Content

Home

A Study on Foreign Direct Investment (FDI) in Indian Tourism

Dr. P. Srinivas Subbarao* Introduction One of the most notable features of economic globalization has been the increased importance of foreign direct investment around the World. Some view is as an engine of economic growth and development while others look upon it as a panacea for all ills. It is, however, important to weigh the costs and the benefits of FDI to gauge whether FDI has positive impact on economic development. FDI has the potential to generate employment, raise productivity, enhancing competitiveness of the domestic economy through transfer skills and technology, strengthening infrastructure, enhance exports and contribute to the long-term economic development of the worlds developing countries. More than ever, countries at all levels of development seek to leverage FDI for development. We in India see FDI as a developmental tool in all sectors and tourism has no exceptions. Liberalization policies have led to rapid growth in FDI flows in recent years. Basing on the benefits associated with FDI several developing; as well developed countries compete fiercely for FDI. They try to attract foreign investors by providing financial and fiscal incentives, undertaking corporate restructuring and economic reforms and inviting foreign investors in the privatization of state-run units. In 2001, for example, 71 countries made 208 changes in their FDI regulatory regimes, out of which 194 have done to attract higher FDI. Tourism Industry in India Tourism sector holds immense potential for Indian economy. It can provide impetus to other industries through backward and forward linkages and can generate huge revenue earnings for the country. In the recent 2007-08 budget, the provision for building tourist infrastructure has been increased from US$ 95.6 million in 2006-07 to US$ 117.5 million in 2007-08 (Min. of Tourism, GOI). Tourism is no longer looking at it as a leisure activity, but as a major source of employment. The labor capital ratio per million rupee of investment at 1985-86 prices in the tourism sector is 47.5 jobs as against 44.7 jobs in agriculture and 12.6 jobs in case of manufacturing industries (Market plus Report, Min. of Tourism). Tourism is one of the third largest net earners of foreign exchange for the country and also one of the sectors, which employs the largest number of manpower. In order to develop tourism in India in a systematic manner, position it as a major engine of economic growth and to harness its direct and multiplier effects for employment and poverty eradication in an environmentally sustainable manner the state and central governments formulated several policies. But it continues to suffer from lack of consistent and comprehensive policy. While little effort has been made to tap the potential of the tourism sector over the last few decades, the central tourism ministry is formulating policies to facilitate private investments through public private partnership and focus on development of this sector. India is rated among the top five travel destinations in the world according to Lonely Planet. ABTA magazine rates India as the most preferred destination on earth. Indian tourism is one of the most diverse products on the global scene. India has 26 world heritage sites. It is divided into 25 bio-geographic zones and has wide ranging eco tourism products. Apart from this it has a 6,000 km coastline and dozens of beaches (WTO 1997). India's great ethnic diversity translates into a wide variety of cuisine and culture. It also has a large number of villages, plantations and adventure locations. Need of FDI in Tourism Foreign tourist arrivals are expected to grow to 10 million by 2010-12 and the domestic tourism is expected to increase by 15% to 20% over the next five years as per the Ministry of Tourism expectations basing on the growth in the last one decade. There is a rapid growth in average room rates and is expected to continue until sufficient new supply come on stream (average increase is 21% since 2004-06 in 4& 5 star segment). Government of India is allowing 100% FDI in Hotels and Tourism, through the automatic route and also identified the investment opportunity of about $8-10 billion in the next 5 years in tourism sector. India has significant potential for becoming a major global tourist destination. It is estimated that tourism in India
*Professor and Head of the Department, Department of Management Studies, M.R.P.G. College, Vizianagaram. pasumarti@yahoo.co.in

