Opportunities in The Indian Defence Sector

Opportunities in the
Indian Defence Sector

An Overview
01 OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR
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OPPORTUNITIES IN THE INDIAN DEFENCE SECTOR 02
Foreword from CII

The opening up of the Indian economy The huge opportunity has attracted the endeavour and has been working with
during the early nineties heralded an era attention of not only a few large players the armed forces and the Ministry of
of unprecedented industrial growth in but also a large number of Micro, Small Defence towards achieving maximum
India. The growth rates seen match and Medium Sized Enterprises (MSMEs) indigenisation.
those of the fastest growing economies. which visualise this unprecedented
A confident and resurgent Indian opportunity as a gateway towards At the policy level as well, there is a
Industry is making forays into almost all entering into the domain of defence clear support for achieving the long
the sectors of manufacturing. Lately, the production. The slowing cherished goal of self reliance in defence
huge opportunities for growth within the down/saturation of markets in other sector. The Government has been
domestic and global defence and sectors has also been responsible for the receptive to suggestions and has been
aerospace industries have attracted the directing their interest towards the willing to make the required policy
attention of Indian industry. unexplored defence sector which changes whenever required. Initially
promises sustained business promulgated in December 2002,
The current profile of equipment held by opportunities. Defence Procurement Procedure has
the Indian Armed Forces with regards to already undergone five revisions. The
‘State of the Art’, ‘Matured’ and The private sector is enthusiastic about recent amendments in DPP 2008
‘Obsolescent’ equipment is 15, 35 and its ability to play a larger role in (Amendments 2009) are a welcome
50 percent respectively. This suggests contributing to the total defence related step. Various provisions have been laid
that the Government will have to make production both within the country, as down to ensure industry participation at
serious efforts towards upgrading its well as looking at export markets once various levels.
defence resources either by developing sufficient experience has been gained in
or procuring defence equipment and particular areas. The need of the hour is
systems. Moreover, modernization, to combine the skills of Public and
upgradation and maintenance of the Private sector, developing this into a Mr Baba N Kalyani
existing equipment will also provide partnership with the aim of achieving Chairman CII National Committee
immense opportunities to the industry. self-reliance in defence production. CII on Defence and Aerospace
India is one of the largest global military believes in creating an environment & Chairman and Managing Director,
spenders. The defence budget for 2009- where both public and private sector Bharat Forge Ltd.
10 has increased by 34.19 percent over grow together and partner with each
the previous year’s budget estimate (BE) other, thereby contributing towards the
of INR 1,056 Bn. national growth. CII has supported this
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.
1. Finance Budget 2009-10

2. DPP Amendment 2009
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
01A CCELERATING THE GROWTH OF THE INDIAN DEFENCE INDUSTRY | 07
02 T HE DEFENCE MARKET OPPORTUNITY IN INDIA | 09
TABLE
03 T HE DEFENCE PROCUREMENT PROCESS | 35
O
F
04 D
CO
| 39
NTEN
EFENCE INDUSTRIALISATION STRATEGY

T
05 T AXATION REGIME AND INCENTIVES | 53
06 F UTURE OUTLOOK | 59
07 GLOSSARY OF TERMS | 69
01 Accelerating
the growth of the Indian defence industry
The defence industry in India is experiencing significant

and progressive change. In keeping with the adage that
‘change brings opportunity’, opportunities abound both
for India Inc. in meeting the Government of India’s (GoI)
defence requirements, and for the Government in
achieving its aspiration of autonomy in defence supply
through the development a home market 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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reserved.
02 The Defence Market

Opportunity in India
The eyes of global defence market are turning to India to

see whether it will fulfil its potential as a future ‘home
market’.
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
Defence Industry World Defence Spending, USD BN

Landscape and Trends
1600
t
2 percen
th rate 4.
1400 annual grow 1,339
Average
1,229 1,263
1,183
1200 1,119
1,047
968 986
1000 923 933
USD BN
800
600
400
200
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Note: The figures are at constant 2005 prices

Source: SIPRI Yearbook 2008
According to 2008 estimates released by multilateral peacekeeping operations,

Stockholm International Peace Research combined with the availability of economic
Institute (SIPRI), global military resources. Eastern Europe has recorded
expenditure was estimated to be USD the highest regional growth in the world in
1,339 billion in 2007 which represents 2.5 military expenditure over the past decade,
percent of the global Gross Domestic followed by North America. The main
Product (GDP) and USD 202 per capita2. contributors to the increase in expenditure
The factors driving growth in world military in these regions are Russia and the United
spending include countries’ foreign policy States of America (US or United States)
objectives, real or perceived threats, respectively.
armed conflict and policies to contribute to
1. SIPRI Yearbook 2008

The United States continues to dominate global military spending, with India as the
10th largest defence spender worldwide
Global Military Expenditure Distribution 2008
India
3%
Russia Rest of the world
3% 28%
Italy
3% US
Germany 44%
3%
Japan
3%
UK
4%
France
5%
China
5%
Note: ROW = Rest of the World

Source: CIA World Factbook 2008
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
3. CIA World Factbook 2008
Russia has the highest annual growth rate with India third
Average Annual Growth Rate of largest defence spenders 1998 - 2007
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.
China has increased its military spending

over threefold in real terms during the past
decade, growing from USD 19 Bn in 1998
to USD 70 Bn in 2008. However, with
defence expenditure accounting for 1.4
percent of the country’s GDP4, China
retains a smaller focus on defence within
the wider economy compared to other key
defence spenders.
4. CIA World Factbook 2008, SIPRI, KPMG Analysis
As a percentage of GDP, Saudi Arabia is highest spender on defence and India is

middle ranking
Focus on Defence Expenditure by the Largest Spenders in 2008
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%
Defence Expenditure as a percentage of GDP

Source: CIA World Factbook 2008
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.
5. CIA World Factbook 2008
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
US companies play a major role in the

global defence industry with various
US companies dominate the list of the largest aerospace and
countries relying on them for a majority of
their imports. US companies such as defence companies
Boeing, Lockheed Martin and Northrop
Grumman form a substantial contributor to
the 79 percent of defence imports made With the US being the largest market for After the American majors, European
by the UK government12. Some countries arms sales worldwide, it is not surprising companies account for the next largest
have tried to reduce their dependence on that many of the largest global defence share with the trans-European giant EADS
US companies (and increase self- companies are situated there. American and UK-based BAE Systems accounting
sufficiency) by creating state-controlled companies account for 6 of the top 10 for approximately 15 percent of the global
organisations such as Korea Aerospace global companies (64 out of top 100), defence market. Other large European
Industries, (created by the South Korean representing a 63 percent share of the defence companies include the Thales
government with the consolidation of global defence market12. Additionally, the (France) and Finmeccanica (Italy)12.
Samsung Aerospace, Daewoo Heavy three largest aerospace and defence Only three Indian companies make it to
Industries and Hyundai Space and Aircraft companies in the world: Lockheed Martin, the list of the top 100 defence companies
Company; The Israeli State-controlled Northrop Grumman and Boeing, although in the world accounting for 1.1 percent
organisations (Israeli Aerospace Industries, based in the United States, garner a share of the global industry; these are the
Israel Military Industries) have gone a step significant market share in several other publicly owned Defence Public Sector
further by not only catering to domestic countries as well. Undertakings (DPSUs) Hindustan
requirements, but also becoming major
Aeronautic Limited (HAL), Ordnance
exporters to various countries worldwide,
Factory Board (OFB) and Bharat
including India as one of their major
Electronics Limited (BEL)12.
customers.
Largest Defence Companies in the world
S.No Company Country of origin Annual Defence Revenue, Defence Related Businesses
2008 (USD Bn)
1 Lockheed Martin US 42.7 A global security company principally engaged in research,

design, development, manufacture, integration and
sustenance of advanced technology systems
2 Northrop Grumman US 33.8 An integrated enterprise consisting of businesses that

cover the entire defence spectrum, from undersea, outer
space and cyberspace
3 Boeing US 32.1 Involved in research, development, production, modification

and support of military products and related systems and
services
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)
5 General Dynamics US 29.3 Focuses on delivering products and services to military,

federal government, commercial and international
customers
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
7 Raytheon US 23.2 Designs, develops, manufactures, integrates and provides a

range of products and services for principally governmental
customers worldwide
8 Finmeccanica Italy 23.2 An industrial holding company engaged in aeronautics,

helicopters, space, defence electronics, energy
transportation, and integrated systems
9 Thales France 18.5 An electronics company providing services for aerospace,

defence and security markets worldwide
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
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
Source: Economic Survey of the respective years
Since India’s first defence budget for 1950-

