ET CONTRIBUTORSBy Ajay Joseph and Vikas Kumar
The last couple of years have not seen any increase in investment by Indian private businesses. Many experts have speculated on the causes ranging from end of quantitative easing by the USA, over-leveraged balance sheets to uncertainty of Chinese economy. Some have even hinted that the current dispensation is unwelcoming towards the ‘business as usual’ attitude of large domestic players. That is to say, they do not extend favours to corporates; a purported departure from the conventional method of conducting business in India.
While the reasons for domestic businesses unwilling to commit new investment could be many, foreign investors have been unrelenting in their desire to invest in India. For years they have circled the Indian markets hoping for a conducive investment environment. Long-term foreign investors have hoped for liberalized foreign investment regimes, tax certainty, a certainty of contractual enforcement etc.
This class of investors has ever since the early 90s been eager to invest and participate in the Indian growth story. That being said, another set of foreign investors, namely foreign portfolio investors (FPI), investing in listed securities on stock exchanges have been extended favours by successive governments. FPIs have been provided with tax incentives at par with domestic investors, easy access and exit, among other benefits. It is not suggested that the government pull back on these incentives offered to FPIs, since the economic considerations for offering such benefits to FPIs is well understood. But, one does wonder about the step-motherly treatment meted out to foreign investments in the unlisted space (FDI) compared to their FPI counterparts. FDI is long-term capital, in the true sense, that is deployed for expansion and scaling of businesses resulting in capital asset formation and creation of jobs.
It was in the news recently that finance minister, Arun Jaitley, met with top representatives of marquee private equity investors to hear suggestions on sprucing up private sector investment. While deployment of capital by domestic Indian businesses is best left to their wisdom, foreign investment can certainly be attracted with limited capital gains tax benefits and a liberalised foreign exchange regulatory regime. As a longer term measure, the centre should channel financial resources into enhancing judicial infrastructure and number of judges. An efficient judicial system is imperative for any economy to continually attract long-term investors.
Some measures that the Centre could consider in the upcoming budget, would be to provide long term capital gains tax (LTCG) exemptions for all investments in certain categories of businesses. But, any form of tax incentives offered has to be considered in light of the revenue requirements of the government. A blanket tax exemption could lead to disproportionate revenue loss.
An alternative would be for the government to consider channeling FDI into the small and medium businesses (SMB) in India. It is common knowledge that in any market economy the SMBs contribute a large share of the GDP and employ the majority of the labour force. Reports on OECD countries state that SMBs makeup over 95% of enterprises and account for 60 to 70% of jobs in these countries. It is an inevitable truth that large corporations will gravitate towards automation resulting in lesser jobs being created. It would be naive to ignore this reality. Conversely, it would be a travesty to ignore the benefits that SMBs can offer to the economy.
However, the thresholds for SMBs in India are out of sync with market realities. SMBs as per the existing definition are not of a critical scale to attract FDI. It would be useful to adopt a higher threshold for SMBs, in which FDI could be channelled.
Thresholds to be considered for providing the LTCG exemption could be investments in securities of operating businesses, such businesses being below a certain turnover (for eg Rs 200 crore), gross block assets on balance sheet below a certain threshold etc. Investments in companies /businesses that meet these criteria should be exempt from LTCG tax provided the investment had been held for a continuous period of 4-5 years.
The LTCG exemption should be available to the investor irrespective of the turnover or size of the company at the time of exit by such investor. Most of the investment that is deployed in such growth companies usually has an investment duration in excess of four years. The exemption should be available to all investors irrespective of their country of origin or residence.
Another useful method that the government could adopt, to achieve twin objectives of tackling generation of fresh unaccounted income and spurring growth investment, is to mandate that tax deductions would be unavailable for payments made in cash. Businesses should not be allowed the benefit of expense deduction under tax laws unless the expense has been incurred through a banking channel or electronically.
Businesses could be offered a 6 – 12 months’ window to ensure compliance with this requirement. Nudging corporate India towards digitising its expenses would also make their accounts transparent. This would provide investors a transparent view into the books and operations of potential target companies. It would augment investor confidence in Indian businesses and open up many potential avenues for investment. Another complementary move could be to permit each individual tax payer the benefit of expense deduction to reduce tax liability for electronically incurred expenditure. Such a move could fuel a consumption boom providing the necessary fillip to various business sectors such as real estate, travel, and tourism, FMCG, automobiles etc.
Last but not the least, the government must undertake a large-scale capital investment exercise to overhaul the infrastructure of the existing courts and tribunals. Significant resources should be allocated to allow an ‘across the board’ increase in a number of judges across the country. Reports suggest that case pendency in the judiciary is steadily increasing due to inadequate judges and infrastructure. While many other factors need to be addressed to improve the justice system, the budget can address the funding needs. Judiciary is the cornerstone of our democracy and an inefficient judicial system renders India an unattractive destination for investment capital.
The current ruling dispensation has undertaken various laudable measures to improve the living conditions of people at the bottom of the economic pyramid in India. But, it seems the government still believes that a benign and an all-encompassing government can outperform market forces in the economic sphere. Empirical data from many countries across the world has shown otherwise. Governments must provide an attractive level playing field to market players and let the invisible hand of the market shape the economy.
The writers are partners at Lakshmikumaran & Sridharan
(Views expressed by the authors are personal and do not reflect views of the firm or any of its other members.)