Top

IIMK

Part III Tourism and Economic Development

IIML

could contribute Rs.8,50,000 crores to the GDP by 2020 ( approx. 1800 million USD) if you properly plan to develop and invest on Connectivity Infrastructure, Tourism Infrastructure, Tourism Products, Capacity Building and Promotion & Marketing (WTTC report). It is estimated there is a need of around 10 Billion US $ required for development of tourism as per the different state tourism estimates for the next five years. When you think about the long term capital requirement of all states, it is estimated around 56 billion US $ for the next 20 years. A rapidly growing middle class, the advent of corporate incentive travel and the multinational companies into India has boosted prospects for tourism. India's easy visa rules, public freedoms and its many attractions as an ancient civilization makes tourism development easier than in many other countries. In order to attract more visitors, India needs to increase room supply, open further its skies to increase air capacity, and upgrade its airports, roads and other infrastructure to global standards. Also tourism development needs to be pursued with a focus on sustainability. Though the Government of India is allowing 100% FDI in automatic route to India in tourism sector and there is a wide gap between the demand and supply of hotel rooms and other tourism infrastructure projects, we have attracted the FDI for a volume of 660.87 million US $ which is 1.46 percent of the total FDI inflow into our country from April 2000 to December 2007. Reasons to invest in this sector Economic liberalization has given a new impetus to the hospitality industry. The Indian hospitality industry is growing at a rate of 15 percent annually. The current gap between supply and demand expected to widen further as the economy opens and grows. The government forecasts an additional requirement of 200,000 rooms by the turn of the century. The travel and hospitality industry continues to be the sector, which has largely profited from the fast growing economy of India. This has largely been due to the 3.9 m tourist arrivals in FY06 (15% growth) over the previous period. The compounded growth in tourist inflow over the last ten years (FY96-FY05) has been 8.2%, while in the last five years, growth stands at 9.1% per annum. This increase in the number of tourist arrivals in the country lifted the countrys standing in the world of tourist destinations. The country is ranked fourth among the worlds must see countries. The sector continues to face certain problems. The country continues to be marred by poor infrastructure facilities like poor road management, rail, air and sea connectivity. However, the present government in its endeavor has taken a few initiatives like opening of the partial sky policy. This allows private domestic airline operators to fly on the Indian skies. Some states continue to be in political uncertainties. As per the 2004 findings, the total number of approved rooms by the Government of India stands at around 99,000 (estimated). These rooms are further classified into various segments out of which, Five star and Five star deluxe hotels account for around 27% of the total capacity, three star hotels (22%), four star (8%), two star (9%), one star and Heritage hotels (2% each) and the rest is divided between unclassified and unapproved hotels. A rapidly growing middle class, the advent of corporate incentive travel and the multinational companies into India has boosted prospects for tourism. India's easy visa rules, public freedoms and its many attractions as an ancient civilization makes tourism development easier than in many other countries. The five star hotel segments have grown the fastest during the last five years at a CAGR of 12%. Further, this segment can be divided into 3 sub-segments Luxury, Business and Leisure. The growth in this segment indicates the genre of travelers coming into the country. Over the last few years the country has witnessed a large influx of business travelers in the country owing to relaxation of the governments stand on Foreign Direct Investments (FDI) for most of the sectors in the country. Many foreign companies have already tied up with prominent Indian companies for setting up new hotels, motels and holiday resorts. The entry of McDonalds, Pepsicos Kentucky Fried Chicken, Dominos and Pizza Hut has given an international glitz to the hospitality sector. It costs an average of US$50-80 million to set up five-star hotels with 300 rentable rooms in India. The gestation period is usually between three and four years. Reasons for Low FDI in Indian Tourism The following are the some of the reasons for low foreign direct investment in this sector. They are:
Conference on Tourism in India Challenges Ahead, 15-17 May 2008, IIMK 108

Top

IIMK

Part III Tourism and Economic Development

IIML

Multitude of taxes Ours is the highest tax structure on tourism projects in the Asia Pacific region. Multitude of central and state taxes is the fundamental problem plaguing the tourism sector. Expenditure Tax of 10% is charged in hotels wherein room charges for any unit of residential accommodation are Rs.3000 or more per day while, simultaneously, States levy Luxury Tax ranging from 5% to 25% on the hotel tariff. Taking into account heavy administrative costs of collection of HET by Central Govt. and Luxury Tax by State Govt.s, the net benefit to the economy is considerably smaller and is not compatible with the loss in revenue accruing due to diversion of tourists to lesser-taxed destinations. The problem has got magnified due to increase in the threshold limit, which used to be Rs.2000 per day per individual to Rs.3000 per day during Union Budget 2002-03. With the removal of the words per individual, the benefits of raising the threshold limit were nullified and therefore benefits could not be passed on to tourists. The revenue stream that the Union Government shall have to forego on abolishing Expenditure Tax would not be substantial, and would be more than matched by the benefits that could accrue from the increased flow of tourists who are currently diverted to other less taxed destinations. There is no national wide tax policy there by some international hotel chains are hesitating to establish their subsidiaries in the India High Taxes One of the fundamental problems plaguing the Indian tourism sector is a multitude of Central and State level taxes, which lead to an increased cost to the tourists. A comparison of the Corporate Tax level in India, which affects the hospitality sector, in comparison with our neighbors, shows Indias poor competitive positioning.