51 of INR 1.61 Bn13, spending has grown
to INR 1,420 Bn in 2009-10. The current
announced budget refers to a significant
increase of 35 percent in the overall
spending, placing India amongst the top
10 spenders on defence worldwide.
13. Finance Budget 1950-51
Defence Expenditure as percentage of GDP and Central Government Expenditure (CGE)
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
Source: Economic Survey of respective years
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
Source: Defence Service Estimates of respective years
Revenue expenditure has historically spending as categorised in the current

accounted for a major share of the budget. The recently announced budget
defence expenditure. Although the change for the year 2009-10 has seen the highest
in definition has brought about a correction capital expenditure ever, amounting to
in the revenue to capital spending ratio, at over INR 540 Bn which highlights the
39 percent new procurements still focus on procurements for the
account for less than half of the defence forthcoming years by the MoD.
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%
The Air Force, although typically

accounting for approximately one fourth of
the defence budget, forms a majority Navy Army Navy Army
share in the capital expenditure. In recent 19% 46% 25% 28%
years its share has been increasing due to

the procurements of newer aircraft.
Total Military Budget Capital Expenditure
Under its ‘Blue Modernisation’
Note: Others include expenditure on DRDO, DGQA
programme, the Indian Navy’s share in the Source: Economic Survey 2008-09
14. Defence Service Estimates of respective years 16. Defence Service Estimate 2008-09
15. www.janes.com 17. Economic Survey
DPSUs continue to play an integral part to achieve self-sufficiency and

Defence Production in in the defence production indigenisation of defence manufacturing in
India Defence has for a long time been a part of the country.
the public sector since it requires large
investments and substantial research and In terms of value of production, DPSUs
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
manufacture of state-of-the-art weapons nearly INR 192 Bn19 - an increase of over
and systems for the armed forces18. Over 20 percent as compared to the previous
the years, these organisations have aimed year.
Defence Public Sector Undertakings
Company Sales (INR Mn) Products/Services
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
Note: Annual Sales for the Year 2007-08

Source: Company Websites
18. MoD Website and CII Website 19. Keynote Address by Shri A.K.Antony, January 23-24, 2009,
National Seminar on Defence Industry
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
Select Indian Defence Private Sector Majors
Company Year of inception of Products/Services

defence operations
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
Note: The above list is only indicative and not exhaustive

Source: Company Websites
9. IDSA research paper, April 2008
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
Existing equipment profile
15% 35% 50%
Required equipment profile
30% 40% 30%
State of the art

Matured
Obsolescent
Source: Inputs from Maj. Gen. Mrinal Suman
20. CII Website 21. KPMG Research
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
Details of potential deals in the pipeline
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
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
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)
Source: KPMG Analysis, Press Reports
22. Mark Kronenburg, Boeing ASPAC, Defence Industry Daily, April 19th, 2009
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,
Department of Defence Department of Defence Production

Deals with the Integrated Defence Staff (IDS) and three
? Deals with matters pertaining to defence production,
?
services and various inter-service organisations indigenisation of imported stores, equipment and spares
The IDS comprises service officers, civilian officers and

? It also undertakes planning and control of departmental
?
scientists. It formulates joint doctrines in consultation with production units of the OFBs and DPSUs
Service Headquarters (SHQs)
It is also responsible for drafting both long term and short

?
term defence budgets, policies and co-ordination of all
defence-related activities
MINISTRY OF DEFENCE
Department of Defence Research and Development (DDRD) Department of Ex-servicemen Welfare

The DRDO under the DDRD works in various areas of
? Has the responsibility of matters relating to ex-servicemen
?
military technology including pensioners, ex-servicemen contributory health
Also deals with scientific aspects of military equipment
? scheme, directorate general of resettlement and kendriya
and logistics and the formulation of research, design and sainik board and administration of pension regulations
development plans equipment used by the Services relating to the three services
Source: Ministry of Defence, Government of India
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:
Defence Acquisition Council (DAC):

? ‘BUY & MAKE’
23
Main task of DAC is to accord in (GLOBAL)PROCEDURE
principle approval of the capital
acquisition in the LTIPP. In addition, it
is to identify and give approval to Acquisitions covered under the ‘Buy &
‘Buy’, ‘Buy and Make’ and ‘Make’ Make (Global)’ decision would mean
projects. purchase from a foreign vendor
followed by licensed production/
Defence Procurement Board (DPB):
? indigenous manufacture in the
DPB is responsible for all activities country
relating to ‘Buy’ and ‘Buy and Make’
decisions. It is also responsible for
overseeing any revenue acquisition. It progress of all major proposals.
approves the AAP of all three Another key responsibility of the DPB
Services, amendments to their annual is to recommend procurements in a
plans along with monitoring the single vendor case and the approval of
Fast Track Procedures (FTP).
‘BUY & MAKE’
24
(INDIAN) PROCEDURE Acquisition Wing:
?
Acquisition Wing is an integrated body
with three divisions (for land, sea and
‘Buy and Make (Indian)’ means purchase from an Indian vendor including an Indian
air), each responsible for the entire
company forming a joint venture/establishing a production arrangement with an
capital procurement procedure of
Original Equipment Manufacturer (OEM) followed by licensed production/indigenous
floating and receiving tenders and
manufacture in India. Buy and Make (Indian) must have a minimum 50 percent
opening bids. Recommendations of
indigenous content on cost basis.
the three divisions are put up by the
23. DPP 2008 and MoD Website 24. DPP Amendment 2009
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
Steps Timelines Authorities Involved Actions Taken
Drafting of Service 1 Month SHQ, HQ IDS, DPB, Acquisition

? Commenced by the issue of RFI laying down only “Essential parameters”
?
Quality Requirement; Wing of MoD and not the “desirable parameters”
Acceptance of SHQ compiles the comments of the DDP, DRDO, MOD (Finance), MOD
?
Necessity (Admin) and forwards the same to the HQ IDS
Issue of RFPs 4 Months SHQ - Service Headquarters

? Lays down following requirements:
DAC - Defence Acquisition
? Quantity, time frame, offset obligation, training, maintenance etc
?
Council Technical parameters, field evaluation on No-Cost-No-Commitment basis
?
SCAPCHC - Service Capital
? Commercial aspects including payment terms, guarantee/warranty
?
Acquisition Plan
Criteria for evaluation and acceptance
?
Categorisation Higher
Committee
Technical 11 – 17 Technical Evaluation

? Evaluation of proposals and preparation of TEC report
?
Evaluation/Field months Committee (TEC) Vetting of report by Technical Manager and acceptance by Directorate
?
Trials SHQ, DRDO, DGQA,
? General Acquisition DG (Acq.)
Acquisition Wing of MoD Field trials/ DGQA/ maintainability trials, preparation and approval of staff
?
evaluation at SHQ and acceptance of the same by DG (Acq.)
Commercial 4 – 11 months Technical Oversight Committee

? Technical Oversight Committee involved for cases over INR 300 Cr.
?
Negotiations Commercial Negotiation

? Opening of bids and determination of L1
?
Committee Contracts Negotiation Committee (CNC) negotiations, finalisation of CNC report
?
Competent Financial Authority,
? Approval of Competent Fianance Authority (CFA) – MoD, MoF, CCS
?
MoD, MoF, Cabinet Committee
Evaluation of commercial offset offers
?
on Security (CCS)
Contract Signing Thus the cumulative process takes around 20-34 months
Note: Timelines involved with each stage are approximate

Source: DPP 2008
25. DPP 2008 and MoD Website
Development of other regulatory

guidelines
In order to help prepare for such large
procurement plans, the Indian government
has drawn up long-term budgets and
procurement procedures to act as a set of
guidelines for the upcoming acquisitions.
The formulation of the Defence Procurement Procedure (DPP) and specific

organisations within the Ministry of Defence to streamline the acquisition
process has brought about a major restructuring in the industry, enhancing
the efficiency and transparency of the acquisitions undertaken by the Government.
The Defence Procurement Procedure category in 2003. The procedure was

was created in 2002 to formalise the further reviewed in 2005, and reissued as
procurement process DPP 2005. The procedure continued to
To provide a set of guidelines, the Ministry evolve with a further iteration of the DPP
of Defence prepared the DPP in 2002, in 2006 which included a revised Fast Track
which came in to effect from 30 Procedure and a procedure for indigenous
December 2002 . It was applicable to
26
warship building. It also introduced a new
procurements in the ‘Buy’ category as offset policy (described in greater detail
determined by the DAC. The scope of this below) and included procurements
procedure was enlarged to include categorised in the 'Make' category, both
procurements in the 'Buy and Make' moves intended to increase the
participation of Indian industry in the
defence sector.
‘FAST TRACK PROCEDURE
The DPP has further been revised by DPP
2008 with, among other others, changes
Fast Track Procedure was promulgated in September 2001 to ensure expeditious
relating to revision and enhancement of
procurement for urgent operational requirements foreseen as imminent or for a
the offset policy introduced in 2006 and
situation in which a crisis emerges without prior warning
changes to the licensing requirements
discussed below.
26. DPP 2002 and MoD Website
Evolution of the Defence Procurement Procedure
DPP 2002 – 03 DPP 2006 DPP 2008 DPP Amendment 2009

