Tonnage Tax Scheme for Inland Water Transport

Chapter XII-G of the Income-tax Act, 1961¹, contains special provisions relating to taxation of income of shipping companies, comprising of 30 Sections from 115-V to 115-VZC (Scheme). The Scheme was introduced vide the Finance (No. 2) Act, 2004 with effect from 1-4-2005, based on similar schemes prevalent in United Kingdom (UK), Netherlands, Greece, etc. The Scheme broadly exempts the relevant shipping income (Section 115-VI) from taxation and instead provides for computation of income based on gross tonnage of the ship. The tax is charged at standard corporate tax rate on tonnage income so computed. The qualifying shipping business is basically ring fenced from the other activities of the taxpayer. Presently, the “qualifying ship” is defined as seagoing ship of 15 net tonnage or more registered under the Merchant Shipping Act, 1958². Presently, the inland vessels operating in inland waterways are not covered under the Scheme and consequently, income from such inland vessels are charged to tax at standard corporate tax rate.

Vide the Finance Bill, 2025, the said Scheme is proposed to be extended to the inland vessels operating in inland waterways in India.

India has an extensive network of inland waterways in the form of rivers, canals, backwaters and creeks. The total navigable length is 14,500 kms, out of which about 5200 km of the river and 4000 km of canals can be used by mechanised crafts. Freight transportation by waterways is highly underutilised in India compared to other large countries and geographic areas like the United States, China and the European Union. The total cargo moved (in tonne-kilometres) by the inland waterways was just 0.1% of the total inland traffic in India, compared to the 21% figure for the United States.

Inland water transport (IWT) is a highly fuel-efficient and cost-effective mode of transport compared to road and rail. As per Rail India Technical and Economic Service (RITES) Report of 2014 on “Integrated National Waterways Transportation Grid (Inwtg),” one litre of fuel moves 24 tonne per kilometer on road, 95 tonne per kilometer on rail and 215 tonne per kilometer on IWT. ³

Considering the importance of the subject the distribution of legislative powers qua inland waterways is as follows:

List name	Entry No.	Subject
List I — Union	24	Shipping and navigation on inland waterways, declared by Parliament by law to be national waterways, as regards mechanically propelled vessels, the rule of the road on such waterways.
List II — State	13 and 56	Inland waterways and traffic thereon subject to the provisions of Lists I and III with regard to such waterways, vehicles other than mechanically propelled vehicles , taxes on goods and passengers carried by road or on inland waterways.
List III ― Concurrent	32	Shipping and navigation on inland waterways as regards mechanically propelled vessels, and the rule of the road on such waterways, and the carriage of passengers and goods on inland waterways subject to the provisions of List I with respect to national waterways.

The Government has been giving importance in the recent time, to the development of Indian waterways. In furtherance of the same the Government has enacted the National Waterways Act, 2016⁴ repealing 5 erstwhile National Waterways Act and declaring 111 national waterways which will be under the control of Central Government.

The Government has also enacted the Inland Vessels Act, 2021⁵, which replaced the Inland Vessels Act, 1917⁶ and introduced uniform regulatory framework for inland vessel navigation across the country. It provides for the regulation of inland vessel navigation by States including the registration of vessels, and safe carriage of goods and passengers. The Finance Bill, 2025 proposes to add “inland vessel” along with ship throughout Chapter XII-G and inland vessel has been defined to have same meaning as in Section 3(q)⁷ of the Inland Vessels Act, 2021. The term qualifying ship will now include “inland vessel” also which is registered under the Inland Vessels Act, 2021.

However, in view of Section 115-VD of the Income-tax Act, 1961 certain types of ships are excluded from the Scheme which exclusions will apply for inland vessels also, namely, pleasure crafts, fishing vessels, harbour and river ferries. Pleasure craft is defined as a ship of a kind whose primary use is for the purposes of sport or recreation.

Creation and usage of tonnage tax reserve

As per Section 115-VT of the Income-tax Act, 1961, a tonnage tax company is required to transfer 20% of the book profits relating to shipping business under the Scheme to the Tonnage Tax Reserve Account. The company is also obliged to purchase a new ship within 8 years of the credit of such amount to the Tonnage Tax Reserve Account and till such purchase of a new ship the amount must continue to be used in the business of operating qualifying ships. With effect from 1-4-2026, the tonnage tax company may also use the tonnage tax reserve for acquiring “new inland vessel” and till such acquisition utilise the reserve amount in business of operation of qualifying ships (which now includes inland vessels).

This amendment will help shipping companies presently engaged solely in international traffic to direct the flow of their capital into inland water transport business and expand their fleet of inland vessels.

