Private starts-ups and other MSMEs are receiving notices to pay 18 per cent taxes under the CGST Act on funding received from the Ministry of Defence for research and development (R&D). Government officials say this amounts to “taxing innovation” as it disincentivises Prime Minister Narendra Modi’s focus on ‘aatmanirbharta’ in the military sector.
Government research associations, universities, colleges and other entities, registered under the Department of Scientific and Industrial Research (DSIR), have been exempted from the tax by the GST Council through a notification issued on October 8, 2024.
Private organisations, which continue to be taxed at 18 per cent under the GST Act have raised this issue with the MoD, sources said.
The MoD funds innovation through R&D allocations to Defence Research and Development Organisation (DRDO) as well as offerings through iDEX (Innovations for Defence Excellence) scheme to financially help MSMEs become self-sufficient as the central government realised limitations of defence PSUs in meeting the modern technology requirement of the armed forces.
18 per cent tax
In one of the notices issued by a Commissionerate of Central Goods and Services Tax (CGST) of Maharashtra, which businessline accessed, a company was asked to shell out 18 per cent tax under Section 13(2) of the CGST Act, 2017, on receipt of advance of the first of five instalments of the grant for an R&D project for the Indian Navy.
Countering the tax liability generated against the grant received from the MoD, the start-up said they were working for the government and not giving any service but developing and will be manufacturing the product for the Indian Navy. The amount is meant to cover the initial expenses and, therefore, it cannot be treated as advance as they are manufacturing a product for the Ministry, the company said in its defence.
An MoD official dubbed the CGST levy on the government R&D money to private players as “taxing innovations” since it will eventually discourage start-ups and other MSMEs which are starved of funds. Furthermore, , it is not a true reflection of the government’s own announcement of large expenditure on R&D since, by way of 18 per cent CGST, it is taking back money from private players.
A member of the Society of Indian Defence Manufacturers (SIDM), an apex body of the Indian defence industry, said that the CGST levy on private innovators disturbs the level playing field the MoD is trying to create through large participation of private players in manufacturing of military hardware and software through DRDO’s iDEX and Technology Develop Fund (TDF).
“It calls for a reform in the grant-in-aid policy framework,” the SIDM member, who is also a head of a private defence company, said.
Another top defence start-up company owner said: “The move defeats the initiative like that of i-DEX, which has helped 10 to 15 start-ups like me to grow and become a formidable player in developing indigenous defence products which can compete in the global space.”
Private industry sources said that the notices might have come since the MSMEs do not know how to position the government funding in their books of accounts. Some of them are showing grants under the sub-head ‘revenue’ rather than declaring them as liability which they have to clear after their innovations take the form of products and end up in contracts received from tri-service, sources pointed out.
Of the budgetary allocation of ₹26,816.82 crore in FY25-26 for the DRDO, which is 12.41 per cent higher than the BE of ₹23,855.61 crore in FY24-25, ₹14,923.82 crore was earmarked for capital expenditure and for funding the R&D projects, including that of private players. Likewise, ₹449.62 crore was allocated to iDEX scheme, showing a jump of almost three times in two years.