Cross credits for aircraft lease taxes under the GST system will be a great boost for the local service industry.  However, the Government will need to carefully consider the inflationary impact of keeping aircraft fuels outside GST.

With increasing liberalisation and focus on infrastructure development, the aviation sector is one of the fastest growing sectors in India.  However, certain tax inefficiencies have crept in over the years, some of which are sought to be addressed under the model goods and services tax law (Model GST Law).

In this update we analyse the key impact of the Model GST Law in the aviation sector.  To read our previous updates on the impact of the Model GST Law in the e-commerce and manufacturing sector, please visit our website.

KEY IMPACT AREAS

(a) Increased cost of air travel
 
Increased rate of tax: Air travel is currently subject to lower service tax rates on account of the relaxation offered in the form of abatements on the value of air fare.  The current service tax rate is effectively 6% for economy air tickets (after an abatement of 60% of the value of services) and 9% for non-economy tickets (after an abatement of 40% of the value of services).  With the GST rate likely to be 18%-20%, the cost of air travel will consequently increase.  Though cross credits will be available, these would be insubstantial for a sector that has minimal consumption of goods, other than Aviation Turbine Fuel (which will initially be kept outside the GST regime as discussed below).
 
Aviation Turbine Fuel (ATF) outside the purview of GST: ATF will not be included within the GST regime and therefore the Central and State governments will continue to impose excise duty and Value Added Tax (VAT), respectively.  Since the levy of these taxes will not be creditable for carriers under the GST regime, it will result in a cascading effect of taxes.
 
While the current service tax abatements are conditional on carriers not availing credit of ATF, the increased GST rate coupled with the non-inclusion of ATF (which forms 30-35% of the input cost for carriers) will significantly burden the aviation sector and therefore, there is a strong case for a merit rate of GST for air travel.
 
(b) Realignment of ticketing structure
 
Place of supply for air travel: The Model GST Law stipulates guidelines to determine the place where supplies will be taxed.  Detailed provisions that determine the place of supply of goods and services are also provided.

These guidelines divide the place of supply for air travel services under two sub-heads:

Supplies made to customers registered under GST: Under this head, the place of supply is deemed to be the location of the registered person.  Location in this case refers to the premise of the recipient where the supply is received.  In case such premise is indeterminable or is multiple in number then the place most directly concerned with the receipt of supply will be considered the registered place of such person.  Therefore, for such customers (including individuals, proprietary concerns etc.) carriers will have to ascertain, on a ticket to ticket basis, whether such supplies would qualify as an inter-state supply (subject to Integrated GST, levied by the central government) or an intra-state supply (subject to Central GST (levied by the central government) and State GST (levied by the State governments) on intra- state supplies);
 
Supplies made to customers not registered under GST: The place of supply in this case is deemed to be the location where the passenger embarks for the journey.  Carriers will have to pay GST in such State if they are located in that State, and if not, will be required to pay Integrated GST.  This will increase compliance costs for carriers.
 
Further, the definition of location of service provider provided under the Model GST Law is ambiguous.The fixed establishment of a supplier that is most directly concerned with the provision of services is included as a location.It is not clear whether ticketing counters, baggage counters will qualify as fixed establishments under the Model GST Law.

Tax impact for international flights: Under the current indirect tax regime, international air travel is subject to service tax on the ticket fare for both the outward and return leg, (less applicable abatements), so long as the air travel commences in India.  However, air travel commencing outside India is not subject to service tax.
 
Under the Model GST Law, air travel commencing outside India will now be subject to GST in India, if provided to customers registered under the GST.
 
Further, the Model GST Law stipulates that a return journey will be treated as a separate journey and will be taxable in India if such services are provided to customers registered under GST in India.  However, where customers are not registered in India, the return journey will not be taxable.
 
(c) GST applicable on cross-border leasing of aircrafts
 
Carriers around the world are increasingly operating their fleets on a lease model, where aircrafts are leased from specialist leasing companies.  This option is preferred for a wide range of economic benefits.
 
Lease agreements executed in India, are currently subject to VAT.  To avoid this levy, carriers enter into aircraft leasing arrangements outside India.
 
Under the Model GST Law, leasing of goods is regarded as a service.  Further, the place of supply for cross border leasing of aircrafts is deemed to be the location of carriers.  Therefore, carriers operating in India will be subject to GST on lease of aircrafts, whether such lease transaction is executed in India or outside.  Consequently, along with lease rentals (which is a significant outflow for companies), applicable GST will now be required to be paid upfront.  Though GST paid at this stage would be available as credit, realization of this GST will only occur in a gradual manner through sale of air tickets.  Therefore, such upfront GST payment is likely to result in significant cash flow blockages for carriers.
 
(d) Impact on Maintenance, Repair and Overhaul (MRO) Services
 
MRO services involve transfer of both goods and services and qualify as 'works contract', subject to both VAT and service tax.  VAT levied by MRO service providers is a cost for aircraft carriers, as VAT cannot be set off against service tax.  To avoid VAT, most carriers opt to avail MRO services outside India.  The Model GST Law specifies that works contract transactions are deemed to be services.  Further, where carriers operating in India avail MRO services, whether in India or outside, the services will be deemed to be supplied in India and would be subject to GST.  Therefore, GST will be paid by carriers for MRO services but will be a pass through, which will reduce the cascading effect of taxes.
 
Further, carriers also renew lease arrangements outside India to avoid levy of VAT.  As an indirect consequence, end of lease refurbishment of aircrafts, which account for a big chunk of MRO revenues are also undertaken outside India.
 
On account of the above, MRO operators in India are at a disadvantage.  However, the provisions of the Model GST Law combined with the applicability of GST on cross border lease transactions will place MRO operators in India on par with their foreign counterparts.
 
(e) Increased compliance costs
 
Under the existing tax regime, carriers are only required to take a single service tax registration.  The Model GST Law prescribes registration in each State where a carrier undertakes a supply.  Carriers will thus have to register in every State where the registered passenger is located and also in each State from where its flights originate.  Further, the carrier will also be required to upload onto the GST Network, invoice wise details of supplies made to registered persons.
 
These compliance requirements will result in escalation of costs of doing business.
 
CONCLUSION
 
GST seems to have received a lukewarm reception from stakeholders in the aviation sector.  Though it is likely to give a boost to the MRO sector (as the incentive for carriers to undertake MRO services outside India is reduced), the anticipated increase in cost of fuel has not been well received.  In a sector already plagued with high tax and royalty burden, it is hoped that the government may reconsider the exclusion of ATF from the GST regime.