The Indian Budget 2015-16 presented by the Finance Minister Arun Jaitley heralds a “center-right” economic philosophy, dramatically different from the left wing “reluctant reform” philosophy that has guided government finances for the last two decades.
The FM’s ambitions for reform are consistent with the country’s philosophy of “slow & steady” reform as opposed to “big bang” reform. However, given the size of the Indian economy, if the FM implements modest reforms on a similar scale every year, the cumulative actions over a five-year period would amount to a big bang (“The Big Bang Theory”, VCCircle, 26 May 2014)!
Five key reform messages from the budget:
1. Ease of Doing Business: ability to enter & exit businesses, simplifying regulations, improving contract law enforcement & dispute resolution, improving bankruptcy procedures etc are the focus of reform; the days when tinkering with FDI limits passed for reform are over.
2. Infrastructure: government would take a larger share of expenditure & accept a larger share of risk in creating infrastructure.
3. Labour: more flexibility to enable employees invest social security contributions (employees should not be “hostages” to social security schemes), government role in social security schemes to be expanded to include poor, self employed and unorganized labor, government role for skill development etc; flexible labor policies are to be driven by states and can’t be too far.
4. Taxation: simpler, non-adversarial tax regime, where potential for disputes is low, for both direct and indirect taxes; incentives for electronic transactions to create a cashless economy, jail time for tax evaders & stringent laws to penalize black money.
5. Savings: programme to monetise India’s gold stock (monetisation bonds), incentives to direct savings to financial assets (away from gold), incentives for social security contributions & a robust debt capital market that can rival our equity capital markets.
As far as the PE/VC industry is concerned, the budget makes big strides. Calling this a “Manage in India Budget” may be a bit of an exaggeration but the entire wish list of the PE/VC industry has been granted:
1. GAAR will be postponed for 2 more years; the government will work with the industry to iron out issues & only investments that will be made after April 2017 will be covered by GAAR!
2. The tax residency of a Fund will be evaluated independently and not be connected to the tax residency of its Fund Manager. i.e. if a Fund Manager sets up an Indian office, it does not make the Fund a tax resident in India.
3. Foreign Investors can invest in domestically incorporated Alternative Investment Funds (AIFs); domestic investors can pool capital with foreign investors, a positive development all around.
4. AIFs in Categories I and II would be tax pass through vehicles. Firstly, this would enable tax-exempt investors pool capital with tax paying investors. Pooling Mauritius based foreign investors into AIFs will now be viable. Secondly, investors will be able to set off tax losses from all their investments across funds & from previous investments, if any, & pay taxes only on net capital gains! Lastly, double taxation disputes at the level of the Fund and the investor has been eliminated.
The only dark cloud is the denial of tax pass through status to domestic hedge funds in Category III. The denial indicates that the MoF/CBDT still haven’t accepted the principles of fairness in taxing investors instead of taxing funds i.e. taxing intermediate vehicles.
However, the FM has indicated in his speech that the direct tax regime will evolve towards a day when intermediate vehicles will not be taxed & one can hope that it is only a matter of time before Category III funds are also considered tax pass through vehicles.
The Category III denial also indicates that there must be a googly or two in the fine print on other provisions that favor PE/VC industry. However, the overall direction of the Budget is positive for the PE/VC industry, and the fight to get the fine print sorted will be a worthwhile effort.
As indicated by the FM in his budget speech, India needs to re-import the Indian asset management industry back to India! A great beginning has been made on 28 February 2015!
(The author is a private equity professional).
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