Introduced after the Kargil
? Extended to include
? Introduced concept of offset
? Introduced a new category
?
conflict to formalise the procurements under the FTP, banking; allowing vendors to of procurement – “Buy and
procurement process by the ‘Make’ category and discharge their offset credits Make (Indian)” to issue RFPs
Ministry of Defence procedure for indigenous against RFPs issued within to only Indian vendors who
warship building two financial years of date have the requisite financial
Applicable to procurements
? of approval of banked
and technical capabilities
flowing out of ‘Buy’ decision Concept of offsets
? credits
of the DAC introduced; envisaged USD Public version of LTPP
?
Removal of offset obligation
?
10 Bn to flow back between covering a period of 15
Document revised in 2003 to
? for contracts with at least
2007-2012 years to be widely
include procurements under 50 percent indigenous
content publicised
‘Buy and Make’ category Transfer of Technology
?
envisaged in the ‘Buy’ Increased offset obligation
? Enhancement of role of
?
category to 50 percent on a per case independent monitors in
basis Integrity Pact
Level playing field between
?
DPSUs and RURs addressed Change in licensing policy,
? Liberalisation in offset
?
with a private company provisions by permitting
Decision taken to review the
?
requiring license only if change in offset partner
DPP after every two years
stipulated under licensing
requirement for defence
industry, issued by Ministry
of Commerce
Increased information
?
provided during issue of
RFPs
Offset penalty introduced for

?
…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
Source: KPMG Analysis
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
A major new policy of DPP 2006 was

Offsets the introduction of ‘Offsets’ in defence
procurements, a tool to indigenise the
defence industry
Offsets were introduced in India in DPP
2006 as a policy to promote the
indigenisation of the Indian Defence
industry. Under the current policy,
procurements over the value of INR 3 Bn
in the ‘Buy (Global)’ and ‘Buy and Make
with Transfer of Technology’ category face
an offset obligation of a minimum of 30
percent of the procurement value.
However, these provisions do not apply to
procurements under the FTP.
Approved methods of discharge of offset obligations
DIRECT PURCHASE DIRECT FDI OFFSETS CREDITS
Direct purchase of products/services

? Direct FDI in Indian defence industries for
? Credit based on creation of offset
?
provided by the Indian Defence industries, industrial infrastructure for services, co - programmes created in anticipation within
i.e. DPSUs, OFBs and the private defence development, JV and co-production of two financial years before the issue of
industry defence products and components RFPs
Direct FDI in Indian organizations

?
engaged in R&D as certified by the
Defence Offset Facilitation Agency (DOFA)
Source: DPP 2008
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
27. DPP 2008
Offsets are a widely used mechanism by OFFSETS

countries with trade imbalances in target
sectors, or other development
Offsets are compensatory, reciprocal trade agreements for industrial goods and
objectives, to promote counter trade and
services applied as a condition of military-related export, sales and services. Globally,
investment offsets have been implemented successfully to promote the domestic defence
In some countries offsets are applicable industry and support the setting up of critical technologies within the procuring nation.
for transactions as small as USD 1 Mn and
the offset obligations can be as high as
300 percent of the procurement value. In
India the current threshold for offsets is
set at INR 3 Bn28 and the offset obligation DIRECT AND INDIRECT OFFSETS
ranges between 30-50 percent on a per
case basis29. Direct offsets require the supplier to purchase goods or make investments which are
related to the sector of the primary transaction, thereby encouraging the growth of
Most nations focus the offset obligations the domestic industry in that specific sector
of suppliers towards transfer of technology
or increased R&D activity within the Indirect offsets obligate the supplier to purchase goods or make investments from the
country to enhance the technology level of purchasing country which may be in certain stated sectors or be entirely at the
the domestic industry. India has a direct discretion of the vendor. Their purpose is to stimulate economic growth in the vendor
offset policy for defence with the country more generally
consequence that only procurements or
investments in 13 categories of defence
products specified in DPP 2008 qualify as
offset. Other nations, by allowing indirect Indirect offsets, when routed properly
offsets, have let offsets act as a catalyst in have provided a key source of investment
the growth of non-defence related key and growth for the economy.
industries as well.
28. DPP 2008

29. KPMG Analysis
Offset Regulations in select countries across the world
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
Note: MTV = Minimum Transaction Value

Source: European Defence Agency, Kuwait National Offset Company
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
30. Jane’s Information Group, Defence Industry Analysis, December

01, 2007, “Offsets in Europe: A matter for debate”
Homeland security is increasingly Greater visibility of the opportunities

Focus on Homeland regarded as an integral part of defence would lead to an increased focus on
Security and security business by the global homeland security by Indian industry
systems OEMs and a critical area for a Due to the increase in projected spends in
nation dealing with internal as well as homeland security, the private sector has
external threats. recognised its importance marking it as
The global defence industry is increasingly one of the key growth sectors for the
reflecting the steady convergence coming years. However, the lack of clarity
between nations' defence and homeland on the level of opportunity has dissuaded
security requirements. In India, homeland some players from making extensive plans
security concerns have come to the for the sector. The importance of long term
forefront especially in light of the 2008 planning for defence procurements has
26/11 Mumbai attacks; extra requirements been recognised by the Ministry of
of the forthcoming Commonwealth Defence and similar initiatives would
Games in 2010; and other real and assist the homeland security sector
perceived threats. Homeland security is significantly. It would also allow the private
projected to be one of the key areas of players to target their capabilities to match
focus, for Government, both Central and requirements enabling them to serve
State, with research indicating that by government better. Globally, the private
2016 India's total expenditure on sector has played a significant role in
Homeland security might have grown to meeting the homeland security
approximately USD 9.7 Bn. requirements of various countries across
the world, and this could be replicated in
India. A key example is the role played by
HOMELAND SECURITY
Raytheon Systems in the e-Borders
initiative taken by the UK Government.
In India homeland security principally comprises equipping the State police forces and
paramilitary forces such as Central Rescue Police Force (CRPF), Border Security Force
(BSF) and Central Industrial Security Force (CISF) and also development of surveillance,
monitoring and infantry soldier capabilities. The Indian homeland security falls under the
purview of the Ministry of Home Affairs (MHA) which undertakes procurements, the “ We have identified homeland security
and aerospace as the two key focus
areas in India post 26/11...
handling of budget allocations and other concerned regulations
- Private Defence Contractor

”
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:
Foreign tie-ups in Homeland Security
Indian Company/ Foreign Company Nature of Tie-up

Organisation
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
Source: Press Reports
The defence industry in India is poised Defence Industrialisation Strategy:

?
Factors likely to at an inflection point in its expansion relating to the need for a
influence growth cycle driven by the three Services’ comprehensive industrialisation
modernisation plans, the increased focus strategy and, within this, the roles of
on homeland security, and India’s offsets, multipliers, transfer of
growing attractiveness as a ‘home technology regulations, FDI, and
market’ defence sourcing hub. different industry players; and
The Government of India has put in place
Taxation Regime and Incentives:
?
the building blocks to incentivise the
relating to the role of the taxation
growth of a domestic defence industry via
regime in supporting the
its organisational restructuring, its revised
industrialisation strategy by providing a
acquisition planning procedures, the DPP,
fiscal environment that incentivises
FDI and other regulations. In the following
and supports the long term risk taking,
three sections we highlight some of the
investment and R&D by businesses
factors identified by participants in
required to build the industry.
KPMG’s survey of CII’s Defence and
Aerospace Division members as likely to
influence the future growth trajectory of
India’s defence industry. These factors are
grouped under three broad headings:
The Defence Procurement Process:

?
relating to the clarity of the defence
spending pipeline, the speed and
flexibility of the procurement process
and the costs involved for bidders
through aspects such as ‘no cost, no
commitment’ trials;
03 The Defence
Procurement Process
The DPP has evolved significantly since its first edition to

address perceived shortcomings in previous versions and
in response to industry representations. Throughout,
Government has indicated its willingness to improve the
policy and its desire to create an effective and efficient
procurement process.
Defence procurement procedures and Develop an indigenous Indian defence

