Background:
Since 2015, all eyes have been on India's first and only International Financial Services Centre (IFSC)1, known as Gujarat International Fin-Tech City (hereinafter referred to as GIFT City). GIFT City has been declared a multi-service Special Economic Zone (SEZ)2, strategically positioned for entities engaged in financial service activities. Given India's extensive coastline, which facilitates substantial global and domestic trade via maritime routes, the maritime industry holds strategic importance for India3. However, many leading global shipping operators have chosen countries like Singapore, Hong Kong, and Dubai as their bases. Consequently, there was a compelling need to align India's shipping regime with these international centers.
The GIFT City has been rapidly evolving into a comprehensive maritime cluster, akin to its global counterparts. GIFT City is poised to host a diverse array of stakeholders, including regulators and service providers. This ambitious development aims to become a go to solution hub for the entire spectrum of maritime services and support, offering a seamless and integrated experience for industry players and investors alike.
One of the such lucrative aspects of this maritime service cluster is ship leasing and aircraft leasing. Accordingly, International Financial Service Centre Authority (IFSCA) published the Framework for Ship Leasing on August 16, 20224. To stimulate the ship financing and leasing market, various tax and regulatory incentives are extended to entities established in GIFT City. These steps make the Indian ship leasing and financing market fairly attractive.
IFSC mandates compliance with the provisions of the Merchant Shipping Act, 1958 (Shipping Act), for all entities5. The entities engaged in operating leases are required to maintain a minimum owned fund of USD 200,000 at all times6. In the case of financial leases or hybrids of operating and financial leases, the minimum owned funds must be USD 3 million7. All transactions conducted by IFSC entities must be in a freely convertible foreign currency. However, they are permitted to maintain an INR account to cover their administrative expenses. IFSC GIFT City allows entities to be set up as companies, LLPs, Trusts, or Branches, engaging in activities such as operating leases, finance leases, or a hybrid of operating and finance leases of ships or vessels. To act as a lessor, the entity must obtain registration from IFSCA by submitting the prescribed application.
Let us analyze the fundamental distinction between ship financing and ship leasing for better understanding of procedural mandate in IFSCA in GIFT City.
Ship Leasing Vs. Ship Financing:
1. SHIP LEASING:
Ship leasing refers to the practice of renting or leasing a ship for a specific period, typically involving an agreement between a shipowner and a lessee. This practice, also known as chartering of a vessel, is commonly observed in the maritime industry. It allows companies or individuals in need of ships for various purposes to lease them instead of purchasing them outright8. Ship leases can take various forms depending on the terms and conditions negotiated between the shipowner and the lessee.
Different modes of ship leasing include Bareboat charter (Demise charter), Time charter, Voyage charter, Consecutive Voyage Charter, Slot Charter, Profit Sharing Lease, and Real-time Lease among others could be adopted. These diverse leasing arrangements accommodate the specific requirements of the lessee9. As an illustration, a time charter allows the vessel to be leased for a pre-determined period at a fixed rate, which can range from a few months to several years, a voyage charterparty involves leasing the vessel for a single voyage or a specific route. Various modes of ship leasing offer flexibility to both shipowners and lessees, enabling them to choose the most suitable arrangement based on their specific needs and level of control over the crew and vessel.
2. SHIP FINANCING:
Financial leasing, also referred to as a capital lease, is a common type of lease agreement employed in the shipping industry to finance the acquisition of vessels and other maritime assets. It is a long-term lease arrangement wherein the lessee (the shipping company) gains the right to use the asset for a specified period, similar to owning the asset, while the lessor (the financial institution or leasing company) retains ownership throughout the lease term10. In a financial lease, the lessee generally assumes most of the risks and rewards associated with ownership, and the lease structure resembles a loan for the purchase of the asset. Financial leases in shipping typically cover a significant portion of the vessel's useful life, making them long-term arrangements. Under such leases, lessees are responsible for the maintenance, repairs, insurance, and operational costs of the vessel during the lease term. These leases may also include a purchase option at the end of the lease term, allowing the lessee to acquire ownership by paying a predetermined residual value or nominal amount. The financing structure of financial leases typically involves fixed lease payments covering both the principal amount and interest charges.
