State Subsidies in India

/State Subsidies in India
  • State Subsidies in India

Bhavesh Thakkar | Partner | BDO India LLP

First published in M+V’s India Insight in June 2015

Today, India is considered to be one of the major forces in the global economy. Due to its large consumer market, rapid infrastructural developments, ample pool of talent, abundant natural resources, and low manufacturing costs, India trumps other countries in terms of being an ideal destination for business investments. The ‘Make in India’ campaign is being marketed in a big way. However, the jury is still out on its success – but the entire focus is on pushing manufacturing and employment in India, which was hitherto missing. Due to the fact that India is a federal economy and it is deemed to become a global manufacturing hub, the overall contribution and role of the state governments must not be denied. Rather, the role of the state governments is predominant to attract investors to set up a manufacturing facility in their respective states. The last two years have been an era of competitive federalism wherein the state governments have been trying to outdo each other in attracting investments. Off late, this has become a very important indicator of the state’s economic growth, with huge media coverage of the states attracting the maximum investment.

In the quest to attract investments there has been stiff competition among various states to offer subsidies and grants to industries being set up. Each state is trying to surpass the other in declaring industrial policies, offering maximum possible benefits. Industries planning to invest in India are required to be acquainted with these subsidies as these can significantly impact the cash flow and the payback period of their enterprise. There are innumerable instances wherein manufacturing units have failed to claim these substantial benefits just because of lack of awareness. The benefits range from 30% to 100% of the capital cost – and thus should not be ignored.

Though each state comes up with its own policy, there are certain common points in all state subsidies in India:

  • Each state develops an industrial policy, generally spanning a period of five years; the applicable period may be different in each state
  • The industrial policies are applicable to almost all manufacturing enterprises; in the recent past, even sector specific policies have been unveiled
  • The states have been generally divided into zones, and for lesser developed zones the benefits are bigger; this is in line with practices followed worldwide; some states do not follow the zone-wise classification and offer uniform subsidies
  • Subsidies are available to new units set up in the state but also to existing units which undergo expansion
  • The percentage of benefits normally depends on the size of investment: It is important to note that the benefits for large projects with substantial capital or employment generation capabilities are kept flexible and normally decided by a special committee; this is to provide tailor-made subsidies to those units and help states compete with other states to formulate the benefits
  • There is no difference between the benefits available to a foreign company and those available to an Indian domestic company

The benefits can be broadly summarised into two categories:

a) Cost Reductions: Benefits are in the form of reduction in payments for certain percentage of energy, stamp duty, water, or other utility bills that the manufacturing unit needs to pay; this helps the unit in reducing production costs and making the product competitive in the market.

b) Tax Reimbursements: Benefits are linked to the capital cost of the company; the benefit is capped as a certain percentage of the capital cost and the encashment of the benefit is in the form of tax reimbursements of various taxes paid to the state government.

There are two methods by which the tax reimbursements are given by the state:

1) Cash Back Method: Enterprise charges and collects sales tax from the customers. Sales tax collected net of input tax credit is paid to the state government. Certain percentage tax paid to the state government is reimbursed to the enterprise.

2) Defferal Method: Enterprise charges and collects sales tax from the customers. Enterprise retains specified percentage of net tax for stipulated number of years as a soft loan. The retained amount is paid back to the state government after the end of stipulated number of years.

The majority of state governments currently follow the cash back method and the other states are also expected to phase out the deferral method and switch to the cash back method. The benefits of state subsidies in India are tremendous and form an important part of the decision making process. Like in the state of Rajasthan or Madhya Pradesh, the benefit percentage is 100% of the investment.

Subsidies cannot be the sole guiding factor in choosing the location of the enterprise, but since the benefits are indeed quite substantial, it certainly plays an important role when making such a decision. The moot point here is that the overall awareness of the scheme is pretty low and that manufacturing units set up in the recent past have not claimed these benefits. Investors should be informed about these possibilities so that they do not miss out on these substantial benefits.