Fig. 1. Corporate Taxes in comparison with other tourist destinations in Asia On the indirect taxes front also, India fairs poorly as compared to competing destinations. The following table and figure showcases tourism related major indirect taxes benchmarked across comparable locations.
Table 1: Benchmarking of tourism related taxes to taxes across comparable tourist destinations Cities/Taxes Kuala Lumpur Bangkok Hong Kong Singapore New Delhi Mumbai Lowest rates Highest rates Airport related 1.70% 1.26% 0.72% 0.94% 0.94% 0.90% 0.53% 7.66% Accommodation related 4.76% 6.54% 2.91% 3.85% 16.67% 13.79% 0.25% 20.00% Food & Beverages related 4.76% 6.54% 0.00% 3.85% 6.54% 19.03% 0.00% 20.00% Car Rentals related 4.76% 6.54% 0.00% 4.38% 4.76% 4.76% 0.00% 33.22% Total taxes 6.46% 7.86% 2.18% 4.98% 13.18% 13.90% 0.97% 24.25% Rank 7 8 2 3 19 21 1 52

Conference on Tourism in India Challenges Ahead, 15-17 May 2008, IIMK

109

Top

IIMK

Part III Tourism and Economic Development

IIML

20.00%

18.00%

16.00%

14.00%

12.00%

10.00%

8.00%

Kuala Lum pur Bangkok Hong Kong Singapore New Delhi M um bai

6.00%

4.00%

2.00%

0.00% Airport Accom m odation Food & Beverages Car Rentals

Fig. 2. Comparison of other tourism expenses with neighboring Asian Countries Delay in FDI Approvals & Govt. Policies Huge delay in Foreign Direct Investment approvals in Hotel & Tourism sector. Due to delay in approvals and lack of guidelines in the tourism policy, the Alfred Fords proposed Himalayan Sky Village is pending since last three years. If it is approved it is one of the highest FDI in the country in tourism sector with US$ 300 million which also provides employment to around 3000 people. Highest import duty on imported liquor used in hotels: Under the WTO Negotiations for Market Access under the Agreement of Agriculture (AoA), India had bound its tariffs at 100% for primary products, 150% for processed products (this is the relevant category for liquor) and 300% for edible oils, except for certain items (comprising about 119 tariff lines), which were historically bound at a lower level in the earlier negotiations. Although in Union Budget 2002-03, the rates of basic duty have been brought down to 182% from 210%, the same remain at considerably high levels. As regards the additional customs duty, 75 per cent is levied on imported liquor costing up to $25 per case. Liquor costing above $25 per case attracts a CVD of 50 per cent. Special additional duty is capped at 4%. With the additional duties and sales tax levied by the State Governments the cost of alcoholic spirits sold in hotels to bonafide guests is exorbitant. The international precedence for liquor related levies also do not substantiate the current level of taxes. Rationalization of the tax on liquor is therefore important to make Indian hotels competitive internationally and enable them to extend facilities, considered important by tourists, on par with the hotels in competing destinations. Service Tax on Tour Operators The services provided by a tour operator typically includes a wide range of services covering transportation, boarding and lodging arrangements, local sight-seeing and guide services, etc. which are procured through sub-agencies. Even though 60% abatement is provided, taxation of the gross service amount leads to double taxation and increases the burden for the tourists. Inland Air Travel Tax Air connectivity and Pricing are proven to be critical barriers in Indias ability to become competitive in the global tourism market. In the current context, domestic air travel is much more expensive than
Conference on Tourism in India Challenges Ahead, 15-17 May 2008, IIMK 110