?
accompanying policies have to balance industry capable of providing near
three competing aims: autonomy in defence production.
Facilitate the expedient acquisition and

? These three aims will not always pull in
scaling up of new technologies and the same direction, and their relative
capabilities for the Indian Armed priority will change over time, so it is only
Forces through the regular tuning and finessing of
the procurement policy that Government
Conform to the highest standards of
?
can help ensure that it is continuing to
transparency, probity and public
serve its intended purposes. It is against
accountability
this background that respondents to
KPMG’s survey have made the following
observations and recommendations.
Pipeline, RFI and RFP

It is apparent that the lack order book visibility of Ministry of
process Defence, and the consequent limitations on industry’s ability to
focus on long-term market opportunities, is one of the major reasons
why more Indian companies are not attracted to the Indian defence
opportunity. Furthermore, despite on-going improvements through
successive DPPs, the RFP process remains a significant source of
concern for both foreign and domestic defence industry players.
The procurement pipeline needs greater issuing on the Ministry of Defence’s

definition and visibility website of advance information
Given the investment and timelines concerning a forthcoming RFP was also
involved in defence manufacturing, included.
feedback from industry reveals that it is
seeking clearer definition and enhanced There is scope for further industry input
visibility to be given to the Government’s to the RFP process
order book. This, it says, would make it Successive DPPs have taken steps to
easier for the industry to plan strategically improve the RFP process and give
and to align its business planning with industry more opportunity to influence
Government’s defence needs, while also RFP development. DPP 2008 introduced
providing Government with the benefit of the option of an RFI into procurements,
greater security of supply. This is being a pre-RFP stage intended to provide
particularly the case for the support and vendors of early notice of a forthcoming
maintenance of existing systems and RFP and request information and
equipment (as compared to new comment from vendors in respect to
purchases), which can often be worth performance parameters, ‘whole-life’ cost
three to four times the value of the initial considerations and other aspects of the
order and in many cases will present an requirements. DPP Amendments 2008
easier entry point for Indian defence has recently made the issue of an RFI
industry. The Ministry of Defence’s LTIPP, mandatory for all procurement cases.
due to be finalised shortly, and covering
the fifteen years, provides a key Industry sentiment suggests that there is
opportunity to begin addressing this issue, still scope for further improvement.
though much will depend on the degree to Companies believe that there should be
which the details of the plans will be greater participation by industry during the
communicated to the industry. DPP 2008 formulation of the RFPs. There is common
also included a new procedure for the consent that the RFI process is not being
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
11TH DEFENCE PLAN 0 0%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Defence Expenditure % Underspend
Source: Economic Survey of the respective years-
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.
“ One of the major problems with the

military budgeting process is that it
is done on an annual basis and
procurement of arms and
particular year a major procurement spend
will be incurred. This can lead to under
spending of the allotted budget if the
spend fails to materialise in the relevant
planned years but is deferred to later
As a consequence, when matters do not
go to plan, for example insufficient
compliant bids are received against a
demanding specification, the only
procedural option often available is to
ammunitions is a long process,
hence the military is unable to plan years. The surrendered amount is restart the tender process. This results
relocated to the MoF and may not be the retraction of a significant portion of
the years in which particular spends
available for the MoD under the following RFPs.
will fall leading to major under
year’s annual budget. Hence, there has The need for transparency also results in
spends...
”
- 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
04 Defence
industrialisation strategy
“ For India of to realise its objective of building the military

capabilities it requires, Government needs to develop a
”
comprehensive industrialisation strategy for defence.
- Global Defence Contractor
An industrialisation strategy for the Indian optimising the value of technology

aerospace and defence industry would transfer, the role of foreign OEMS vis-a-vis
identify the target the areas for industrial FDI policy, and the roles of the different
development in India and articulate an industry players in India, namely the
integrated plan for, among other things, DPSUs, Raksha Udyog Ratnas (RURs) or
the use of offsets, including the possible defence champions, and MSMEs.
introduction of offset multipliers,
Given the multiple barriers to entry, a An industrialisation strategy would seek to

The need for a broad defence industry capable of competing match India’s own requirements and those
ranging defence on the global stage is unlikely to grow of of the global market against India’s
its own accord in India and will need specialisms and areas of comparative
industrialisation strategy significant Government intervention and advantage, eg IT, light-heavy engineering,
incentivisation. skill intensive engineering, high-end
Government has stated an aspiration for quality innovation rather than mass
India’s defence industry to become 70 production, and from this to develop a
percent indigenised by 2010. Whilst the vision of India’s position in the global
date may need revising, Government has defence market. It would then enable the
long signalled its intent to pursue this development of a comprehensive strategy
course by the opening up of the defence and plan to provide its industries, both
industry to the private sector in 2001, the public owned and private, with the
introduction of direct offsets in DPP 2006, platform and road-map to develop these
its RUR initiative and the on-going FDI industries, setting out how India will over-
constraints on foreign investment in time move up the value chain in defence
defence industries.1 manufacturing and production. This should
include the fiscal and regulatory
Nevertheless, given the technical framework (discussed in the following
complexity and specialist nature of much section) and the use of offsets, offset
of the military’s requirements, significant multipliers, technology transfer, FDI policy,
barriers remain if India is to develop the and the roles of DPSUs, RURs and SMEs.
tooling, plant, materials, training, logistics
and infrastructure required to build a
defence industry capable of meeting its
military and security needs, and the
related aerospace and homeland security
capabilities.
1. Defence Minister’s Speech, Press release, Press note 4 of

2001, DPP 2006
The role of offsets

Indian offsets policy provides a powerful investment driver,
but could benefit from greater focus and direction
There is a significant risk of Indian management and direction of offset

defence industry capacity shortfall investments, a foreign vendor could at
According to estimates, offset obligations present outsource the manufacturing of
of up to USD 9 Bn could flow back into minor components requiring bulk
India by 20122 as a result of the offset production with a minimal technology
regulations. Given the likely prevalent value addition to its Indian offset partner to
scope of offsets, as required by DPP discharge its offset obligations. Such
2008, and the limited extent of the arrangements are unlikely to benefit Indian
indigenous defence industry capabilities industry and may fail to provide the
currently existing in India, certain intended technological development. In
commentators fear that India may not such circumstances, the benefits derived
have the industrial capacities and know- from the offset policy are likely to fall well
how to absorb all of these obligations. In short of their intended potential.
such cases, foreign vendors, faced with
significant offset obligations, may be The recent offset credit banking
forced to seek uncommercial and artificial procedures require clarification and a
offset trades with Indian businesses longer period for discharge
simply to meet these obligations. A major change introduced in DPP 2008
was to allow foreign vendors to bank
There is also the risk that offsets are offset credits. The procedure allows
directed to low technology addition vendors to ‘bank’ offset credits for offset
components transactions (i.e. direct defence purchases
A related industry concern is that though from India, or FDI into Indian defence
offsets are directed to develop the businesses or defence R&D) not related to
indigenous defence industry, the industry any existing offset obligations. Proposals
believes that there is a need for greater for banking offset transactions have to be
focus in the regulations to ensure tangible submitted to the Ministry of Defence for
value addition both to the country’s approval. These banked offset credits can
research and development and then be applied to future RFPs, provided
manufacturing capabilities in this sector. the RFP is issued within two financial
For instance, in the absence of a defence years of the date on which the banked
industrialisation strategy and more active offset credit was approved.
Offsets Credit Banking Procedure
Creation of offset programmes in

? Offsets Banking proposal to be approved
? Foreign vendor will be able to discharge
?
anticipation of future offsets obligations by MoD and unique Project Identification banked offset credits against projects for
Proposal for banking of offsets to be
? Number to be allotted to each proposal at which an RFP is issued within the two
submitted to Joint Secretary, MoD for the time of approval financial years of the date of approval of
approval banked offset credits
Proposals to be in conformity with the

? Surplus offset credits can be banked and
?
valid discharge of offset obligations as will remain valid for two financial years
specified in DPP 2008 after the conclusion of the contract
2. CII Press Release dated 6 January 2010
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.
“ Government should come up with a

National Offsets Policy which is
much broader in scope as compared
to the MoD offset policy. Countries
Some commentators would like to see a
broadening of the scope of offsets, even
to indirect offsets
Some industry players believe that the
scope of the offsets should be broadened
with various industry participants suggest
that the creation of a National Offset Policy
Group bringing together a focused group
comprising experts on the subject may be
beneficial. Their remit would be to advise
like Turkey, Greece, Saudi Arabia and
to include aerospace and other government on the development of all
Kuwait are doing better than India
complimentary technologies that are easily offset policies, not only for defence but for
on this front…
” 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
Benefits from the offset policy
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
Yes No Some What

