Union Budget 2015 Inspiring confidence, empowering change in India. Private equity Post-budget sectoral point of view

Transcription

1 Union Budget 2015 Inspiring confidence, empowering change in India Private equity Post-budget sectoral point of view

2 Table of contents 1. Context 2. Key policies/fiscal and tax proposals 3. Unfinished agenda 3

3 Context Where are we The industry in the last four years has invested about USD10 billion, every year. This year they have invested USD11 billion, which is a positive step. E-commerce became the preferred choice given its growth potential vs. other sectors. IT benefited due to rupee depreciation. The industry had been moving side ways for the last few years due to slow economic growth and an uncertain political scenario. 1 With a new government at the centre and positive signs of economic growth, the private equity industry is expected to invest more actively into India in This change in sentiment was witnessed in 2014 with an 8 per cent growth in the funds invested and 34 per cent growth in the funds raised. 2 However, exits have been a challenge. With economic growth, improving mergers and acquisitions environment and favourable capital markets, this will likely be a key focus area for PE investors along with new investments. Key issues/challenges Growth: Slow economic growth affected almost all sectors; but certain sectors like real estate and infrastructure have been hit harder. Exits: Of the USD100 billion invested into India since 2005, exits have been a fraction of the same at USD30 billion. Issues with respect to approvals in sectors like pharma, slow capital markets, low economic growth, have all played a role in slowing down the exit process. 2 With the revival of the economy, capital market itself can help facilitate exits of USD2-3 billion in 2015 through the IPO route. Tax and regulatory bottlenecks: Tax has been one of the issues plaguing the PE industry and here the primary pain points are on two fronts. Firstly, tax treatment on exits, arising mainly as a result of GAAR being in the offing and ground level issues over treaty eligibility; has resulted in litigation risk. Secondly, no tax code being prescribed for domestic funds (other than those qualifying as venture capital funds ), has resulted in a huge chunk of domestic funds being compelled to force-fit under the trust taxation provisions which were not meant for contributory trusts; but family trusts. On the regulatory side, the PE industry has been facing constraints on account of domestic fund managers being unable to raise funds from overseas, in the absence of an enabling regulatory mechanism. What was expected Several PE players were buoyant given the government s stated objective to provide a non-adversarial tax regime and were hopeful that uncertainty and litigation over tax matters would be resolved. Also, given that the Indian economy is in a sweet spot, with inflation having steadily tapered down, fiscal deficit reduced, domestic demand picking up and external value of the Indian rupee stabilised; the sector was expecting bold measures and substantive reforms from the FM, which could further propel growth. 1. VCC edge annual deal round-up The PE industry had made strong representations to the government for inter alia a conducive tax regime and regulatory environment. Some of the aspects on which representations were made to the government by the PE industry were as under: Provide tax pass-through to all categories of Alternative Investment Funds (AIF) Deferral of GAAR No permanent establishment for offshore managers/funds in India Rationalisation of indirect transfer provisions Safe harbour for the advisory entity in India (from a transfer pricing perspective) Clarity on tax rate on long-term capital gains from transfer of shares of private limited companies Period of holding of convertible securities Clarity on characterisation of income Align tax on buyback of unlisted shares with DDT Encourage insurance companies, EPFO, pension funds and charitable trusts to invest in AIFs KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 4

4 Key policies/fiscal and tax proposals Key announcements Tax Tax pass-through for AIF1 and AIF2 Other than business income, is eligible for pass through; funds exempt and investors taxable in the same manner In respect of other than business income tax at 10 per cent on income credited/paid to investors Income received by the fund to be exempted from TDS by portfolio companies (notification to be issued) Capital loss cannot be passed on to the investors. Fund to carry it forward for set off in the future years Business income taxable at fund level, correspondingly distribution of such income exempt for investors No distribution tax on income paid/distributed by AIFs VCFs registered under the VCF regime continued under those provisions. Rationalisation of indirect transfer provisions Substantial assets in India deemed at 50 per cent Small shareholders not having control or management status, nor holding 5 per cent or more, directly or indirectly, excluded from indirect transfer tax Income attributable to transferor, taxable on a pro-rata basis Reporting obligation on Indian entity in case of indirect transfer. GAAR Deferred to FY onwards All investments made upto 31 March 2017 protected from applicability of GAAR (Rules to be notified). Safe harbour for offshore funds Fund management activity undertaken in India by an eligible fund manager on behalf of an eligible offshore fund does not create a business connection or residency risk for offshore fund in India. Qualifying criteria for eligible offshore fund and eligible fund manager, prescribed. MAT MAT exemption for capital gains income earned by FIIs (other than short-term capital gain on which STT is not chargeable). Residency of foreign companies Linked to place of effective management in India ( POEM ) at any time during the year. POEM linked to key management and commercial decisions, in substance, of an entity as a whole. REIT/InvIT Tax parity for sponsors of REIT/InvIT on listing of units Pass through on rental income, in respect of property directly held by REIT No WHT on Rental income received by REIT Taxes to be withheld by REIT at the time of distribution of such rental income to unit holders at 10 per cent for residents and at applicable rates for non-residents KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 5