2.1. Role of SPV's:
To facilitate ship financing further, an offshore Special Purpose Vehicles (SPV) is established to act as the borrower in a ship financing transaction11. SPVs play a crucial role in financial markets by securing funds through borrowing for the purchase of vessels. They assign various forms of collateral, including the ship's mortgage, shipbuilding contract, hull insurance receivables, and charter fee receivables. Subsequently, the SPV takes possession of the vessel and leases it to a charterer who pays charter fees. These fees are then utilized by the SPV to repay the loan used to purchase the vessel, creating a mechanism for loan repayment and security for the ship financing transaction.
Traditionally, private resources were the primary mode of ship finance, leading to the establishment of large fleets by promoter groups and shipping families in countries such as Greece, Norway, and Hong Kong12. Bank loans, on the other hand, remain a significant source of ship finance, many commercial banks have specialized ship finance departments. Mortgage-backed loans, secured by a ship mortgage, give banks priority in case of insolvency.
Other common financing methods include corporate loans, where larger shipping companies use their balance sheets as collateral, and for private placements. Equity can also be raised through public offerings, such as initial public offerings (IPOs). For new buildings, progress payments are typically made during construction, with the final payment made upon successful sea trials and formal delivery of the ship. Loans for new buildings can come from various sources and can be negotiated even through the shipyard's banks. Alternatively, the seller/owner may charter the vessel to a buyer under a demise (bareboat) charter, where the charterer has full operational control and the option to purchase the vessel at the end of the charter.
Ship finance differs from other asset-based loans as it involves volatile earnings in the shipping industry and highly mobile collateral (the ship). The process includes a financial institution providing funds to acquire a ship, whether new built or second-hand and refinancing existing debt. Repayment depends on charter hire earned by the vessel. Collateral like shipbuilding and charterparties are typically used to reduce credit risk. Ship financing is a complex field that involves understanding the shipping industry, navigating various financing options, collateralization methods and to acquire or build ships with managing financial risks.
Financial leases, on the other hand, offer shipping companies advantages by providing an alternative to purchasing vessels outright, conserving capital for other needs. This also offer tax benefits as lease payments may be tax-deductible. Additionally, financial leases offer flexibility and can be tailored to match specific requirements and cash flow capabilities. However, the accounting treatment of financial leases may vary depending on applicable standards. Lessees may need to recognize leased assets and liabilities on their balance sheets. Overall, financial leases allow companies to access maritime assets while spreading costs over time.
3. How far Ease of doing business aligned for shipping at GIFT CITY:
From the investors' and entities' perspective, it is essential to assess how the aspect of "ease of doing business" aligns with GIFT CITY's attractive ship leasing and ship financing services. To facilitate ship leasing activities in IFSCs and establish a mechanism under the Finance Company Regulations. In the present IFSCA framework of ship leasing has been notified as financial product. This framework provides guidance to Finance Companies and Finance Units registered with IFSCA for engaging in operating leases, financial leases, or a combination of both for ships, ocean going vessels or their parts. Entities can register for either core or non-core activities.
- Under Clause 3E of the Framework, entities registered for operating leases are also allowed to engage in Asset Management Support Services for assets owned or leased by them, their wholly-owned subsidiaries (WOS), or a branch of their WOS set up in an IFSC in India13. They can also undertake sale and leaseback transactions, purchases, novations, transfers, assignments or similar activities related to ship leasing, subject to the prior approval of IFSCA. Additionally, other related activities may be undertaken with the approval of IFSCA.
- Clause 3H permits entities registered for financial leases or a combination of financial and operating leases to engage in activities allowed under operating leases and other related activities, subject to prior approval14. However, entities with operating lease registration require permission to undertake activities permitted under financial leases according to Clause D (iii) of the Framework15.
Furthermore, finance units engaged in core activities, including financial leases, must also comply with additional requirements outlined in the IFSCA (Finance Company) (Amendment) Regulations, 2022.
3.1. Compliance with Shipping Laws:
Pertinently, all IFSC entities conducting activities permitted under the Framework must comply with the requirements, exceptions, regulations, and conditions imposed by relevant statutes, including the Shipping Act. Circulars or orders issued under the Shipping Act are applicable to entities registered in the IFSC, whether they own Indian or foreign-flagged vessels. This may result in certain restrictions for foreign vessels. For example, the existing framework under the Shipping Act gives preference to Indian vessels in chartering activities through the tendering process. Additionally, Indian entities acquiring vessels flagged outside India must comply with tonnage and crew requirements in India. These requirements have led to the establishment of offshore vehicles by Indian entities.