Source: KPMG Survey, 2009
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.
How do you rate India's defence offset policy on an overall basis?
Needs Improvement Good

47% 24%
Satisfactory
29%
Source: KPMG Survey
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
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
FDI: The Big Debate
26% 49% > 51%
POSITIONS
PRO
Y
FO
G
OLO
RE
IGN
N
TECH
PLAYERS
FDI 26%
Source: KPMG Survey
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
4. Press note 4 of 2001
The industry view on the case for increasing the FDI limit appears to be divided:
“ [India is] Not yet an attractive as

investment target because of the FDI
cap. Without adequate economic
returns and control, foreign
Do you believe there is a need to increase the FDI limit from 26% to 49%, or higher
in the defence sector in India
defence/security companies will find

other markets more attractive as Yes No
57% 17%
focus for investment and technology
”
development centres…
- Foreign Company,
Maybe
Defence Contractor 26%
Source: KPMG Survey
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,
5. DIPP FDI Statistics, February 2009
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:
Tie-ups between Indian Companies and Foreign Defence Contractors
Indian Company Foreign Company Nature of Tie-Up
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
Note: The above list is only indicative and not exhaustive

Source: Press Reports, Company Websites
While industry continues to have varying between aspirations of different

views on the subject, Government faces stakeholders and the security issues of
the onerous task of striking a fine balance the country.
6. Interviews with MoD officials 7. Interviews with Foreign Vendors
The Industry roles of

The DPSUs continue to dominate domestic defence production
DPSUs, RURs and and R&D facilities in India. Their role, and that of RURs and
MSMEs other private sector companies, needs on-going appraisal and
alignment to ensure their respective strengths and capabilities
are best optimised.
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%
Source: KPMG Survey
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).
In theory, there are no specific restrictions

on private sector firms also receiving such
The private sector seeks greater sharing
of the DPSU’s technology assets
Most private players believe that a lack of
access to the latest technologies is one of
“ it will serve better to continue to use
DPSUs in areas where they have
already created substantial
capacities which would be a national
waste if not utilised...
benefits since these are typically available
to any person authorised by Government
to import or manufacture goods required
for defence purposes. However, the
DPSUs do enjoy significant advantages in
the greatest inhibitors to the growth and
development of the private sector in this
sector. While many technologies are
available within the DPSUs, the private
sector does not have access to these. Greater partnership between the public
”
- Defence Consultant
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-
The import of aircraft (including aircraft

?
parts, engines, guided weapons etc.),
pursuant to orders by the Ministry of
Defence, have been granted
“ private players have greater
operational felxibility and hence are
able to negotiate more favourable
commercial terms with
core capabilities, would contribute to the
development of the private sector
industry.
The private sector should also be
”
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.
8. Interview with DRDO official
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.
The role of RURs
RURs were conceived as private sector

defence champions which would be
‘treated at par’ with DPSUs.
In practice, this means that they would be
equally eligible along with the DPSUs for
receiving for technology and undertaking
licenced production under ToT and should
have equal tax treatment. The
appointment of RURs was put on hold in
August 2008 and the status of the policy is
still unclear.
9. MoD Website
Industry players are sceptical about the RUR

advantages of introducing an additional
class of defence company
The criteria for the selection of any company as an RUR or ‘Raksha Udyog Ratna’
The creation of RURs continues to be
was first outlined in DPP 2006. With the aim of ensuring a level playing field between
viewed with a degree of apprehension by
private sector RURs & DPSUs. The RUR status would be granted only to those
the defence industry. Some players
companies which fullfiled certain benchmark condition prescribed by the MoD. 12
believe that it would create an extra
companies contended for the RUR status. However following protests from the
category of player within the sector which
industry the process of enlisting of RURs had been delayed.
may not be effective or necessary. They
believe it risks repeating many of the
privileges and barriers to entry inherent in
the DPSUs. They argue that Government
RUR entitlements should be extended to all The Role of MSMEs
should be breaking down barriers and
creating a level playing field for all rather As mentioned above, the private sector’s MSMEs play an important role in the local
than the choosen few. ability to compete with DPSUs for ToT and and global supply chain of any major
for R&D funding, and the provision of defence integrator as key outsourced
equal tax treatment, are all seen as critical suppliers. Most large companies use
Companies are also critical of the RUR to advancing the development of the MSMEs to deliver significant parts of their
selection criteria private sector defence industry in India. projects. However, currently in India only a
Companies are also critical of the Industry argues that companies bidding to fraction of the total outsourcing done by
requirements for the RUR status as set receive ToT and R&D funding should be the major DPSUs is undertaken by the
out most recently in DPP 2006. Private assessed for eligibility on a case-by-case MSMEs.
sector players believe that certain basis having regard to the size, nature and
eligibility clauses10 relating to the criticality of the particular assets in As mentioned previously, MSMEs are
mandatory prior experience required in the question. Given the reservations with restricted by the FDI regulations, which
sector and the turnover requirements may respect to RURs, and in the absence of constrain their ability to source
act as inhibiting factors towards the any strong advocates or arguments in technologies and funding from foreign
development of an important segment of favour of the RUR initiative, they argue it is players. As part of a defence
smaller Indian defence companies with difficult to see why the scheme should be industrialisation strategy, the promotion of
nonetheless critical niche products or revived. MSMEs should encourage a greater and
capabilities. broader investment in leading
technologies and bring about an increase
in the overall technological level of the
Indian defence industry.
10. Appendix 4 for details on criteria for RUR selection
05 Taxation
regime and incentives
The fiscal regime plays a critical role in any defence

market in creating an environment that incentivises and
supports the long term risk taking, investment and R&D
required by the industry.
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
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.
Indirect tax implications of typical defence transactions 1
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
1. Customs duty – Customs Tariff Act, 1975

Excise – Central Excise Tariff Act, 1985
Service Tax – Chapter V of the Finance Act, 1994
VAT – VAT being a state specific levy, State VAT legislations of various states
Judicial interpretations in relation the above issued (Supreme court, High Courts and various tribunals)
Any taxable services involved in the

? A tax exemption is available on royalties Rendition of such services may attract
ToT agreement would attract Service and fee for technical services under ‘Buy Service tax under various taxable
tax at applicable rates. For instance, and Make with ToT’ category categories including;
ToT agreements or licensed production procurements Consulting engineer’s services where
?
agreements may involve licensing of Under section 10(6C) of the Income Tax the training relates to use of
intellectual property (‘IP’) owned by equipment etc.
Act, 1961 [duly incorporated in the Sixth
the supplier (such as patents on
Schedule to the Draft Direct Tax Code Bill
equipment, copyright on designs IPR services where provision of
?
2009] any income arising to a foreign
drawings etc.). Transfer of such IP training involves transfer of IP such as
company by way of royalty or fee for
would be chargeable to Service tax training manuals, techniques or
technical services (typical under ToT
under the taxable category of IPR patents etc.
arrangements) is exempt from tax in India.
services
This provision is intended to catalyse ToT
Management consultancy services in
?
Further, where such ToT occurs under a
? under ToT agreements and may be further
situations where services such as
foreign collaboration between Indian clarified to include ToT under offset
programme management etc. are
and offshore entities, this would have obligations. The relevant provision is as
concerned.
to be examined in the context of follows:
Research and Development Cess In the event such services are rendered by
(‘R&D Cess’) Act, 1986;
‘Any income arising to a foreign company, offshore service providers, the liability to
as the Central Government may, by pay Service tax would devolve upon the
R&D Cess is chargeable at the rate of
?
notification in the Official Gazette, specify service recipient under the reverse charge
5 percent on import of technology in
in this behalf, by way of royalty or fees for mechanism i.e. DPSUs, OFBs etc.
India under a foreign collaboration
technical services received in pursuance
of an agreement entered into with that Further, unless specifically provided by
The R&D Cess Act defines
?
‘Technology’ as: Government for providing services in or notification, no Service tax exemptions
outside India in projects connected with would be available on such services.
security of India’
“any special or technical knowledge or Repair and Maintenance services may
any special service required for any attract both Customs duty and Service
purpose whatsoever by an industrial To encourage ToT under offset tax (subject to Customs duty exemption)
concern under any foreign transactions, this exemption could be Repair and maintenance is an integral part
collaboration, and includes designs, extended to royalties from these of most defence procurement
drawings, publications and technical transactions also programmes. Such agreements typically
personnel.” It is suggested that the scope of the provide for supplies of spares and
section may further be enlarged to include accessories to equipment and machinery
As can be seen from this definition, R&D royalties and fee for technical services etc. along with repair services.
Cess is comprehensive its application and (transfer of technology payments) to
any ToT occurring through foreign foreign as well as Indian technology As mentioned earlier, the import of capital
collaboration would be caught in the tax suppliers, thereby also including ToT under goods, spares, consumables etc. imported
net. Further, since R&D cess is usually a offset investments into India under repair and maintenance
non-creditable levy (exceptions being if the contracts would be chargeable to Customs
output service provided is either Training services may attract Service tax duty unless specifically exempted.
consulting engineers’ services or IPR Armed forces and defence manufacturing
services, in which the Service tax liability establishments may enter into various However, Customs laws provide for a
under such taxable categories is reduced training contracts with domestic or mechanism whereby, machinery and
to the extent of R&D cess paid) the R&D offshore service providers for provision of equipment sent outside India for repair
cess would become a cost to the training services. This may include training and maintenance can be subsequently re-
transaction. imported without payment of Customs
in use of equipment and machinery,
training in manufacturing processes, R&D duty subject to fulfillment of specified
However, the R&D Cess Act empowers
related training, etc. conditions.
the Government to exempt any industrial
concern from payment of R&D Cess by
notification.
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:
accommodate representations and Such exemptions should be transitioned