Top

IIMK

Part III Tourism and Economic Development

IIML

international destinations located at a similar distance. The disparity between Foreign Travel Tax (FTT) and Inland Air Travel Tax (IATT) is one of the major factors. FTT constitutes between 2%- 3% of the ticket price while IATT effectively constitutes 12%-13% of the total ticket price, except for north-eastern states where the latter has been exempted. The cost of domestic air travel is too high in India as compared to international standards. The primary reason for this is costly Aviation Turbine Fuel, which constitutes close to 40% of an airlines operating cost. This in turn is due to the structure of duties and levies prevalent in India. The basic customs duty of 20% with a CVD of 16% results in a total tax of 39.2%. The differential rates of sales tax being charged by state governments further complicate the duty structure. This has led to increased costs to the airlines, which in turn gets passed on to the consumer. Hardships in Income Tax Act Relating 7o Hospitality Industry Section 194-1 of the Income Tax Act & Tax refunds The provisions of Section 194-1 of the Income Tax Act are applicable to the payments made by the touroperators and travel agents to various hotels on behalf of foreign tourists for the services provided to the tourists by the hotels. Tax is deducted @ 20% with a 1% additional surcharge for the FY 2002-2003. (Tax is deductible if payment to payee during the year is expected to be Rs. 1, 20.000 or more) The tourism industry typically experiences cancellations to the tune of 50%, which is a situation peculiar to the Tourism sector alone. With tax refunds in India being a long and tedious process, the cash flow of the service provider suffers and leads to a liquidity constraint. Sec 10(5)(B) OF IT Act, 1961 Hotel industry was getting a concession under section 10(5)(B) of Income Tax Act, under which income tax on salaries of specified class of technicians was being paid by the employer. Chefs in the hotel industry were specified under this category of preferred technicians by notification of Ministry of Finance. This section has been abolished from 2002-03. But still technicians in Spa are come under this section. Depreciation on Hotel buildings Hotel Buildings are synonymous to a Plant in case of a manufacturing enterprise and operate through the year. A large number of F&B facilities like conference rooms, banquets, bars remain open up to 18 hours a day. Moreover, the investments to be made are also capital intensive and the facilities require periodic renovation, up-gradation and up-keep much like plant and machinery. In due consideration of this, it would be necessary to provide to Hotels depreciation rates that match the nature of investment and operations. The relevant provisions of section 32 of the IT Act may be amended. Section 72 A of IT ACT, 1961 (amalgamations, demergers etc.) In case of an amalgamation of an industrial undertaking with another, Section 72 (A) of the Income Tax Act provides for the accumulated loss and the unabsorbed depreciation to be treated as loss or depreciation respectively in the balance sheet of the amalgamated company thus enabling the amalgamated company to set off and carry forward the loss and allowance for depreciation. Hotels, being under the service industry, are not considered an industrial undertakings and thus denied the concessions under this clause. Since the Hospitality sector is vibrant and amalgamations and takeovers often happen for strategic reasons, it is recommended that these concessions by making the provisions of Section 72 (A) of the Income Tax Act applicable to the services sector as well. Moreover, Applicability of Section 72 (A) to hotel companies would stimulate further investment by strategic investors including venture capitalists in the hospitality sector and help revival of loss making hotel units thereby meeting the demand of hotel room requirements as envisaged in the 10th Planning Period. Depreciation on Pollution Control Equipment and Eco-generations System India requires seriously addressing issues pertaining to pollution control and power generation and adopting measures that will motivate the hotel industry to make the investments required to be environment friendly and energy efficient. The reduction of the depreciation rates allowed on pollution control equipment and
Conference on Tourism in India Challenges Ahead, 15-17 May 2008, IIMK 111