The last couple of years have not seen any increase in investment by Indian private businesses. Many experts have speculated on the causes ranging from end of quantitative easing by the USA, over-leveraged balance sheets to uncertainty of Chinese economy. Some have even hinted that the current dispensation is unwelcoming towards the ‘business as usual’ attitude of large domestic players. That is to say, they do not extend favours to corporates; a purported departure from the conventional method of conducting business in India.
While the reasons for domestic businesses unwilling to commit new investment could be many, foreign investors have been unrelenting in their desire to invest in India. For years they have circled the Indian markets hoping for a conducive investment environment. Long-term foreign investors have hoped for liberalized foreign investment regimes, tax certainty, a certainty of contractual enforcement etc.
This class of investors has ever since the early 90s been eager to invest and participate in the Indian growth story. That being said, another set of foreign investors, namely foreign portfolio investors (FPI), investing in listed securities on stock exchanges have been extended favours by successive governments. FPIs have been provided with tax incentives at par with domestic investors, easy access and exit, among other benefits. It is not suggested that the government pull back on these incentives offered to FPIs, since the economic considerations for offering such benefits to FPIs is well understood. But, one does wonder about the step-motherly treatment meted out to foreign investments in the unlisted space (FDI) compared to their FPI counterparts. FDI is long-term capital, in the true sense, that is deployed for expansion and scaling of businesses resulting in capital asset formation and creation of jobs.
It was in the news recently that finance minister, Arun Jaitley, met with top representatives of marquee private equity investors to hear suggestions on sprucing up private sector investment. While deployment of capital by domestic Indian businesses is best left to their wisdom, foreign investment can certainly be attracted with limited capital gains tax benefits and a liberalised foreign exchange regulatory regime. As a longer term measure, the centre should channel financial resources into enhancing judicial infrastructure and number of judges. An efficient judicial system is imperative for any economy to continually attract long-term investors.
Some measures that the Centre could consider in the upcoming budget, would be to provide long term capital gains tax (LTCG) exemptions for all investments in certain categories of businesses. But, any form of tax incentives offered has to be considered in light of the revenue requirements of the government. A blanket tax exemption could lead to disproportionate revenue loss.
An alternative would be for the government to consider channeling FDI into the small and medium businesses (SMB) in India. It is common knowledge that in any market economy the SMBs contribute a large share of the GDP and employ the majority of the labour force. Reports on OECD countries state that SMBs makeup over 95% of enterprises and account for 60 to 70% of jobs in these countries. It is an inevitable truth that large corporations will gravitate towards automation resulting in lesser jobs being created. It would be naive to ignore this reality. Conversely, it would be a travesty to ignore the benefits that SMBs can offer to the economy.
However, the thresholds for SMBs in India are out of sync with market realities. SMBs as per the existing definition are not of a critical scale to attract FDI. It would be useful to adopt a higher threshold for SMBs, in which FDI could be channelled.
Thresholds to be considered for providing the LTCG exemption could be investments in securities of operating businesses, such businesses being below a certain turnover (for eg Rs 200 crore), gross block assets on balance sheet below a certain threshold etc. Investments in companies /businesses that meet these criteria should be exempt from LTCG tax provided the investment had been held for a continuous period of 4-5 years.
The LTCG exemption should be available to the investor irrespective of the turnover or size of the company at the time of exit by such investor. Most of the investment that is deployed in such growth companies usually has an investment duration in excess of four years. The exemption should be available to all investors irrespective of their country of origin or residence.
Another useful method that the government could adopt, to achieve twin objectives of tackling generation of fresh unaccounted income and spurring growth investment, is to mandate that tax deductions would be unavailable for payments made in cash. Businesses should not be allowed the benefit of expense deduction under tax laws unless the expense has been incurred through a banking channel or electronically.
Businesses could be offered a 6 – 12 months’ window to ensure compliance with this requirement. Nudging corporate India towards digitising its expenses would also make their accounts transparent. This would provide investors a transparent view into the books and operations of potential target companies. It would augment investor confidence in Indian businesses and open up many potential avenues for investment. Another complementary move could be to permit each individual tax payer the benefit of expense deduction to reduce tax liability for electronically incurred expenditure. Such a move could fuel a consumption boom providing the necessary fillip to various business sectors such as real estate, travel, and tourism, FMCG, automobiles etc.
Last but not the least, the government must undertake a large-scale capital investment exercise to overhaul the infrastructure of the existing courts and tribunals. Significant resources should be allocated to allow an ‘across the board’ increase in a number of judges across the country. Reports suggest that case pendency in the judiciary is steadily increasing due to inadequate judges and infrastructure. While many other factors need to be addressed to improve the justice system, the budget can address the funding needs. Judiciary is the cornerstone of our democracy and an inefficient judicial system renders India an unattractive destination for investment capital.
The current ruling dispensation has undertaken various laudable measures to improve the living conditions of people at the bottom of the economic pyramid in India. But, it seems the government still believes that a benign and an all-encompassing government can outperform market forces in the economic sphere. Empirical data from many countries across the world has shown otherwise. Governments must provide an attractive level playing field to market players and let the invisible hand of the market shape the economy.
The writers are partners at Lakshmikumaran & Sridharan
(Views expressed by the authors are personal and do not reflect views of the firm or any of its other members.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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