recommendations for easing the VAT to and included in the new GST regime:
regime applicable on various sectors The Government has proposed
?
which entail significant investments switching to a Goods & Services Tax
and are seen as major growth (‘GST’) regime by 2010 which would
multipliers in the economy (such as subsume all Indirect taxes (except
telecom sector, auto sector, power Customs laws). Accordingly, the
sector etc.) Government may consider
incorporating the above exemptions in
Given the strategic importance of the
?
the new regime
defence sector as well as the
opportunity to attract major Moreover, since the Indirect taxes are
?
investments, the State Governments ultimately a cost to the defence sector,
should consider providing significant the exemptions already existing under
tax incentives to industries operating the current regime (under Customs,
in the defence sector (for instance, Excise, VAT etc.) should also be
VAT exemption on supplies made to/by suitably transitioned in the GST regime
the manufacturing units catering to the
defence sector etc.)
Direct tax regime Deductions to be made in computing total income

proposals
An overview of the direct tax
The following exemptions or Special deductions for license charges,
regime governing the defence concessions are suggested for expenditure on purchase, lease or rental
sector is provided in consideration in the direct tax regime: of land or land rights, capital
expenditure, expenditure before
Appendix II. The provision of tax holidays commencement of business etc.
The Government may consider extending Similarly, under the proposed DTC, under
benefits akin to existing provisions of Sec Section 30(2) read with Schedule Thirteen
80 I A/ IB of the Income-tax Act, 1961 to of DTC, a special mechanism for
the defence sector. Accordingly, where the computation of profits for entities
gross total income of an assessee operating in the defence scetor may be
includes any profit and gains derived by an provided. Such entities may, as a special
undertaking or an enterprise involved in case, be allowed deduction in respect of
production of goods/ supplies for defence expenditures such as license charges,
sector, there may be allowed, in expenditure on purchase, lease or rental of
computing the total income of such an land/land rights, capital expenditure,
assessee, deduction for an amount equal expenditure before commencement of
to 100 percent of the profits and gains business etc.
derived from such business for a period of
10 consecutive assessment years.
Consideration can also be

Concessions for dedicated
given to an alternative tax
SEZs catering to the
concession mechanism - a
defence sector
tax equalisation subsidy
Tax holiday concessions to Tax policy objectives being compliance,

manufacturers in SEZs coverage and collection and the direction
Under the Income Tax Act, 1961, Tax emerging from the Direct Tax Code Bill
holiday benefits are provided to 2009 expected to be implemented in 2011
developers of SEZs (including Defence it appears that the policy regulatory
SEZs), as per the provision of section 80- direction going forward would aim to
IAB. enhance the core objectives and reduce
distortions. SEZ and other similar enclave
Under the DTC, a special mechanism for
based provisions as well as provisions
computation of profits is provided for a
based on the ‘infant industry’ arguments
developer of SEZs [akin to Section 30(2)
may not find favour with the policy makers
read with Schedule Twelve of DTC],
going forward. To encourage investments
whereby such developers will be allowed
in Defence Production the Ministry of
deduction in respect of expenditures such
Defence may establish a tax equalization
as license charges, expenditure on
subsidy linked to value of goods and
purchase, lease or rental of land/land
services supplied to the Defence Sector.
rights, capital expenditure, expenditure
This will cover all goods and services as
before commencement of business, etc.
well as capital works executed for the
Defence SEZs shall also be entitled to
Defence Sector.
such benefits under the DTC.
A tax equalisation subsidy could be in the
Similar to existing provisions of section
form of cash back to the defence industry
10AA of the Act, any assessee who
of the amount of taxes which it has paid to
manufactures or produce articles or things
the government on its profits/sales, on
or provide any services to defence sector,
satisfaction of certain minimum conditions
and sets up a unit in Defence SEZ may be
of performance. Hence, under the tax
allowed a tax holiday for certain number of
equalisation subsidy, the amount of taxes
years. This would help defence
paid by a defence player may be remitted
manufacturers and service providers
back to it, subject to satisfaction of agreed
optimize their tax costs. Defence Sector
performance conditions, say quality of
specific provisions similar to section 10AA
goods and services supplied, timeliness of
may likewise be incorporated within the
supply, adherence to regulatory
framework of the DTC.
requirements, other conditions as may be
imposed by the government etc. This
would also ensure that only those defence
players which are satisfying agreed
performance milestones are rewarded in
terms of the policy.
06 Future outlook
With skilled intensive manufacturing capabilities

and a world class IT base, India has the right
ingredients to become a key link in the global
defence supply chain
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
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
IT services which would be utilised by

? concessions are provided under the state
the entire defence establishment VAT laws.
Scientific or technical consultancy

? Accordingly, VAT would be applicable on
service/ Technical inspection and supplies made to the armed
certification service, Technical testing forces/manufacturing units etc. Further, in
and analysis service for testing of the absence of any output VAT liability, VAT
various defence equipment charged on supplies made directly to the
armed forces would amount to a cost to
Since majority of such activities are
the transaction.
covered under the current Service tax net,
rendition of such services would attract
Service tax which would subsequently be
charged to the recipient (JVs or DPSUs as
the case may be).
As regards taxability, onshore service

providers would generally charge Service
tax on provision of taxable services.
Further, with regard to offshore service
providers not having any place of business
in India, where any taxable services are
rendered to an Indian service recipient,
the liability to deposit Service tax would
devolve on the said service recipient
(which may be the JV, DPSU, etc) in India
under the reverse charge mechanism.
Value Added Tax (‘VAT’)

Apart from certain specific exemptions on
sale of notified goods (including arms such
as rifles, revolvers; Telecommunication
equipments; Cinematographic
equipments; Motor Vehicles; Transmission
towers etc) to specified bodies, which are
part of the defence establishments (such
as armed forces canteens etc.), no general
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
owned subsidiary/joint venture) post the

initial approval period. Maximum number of directors 7 12 (can be increased with Government approval)
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)
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.
Key Tax & Regulatory

ramifications on
Repatriation/Investment
structuring
Joint Venture Company
Cash remittance by the JV to the parent

company can be achieved through the
following modes:
Dividend pay out;

?
Interest payments;
?
Royalty/Fee for technical services;