From a broader perspective, the Shipping Act requires the Director General of Shipping (DG Shipping) to issue licenses for coastal and international trade in certain scenarios. While there are exceptions for chartering by entities registered in India and for specific agricultural, fishery, farm produce, and horticulture commodity-related activities that do not require licenses from DG Shipping, the requirement for obtaining such licenses for other chartering activities, including within the IFSCs continues to remain in effect. These regulatory requirements may also impact sale and leaseback transactions, depending on the structure being considered.
3.2. Other Regulatory Requirements:
Under the Shipping Act, the DG Shipping has the authority to regulate the movement of Indian vessels, which also applies to activities carried out in IFSCs. For instance, ships built or acquired outside India that are provisionally registered under the Shipping Act are subject to various rules for further registration in an Indian port, which does apply to the IFSC regime. The approval of the DG Shipping is required under the Merchant Shipping (Registration of Indian Ships) Rules, 196016, for ship transfers. Another essential aspect in ship finance is the creation of security interests over marine assets, typically done through mortgages. However, according to the Shipping Act and the Registration Rules, such charges can only be created over Indian-flagged ships.
3.3. Tax and other Regulatory Benefits:
As on date, a company and other financial unit in the IFSC are eligible to 100% tax exemption for 10 consecutive years out of 15 years with MAT / AMT @ 9% of book profits17. For investors, interest income paid to non-residents on funds lent to IFSC units is not taxable. Additionally, interest rates on long-term bonds and rupee-denominated bonds listed exclusively on recognized stock exchanges within the IFSC are subject to favorable tax rates. In terms of indirect taxes, units operating within the IFSC enjoy a GST (Goods and Services Tax) exemption on services received, but GST is applicable on services provided to the Domestic Tariff Area (DTA). Furthermore, investors benefit from no GST on transactions conducted on IFSC exchanges18.Additionally, various other tax incentives are extended to units within the IFSC, including state subsidies covering lease rentals, provident fund contributions, and electricity charges. Moreover, investors enjoy exemptions from Securities Transaction Tax (STT), Commodities Transaction Tax (CTT), and stamp duty concerning transactions executed on IFSC exchanges19. These favorable tax policies and incentives collectively create an attractive environment for investment and financial activities within the GIFT IFSC.
Conclusion:
The IFSCA regulatory framework fosters a favorable environment for maritime finance endeavors. IFSCA's framework for Ship Leasing, tax incentives and other regulatory benefits, offers financial institutions far better roadmap for participation in ship financing. The Union Budget for the fiscal year 2023-24 made significant policy changes to enhance the growth of the GIFT IFSC ecosystem. These changes include delegating SEZ Act powers to IFSCA, establishing a single-window streamlined processes, recognizing offshore derivative instruments (ODIs), extending the time for fund relocation, and permitting IBUs of foreign banks in GIFT IFSC to undertake acquisition financing20. These measures aim to boost regulatory efficiency and make GIFT IFSC a more captivating destination for international financial services and investments.
In an era marked by dynamic shifts in global trade and transportation, the maritime industry stands as a cornerstone of economic growth and sustainability. The emergence of GIFT City as India's foremost maritime cluster signals a strategic opportunity for financial institutions and banks to embark on an exciting journey into the ship financing market. Recent research highlights the immense potential within maritime finance. Current statistics reveal a remarkable 43% growth in seaborne trade, and industry analysts anticipate substantial expansion in global shipping with increased volumes of seaborne trade21. This surge in maritime activity is driving demand for ship financing solutions, presenting a ripe landscape for banks to explore and exploit22. The Indian shipping sector presents a compelling opportunity for private investors to enter the ship financing market and drive its growth. Despite India's burgeoning global trade, its fleet size remains relatively small, accounting for just 1.3% of the total global deadweight tonnage (DWT)23. India's maritime transport contributes significantly to trade with its neighbors, but a substantial portion is carried by foreign-flagged vessels, highlighting the need for a robust domestic fleet24.
However, this narration can be changed as the maritime ecosystem evolves within GIFT City, it becomes evident that banks and financial institutions have the opportunity to become pivotal players in this transformative journey. By strategically entering the ship financing market, not only can they capitalize on the growing demand for maritime finance but contribute to the development of a prospering maritime industry in India and beyond.
