Legalese in India

This year, India’s GDP growth rate is projected at 9.7%, according to the IMF. Increasing domestic consumption is linked to the rise of disposable income among a growing middle class population, and healthcare spend across the country is creating opportunities for business as well.

Although all of this theoretically bodes well for private equity players and returns on investment, competition from the public markets is often beating PE to the punch with higher valuations, and regulatory and legal issues have caused some firms to take pause as well.

“There are several macro and micro-economic factors that influence public market valuations, and stability of government from a policy framework. We worry about the pace of regulatory oversight and refinements in the many areas: creditor protection, efficiencies of judiciaries and approval timing continues to disappoint Indians despite the public awareness and focus on the issue,” Karthik Athreya, Director at Clearwater Capital told AVCJ.

Vikram Utamsingh, Executive Director, KPMG India, echoed Athreya’s concerns saying, “Another major challenge for private equity will be dealing with the structural changes brought about by the changes in the regulatory environment. The upcoming Direct Tax Code (DTC) proposes to tax income arising in India by the transfer of shares in a foreign company by a non-resident outside India. It also proposes to introduce General Anti-Avoidance Rules, where tax authorities have the power to disregard, combine or re-characterize any part or whole of a transaction if the arrangement is considered to be an ‘impermissible avoidance arrangement’.”

The new tax laws, which will take effect on April 1, 2012, are untested and open to interpretation, which is certainly worisome. One of the crucial changes that the DTC proposes is the General Anti-Avoidance Rules (“GAAR”), which will make claiming tax treaty benefits fairly difficult, according to Majmudar & Co, a legal firm based in India.

Under the GAAR regime, the tax authorities may declare any re-characterizations of the arrangement or treat the arrangement as never having occurred. An “impermissible avoidance arrangement” has been defined to include an arrangement in which the main purpose is to obtain a tax benefit. Further, the arrangement that provides a tax benefit will be presumed as having been entered into for the main purpose of obtaining a tax benefit unless proven otherwise by the tax paper, according to the firm.

The chief implication of the DTC for private equity is the disruption of offshore establishment in jurisdictions like Mauritius, where many have set up funds in order to enjoy a lower tax rate. There is also a real risk that the tax authorities will attempt to tax capital gains on private equity exits, all of which will adversely impact returns for investors.

When asked whether the government would address this new rule with regard to the private equity industry, Akil Hirani, Managing Partner at Majmudar & Co. explained, “A number of people are lobbying and trying to make their points to the government, but the government is unlikely to be swayed because it has observed the PE model in other counties and knows that it has lost revenue through the current tax regime.”

With India’s new requirements, offshore funds may be required to have tax payers, employees and administrators in India. And if they are implemented according to the letter of the law, India could see repercussions in the PE space. Hirani believes that, “foreign funds may be migrating to jurisdictions where you have other business activities, such as in Singapore.”

“Funds are not going to go back to their [previous level of] success with their investments,” he added.

The Indian private equity landscape has already been hit by a skew toward IPOs and PIPEs, which offer promoters more money to relinquish the same stake. Now, with the new tax regulations potentially on the horizon, how will the industry adapt, and what will the next generation of funds look like? 

Further reading

India private equity: taking up the challenge

• South Asia
• 24 Nov 2010

Indian private equity’s characteristics

• South Asia
• 24 Nov 2010

India emergent

• South Asia
• 24 Nov 2010

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Regulation
• South Asia
• Clearwater Capital Partners
• Karthik Athreya