The Hindu Business Line : Little more buoyant now

The new tonnage tax regime will be providing a level-playing field for the domestic shipping companies to compete with foreign companies, as their tax liability will now drastically come down. The new regime will also trigger off spin-off benefits for India in terms of increased tonnage and likelihood of foreign investments in the shipping sector.

At this stage, it can be safety estimated that the shipping companies, which are at present paying an effective tax of 7.5 per cent (it was 22 per cent prior to 2002-03), will have a tax liability of two to three per cent of their book profits under the new tax regime. The estimated sum paid by the entire industry to the Government during the Ninth Plan had increased from Rs. 114.2 crore in 1996-97 to Rs. 274.7 crore in 2000-01.

About 70 per cent of the world shipping is owned by a group of countries following the conventional tonnage tax system, envisaging a very low (one to two per cent) and fixed amount of tax.

What are the components of a tonnage tax regime? The Rakesh Mohan Committee has recommended a tonnage tax system in which the tonnage tax is obtained by multiplying the net registered tonnage (NRT) of a vessel with the prescribed rate to compute a notional daily taxable income. This value is then multiplied by the prevailing corporate tax rate and the number of days the ships operate in a year, yielding the total tax liability. For arriving at the daily notional profit, the committee had used a weighted average notional income rate of three countries — the UK, Germany and the Netherlands.

Thus, the tax liability is worked out as follows: Daily notional income x 365 (days) x 35.7/100 (corporate tax rate). Given that the new tax regime will more or less follow this basis, the taxation level will work out to 2 to 3 per cent of the book profits. Given the fact that Indian companies now carry only about 13 per cent of India's sea-borne trade, an increased Indian tonnage in the wake of the new tax regime will significantly increase this share to the benefit of the Indian economy.

Analysis

Shipping companies are now well-placed to report a higher level of per share earnings. If they move over to the tonnage tax system, they would not have to provide for deferred tax liability, which now can detract from the earnings reported to shareholders. There would also be a higher degree of certainty attached to their tax liability, which could perk up valuation levels over a period of time. Companies such as Great Eastern Shipping, Shipping Corporation of India and Essar Shipping may be the prime beneficiaries over the long term.

The quantum of benefits may not appear significant in the near term due to tax incentives that the shipping companies have enjoyed under the present dispensation. For instance, G E Shipping shelled out about 11.1 per cent and 4.9 per cent in FY03 and FY04 respectively of its earnings before tax when the base corporate tax rate was 30 per cent. If it had not had the benefit of fiscal incentives, its tax outgo would have been in excess of 20 per cent.

This would be the more appropriate benchmark to evaluate the impact of the new system as the existing fiscal incentives have now been removed. There is bound to be a substantial reduction in the tax outgo compared to what the companies were paying out a few years ago.

As shipping companies are expanding their fleet, the new tax facility could not have come at a better time. The shipping industry is in the midst of a bull market in freight rates encompassing both the dry cargo and tanker segments. Though the market is not as firm as it was last year, freight rates are at levels that should ensure earnings bounty.

Strong earnings and cash flows have been used, especially by G E Shipping, to scale up and modernise its fleet. Its tonnage has risen by over 70 per cent over the past one-and-half years. G E Shipping and Shipping Corporation of India also have sizeable tonnage on order. As these join the fleet over the next three years, these companies would gain as they move away from the present system of corporate tax.

As the listed shipping companies are pure industry plays, there would be no need for any re-organisation of businesses if they opt to transit to the new system. If companies had a diversified business profile as G E Shipping and Essar Shipping had a few years ago, they would have to restructure to fence shipping activities from other businesses as only the former's earnings are taxed under the new tax system. As no such restructuring is required, compliance costs for a shift to tonnage tax are likely to be insignificant.

Incremental training costs are also likely to be negligible as Indian companies already spend sizeable sums on their sea-farers. The training requirement is intended to ensure replenishment of trained sea-farers for use in Indian fleet and shore-based activities. Creation of reserves out of profits, which is another requirement for opting for the new system, would not be not be a problem for the bigwigs of the industry.

The lock-in period of ten years, once a company opts to for the tonnage tax system, is unlikely to be deterrent for the likes of G E Shipping and Essar Shipping.

Smaller players may find the choice between the two systems a tough one to call, as tax would be payable under the tonnage tax system even in a year when they make losses.