The Indian economy has witnessed transformational change since the reforms of 1991. These reforms indicated a structural shift to a more open economy and paved the way for liberalisation, privatisation and globalisation, thereby giving impetus to merger-and-acquisition (M&A) activity in India.
The narrative of reforms since then has been one of eliminating entry barriers. This government has endeavored to push ahead the reform agenda by embracing a series of measures such as Make in India, Start-up India and other entrepreneurship initiatives. India has also endorsed radical changes in the foreign investment policy and, with the recent set of reforms, most sectors are now open to 100% foreign ownership. The overall theme has been directionally positive, collectively meaningful and resonates with the government’s commitment to facilitate growth and stability.
This column offers a perspective on the role that post liberalisation reforms and tax policies have played in shaping the M&A activity in India, the key challenges and the potential game-changers for this sector.
Impact of reforms on M&A
M&A in India evolved through a distinct phase in regulations. This trend is seen through the 1990s, post-reforms. The pre-liberalisation era was marked by two distinct features. One that it was dominated by family-owned and government-controlled institutions, which has been a traditional feature of this economy. Second, it was governed by restrictive legislations such as MRTP Act, Industrial licensing and FERA which prevented growth-oriented decision-making.
This combination proved a huge deterrent to M&A activity. With the introduction of reforms and relaxation of controls on production, trade and investment, Indian companies were exposed to considerable competition and hence were forced to restructure and re-engineer to accelerate growth. This is a clear example of regulations shaping the business environment.
By the turn of the 21st century, India had progressed to a free-market economy resulting in a spur in M&A activity. Thus, one would see an overhaul of almost all key regulations governing M&A in the last decade—the competition law, the takeover code, the companies Act, changes to the income tax Act and liberalisation of the exchange control laws are expected to ease the investment climate in India. The theme underlying these changes is to align India’s policy framework with international best practices.
Emerging trends and potential game-changers
Traditionally, India’s tax environment has often been viewed as being complex and uncertain. High-value litigation emanating from retrospective amendments and abstruse tax provisions continue to dominate headlines. Retrospective amendments are completely antagonist to the entire theme of reforms.
In the face of mounting concerns over uncertainties on tax positions, transfer-pricing adjustments, the multiplicity of indirect levies and stamp duties, there are three emerging trends that merit consideration.
First, the endeavour on the tax policy front has been to regulate aggressive tax planning on transactions. Introduction of taxability of indirect transfer of shares of an Indian company—as in the case of Vodafone—the general anti avoidance rules (GAAR) for regulating transactions done merely for tax benefits, rules for place of effective management (POEM) of foreign companies which governs their tax residency, introduction of Base Erosion and Profit Sharing (BEPS) framework for reporting are a few examples of the government’s initiative in this direction. The most recent case in point is the amendment to the India-Mauritius tax treaty that prospectively withdraws the favourable tax regime offered to companies investing from Mauritius. While one awaits more clarity on these new provisions, it is expected that eventually companies will start to factor in these costs as part of the transaction and continue to do business.
Second, there has been an attempt to introduce tax policies for effective tax administration and efficient dispute resolution, the need of the hour. There has been a clear intent and promise stated in this year’s Budget to offer a stable and predictable tax structure and framework for speedy dispute resolution. This year’s tax proposals further make a provision for time-bound disposal of appeals, paperless assessment, an income declaration scheme and finally an assurance that no new tax liability will be created using retrospective amendments.
Third, tax policies have to integrated with measures to promote development. The Goods and Services Tax is expected to be a game-changer and if implemented effectively could potentially lead to economic integration. Rationalising corporates tax rates and phasing out multiple exemptions, the newly introduced patent box regime which offers a concessional 10% tax on royalty from exploitation of patents developed in India, tax benefits to start-ups are some other measures to promote innovation and entrepreneurship.
The road ahead
Though India’s macroeconomic outlook looks fairly positive, there appears to be an overhang of the legacy of several decades of economic policy making.
Three factors which could influence M&A are:
a) Pushing for more reforms to ease exit: The new bankruptcy law is one such example. India has made good progress in terms of relaxing entry barriers; however, in a free-market economy flexibility to exit is equally important to channelise resources effectively and improve long-run efficiency;
b) The government’s ability to implement more structural economic reforms such as the GST; and
c) An integrated policy framework which can be usefully leveraged to add value and manage transaction risks.
Overall, though India is well-positioned to take advantage of the external opportunities, there are still a number of challenges on the execution front that will need to be ironed out progressively for India to be able to seize the global market. The country’s economy is expected to remain an opportunity for investors, given the government’s focus on growth, entrepreneurship, innovation and technology. However, sustaining M&A growth in an uncertain global environment will remain key.
Gupta is partner, and Venugopal is director, BMR Advisors.
Views are personal