Shipping companies haven't got exactly what they wanted, but they do get an opportunity to save on taxes. This will, however, depend on their ship acquisition schedule
The shipping industry has been given a boost from changes in a regulation that relates to the accretion of shipping assets. While earlier, the industry was allowed a deduction under Section 33AC of the Companies Act, the new ruling, applicable from FY03, will enable them to transfer greater amounts to the reserve. The cap on the reserve has been hiked from twice the paid-up capital only to twice the sum of paid-up capital, general reserves and share premium account.
In simple speak, if the Section 33AC reserve stood at Rs 500 crore and the sum of equity and reserves were Rs 1,000 crore, then the cap on transfer becomes Rs 2,000 crore. Thus, a company can transfer an additional Rs 1,500 crore, subject to 100 per cent of profits.
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The tax benefit for companies arises because the amount transferred to the 33AC reserve will be deducted from book profits. Therefore, if a company transfers 100 per cent of its profits to the reserve, then it would not be required to pay any corporate tax.
If a company has a really good year, it can either take advantage of the reserve in the year itself or transfer a greater quantum to the general reserve. In the case of the latter, it will pay corporate tax in the good years and in bad years, utilise the tax benefits by placing orders for ships.
The reserve is to be utilised within eight years for the purpose of acquisition of ships failing which, the transfer would have to be given a reverse effect in the income statement with respect to the tax saved. The move is extremely beneficial for companies like Shipping Corporation of India and Great Eastern Shipping, who are pro-active on the ship-acquisition front.
However, the aforesaid reserve account is solely for the purpose of acquisition or replacement of ships. To that extent, the taxability of profits will depend on the company's ship acquisition schedule.
Thus, in a year when there is no accretion to such reserves, the company will have to pay regular corporate tax applicable. The expansion in the cap will come into effect from FY04. With a US recovery expected in the latter half of 2002, it places companies in a good position to build reserves for their anticipated acquisitions, which typically take 18 to 24 months for delivery.
In the past year, the industry has been on a roller-coaster ride with tanker rates touching highs of $50,000-60,000 per day to lows of around $10,000 per day. Currently, rates are hovering around $30,000 per day. It just goes to show that earnings of shipping companies have become much more volatile in recent times.l
Shipping Corporation
This government-owned shipping company, also one of the best buys in the sector, has got a shot in the arm thanks to the new budget proposal. As per current guidelines, the maximum that a company can transfer to the reserve account in FY02 is approximately Rs 107 crore.
If the new norm was applied for FY02, the transferable amount would have been Rs 2,431 crore. No doubt this change will have a considerable impact on the valuations of SCI, now due for divestment. The government plans to divest 51 per cent of SCI's equity, which would also entail an open offer for 20 per cent. This could also lead to an eventual de-listing of the company.
The largest shipping company in India with a share of 40 per cent of shipping tonnage, the company is also the nodal agency for transporting crude for Indian Oil Corporation. IOC, until the dismantling of administered pricing mechanism, is the sole canalising agency for importing crude. The shipping business has been very lucrative in FY01, but rates have fallen sharply in FY02.
Tankers are the mainstay of SCI contributing around 80 per cent to profits, with the rest coming in from the bulk carrier and offshore division. It's liner division, however, is a loss-making one.
The change in the reserve norms will be of immense benefit to SCI as in FY01, it placed orders for eight vessels at a cost of Rs 821 crore. The initial plan was to acquire 11 vessels at a total outlay of Rs 1,220 crore. The target for acquisition during the Ninth plan was 44 vessels with an investment of $1.3 billion. The Planning Commission had approved an outlay of Rs 521 crore.
SCI was a tax-payer in FY01, paying the corporate rate with an effective tax rate of 31 per cent. The gain, therefore, will be immense since most of the tax liability will be recouped through the new norms.
GE Shipping
The country's most profitable shipping company will benefit from the budget proposals. The benefit of the higher cap, if it had been introduced in FY02, would have resulted in the cap increasing from Rs 435 crore to Rs 1,100 crore approximately.
The largest private shipping company in India, it is second to SCI in terms of share of tonnage. Unlike SCI, which has to account for wage agreements, GE Shipping is more profitable, with operating margins close to 40 per cent.
As in the case with SCI, close to 65 per cent of its profits are contributed by the shipping division and the rest by its offshore division, which provides the entire gamut of offshore services for exploration companies like ONGC, Cairns Energy, Hardy Oil & Gas etc.
Gesco also has an aggressive ship acquisition plan of around Rs 1,200-1,300 crore over the next 4-5 years. Its capital expenditure plans include the acquisition of five ships in next two years, two ships in FY03 and three in FY04.
The tax break for GE Shipping will be considerably lesser than for SCI as its effective tax rate in FY01 (for paying corporate tax) was only 12 per cent. Gesco's strong cash flows have enabled it to repay debt and the new ruling will further improve cash flows. Its improved cash flows can also be used for their continuing buy-back programme.
Gesco is a potential bidder in the race for the disinvestment of SCI along with others like Essar Shipping and foreign companies. Gesco has been able to partially ride through the downturn by ensuringthat a greater proportion of revenues accure from long-term charter contracts.
This has resulted in its earning fixed charter rates while taking advantage of lower fuel costs. Though times may be looking up again, the long-standing demand of introducing tonnage-based tax. Despite the grant of a higher cap to reserve, that of tonnage tax continues, which would result in a tax outgo up to a maximum of two per cent.