With one year of ‘minimum government, maximum governance’ already over, one would hope we have four years dedicated to establishing a certain regime, if not an investor-friendly regime
The NDA government, in the last one year, has been working extensively on pursuing reforms to ease doing business in India. There have been some positives and some negatives that we can take away from the last one year. The government’s effort to ease doing business varies from labour reforms to liberalisation of sectors where FDI was either prohibited or severely restricted.
However, there still appears to be a lot that needs to be achieved for Indian companies and foreign investors to continue to look at India as a market conducive for investment. This seems to be because a lot of Indian companies, including start-ups, are vying for fund-raising either by incorporation outside India or by inversion of the existing Indian companies by externalising their holding companies outside India.
The desire for this trend seems to emerge due to exposure to taxation, attracting financing, and operating amidst more business-friendly legal regimes.
The process of enforceability of legal rights in India is amongst the slowest. Doing Business rankings do not even place India in the top 150 countries as far as enforcing contracts is concerned. This is not a risk that foreign investors would want to take, considering that they are willing to pump in millions of dollars on the basis of a contract that they execute with Indian promoters. The fact that the same ranking also confirms that approximately 12 procedures need to be completed before a business can be started in India does not augur well for the Indian investment climate.
Though the government has been trying to do its bit, the results are still not visible.
Then there is the issue of the uncertainty of tax regime in India. On one hand, we have the government seeking to retrospectively apply a taxing statute, and on the other there are fresh tax legislations/concepts (such as GAAR), which few would know when and in what shape would be applicable. Even the Companies Act, 2013, and the rules made thereunder have not had a positive impact on the confidence of foreign investors. The undergoing of changes on a weekly basis does not help when transactions are to be effectively structured by foreign investors. It is estimated that over $1 billion in foreign investment is likely to be forgone in lost opportunities in the last few years due to tax ambiguity and unpredictable laws.
The rapid evolution of the exchange control norms is another area of concern for the investors. The restriction on the ability of foreign investors to put their shares on Indian promoters for an assured return is not encouraging.
Considering that now all foreign investments can be exited at a value not higher than the fair market value, the mandate is clear that if the return is to be shared, then so must the risk by foreign investors. This, coupled with the fact that there are significant currency fluctuations which increase the exposure to an appreciating rupee, only encourages the investors to prefer funding in dollars in offshore jurisdictions rather than in India.
However, it is not that all is well when it comes to externalisation of Indian companies. The process of externalisation has its own challenges. A holding company in a foreign jurisdiction, which still wants to run operations from India (due to the cost-effectiveness), typically incorporates a subsidiary in India. This also curtails to some extent the exposure of foreign investors to any potential non-compliance with local laws. However, the moment the Indian subsidiary is funded by the offshore holding company, the round-tripping issues clearly emerge and will need to be looked into carefully. This is more so when the Indian promoters initially fund the offshore company and then the same funds are re-infused into the Indian subsidiary.
To curb (only to some extent) the loss to the exchequer by the externalisation of Indian businesses, the new concept of ‘place of effective management’ has been introduced by the Budget this year. A company will be considered as ‘resident’ in India in any previous year if (1) it is an Indian company; or (2) its place of effective management, at any time in that year, is in India. While what constitutes a ‘place of effective management’ is yet to be clarified, if one is to consider the OECD’s Model Tax Convention on Income and Capital, an offshore company may be classified as ‘resident’ in India if its day-to-day affairs (including meetings of the board) take place in India. This would also entrap the foreign subsidiaries of Indian companies which have genuine business activities outside India.
While there are a lot of efforts being made by the NDA government at the micro level, in actually easing out the process of setting up and operating businesses in India this will show limited results if some of the concerns at the macro level are not addressed. Externalisation of businesses not only causes a significant loss to the exchequer, it is also a lost opportunity at generating employment and capacity building. With one year of ‘minimum government, maximum governance’ already over, one would hope we have four years dedicated to establishing a certain regime, if not an investor-friendly regime.
In order to stop the trend of externalisation of Indian companies, the need of the hour could be to improve the enforceability of corporate laws and contracts, mandating accountability for breach of fiduciary duty, and to reduce barriers to exit for foreign investors. Other steps could include clubbing of the Department of Industrial Policy and Promotion (DIPP) and the Foreign Investment Promotion Board (FIPB) to streamline the approval process and providing certainty to the legal framework for attracting foreign investment in infrastructure, health-care and education, etc.
Sidharrth Shankar is partner and Shantanu Jindel is senior associate with J Sagar Associates, Advocates and Solicitors.
Views are personal