?
and/or
Withdrawal of equity share capital

?
a certificate by a chartered accountant (in Interest Royalty/Fees from Technical

prescribed form), to the effect that the
Exchange Control Regulations Services
correct amount of tax has been paid
The maximum all-in-cost (including Exchange Control Regulations
thereon.
interest, other fees and expenses) for Foreign technology transfer is permitted
Tax Implications External Commercial Borrowing (“ECB”) is under the automatic route subject to the
Dividends on shares are paid out of
? as under: condition that the lump sum payment
profits after payment of tax (DDT). towards the foreign technology does not
For ECBs where loan agreements have
Dividends paid on equity shares are exceed USD 2 million and payment of
been signed on or after January 1, 2010
not tax deductible under the provisions royalty does not exceed 5 percent of
with 3 to 5 year maturity period - London
of domestic tax laws in the hands of domestic sales and 8 percent of export
Interbank Offered Rates (“LIBOR”) plus
JV sales.
300 basis points
Further, such dividend income would
? Payment of royalty up to 2 percent for
For ECBs with more than 5 year maturity -
not be subject to tax in the hands of exports and 1 percent for domestic sales
LIBOR plus 500 basis points
shareholders of JV is allowed on use of trademarks and brand
Further, reference may also be made to names. Very recently, the Government of
Tax Treaty RBI Circular No 46 dated 2 January 2009 India has issued press note 8 (2009 series)
As income from dividends is exempt in the where in it has dispensed with the wherein the said limit on repatriation of
hands of recipient under the Act, the requirement of all-in-cost ceilings on ECB royalty on brand name/ trade mark has
question of taking shelter under a tax until June 30, 2009. Accordingly, eligible been removed. However corresponding
treaty (“DTAA”) would not arise. borrowers, proposing to avail of ECB change in the RBI regulations is yet to be
beyond the permissible all-in-cost ceilings made. In case of technology transfer,
specified above may approach RBI under payment of royalty subsumes the payment
Interest/Royalty/Fee for Technical the Approval Route. of royalty for use of trademarks and brand
Services Payments name of the foreign collaborator.
Recently, the RBI has decided to extend
Under the domestic tax laws of India, the
the above mentioned relaxation in all-in- Royalty on brand name/trade mark shall be
withholding tax rates may be higher as
cost ceilings, under approval route, until paid as a percentage of net sales, viz.,
compared to rates mentioned under the
December 31, 2010. This relaxation shall gross sales less agents’/dealers’
DTAA between Indian and their respective
be reviewed in December 2010. commission, transport cost, including
country of residence of the recipient of
ocean freight, insurance, duties, taxes and
income. Withholding Tax Implications
other charges, and cost of raw materials,
The rate of withholding tax under the Act, parts, components imported from the
As per the Indian tax act, the income
on the payment of interest to a non- foreign licensor or its subsidiary/affiliated
arising on account of interest, royalty and
resident on the borrowings is at the rate of company .
technical services fees is liable to tax on a
21.115 percent on gross basis, which
gross basis with no deduction of expenses
needs to be withheld by the JV at the time In case of remittance of any fees for
being allowed.
of crediting or before making any payment technical services, no approval is required
However, any royalty or technical services of interest. in respect of remittances up to USD 1 Mn
fees received by a non resident which per project on account of technical
However, if the rate prescribed under the consultancy services procured from
carries on business in India through a
relevant DTAA is lesser than this rate, outside India. Payments exceeding USD 1
permanent establishment situated in India
there is always an option with the parent Mn would require prior approval of RBI.
or through a fixed place of business in
company to be taxed under the provisions
India and where such royalty or technical
of relevant DTAA. The withholding tax/service tax
services fees is effectively connected with
implications would be required to be
such permanent establishment or fixed Consequently, the rates prescribed under examined for such payments.
place of business, is taxable in India on a the DTAA or the domestic tax laws of
net income basis. India, whichever is more favourable for the Further, import of technology is also
parent company, may be exploited by the subject to payment of research and
parent company. development cess of 5 percent
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
? 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
? 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
Glossary of Terms
Definition of Military Expenditure

as used in the report
For the purpose of this study, military Please note that the above definition may
expenditure has been defined as the vary by country depending upon the
expenditure incurred on the following applicability of the above four categories
accounts: for an individual country
the armed forces, including peace
?
Defence Expenditure can also be classified
keeping forces
into two categories, namely ‘Revenue’ and
defence ministries and other
? ‘Capital’. For the purpose of this study the
government agencies engaged in definition of the two mentioned categories
defence projects is as follows:
paramilitary forces when judged to be
?
trained, equipped and available for
military operations
military space activities
?
Revenue Expenditure Capital Expenditure
Training and Maintenance: Procurement of Equipment:

Covers troop training, institutional education, construction and maintenance of Covers Research and Development, experimentation, procurement, maintenance,
?
various undertakings transportation and storage of weaponry and other equipment
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
AAP Annual Acquisition Plan

ATV All Terrain Vehicles
BEL Bharat Electronics Limited
BEML Bharat Earth Movers Limited
Bn/BN Billion
BSF Border Security Force
CAGR Compounded Annual Growth Rate
CCS Cabinet Committee on Security
CGE Central Government Expenditure
CIA Central Intelligence Agency
CISF Central Industrial Security Force
CNC Contracts Negotiation Committee
CRPF Central Reserve Police Force
DAC Defence Acquisition Council
DDP Department of Defence Production
DDP&S Department of Defence Production and Supplies
DDRD Department of Defence Research and Development
DG (Acq.) Directorate General (Acquisition)
DGQA Director General of Quality Assurance
DIEG Defence Industry Enterprise Groups
DIPP Department of Industrial Policy and Promotion
DOFA Defence Offset Facilitation Agency
DPB Defence Procurement Board
DPP Defence Procurement Procedure
DPSU Defence Public Sector Undertaking
DRDO Defence Research and Development Organisation
EADS European Aeronautic Defence and Space Company EADS N.V.
EU European Union
FDI Foreign Direct Investment
F-INSAS Futuristic Infantry Soldier As a System
FIPB Foreign Investment Procurement Board
FTP Fast Track Procedure
FY Financial Year
GDP Gross Domestic Product
GoI or Government Government of India
GRSE Garden Reach Shipbuilders and Engineers
GSL Goa Shipyard Limited
HAL Hindustan Aeronautics Limited
ICG Indian Coast Guard
IDS Integrated Defence Staff
IP Intellectual Property
ISR Intelligence, Surveillance and Reconnaissance
ISRO Indian Space Research Organisation
IT Information Technology
JV Joint Venture
LCA Light Combat Aircraft
LO Liaison Office
LTIPP Long Term Integrated Perspective Plan
MDL Mazagon Docks Limited
MHA Ministry of Home Affairs
MIDHANI Mishra Dhatu Nigam Limited
MMRCA Medium Multi-Role Combat Aircraft
Mn/MN Million
MSME Micro, Small and Medium Enterprise
MoD Ministry of Defence
MoF Ministry of Finance
NATO North Atlantic Treaty Organisation
NCNC No Cost No Commitment
OEM Original Equipment Manufacturer
OFB Ordnance Factory Board
R&D Research and Development
RFI Request for Information
RFP Request for Proposal
RoC Registrar of Companies
RUR Raksha Udyog Ratna
SCAP Services Capital Acquisition Plan
SCAPCHC Services Capital Acquisition Plan Categorisation Higher Committee
Services The Indian Army, Navy, Air Force and Inter-Services Institutions
SHQ Services Headquarters
SIPRI Stockholm International Peace and Research Institute
SME Small and Medium Enterprise
SQR Service Quality Requirement
TEC Technical Evaluation Committee
ToT Transfer of Technology
UAC United Aircraft Corporation
US or United States The United States of America
USD US Dollar
CII Defence
and Aerospace Division
The CII National Committee on Defence Defence Procurement Procedure (DPP) in

works with the overall objective of 2002 and constitution of Dr Vijay Kelkar
promoting the indigenous Defence Committee by the Ministry of Defence in
Industry and creating a level playing field 2004. Various suggestions/
in the area of design, development and recommendations that CII made were
production of defence equipment. The subsequently incorporated in DPP 2006
Committee has been instrumental in and DPP 2008 and Defence
bringing the Industry and Defence Procurement Manual in 2005 & 2006
establishments on a common platform and 2009. This includes the
so that issues of mutual concern can be announcement of Offset Policy:
successfully resolved. The Committee Inclusion of ‘Make’ Procedure as part of
works proactively with the Ministry of DPP 2006 and incorporation of banking
Defence and the Armed Forces, of offsets and other changes in the DPP
facilitates formulation of various policies 2008.
related to Design, Development &
Offset facilitation has remained a
Production, Procurement Procedures,
thrust area of the committee. The
Offset Policy & Exports of Defence
committee has been instrumental in the
products. It represents Indian Industry at
conceptualisation and evolution of the
various MoD Committees and during
Offset Policy for the Defence Sector. CII
bilateral / Government to Government
has worked very closely with the
Meetings. Regular meetings with the
Defence Offset Facilitation Agency
Honb’le Defence Minister, Minister of
(DOFA) towards effective
State for Defence, Defence Secretary,
implementation of the Indian Defence
Secretary (Defence Production) and
Offset Policy. It provide policy Inputs to
Director General Acquisition are held to
Government on Offset Policy.
apprise the key decision makers on the
industry perspective on various policy It conducts various Seminar /
and procedural issues. Workshops and facilitation meetings on
Offset Awareness. With an objective to
Policy advocacy is the important area of provide a platform for the decision
the Committee’s work. CII has been makers and the Indian Industry on the
integral to the conceptualisation and best offsets practices followed in
evolution of policies in the defence various countries, CII in partnership with
sector. Its constant advocacy towards the Global Offset and Counter-trade
opening up of defence production for Association of US and the Defence
private industry led to the formation of 6 Manufacturers Association of UK
Joint MoD – CII Task Forces and Two organise International India Regional
Core Groups in 1998. The efforts Offset Conferences every alternate year.
ultimately led to the opening up of Such initiatives have proven to be
Defence Production to Private Sector in effective in enhancing the understanding
2001 and drawing Government of about Indian procurement and offsets
India’s Guidelines on “Awarding Licence (defence and civil) among the
for Defence Production to Private Sector International OEMs and subcontractors.
in January 2002. CII has also been CII has been providing inputs (as and
instrumental in putting into place the when required) to the Ministry of
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
About Confederation of Indian Industry (CII)
The Confederation of Indian Industry (CII) works to create and sustain an