In essence, the ship financing business holds an interest that extends beyond its financial prospects. It represents a voyage into an industry at the nexus of economic growth, global trade, and environmental sustainability. For financial institutions and investors, this is not just an opportunity to diversify portfolios but a chance to be instrumental in shaping the future of maritime finance and propel the maritime industry to new horizons.
The time is ripe for financial investors to set sail into the vast ocean of the Indian maritime finance market, charting a course toward long-term prosperity and fostering positive industry transformation
Footnotes
1. Government of India. 2020. "International Financial Services Centres Authority." Ifsca.gov.in. 2020. https://ifsca.gov.in/Pages/Contents/AboutIFSCA.
2. IFSCA. 2016. "Gujarat International Finance Tec-City - Global Financial Hub." Giftsez.com. 2016. https://giftsez.com.
3. Pandey, Shivam, and Manish Singh. 2023. "India's Strategic and Economic Perspective in Maritime Affairs: A New Horizon." Lex scripta magazine of law and policy 01 (Issue-3): 1–14. https://doi.org/10.5281/zenodo.8373841.
4. IFSCA. 2022. "Press Release IFSCA Issues 'Framework for Ship Lease.'" Ifsca.gov.in.
5. Merchant Shipping Act, 1958.
6. International Financial Services Centres Authority. 2022. "Framework for Ship Leasing." Ifsca.gov.in. August 16, 2022.
7. IFSCA. Framework for Ship Leasing, 4-5.
8. Li, Ying. 2004. "The Maritime Commons: Digital Repository of the World Maritime University the Lease as a Financing Vehicle in Ship Acquisition: Legal Implications and Empirical Evaluation of Theory and Practice." World Maritime University. https://commons.wmu.se/cgi/viewcontent.cgi?article=1390&context=all_dissertations.
9. Li, Ying. The Maritime Commons, 13-20.
10. Ibid, 28-30.
11. Seward, Hoyoon, Kissel Llp, and Mike Seward. n.d. "Practical Guidance Ship Finance Basics a Practical Guidance Practice Note by Hoyoon Nam and Mike Timpone, Seward & Kissel LLP." LexisNexis. Accessed September 30, 2023. https://www.sewkis.com/wp-content/uploads/Ship-Finance-Basics-1.pdf.
12. Hultin, Daniel. 2004. "Financing Sources for Shipping -A Case Study at Wonsild & Son." https://core.ac.uk/download/pdf/289933444.pdf.
13. International Financial Services Centres Authority, Framework for Ship Leasing, 4.
14. Ibid.
15. Ibid, 3-4.
16. Directorate General of Shipping. 1960. "Merchant Shipping (Registration of Indian Ships) Rules, 1960." www.dgshipping.gov.in. December 17, 1960. https://www.dgshipping.gov.in/Content/PageUrl.aspx?page_name=RegistrationofIndianShipsRules1960#:~:text=(a)%20her%20name%20shall%20be.
17. GIFT City. 2023. "Tax framework." Giftgujarat.in. 2023. https://www.giftgujarat.in/business/ifsc?tab=Tax%20Incentives.
18. GIFT City. 2023. "Tax framework
19. Ibid
20. Press Information Bureau. 2023. "Highlights of the Union Budget 2023-24." Www.pib.gov.in. February 1, 2023. https://www.pib.gov.in/PressReleasePage.aspx?PRID=1895315 .
21. Placek, Martin . 2023. "Ocean Shipping Worldwide - Statistics & Facts." Statista. Statista. September 28, 2023. https://www.statista.com/topics/1728/ocean-shipping/#topicOverview.
22. "Ship Leasing Market Size & Share Analysis - Industry Research Report - Growth Trends." 2023. Www.mordorintelligence.com. 2023. https://www.mordorintelligence.com/industry-reports/ship-leasing-market.
23. Ministry of Ports Shipping and Waterways. 2023. "Indian Shipping Statistic 2022." Shipmin.gov.in. https://shipmin.gov.in/sites/default/files/ISS%202022%20_31032023.pdf.
24. Simhan, TE Raja. 2023. "Private Sector Needs to Invest More to Boost the Desi Fleet." BusinessLine. August 21, 2023. https://www.thehindubusinessline.com/economy/logistics/private-sector-needs-to-invest-more-to-boost-the-desi-fleet/article67209317.ece.
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