5 Others Definition of GDRs modified to cover those with underlying shares of listed companies only Tax withholding at 5 per cent applicable to FPIs on interest on rupee bonds extended up to 30 June 2017 (earlier up to 31 May 2015), subject to conditions Domestic Transfer Pricing threshold enhanced from INR5 crore to INR20 crore Tax rate on royalty and FTS for non-residents reduced from 25 to 10 per cent Surcharge of 2 per cent applicable to individuals with an income more than INR1crore Direct Taxes Code abolished NBFCs registered with the RBI, with asset size of INR5 billion and above, would be considered for notifications as Financial Institution under the SARFAESI Act, 2002 Bankruptcy code to be introduced Forwards Markets Commission to be merged with SEBI Tax free infrastructure bonds for rail, road and irrigation sectors Regulatory reform bill proposed Foreign Investments in Alternate Investment Funds to be allowed Distinction between FPI and FDI to be done away with, composite caps for various sectors Control on Capital Account transactions (except debt instruments) under FEMA to be exercised by the government in consultation with the RBI Measures proposed to curb black money KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 6

6 Impact For the PE industry, this is indeed a big bang budget and bears testimony to the collaborative approach of the government, with many of the PE industry demands being considered and addressed. The announcements made in respect of bankruptcy laws, intention to deepen the Indian bond market by inter alia overhauling debt laws, the Make in India programme and Ease of Doing Business initiative should, in conjunction, make India an even more attractive and alluring destination for PE deal activities. The gradual reduction of corporate tax rate to 25 per cent over four years and easing out of incentives is reflective of the government s long-term vision. The FM having mentioned the introduction of GST from 1 April 2016 seems conducive for overall growth. Also, the additional fiscal spend being proposed to be funneled into funding infrastructure investment, could augur well for the industry at large. The tax and regulatory proposals introduced in the budget should result in accelerated deal activity, fund raising gaining momentum and fund management activity shifting to India, albeit in the long run; which would then have a positive spill over effect on various sectors of the economy. Analysis of some of the key tax proposals Providing tax pass-through status to Category I and II AIFs is in line with the industry s demand. This, in combination with foreign investment being allowed in AIFs, could promote fund raising activity. However, tax withholding by AIFs at the rate of 10 per cent may deter foreign investors from coming into AIFs. This may also have the unintended consequence of 10 per cent tax withholding being applied by AIF on other exempt income such as dividends and long-term listed gains. Also, by carving out separate treatment for business income (while not laying out the criteria for distinguishing capital gains from business income) for AIFs, there is room left for litigation over characterisation of income. Secondly, the introduction of safe harbour norms for fund managers is clearly a step in the right direction to incentivise offshore fund managers to be based in India. The dual play of no business connection and no residency risk for offshore funds having a fund manager in India, is a strategy that could yield results in the long run. However, while the intent of the government is noble and encouraging, the conditions laid out may not be practically feasible, given how typically funds are raised, with anchor investors, limited set of LPs, buyout deals where business in India may be controlled by the fund, etc. Some of these issues would need to be ironed out for the real impact of this reform to be felt and seen. Having said that, the safe harbour norms seem to be relevant only in case of funds earning business income and should not impact those earning capital gains. Deferment of GAAR to 1 April 2017 and grandfathering of investments made before 1 April 2017 (as against August 2010 which was the case earlier) is encouraging for the investment community. Clarification on aspects related to indirect transfers gives a much needed clarity on situations where these provisions would be applicable. Change in residency criteria for foreign companies sets a higher threshold for qualifying as a nonresident and may be a cause of concern for some of the PE investors. One needs to look out for the guiding principles that are to be issued for this purpose. Specific provisions of MAT not being applicable to FIIs in respect to capital gains (other than short-term capital gains not subject to STT) was much needed given the plethora of tax notices issued to FIIs seeking levy of MAT. FIIs would however continue to be liable to MAT on interest income and shortterm capital gains on sale of NCDs, sale of shares through delisting, buyback, off market open offer, etc. However, there is now uncertainty over MAT applicability to offshore funds (other than FIIs). In a nutshell, we believe that the PE industry did receive its due attention this year and its long pending demands have been attempted to be met. But there are some gaps in the fine print, which need to be addressed KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 7

7 Unfinished agenda Certain areas still need to be addressed Tax has been one of the roadblocks for the PE industry. The measures announced in the budget are in response to the long standing pleas of the industry and are path-breaking in some respects. They provide the much needed relief to the industry and an assurance that the government finally understands their concerns. The budget proposals are positive for the sector; but there is an unfinished agenda that remains. Some of the issues that need to be addressed are: Clarity on characterisation of income Safe harbour conditions that need to be rationalised Rationalisation of tax withholding obligation of AIFs Exemption for a listed entity from indirect transfer Guiding principles for Place of Effective Management MAT for non-fii investors Period of holding for convertible securities Capital gains tax rate on transfer of unlisted shares of private companies Rationalisation on DDT/BDT rates Overhaul of the tax administration to address litigation. What is expected going forward One expects that the positive momentum continues and the government is receptive to the suggestions of the PE industry so as to give an even more practical perspective to the reforms that have been proposed. This would go a long way in making India a truly global financial hub KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 8

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10 KPMG in India contacts: Nitin Atroley Partner and Head Sales and Markets T: E: Vikram Hosangady Partner and Head Private Equity Sector T: E: kpmg.com/in/budget2015 Follow us on: Latest insights and updates are now available on the KPMG India app. Scan the QR code below to download the app on your smart device Play Store App Store kpmg.com/in/socialmedia The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Printed in India (BRA0115_043)