Why tonnage tax makes sense

In all the hoopla around the feel-good Budget and the reduction of the fiscal deficit, commentators in general missed out on one path-breaking feature of Finance Minister Jaswant Singh's interim Budget.

By proposing the introduction of tonnage tax in place of the existing taxation regime, the finance minister not only met a long-standing demand of the shipping industry, but also created an atmosphere that enables Indian lines to compete successfully against their rivals anywhere in the world.

Tonnage tax was always considered the perennial bridesmaid, forever on the verge of being introduced as law, but never quite making it at the last moment.

What is tonnage tax and why is it so significant for the shipping sector? Simply put, tonnage tax is calculated not on the profit or loss of a company in a given year, but by applying a notional annual income on its net registered tonnage.

This means that the tax burden is known in advance and is neutral to the performance of the company. The effect is to ring-fence the company's tax liabilities, making financial planning and long-term strategic operations easier.

Typically, tonnage tax places a negligible burden of about 2 or 3 per cent on the company. When recollected that shipping companies are currently subject to a tax liability of about 35 per cent, the benefit that tonnage tax brings to the bottomline becomes apparent immediately.

Critics will invariably ask why the shipping industry alone should qualify for this largesse from the government. Is it right that one industry should be given a special status not available to other industries?

The answer is to be found in the peculiar environment in which the shipping industry functions. Nearly 90 per cent of the world's fleet enjoys the benefit of a tax-friendly regime in which only a nominal tax is levied.

Normally, this would not be a relevant factor when framing taxation policies. As long as there is a level playing field within the domestic tariff area (DTA) and all players are subjected equally to it, there should be no case for special treatment. The shipping industry, however, does not function in such an environment.

Typically, the Indian shipping companies compete, not with rivals in the DTA, but in the international arena. If 90 per cent of their competitors pay only a nominal tax, Indian shipping lines cannot be expected to perform well when they are subjected to tax rates of 35 per cent. If India's shipping industry is to retain its competitive edge, it must be brought on par with the rest of the world.

But should India encourage a domestic shipping industry at such a cost? After all, if we do not manufacture our own aircraft (HAL notwithstanding) why should we have our own fleet of ships? The answer lies in the strong linkage between freight rates and the existence of a domestic fleet.

A study by the United Nations Conference on Trade and Development shows that developed maritime nations with a respectable fleet pay about 4 per cent of the value of their trade by way of freight. For developing maritime nations, the figure is about 8 per cent.

For India, the figure rises to 10 per cent. When one considers that India's foreign trade is in excess of $ 100 billion and that about 90 per cent of this trade (by volume) goes by sea, the importance of reducing the 10 per cent figure becomes evident. One way of doing this is to encourage the growth of the domestic fleet through supportive fiscal measures.

The growth of the flag is not the only positive fallout of tonnage tax. A larger fleet brings a host of economic benefits, the most important being a rise in gainful employment. Every ship flying the Indian flag is invariably manned by an Indian crew.

In the context of the frequent charges that reforms and the economy's liberalisation have brought about jobless growth, this is a meaningful factor. If each ship carries a crew of about 45 to 50 people, the rapid increase of tonnage in the flag will have a significance for employment that can hardly be over-emphasised.

More than direct employment, however, we should look at the ripple effect that tonnage tax has on indirect employment and development.

The case is best seen in the electrifying effects that tonnage tax has had on employment and development in the UK. In each of the first three years following the introduction of tonnage tax, the British fleet strength went up by more than 1 million tonnes, rocketing the country from a lowly 21st position to the 9th largest in the world.

During this period, the beleaguered British economy was given a boost through earnings of nearly $ 3 billion by way of invisibles.

Maritime services like chartering, ship broking, insurance, legal affairs, ship classification and publishing brought in nearly $1.5 billion while the rest was accounted for by the net overseas earnings of British ships.

In addition, it was estimated that nearly $ 3 billion was saved by way of payment to foreign ship owners, and ploughed back into the British economy.

This success story is not confined to the UK. Norway added 5.5 million tonnes to the registered fleet in just two years after the introduction of tonnage tax and the experience of countries like the Netherlands and Germany has been equally encouraging.

Tonnage tax can give an even greater fillip to the economy in India. To begin with, the victualling requirements of an Indian crew are likely to be met within the country. This will give a shot in the arm to chandlering operations. With more and more vessels being staffed by Indians, the manning industry will take off.

It is ironical that though India is the largest supplier of trained officer manpower to the world maritime industry, the big manning companies are headquartered in countries like Hong Kong, Singapore and Malaysia.

A larger Indian fleet could change this and motivate manning companies to relocate to India. Activities like ship broking, maritime insurance, maritime law and surveying for ship classification would get an immense shot in the arm.

Above all, this measure should arrest the declining share of Indian vessels in India's foreign trade and "" if the British experience is anything to go by "" should result in considerable savings in payments to foreign ship owners.

Some critics believe that the provisions of Section 33 AC of the Income Tax Act, which mandate tax breaks for companies ploughing back profits up to twice their paid-up capital and reserves into a fund dedicated to the acquisition of new vessels, is a better option than tonnage tax.

Actually, these provisions suit existing companies with large reserves. They do not encourage newer entrants to flag in India since the reserves of a new company will usually be low and the benefits of Section 33 AC insignificant.

The British experience and indeed the experience of 90 per cent of the world fleet show that the most effective way of encouraging the growth of tonnage in the flag, especially by attracting new players, is through meaningful fiscal policies like tonnage tax. Its importance as a vital tool in the growth and development of shipping is second to none.

(The writer is former secretary, shipping, Government of India)