Budget gives a fillip to PE investment

By: | Updated: March 18, 2016 8:40 AM

From the deferral of PoEM applicability to clarity on MAT, Budget 2016 provides for a better business environment

investment tipsThe Narendra Modi-led government’s mantra—of encouraging foreign investment, foreign collaboration and Make-in-India—backed by strong macroeconomic landscape, made India the most attractive investment destination (among other emerging markets).

The success of private equity (PE) investment is predicated on an encouraging business environment, with favourable policies for investment and exit and a great degree of ease in doing business. The Narendra Modi-led government’s mantra—of encouraging foreign investment, foreign collaboration and Make-in-India—backed by strong macroeconomic landscape, made India the most attractive investment destination (among other emerging markets).

Budget 2015 introduced favourable amendments such as the deferral of the applicability of General Anti-Avoidance Rules by two years, some clarity on indirect transfer taxation provisions, tax provisions pertaining to Real Estate Investment Trusts and Infrastructure Investment Trusts, tax “pass through” status provided to Category I and Category II Alternative Investment Funds and the non-applicability of Minimum Alternate Tax (MAT) to foreign companies. These amendments were seen as a concerted effort by the government to regain investor confidence.

Over the course of 2015, numerous tax clarifications were made by the Central Board of Direct Taxes (CBDT). In a move welcomed by offshore Indian funds paying dividend to their investors, the CBDT clarified that dividend declared outside India by a foreign company would not be subject to tax in India under indirect transfer provisions. Further, the CBDT expressly clarified that the MAT provisions will not be applicable to a foreign company having no Permanent Establishment in India with retrospective effect from April 1, 2001, which was a long-pending demand of the industry.

In 2015, the government also announced the formation of high-level committees to interact with trade and industry on existing tax laws and suggest simplifications in the provisions of the Income Tax Act, 1961. Formation of these committees was in line with the objective of easing the doing of business in India and simplifying the legal environment

With a barrage of favourable tax amendments and FDI liberalisation for various sectors, PEs and venture capitalists (VCs) enjoyed a positive run in the year 2015. Some of the amendments focused on providing clarity, increasing investor confidence and fostering a healthy and investment-friendly climate. As a result, VC and PE investors pumped in $22.4 billion—the highest ever for India, as per one report.

Private equity in India has evolved significantly over the last decade. It is viewed as a source of strategic capital that can help businesses grow exponentially by bringing in new capabilities and discipline that other credit lines cannot offer. A clear and consistent tax regime would play a catalystic role for increasing capital inflows to India

Accordingly, in line with the initiatives taken in 2015, the government proposed key tax amendments in Budget 2016, which include:

* The applicability of concessional capital gain tax rate @10% (excluding surcharge and cess) to non-residents on sale of private company shares—this will provide much need parity on taxation of sale of unlisted public company and private company shares.

* The proposed reduction of the period of holding for unlisted equity shares to be considered as long-term capital asset to two years from current three years; this is indeed a welcome move, but the Finance Bill needs to be amended accordingly,

* The non-applicability of MAT provisions with retrospective effect from April 1, 2001 on a foreign company, subject to fulfilment of prescribed conditions; accordingly, the proposed amendment will provide statutory recognition in terms of clarity on applicability of MAT provisions to foreign companies and should end a plethora of litigation on this subject, and

* The deferral of the applicability of the Place of Effective Management (PoEM)-based residence test by one year; the government gets a window to issue detailed guidelines and roadmap on PoEM.

Last year, the Budget speech indicated a phased reduction of the corporate tax rate, from 30% to 25%, over the next four years. In this regard, Budget 2016 (considering the recommendation of the expert committee) has outlined a detailed roadmap.

Key proposals include:

* No tax deduction to be available to SEZ units commencing operations on or after April 1, 2020,

* No weighted deduction for expenditure incurred on notified skill development and in-house scientific research from April 1, 2020; moreover, restricted weighted deduction upto 150% (from the existing 200%) for in-house scientific research upto March 31, 2020, and

* No weighted deduction on capital expenditure in respect of cold-chain, warehousing, etc, from April 1, 2017, onwards.

This roadmap would ensure accurate assumptions in financial modelling at the time of investment by PE investors. To boost the growth of start-ups, 100% percent of profits earned by a start-up for three out of initial five years are proposed to be exempt from taxation. However, MAT provisions shall apply. The success of PE investments heavily depends on the adoption and implementation of globally competitive tax policies. With the proposed amendments in Budget 2016, the government has taken steps in the right direction and this should go a long way in boosting investor sentiments.

With contributions from Vinit Desai, senior tax professional, EY

The author is leader (private equity tax), EY India. Views are personal

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