The change in the tax structure for services relating to the maintenance of aircraft and engines was announced earlier this year. This was reiterated in the Finance Ministers economic package announced to help revive the economy. These services referred to as Aircraft Maintenance Repair and Overhaul (MRO) services are critical in the aviation value chain. And with this tax policy change, the government is hoping to finally address the disadvantages due to which this sector never prospered in India. Indeed, majority of the MRO work even today is done outside the country leading to a huge loss of capital and employment. Yet the tax reform is just the first step towards revitalizing the sector. Some key items remain.
The older taxation regime put Indian MROs at a gross disadvantage
Until recently MRO services were taxed at 18% while the same services if done overseas attracted a tax of 5%. Additionally, no customs duties were levied on import of MRO services from overseas. This severely limited the ability of India’s MROs to compete and they were left competing for contracts where the labour pay arbitrage made for a more economic proposition. The high-value work including heavy checks on aircraft and engine overhauls continued to be sent to overseas. This then led to a situation where the infrastructure required for high-value work was never developed and India’s airlines (with the exception of Air India) continued to depend on foreign contractors for majority of their high-value MRO requirements. Despite labour advantages, a qualified talent pool and exponential growth in airline fleets, Indian MROs continued to be unviable. The nature of the taxation was such that 90% of India’s MRO requirements were imported.
India’s MRO providers were unable to target high value work
Within the MRO services there are four main segments. These include airframe maintenance, engine maintenance, components maintenance and daily and weekly checks (termed as line maintenance). Of this, engines and airframes constitute ~50% -55% of the work by value. The most lucrative segment is that of engine overhauls and component maintenance.
For India’s airlines the line checks – which refer to overnight and transit inspections of the aircraft – are done in-house. The more complex aircraft checks are mostly outsourced to providers within the country. Mostly because they are labour intensive and thus the labor cost provides an arbitrage opportunity. However, the extensive checks that come at the 6 year – 12 year intervals, and which include the engine and component maintenance, are all sent overseas. It is in this area that India remains far behind.
The fact that most of the high value work was sent overseas was due to policy distortions. Firstly, aircraft parts were subject to levy of 5%, under the tax code but aircraft parts were also described under various other nomenclatures and classified under different tax chapters as generic items, which attracted GST of 18%. If that was not bad enough, items such as paints, adhesives, consumables etc. that are extensively used in the servicing of aircraft, attracted the highest burden due to their classification: a GST of 28%. Foreign companies using the same material were not subjected to any tax burden. The justification was that the as the item reaches India in a “finished” state. Finally there was a 19% import duty on tools and spares which further drove up costs of doing business.
For an airline looking at providers, India’s MROs did not even stand a chance.
The grand correction puts India’s MROs in the consideration set
Earlier this year, in one fell swoop, the government adjusted the rates of MRO to 5% via a notification on 25th March, 2020. Further, it changed the place of supply for B2B MRO services to the location of recipient. Clearly, the move is aimed at encouraging India’s airlines to source their maintenance needs from providers within the country and not from providers overseas.
This move not only reduced taxes for India’s MRO providers but also gave them full input tax credit (ITC). Foreign MROs continue to not be eligible for Input Tax Credit (ITC) as opposed to their Indian counterparts. The issues of subcontracting and taxation thereof were also addressed.
With this correction, almost overnight India’s MROs can now be a part of the consideration set.
However, policy distortions still remain
In spite of the tax rationalization, other pending issues remain. Key amongst these is the issue of airport royalties which is in direct contravention of the country’s Civil Aviation Policy (NCAP 2016). Per the policy, airports had to refrain from a levy of royalty and additional charges on MRO service providers for a period of five years from date of approval of policy. The intent of the policy was presumably to give boost to MRO services which would then gain volume and be able to afford the levy in 5 years. Yet airports including the Airports Authority of India went ahead and levied such charges albeit under a different classification such as ground handling, revenue share, demurrage etc. ranging from 11%-20%. A weak enforcement mechanism coupled with the strong airports lobby did not help either. MRO services continued to falter with most providers racking up significant debt.
There was also the issue of location. Ideally MROs need to be co-located at an airport where there is significant cargo-flow. This as high value components are best transported by air. Industry watchers indicate that this is also reason that MROs that are situated at a location away from a metro have not quite worked. But given the space limitations at airports this too continued and continues to be a challenge.
Finally there is the outstanding issue of certification of workers. Due to a regulatory misalignment, aircraft technicians who are able to service the aircraft overseas are forced to take an exam for certification of the same in India. This in spite of same amount of practical experience or in many cases extensive practical experience. Effectively, this not only increases time (from hiring to release towards maintenance duties) but also deters folks from returning to the country.
The outlook for MROs in India
There are eight key MROs in India. Until now they have seen limited success due to the inability to capture high value work. The prohibitive cost structure led to MROs saving on expenses on other areas. For instance not taking multi-certifications from the European, American and Indian regulator till absolutely required. Which then led to a chicken and egg situation as airlines and aircraft lessors required the tri-certification as a part of the contractual obligations.
With maintenance constituting approximately 12% of an airlines cost base, airlines continuously looked for more economic options. And until now, India’s MROs didn’t stand a chance.
With the tax policy changes, India’s MROs have for the first time been able to start to see light at the end of the tunnel. Significant Capex coupled with additional policy alignment is still required. As these issues are gradually addressed, MRO’s in India’s may finally take-off.