Top

IIMK

Part III Tourism and Economic Development

IIML

eco-generation system tinder Sec 32 of the Income Tax Act, 1961 from 100% to 60% in last years budget would act as a deterrent to such initiatives. Section 80 IA and 10(23) G of the IT Act, 1961 The WTTC in its status report on tourism in India has underlined the need to open up the accommodation sector stating that, if India is to achieve its full potential in tourism, it needs a manifold increase in the number of rooms for all categories of visitors. Other sectors like roads, power, telecommunications, airports, ports etc. have been recognized as infrastructure and given higher incentives under the Income Tax Act. These benefits also need to be extended to tourism, duly recognizing its multiplier effect on the employment generation, income earning and foreign exchange earning potential of the economy. Such a step would boost the much-needed expansion of the accommodation sector. Sec 80IA allows a deduction of an amount equal to 100% of the profits and gains derived from an infrastructure project for ten consecutive assessment years. Sec 10(23) G allows the Net Income after taking into account all related expenses of an Infrastructure Finance Fund/Company to be exempt from tax if it has earned income by way of financing an enterprise which is wholly engaged in the business of developing and/or maintaining and/or operating an Infrastructure Project as defined in Sec 80 IA of the Income Tax Act, 1961. 0IB of the IT ACT, 1961 Section 80IB covers the deductions available to hotels classified under two categories, Specified and NonSpecified. Income Tax exemption of 30% and 50% , for a period of 10 years, is available to hotels, except in the four metro cities. This section also covers the deductions available to convention centres and multiplex theatres. This incentive is not available to hotels coming into operation after 01.04.2001. Measures to attract more FDI in Tourism sector According to WTTC India is fully poised to seize this opportunity given its outstanding wealth of natural reserves and rich cultural heritage, its thriving business community and high levels of entrepreneurship However, this opportunity can be seized only if India adopts a fundamentally new and proactive approach to tourism development. Among the many measures proposed by WTTC, rationalizing of taxation and evolving a uniform taxation system conducive to tourism forms a significant recommendation. India is losing out on the market share, vis-a-vis competing destinations. As is evident from the adjacent figure, from 1990 onwards Indias market share has come down in respect of the major source countries. On the other hand, competition is increasing. The number of countries with over 1 million tourist arrivals has increased from 15 in 1950 to 70 in 1999, whereas Indias rank is at 40. Recommendations: There was need to rationalize the taxation on the hotel industry and adopt a single luxury tax across the country. For provision of single-window clearances at the local, State and Central Government levels to reduce procedural delays. Tax holiday would encourage FDI in this sector and more players to set up hotels, to bridge the shortage of rooms which according to Government estimates stood at one lakh rooms. Section 72 (A) of the Income Tax Act should be amended such that it is made applicable to the Hospitality sector also by using the word undertaking in lieu of industrial undertaking. It is recommended to increase the depreciation rate to 100% in order to incentives hotels to install pollution control equipment and energy generating devices to protect the environment. For the calculation of Book profit for the MAT provisions under Sec. 115 JB, Sec 80HHD profits should be allowed as a deduction on par with the deduction available to Sec 80HHC/E/F profits, as under these relevant sections all the assesses deal with foreign Exchange. Service Tax should be computed based on the value of service provided, in the nature of VAT; rather than on the gross amount Concessions under Section 10(5) (B) of IT Act should be restored and spa consultants should also be included Inland Air Travel Tax should be applied at the rate of 5% of the basic ticket price.
Conference on Tourism in India Challenges Ahead, 15-17 May 2008, IIMK 112

Top

IIMK

Part III Tourism and Economic Development

IIML

The Government should implement the kelkar Committee recommendations in reduction of basic custom duty on aviation turbine fuel. There by the inland travel prices will reduce. Tax Deduction at Source pertaining to payments made to hotels under Section 194-1 of the Income Tax Act should be reduced to 5%. The depreciation rate on hotels should be reverted to 20% from the current rate of 10%. Section 72 (A) of the Income Tax Act should be amended such that it is made applicable to the Hospitality sector also by using the word undertaking in lieu of industrial undertaking. Tourism should be declared as infrastructure industry and Hotels and Convention centre should be included in Sec 80IA of the Income Tax Act,1961 and also entitlement to tax-exempt income on investment under Section 10 (23) G of the Income Tax Act,1961. Extend the exemption available under sec 801B for Specified hotels and Non-specified hotels till 2010 and also apply these exemptions to convention centers/multiplex theaters in parity with hotels for a period of 10 years. The Travel & Tourism industry provides tremendous opportunity to India in terms of contribution to its GDP and employment generation. According to CII estimates, an additional 1 million visitors can help generate revenues of Rs.4, 300 crore annually. Thus, Government policies, which would focus at increasing tourist arrivals in the country and facilitate investments in tourism infrastructure, would lead to significantly higher multiplier effect on the key economic parameters of the Indian economy. References
Batra G.S., Tourism in the 21st century, (1996) Anmol publications Pvt. Ltd.,.245 Pgs Dirk William velde and Swapna Niar, (2005), Foreign Direct Investment, service trade negotiations and development The case of tourism in Caribbean, Overseas Development Institute. Federation of Hotels & Restaurants Association of India ltd, www.fhrai.com, Govt. to review FDI in Tourism Sector, News and Features, New Delhi, February 13, (2007), www.sarkaritel.com Investment opportunities in Tourism Sector, Government of India portal Investment Commission http://www.investmentcommission.in/tourism.htm#v Manpower recruitment in Hotel industry, A market plus report of Ministry of tourism, Government of India. http://tourismindia.com, Meyer, D, Foreign Direct Investment in Tourism - The Development Dimension - Expert Advisory Committee (20052006). Funded by United Nations Conference on Trade and Development, Geneva, Switzerland. Meyer, D. (2006) FDI in Tourism: The Development Dimension. Case Study Sri Lanka. Geneva: UNCTAD Usha C.V. Haley, (2001), Tourism and FDI in Vietnam, Haworth Press, pp 67-90

Conference on Tourism in India Challenges Ahead, 15-17 May 2008, IIMK

113