environment conducive to the growth of industry in India, partnering industry
and government alike through advisory and consultative processes. CII is a non-
government, not-for-profit, industry led and industry managed organisation,
playing a proactive role in India’s development process. Founded over 113 years
ago, it is India’s premier business association, with a direct membership of over
7500 organisations from the private as well as public sectors, including SMEs
and MNCs, and an indirect membership of over 83,000 companies from around
380 national and regional sectoral associations.
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”.
For more information, please contact:
Head (Defence & Aerospace) Confederation of Indian Industry

India Habitat Centre
Core 4A, 4th Floor, Lodi Road
New Delhi - 110 003, India
Tel: +91-11-41504514 - 19
Fax: +91-11-24682229
email: gurpal.singh@cii.in
Website: www.cii.in
About KPMG in India

KPMG is a global network of professional firms providing Audit, Tax and Advisory
services. We operate in 140 countries and have 135,000 people working in
member firms around the world. The independent member firms of the KPMG
network are affiliated with KPMG International, a Swiss cooperative. Each KPMG
firm is a legally distinct and separate entity and describes itself as such.
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.
KPMG in India’s Defence Advisory:
KPMG in India’s Defence Advisory in India is an assembly of a strong core senior

team of advisors, who can offer a wide range of technical, commercial and
financial skills, with strong local presence in India and a global knowledge of
defence and aerospace markets, fully supported by the depth of KPMG's
resources.
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.
Our team is well positioned to advise clients based on our technical

understanding of the Indian defence sector, its procurement programs and
policies, combined with KPMG’s range of financial and commercial professional
services.
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.
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.
The support provided by CII has been instrumental in providing us with a

platform to base our industry discussions. We would like to thank the team at
CII’s Defence and Aerospace Division for assisting us during the course of this
study. We also thank Maj. Gen. Mrinal Suman for his insights and inputs to the
report.
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.
in.kpmg.com
KPMG in India KPMG Contacts
Mumbai Kolkata Richard Rekhy

Lodha Excelus, Infinity Benchmark, Plot No. G-1 Deputy Chief Executive Officer and
Apollo Mills Compound, 10th Floor, Block – EP & GP, Sector V Head - Advisory
N.M. Joshi Marg, Mahalaxmi Salt Lake City, Kolkata 700 091 e-Mail: rrekhy@kpmg.com
Mumbai 400 011 Tel: +91 33 44034000 Tel: +91 124 307 4303
Tel: +91 22 3989 6000 Fax: +91 33 44034199
Fax: +91 22 3983 6000 Vikram Utamsingh
Kochi Executive Director and
Delhi 4/F, Palal Towers Head - Markets
Building No. 10, 8th Floor M. G. Road, Ravipuram, e-Mail: vutamsingh@kpmg.com
Tower B, DLF Cyber City Kochi 682 016 Tel: +91 22 3090 0320
Phase ll, Gurgaon Tel: +91 484 309 4120
Haryana 122 002 Fax: +91 484 309 4121 Jai Mavani
Tel: +91 0124 307 4000 Executive Director and
Fax: +91 0124 3074300 Head - Infrastructure and Government
e-Mail: jmavani@kpmg.com
Pune Tel: +91 22 3090 1920
703, Godrej Castlemaine
Bund Garden
Pune - 411 001
Tel: +91 20 3058 5764/65
CII Contacts Defence Advisory Services
Fax: +91 20 3058 5775 Gurpal Singh Gaurav Mehndiratta
Deputy Director General Executive Director
Bangalore e-Mail: gurpal.singh@cii.in Tax and Regulatory Services
Maruthi Info-Tech Centre Tel: +91 124 401 4088 e-Mail: gmehndiratta@kpmg.com
11-12/1, Inner Ring Road Tel: +91 124 307 4172
Koramangala, Bangalore – 560 071 Amit Kumar Singh
Tel: +91 80 3980 6000 Deputy Director - Defence & Aerospace Charles Pybus
Fax: +91 80 3980 6999 e-Mail: amit.singh@cii.in Director
Tel : +91 11 2468 2230/35 Corporate Finance
Chennai e-Mail: charlespybus@kpmg.com
No.10, Mahatma Gandhi Road Tel: +91 124 334 5015
Nungambakkam
Chennai - 600034 Wg Cdr (Retd) Neelu Khatri
Tel: +91 44 3914 5000 Manager
Fax: +91 44 3914 5999 Defence Advisory Services
e-Mail: neelukhatri@kpmg.com
Hyderabad Tel: +91 124 307 4167
8-2-618/2
Reliance Humsafar, 4th Floor
Road No.11, Banjara Hills
Hyderabad - 500 034
Tel: +91 40 3046 5000
Fax: +91 40 3046 5299
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and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on
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Opportunities in The Indian Defence Sector

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Opportunities in The Indian Defence Sector

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Opportunities in the

Indian Defence Sector

Foreword from CII

1. Finance Budget 2009-10

01A CCELERATING THE GROWTH OF THE INDIAN DEFENCE INDUSTRY | 07

02 T HE DEFENCE MARKET OPPORTUNITY IN INDIA | 09

EFENCE INDUSTRIALISATION STRATEGY

05 T AXATION REGIME AND INCENTIVES | 53

The defence industry in India is experiencing significant

02 The Defence Market

The eyes of global defence market are turning to India to

Defence Industry World Defence Spending, USD BN

Note: The figures are at constant 2005 prices

According to 2008 estimates released by multilateral peacekeeping operations,

1. SIPRI Yearbook 2008

Global Military Expenditure Distribution 2008

Note: ROW = Rest of the World

3. CIA World Factbook 2008

Average Annual Growth Rate of largest defence spenders 1998 - 2007

China has increased its military spending

4. CIA World Factbook 2008, SIPRI, KPMG Analysis

As a percentage of GDP, Saudi Arabia is highest spender on defence and India is

Focus on Defence Expenditure by the Largest Spenders in 2008

Defence Expenditure as a percentage of GDP

5. CIA World Factbook 2008

US companies play a major role in the

12. SIPRI Yearbook 2008

Largest Defence Companies in the world

1 Lockheed Martin US 42.7 A global security company principally engaged in research,

2 Northrop Grumman US 33.8 An integrated enterprise consisting of businesses that

3 Boeing US 32.1 Involved in research, development, production, modification

5 General Dynamics US 29.3 Focuses on delivering products and services to military,

7 Raytheon US 23.2 Designs, develops, manufactures, integrates and provides a

8 Finmeccanica Italy 23.2 An industrial holding company engaged in aeronautics,

9 Thales France 18.5 An electronics company providing services for aerospace,

Source: Economic Survey of the respective years

Since India’s first defence budget for 1950-

13. Finance Budget 1950-51

Defence Expenditure as percentage of GDP and Central Government Expenditure (CGE)

Source: Economic Survey of respective years

Source: Defence Service Estimates of respective years

Revenue expenditure has historically spending as categorised in the current

The Air Force, although typically

years its share has been increasing due to

DPSUs continue to play an integral part to achieve self-sufficiency and

manufacture of state-of-the-art weapons nearly INR 192 Bn19 - an increase of over

the years, these organisations have aimed year.

Defence Public Sector Undertakings

Company Sales (INR Mn) Products/Services

Note: Annual Sales for the Year 2007-08

Select Indian Defence Private Sector Majors

Company Year of inception of Products/Services

Note: The above list is only indicative and not exhaustive

9. IDSA research paper, April 2008

Existing equipment profile

15% 35% 50%

Required equipment profile

30% 40% 30%

State of the art

Source: Inputs from Maj. Gen. Mrinal Suman

20. CII Website 21. KPMG Research

Details of potential deals in the pipeline