Introduction
India’s push for self-reliance in defence manufacturing has led to increased financial support for private Micro, Small, and Medium Enterprises (MSMEs) engaged in research and development (R&D). However, a recent issue has sparked debate—private defence start-ups and MSMEs are receiving Goods and Services Tax (GST) notices for an 18% levy on grants received from the Ministry of Defence (MoD). While government research institutions enjoy an exemption, private players argue this taxation is a “tax on innovation.”
The GST Controversy: Innovation vs. Taxation
1. Government Funding and its Purpose
- The Defence Research and Development Organisation (DRDO) and Innovations for Defence Excellence (iDEX) provide funding to MSMEs to drive innovation in military technology.
- In Budget 2025-26, the government allocated ₹26,816.82 crore to DRDO, a 12.41% increase from the previous fiscal year.
- iDEX funding for MSMEs also saw a threefold rise, reaching ₹449.62 crore.
2. Why Are MSMEs Receiving GST Notices?
- The GST Council’s October 2024 notification exempts research associations, universities, and DSIR-registered entities from GST.
- Private MSMEs, however, face an 18% GST under Section 13(2) of the CGST Act, 2017.
- GST authorities argue that government grants constitute an “advance payment” for services, making them taxable.
- Many MSMEs unknowingly classify grants as revenue instead of a liability in their books, further complicating tax calculations.
Industry Backlash: Impact on Defence Start-Ups
- Defence MSMEs argue that the GST burden reduces available capital for innovation and delays project execution.
- The Society of Indian Defence Manufacturers (SIDM) highlights that private players face an uneven playing field against government-funded institutions.
- An iDEX-funded start-up owner stated: “This move contradicts the government’s goal of increasing indigenous defence production. Taxing grants is like taking back what the government offers to encourage innovation.”
Case Law & Legal Standpoint
- Madhya Pradesh High Court Ruling on GST Notices (2024): Stressed that taxability of government grants should be clarified with clear policy guidelines.
- Supreme Court in Commissioner of CGST vs. XYZ Pvt Ltd (2023): Ruled that taxation should align with the intent of policy benefits, especially when grants are not “consideration” for services.
Way Forward: What Needs to Change?
1. Policy Reforms & Clarifications
- The government should align GST exemptions for private R&D firms with DSIR-registered institutions.
- A clearer classification of government R&D grants in GST law can prevent unnecessary tax notices.
2. Accounting Clarity for MSMEs
- MSMEs must properly classify grants as liabilities rather than revenue in their books to avoid GST misinterpretation.
- Workshops by MoD and GST authorities can help businesses understand correct accounting practices.
3. Legal & Industry Representation
- SIDM and industry bodies should petition for GST relief for private defence R&D firms.
- MSMEs can consider filing representations before the GST Council to demand parity with public research institutions.
Conclusion
India’s defence sector requires a collaborative approach to innovation, and MSMEs play a pivotal role in modernizing military capabilities. However, levying GST on government-funded R&D could stifle progress and discourage participation. A balanced approach—tax reforms, accounting clarity, and legal intervention—can ensure that India’s Aatmanirbhar Bharat mission in defence remains strong.