Fortunately for cricket-loving businessmen, investors and professionals in India, they didn’t really have to make a choice between business and pleasure, as the Hon’ble Finance Minister’s Union Budget speech ended well in time for them to be able to catch most of the match between India and the UAE today.
More importantly, the Budget contained some proposals which, while not revolutionary or dramatically reformist, would still have gladdened the business community as a whole on account of there being a fair degree of focus on operational detail and execution while at the same time making sure that the atmosphere of positivity created in recent months continues to flourish.
As an aside, it is interesting to note that even the Railway Budget presented a couple of days ago by the Hon’ble Railways Minister had a similar feel, with the key focus being on enhancing operational efficiencies rather than on blockbuster announcements.
As a transactional lawyer, my focus here is on how the Union Budget 2015-16 will impact the deal environment for PE/VC funds. I think this Budget is certainly a pretty good one from point of view of the PE/VC industry, as it contains certain measures which will address some of the challenges the industry has faced. I will address below some of the key announcements in this Budget which should give the PE/VC industry good reason to increase their exposure to India. I will also, alongside these positives, highlight what I believe to be a couple of missed opportunities.
The most noteworthy change from an FDI perspective is that it has been clearly and expressly clarified by the Hon’ble Finance Minister that FDI will now be freely allowed into all categories of Alternative Investment Funds (“AIF”s). This has always been a bit of a sticky and uncertain issue with respect to setting up PE/VC or hedge funds that propose to raise funding from both Indian and non-Indian investors, and the regulatory uncertainty surrounding this issue has made several LPs reluctant to invest in “feed-in” structure funds set up to invest in India.
I am also gladdened to note that in permitting FDI into AIFs, the Finance Minister has not made a distinction between the various categories of AIFs. I have always been an opponent of iscriminating one category of AIFs against the others with respect to matters like FDI, FEMA and tax treatment, and this announcement by the Finance Minister to make FDI open to all AIFs is a very laudable move indeed. In my view, this will give a huge fillip not just to the Indian Private Equity industry but also to the very nascent Indian hedge funds industry (which is at serious risk of turning out to be a stillborn industry) by allowing Indian sponsors of these AIFs to raise funds from foreign investors.
Apart from the above, there has been virtually no other announcement with respect to FDI reform, which is a bit disappointing. As I had highlighted in my post-Budget piece on www.vccircle.com last year, there is significant scope for this Government to reform our FDI laws further in sectors like insurance and defence by permitting FDI of at least 51% in order to attract the big-ticket global manufacturers to “make in India”.
- The biggest reform on the tax side is the announcement that all Category I and Category II AIFs will now be eligible for the tax pass-through status hitherto accorded only to VC funds. This is a long-standing demanding of the Indian PE Industry and is indeed a welcome development that will boost fundraises by Indian sponsors, which in turn increases funding options for entrepreneurs.
- However, what is disappointing is that the same pass-through treatment has not been extended to Category III AIFs (for example, hedge funds). While the benefits to the Indian economy brought by PE/VC funds is well understood, I would argue that a strong and fast-growing domestic hedge funds industry too could play a very influential role in the Indian economy. For example, Indian capital markets would get a huge boost if the Indian hedge funds industry is encouraged and provided a favourable environment to grow in. A healthily regulated hedge funds industry that is encouraged by facilitative regulatory and tax framework would be critical to ensure that the nascent industry doesn’t die a slow death. Hedge funds in India are structured the same way as PE and VC funds and hence, there is no reason why investors in hedge funds should not get the benefit of tax pass through that investors in VC funds enjoy.
- Another piece of good news on the tax side for the funds industry as a whole is the clarification by the Finance Minister that the mere presence in India of fund managers managing an offshore fund is managed by Indian sponsors, would not mean that those funds would be treated as having “permanent establishment” in India. This is a good move that will come as a relief to global and Indian fund houses that manage offshore funds but which have investment teams based in India.
- The Budget also provides for tax pass through with respect to rental incomes earned by REITs from real estate assets. This is again a welcome step that is aimed at giving a fillip to the REITs regime.
- The GAAR provisions of the DTC, which have been a huge source of fear and uncertainty for foreign investors while viewing investment opportunities in India, have been deferred till 2017. While the extension from the earlier date of 2016 is a minor relief of sorts, this issue will continue to haunt global investors as they would still be worried about what 2017 would bring! In my view, it would greatly help the cause of attracting long-term and deep-pocketed foreign investments if the Government provided clarity on this issue at the soonest rather than take the approach of merely deferring its implementation by 2 years every time.
- On the indirect taxes front, the big news was that there was no announcement with respect to introduction of the GST regime, except for a statement of commitment to put it in place at the earliest! They say “no news is good news” but in this context, I would say “no news is not good news at all”! The speedy introduction of a rational GST regime would go a long way in positively influencing the growth of the Indian economy, and would give Indian manufacturing a major boost. Therefore, given the progress that the Central Government made with getting many State Governments very close to a consensus, we the Indian populace could have been forgiven for hoping for an introduction in this Budget of the GST regime, but it looks like we will have to wait some more on this front. A massive boost to the Indian manufacturing sector would mean a massive boost to numerous other sectors and that in turn would require huge amounts of PE investments to be raised, which PE investors would be more inclined to look at.
Some of the other announcements made in the Budget pertaining to infrastructure are interesting too from a PE/VC standpoint. The key ones that caught my eye were:
- The allocation of Rs. 70,000 crores for infrastructure is a very encouraging sign. Several of these could be allocations for greenfield and brownfield PPP projects as well, which present great opportunities for PE funds and Indian business groups to team up.
- The Finance Minister also announced a proposal for setting up single-window clearances for all PPP projects. If implemented rationally, this would be the most crying need of the infrastructure sector, as most projects are bottlenecked by massive delays in receiving regulatory approvals.
While many of these proposals are good measures focused on removing irrationalities in the regulatory and legal framework, as I have highlighted above, there are also some clearly missed opportunities which one hopes that this Government will address soon. I think taking a more holistic view of the various factors affecting an industry (including the funds industry), and then legislating suitably, would be far more beneficial and would deliver better results.
Also, as is often the case in our country, there can be many a slip between intent and text of legislation. One hopes the good intent expressed in the Budget speech does not get diluted or obfuscated by the time the said proposals make it to the statute books. If the proposed changes are not drafted into law in very unambiguous and non-dilutive terms, the objectives sought to be achieved by the Budget to facilitate a dramatic growth in deal-making would not happen.
The Finance Minister also made it clear in his speech that this Government is committed to not applying taxes retrospectively, which is of course, an important message to be sent loud and clear to the global market. However, there continues to be lack of clarity on what would happen to the cases already initiated in the past. This point would have been an important one for the Finance Minister to reassure the global business community on, which has not been done.
All in all, may be this is not a blockbuster Budget, but it certainly is a pretty good Budget that focuses on some of the important nuts and bolts. Will this “nuts-and-bolts tweak” rev up the engine of the Indian economy? Let’s certainly hope so!
(Vijay Sambamurthi is the founder and managing partner of Lexygen)
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