal reduction in effective tax rate for domestic companies from 33.22% to 32.45% and for foreign companies from 42.23% to 42.02% on account of reduction in surcharge to 5% and 2% respectively, is a welcome move.

With both inbound and outbound investments by the auto players, transfer pricing is one area which will continue to impact the sector. The budget proposes to change the variation between transfer price (TP) and arm's length price (ALP) from 5% of the TP to a percentage of TP as the Government may notify, which will lead to uncertainty. Further, the transactions with persons located in a notified jurisdictional area (NJA) would come within the purview of transfer pricing provisions. These transactions would be subject to adverse tax implications in absence of adequate documentation/justification and subject to higher tax withholding.

On other proposals indirectly affecting the auto industry include a slew of measures announced in the budget for aiding development of agriculture sector and rural areas, increased thrust on road infrastructure and marginal increase in income-tax slabs for individuals. However, issues such as completion of a majority of the infrastructure projects on time, land acquisition, etc still need to be resolved. Marginal increase in personal tax slabs would be offset by the reigning inflationary pressures. Further, no incentives were announced for the dedicated freight corridors which are supposed to provide necessary thrust to the manufacturing and allied industries. Increased focus of the government on defence sector is expected to aid major auto players and OEMs in defence vehicle segment.

Auto industry is a capital intensive industry having a strong value chain. Growing fuel prices is fast becoming a global concern. Specific measures such as rationalization of duties on key commodities such as fuel, steel, rubber, etc backed by access to low cost capital, faster duty refund mechanism, better working capital cycle, etc would have ensured necessary impetus to the auto industry. However, no relief has been announced on this front.

The Cenvat credit related proposals made by the FM are likely to adversely impact the margins of auto companies, with the scope of claiming credit on inputs and input services getting further restricted. For manufacturers or importers availing significant services from outside India, there could be a marginal impact on the cash flow situation as well, with the introduction of Point of Taxation Rules 2011, which deems the time of provision of service to be the date of provision of service or date of invoice or date of payment, whichever is earliest. There has been no change made to the CST rates applicable to the sector.

 
One of the key issues thrown up by Budget 2011 for the auto sector is the introduction of a definition of Completely Knocked Down (CKD) unit for the first time, as an explanation to a customs notification. There is a difference of 50 per cent in the basic customs duty rates applicable to motor vehicles imported as a CKD unit vis-à-vis vehicles imported in any other form, and the proposed definition in its current form could lead to an increase in customs duties payable on imports by many auto companies. To add to the woes of industry, this proposed definition appears open to multiple interpretations and thus, could lead to classification related litigation. The industry is already in close discussions with the authorities to address the issue on a priority basis.

A welcome change has been the grant of partial excise duty refund of 2 per cent on small cars cleared for use as taxis, although similar refund available on large cars has been significantly reduced from approximately 12 per cent to 4 per cent. The introduction of self assessment mechanism under customs is also likely to benefit the industry by reducing procedural compliances.

There are various other indirect taxes related budget proposals which would impact the Auto sector, such as, widening of scope of taxable authorised service station services, and availability of Cenvat credit on accessories cleared with vehicles as well as replacement parts/goods for free warranty purposes, and the industry is gearing up to implement such changes.

The auto makers are now keenly tracking the developments on introduction of GST, as the proposed regime is expected to significantly reduce the indirect tax burden on the sector and give further boost to consumer demand.