The Indian economy, one of the largest economies in the world, aims to achieve a GDP growth rate of 8-9% in the current year. To accomplish this objective, it needs a huge inflow of investment. However, the current financial market crisis and precipitous economic decline has spoiled the party.
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This economic meltdown can be addressed by the Private Equity (‘PE’) investors, one of the major suppliers of funds. Apart from bringing money to a deal, PE firms also bring international networks that can help fill gaps in growth strategies, build alliances and add management depth. Thus, using all of their expertise, PE firms create value, in real terms, for the target company in particular and the economy in general. However, the question that arises is whether the investing climate in India is conducive to encouraging more PE investment.
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PE investors face certain barriers while investing in India. Lack of clarity in foreign investment regulations is one of the primary concerns for PE investors. With a spate of recent press notes, the government has attempted to clear up uncertainty on the issue of indirect foreign investment. However, some confusion still persists, for example; can an operating cum holding company owned and controlled by residents, but having some foreign investment (say 40%), invest in sectors in which foreign investment is prohibited like multi-brand retailing? The government is expected to clarify this shortly.
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Level Playing Field For FVCI's
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Another area of concern is the absence of a level playing field in respect of foreign venture capital investors (‘FVCIs’). FVCIs have certain regulatory benefits over other forms of investment in India. Historically, SEBI granted blanket approvals to FVCIs for investment across all sectors. However, a couple of years back, the regulators prohibited investment by FVCIs in the real estate sector. Furthermore, per the recent FVCI approvals, FVCIs are permitted to invest only in ten specified sectors. Given the fact that investment restrictions are not incorporated by way of amendment to FVCI regulations, there are currently three categories of FVCI approvals that are available to different private equity players (depending on the time when they made the application); blanket approval; approval with prohibition on investment in real estate sector; and approval where investment is restricted to the ten specified sectors.
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Since the FVCIs’ licenses are perpetual, i.e. not requiring renewal, the government has in effect created an unequal playing field among FVCIs. Similarly, there is a disparity in the opportunities available to FVCIs and domestic venture capital funds as the later are permitted to invest in all sectors.
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Legislative loop-holes have also contributed to the worries of the PE community. PE deals often have a slew of clauses designed to protect investor rights. A put option, for example, is designed to protect holders of the option (investors) from fall in share prices. Many PE investors exercised such options to protect themselves as share prices fell. However, certain promoters (option writers), taking advantage of loop-holes in the legislation, claimed put options were not enforceable and attempted to escape their obligations. While litigation on this matter is on-going, such loop-holes act as a deterrent to PE investment. Clarity is needed on such legal aspects.
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Foreign investors often lament the lack of clarity in taxation regime in India. Recent attempts by the income tax authorities to revisit settled positions in law, have further added to concerns of PE investors. The authorities have been denying treaty benefits to Mauritius-based sellers, ignoring the previous Supreme Court decision and internal circular.
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Need Of A Pro Reform Budget
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Furthermore, India’s observations to the OECD commentary on the definition of a permanent establishment have also been a source of worry for the PE firms. India’s observations indicate an intention to further tax foreign enterprises operating in India, by applying a stricter interpretation of the definition of a permanent establishment than what has been suggested by the OECD. The tax authorities are also increasingly seeking to classify income from investment activity as business income (chargeable to a higher rate of taxation) rather than capital gains, leading to increasing litigation on the characterization of income. A clear and unambiguous tax regime accompanied by tax incentives would go a long way in encouraging further PE investment in the economy.
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Some major direct tax reforms in the upcoming budget that might encourage inflow of PE funds into the economy would be certainty on taxation, extending pass through benefits to PE investors and venture capital funds for investments in all sectors, re-introducing section 10(23G) which allowed tax exemption on interest income and capital gains from infrastructure lending and investment and providing a clear distinction in respect of the characterization of income between trading and investing activity.
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A pro-reform budget with steps like easing foreign direct investment norms and providing clarity in the tax regime would go a long way in encouraging more PE investment into the Indian economy. PE investors, by contributing their managerial skills and acumen, would help a great deal in stimulating the Indian economy and would help India achieve its targeted growth rates.
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- By Ritesh Ranawat and Venkatraman Iyer, PricewaterhouseCoopers
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The views expressed are personal.
