India: Summary Of Expert Committee Report On Amendments To DPP 2013

Last Updated: 5 October 2015
Article by Khaitan & Co

In order to leverage the defence procurement programme to develop India's local defence manufacturing capabilities under the Make in India initiative, a Committee of Experts (Committee) has recommended changes to the 2013 Defence Procurement Procedures (DPP).

Some of the key inputs and changes proposed by the Committee are as follows:

Strategic Partnership with Private Firm

The Committee has suggested a Strategic Partnership Model for the development of critical platforms such as aircrafts, warships, armoured fighting vehicles, etc. The key highlights of the proposed model are as follows:

  • A specially instituted task force would select an Indian Strategic Partner (SP) for the development of a particular platform;
  • The SP would participate as a prime contractor in government to government negotiations with foreign Original Equipment Manufacturers (OEMs);
  • Stringent audit and oversight mechanisms for performance and financial review.
  • Each SP would be restricted to only 1 platform to allow for development of structured capabilities in the Indian industry.

Comment: The Government has already constituted a task force to prescribe detailed selection procedure for SPs under the chairmanship of the former chief of the Defence Research and Development Organisation, Mr. V K Aatre.

Offset Policy Changes

The Committee has recommended, inter alia, the following key changes to the extant offset policy:

  • Extended timeline for discharge of Offsets: OEMs be allowed a minimum of 10 years (with a discretionary allowance of 2 additional years) for discharge of offsets, considering the long gestation period involved in creation of facilities and infrastructure for proper absorption of transferred technology;
  • Eligible Offsets: inclusion of services like maintenance, repair, overhaul, life extension, testing infrastructure and engineering design as eligible offsets, limited to 30% of the overall project obligations;
  • Discharge of Offsets obligations: technology enabling production of critical raw materials be allowed as a valid avenue for discharge of offset obligations as a number of specialized inputs (such as metal alloys) are not available in India;
  • Upstream and downstream discharge: permitting discharge of offset obligations through the entire supply chain of OEMs as well as their group companies, subject to prior disclosure at the proposal stage and vesting of primary responsibility with the vendor;
  • Offsets banking: offset banking be allowed for all avenues of discharge of offset obligations and inclusion of carry forward provisions;
  • Exchange Rate Variation: the introduction of Exchange Rate Variation protection for Indian vendors and Indian sub-vendors. This proposal has already been given effect by the Ministry of Defence (MoD).
  • Indian Offset Partners: for promoting ease of operations, the Committee recommended various changes to offsets related provisions, including change in Indian Offset Partners, be allowed through approval of the Secretary, Defence Production instead of the Defence Minister. This MoD has already revised the selection process of Indian Offset Partners.

Comment: It is encouraging to note that the two amendments made to the DPP 2013 (i.e., accord of exchange rate variation protection and flexibility in designating Indian offset partner) are along the lines of the recommendations made by the Committee. It is expected that the new DPP (expected soon) would consider other material recommendations made by the Committee.

Policy Changes in DPP 2013

The Committee has made both substantive and procedural recommendations to improve the extant defence procurement procedures with the overall objective of increasing participation of domestic private firms. Key propositions made include:

  • Indian Vendor: a unified definition of Indian Vendor consistent with the licensing norms, FDI guidelines and other applicable laws should be incorporated in the DPP;
  • Indigenisation: increasing the ratios of indigenous content (IC) thresholds as follows:

    Category IC requirement
    New Old
    Buy (Indian) 40% 30%
    Buy and Make (Indian) 60% 50%
    Make 40% --
  • Agents/Intermediaries: use of agents be permitted only in civil equipment procurements;
  • Price Escalation: inclusion of price escalation clause in the request for proposal to deal with any delays in contract negotiation and execution;
  • Transfer of Technology (ToT): the option of negotiating ToT after the date of execution of the contract as it may not always be feasible to negotiate ToT in the initial stages of procurement;
  • Single Vendor Situations (SVS): extending the exception available to Defence public sector undertakings and Ordinace Factory Boards in SVS (under Paragraph 70, DPP 2013) to the Indian industry, with a view to provide a level playing field in SVS for 'Make', 'Buy and Make (Indian)' or 'Buy and Make' categories;
  • Life Cycle Cost Methodology: use of the life cycle cost methodology for award of contracts for large systems and projects such as aircraft, warships to encourage an analysis of the long term commercial impact of such acquisitions and determination of a just and equitable price band;
  • Standard Contract Document (SCD): The Committee has proposed a legal and financial examination of the SCD with a view to minimizing uncertainty and scope for disputes for the industry. A list of key recommended provisions is as under:

    • Include definitions clause (Article 2)
    • Incorporate a methodology for calculating advance bank guarantee bond reduction values, as reductions to the bonds are not automatic (Article 3 and 4);
    • Clarify that payment would be withheld only until delay is rectified (Article 13);
    • Include provisions relating to limitation of liability (Article 15);
    • Provide vendor the option to terminate the contract in certain specified events (Article 19); and
    • Options clause to be subject to a separate proposal and mutually agreed price and schedule (Article 32).

Tax Reforms and Export Incentives

The Committee has recommended the elimination of the inverted duty structure on inputs for defence items, along with extension of tax benefits to the defence sector that are currently provided to other core sectors such as power, infrastructure. Key propositions include:

  • Deemed export status: extending deemed export status to supplies from Indian Offset Partners to promote the competitiveness of the domestic industry. This is expected to improve the cost efficiency of Indian manufacturers on account of exemption from customs duties;
  • Export promotion: implementation of several pro-investment measures including single window clearance for defence exports, easy availability of export licences, extended line of credit, relaxation of end user certification requirements, etc.;
  • Corporate taxes: non-taxability in India of income arising from sale of defence items manufactured outside India. Further, proper delineation of goods and services must be made in contracts to allow suppliers to take benefit of relevant exemptions. In this regard the Committee also proposes inclusion of provisions pertaining to direct taxes in the SCD, in addition to existing provisions on indirect taxes;

Comment: The suggested measures are industry-friendly, however, the extent of implementation of these proposals would depend on political will.

In a comprehensive attempt to expose the devil, hidden in 360 pages of detail, the Committee's efforts in deconstructing the shortfalls of the DPP 2013 are laudable. With the Government already having set the wheel in motion, it would be prudent for OEMs, strategists and other stakeholders alike to take note of the Committee report and its contents, in the hope that they would be implemented in the new DPP and would pave the path for a more sustainable and easier to hone Make-in-India construct.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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