Compliance with minimum training requirements — Section 115-VU

One of the conditions which the tonnage tax company is required to fulfil to continue to be under Scheme is to comply with the minimum training requirement in respect of trainee officers in accordance with the guidelines framed by the Director General of Shipping (DGS) and notified in the Official Gazette by the Central Government. DGS issues a certificate annually certifying compliance with such guidelines. If the minimum training requirement is not complied with for any five consecutive previous years, the option of the company for tonnage tax scheme shall cease to have effect from the beginning of the previous year following the fifth consecutive previous year in which the failure to comply with the minimum training requirement under sub-section (1) had occurred.

There is no amendment proposed in Section 115-VU of the Income-tax Act, 1961 qua inland vessels. The regulatory authority for the inland waterways is the Inland Waterways Authority of India (IWAI), constituted under Section 3⁸ of the Inland Waterways Authority of India Act, 1985⁹ . IWAI is also the competent authority for the purpose of the Inland Vessels Act, 2021. Like Guidelines¹⁰ issued by DGS for minimum training requirements for trainee officers, no such guidelines are mandated under the Income-tax Act, 1961 to be issued by IWAI for the inland water transport personnel and certification for compliance thereof.

Thus, in the absence of any enabling provision the minimum training requirements mentioned in Section 115-VU of the Income-tax Act, 1961 will not apply to qua inland vessels. This must be clarified by way of an amendment in Section 115-VU or alternatively provisions relating to training and certification scheme to be framed by IWAI may be introduced qua inland vessels.

Applicability of non-discrimination clause under the double taxation avoidance agreements (DTAAs)

Section 115-VC of the Income-tax Act, 1961 provides definition of qualifying company as follows:

(a) it is an Indian company;

(b) the place of effective management of the company is in India;

(c) it owns at least one qualifying ship; and

(d) the main object of the company is to carry on the business of operating ships.

Thus, only a company incorporated in India or having place of effective management (POEM) in India can opt for the tonnage tax scheme. A foreign company having POEM outside India can engage in inland waterways transport in India, however such foreign company owning inland vessels will not be considered as a qualifying company within the meaning of Section 115-VC of the Income-tax Act, 1961. As 100% foreign direct investment (FDI) is allowed in shipping sector under automatic route, one method for the foreign company could be to create a subsidiary in India which can be considered as a qualifying company and hence, eligible for availing tonnage tax scheme. However, can a foreign company having a permanent establishment (PE) in India engaged in inland water transport avail the benefit of the tonnage tax scheme?

Under the Act as well as Article 8 on shipping contained in the most of the DTAAs signed by India, India will have right to tax the profits derived from inland water transport business. Article 24 of the DTAAs entered into by India generally contain non-discrimination clause. The relevant extract of Article 24 on non-discrimination — Organisation for Economic Cooperation and Development (OECD) Model Convention (same in UN Model Convention) reads as follows:

1. Nationals of a contracting State shall not be subjected in the other contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected. This provision shall, notwithstanding the provisions of Article 1, also apply to persons who are not residents of one or both of the contracting States.

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3. The taxation on a permanent establishment which an enterprise of a contracting State has in the other contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities. This provision shall not be construed as obliging a contracting State to grant to residents of the other contracting State any personal allowances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents.¹¹

The term “national” in most of the DTAAs entered by India (except USA) includes legal person deriving its status as such from the law in force in the contracting State. Para 1 prohibits discrimination solely based on nationality. All the circumstances being same including residential status, a foreign company cannot be subjected to a requirement more burdensome than Indian company. A foreign company having POEM outside India cannot be in the same circumstance as the Indian company since it is not a resident for the purpose of the Act and hence Para 1 does not apply.

Coming to Para 3 of Article 24, PE means a fixed place of business through which the business of the enterprise is wholly or partly carried on. A ship plying in inland waters cannot be considered as a PE of the foreign company. However, practically, a foreign company engaged in inland water transport business in India will have a branch or ticketing/admin office in India which can be construed as a PE of the foreign company. The type of discrimination which Para 3 is designed to end is discrimination based not on nationality but on the actual situs of an enterprise. The purpose of this provision is to end all discrimination in the treatment of permanent establishments as compared with resident enterprises belonging to the same sector of activities, as regards taxes based on business activities, and especially taxes on business profits.

Inclusion of IWT in tonnage tax scheme is an incentive measure designed to augment IWT which is capital intensive in nature. There is no reason why, benefit of such a scheme should not be extended to permanent establishments of enterprises of another State. In my view, the PEs of the foreign company subject to fulfilment of all the conditions mentioned in Chapter XII-G of the Act, should be able to opt for tonnage tax scheme based on Para 3 of the non-discrimination clause which exists in most of the DTAAs entered by India.