KPMG: ‘It is high time that British mid-tier companies looked at India’

KPMG India CEO Richard Rekhy shares his views with Asia House Web Editor Naomi Canton on Narendra Modi’s first full year Union Budget.

Please summarise your views on the Union Budget 2015.

It’s a very pragmatic budget with lots of reforms. He is creating structural changes for growth. Of course you have to remember that at this stage everything in the budget is a proposition. He has announced a number of steps to help improve the ease of doing business in India and a lot of policy and tax initiatives to remove ambiguity for foreign investors.

It also has a focus on financial inclusion. In the last few months 125 million poor people have been given getting state bank accounts. This opens up opportunities for insurance and loans that will spur economic activity.

It looks at socio-economic development too as he said that contributions to the Clean India (Swachh Bharat) Fund will get 100 per cent tax deductions.

The budget has also focused on good governance with the announcement of transparent coal block auctions and spectrum auctions.

Whilst doing all that the budget has maintained fiscal discipline. However, a three per cent fiscal deficit is to be achieved in three years instead of two years.  It is pleasing to see that savings are to be used for infrastructure development.

This budget is trying to do something for everyone – offering something to the youth (eg the proposal to launch a new national skills mission to enhance employability of rural youth), for agriculture, for the poor and so on. The phased roll-out of Direct Benefit Transfer (a scheme first introduced by the previous Government in January 2013 to put benefits and subsidies directly into recipients’ bank accounts) will itself increase public spending and consumption.

Modi has also offered tax concessions to Real Estate Investment Trusts and Infrastructure Investment Trusts which is good news. He has raised the threshold for application of transfer pricing rules to Rs 20 crore (US$ three million) from Rs 5 crore (US$ 800,000). This is a very positive move as we don’t want everyone to come into that net  – we only want the large players.

In this budget he has also raised the Indian states’ share in the net proceeds of Union tax revenues from 32 per cent to 42 per cent.

I would say it concentrates on three main areas: the ‘Make in India’ initiative, making it easier to do business in India and creating stability in the tax regime.

Tell me a bit more about what Modi has done to make doing business easier in India. In the World Bank Group’s Doing Business 2015 report, for example, India was ranked 142 out of 189 economies for its ease of doing businesses.

Indeed. The challenge for most foreign companies operating or investing in India has been the ecosystem, especially for the manufacturing sector, and this budget aims to address these issues.

A number of steps have been taken to improve the ease of doing business in India such as the new bankruptcy laws. He said he wants to bring out world-class bankruptcy laws along the lines of what they have in the USA to enable people to wind down companies in India more easily.  He did not spell it out exactly but the idea is that this will help foreign investors to protect themselves. Under the current law it takes too long and there are too many regulations.

A lot of work has been done on the 10 areas that the World Bank Group assesses India on in its Doing Business 2015 publication. It won’t happen overnight but the government is geared up to getting it all changed. They are even planning on bringing out rankings for each state regarding the ease of doing business.

This Government has also announced it will introduce a Dispute Resolution in Public Contracts Bill. This is very important because India was ranked very low in the ‘enforcing contracts’ part of the Doing Business World Bank assessment. It will help make resolving disputes between different parties, foreign or Indian, investors or the Government, much easier

Are there any other elements of this budget that will appeal to foreign companies?

Yes, he announced a reduction in the basic rate of tax deducted at source for Royalties and Fees for Technical Services (FTS) from 25 per cent to 10 per cent. This will appeal to foreign companies selling their services to India, for example technology ones, and is a huge relief Indian companies as well.

The rules regarding the Advance Pricing Agreements (or transfer pricing regulations) four-year roll back mechanism were confirmed bringing relief to companies involved in cross-border transactions and reducing disputes. The Government also announced that foreign funds would not to be taxed on their gains in India, even if the fund manager was based in India.

Which sectors in India may be of interest to Western companies now as a result of this budget?

FDI in Defence was earlier raised to 49 per cent.  Similarly, in insurance too it has been raised to 49 per cent from 26 per cent and the Insurance Bill passed.  These are both positive steps.

There were no specific FDI easing announcements in this budget. The Indian Government had already announced last year that it would allow 100 per cent FDI in the rail sector to develop infrastructure and improve safety features. A few days ago Life Insurance Corporation of India signed an MoU with Indian Railways to commit to investing Rs 15,000 crore (US$ 2.4 billion) in railway infrastructure over the next five years. One hundred per cent FDI is already allowed in construction.

One other important aspect to note is that India’s ports are going to get corporatised. They are currently under statutes. By making them have a corporate structure this will invite private investment, they can easily be sold off and they can get foreign investment into it. It’s a big change so that’s a good move.

Tell me more about the ‘Make in India’ initiative, an initiative by the Government of India to encourage companies to manufacture their products in India – and how foreign companies may benefit.

This budget has said quite a few things about the Make in India initiative. This is one of the key initiatives of this Government. The prime minister has reiterated his support on many occasions. India needs to create jobs to provide employment to millions of people joining the work force every year. Entrepreneurial activity has to be encouraged and supported. The big opportunities lie in sectors such as defence, automotive and automotive components, agriculture and allied industries like food processing.  There needs to be increased cooperation and coordination at government level to put it into action.

KPMG India CEO Richard Rekhy with Asia House CEO Michael Lawrence

India is currently the world’s largest importer of defence equipment. According to India’s Defence Offsets policy, foreign companies selling defence equipment to India worth more than Rs 300 crore (US$ 48 million) have to invest at least 30 per cent of the worth of the deal in Indian defence, civil aviation and homeland security sector. The Government’s idea is that foreign companies can come and set up manufacturing facilities in India.

At the moment 49 per cent of companies operating in the defence sector in India can be owned by foreign companies and 51 per cent must be owned by multiple Indian companies.  However, technology is dealt with on a case-by-case basis. The Government will look at giving 100 per cent FDI approval in the case of foreign companies bringing very high-tech technology to India. I don’t know how many foreign defence companies are looking at India but I am sure this will be of interest to them. India has become the global supply chain for some of these defence MNCs, as it is.

One of the key concerns of foreign investors has been the retrospective changes in tax laws.  What are the key announcements in this year’s Union Budget on retrospective tax changes, especially on indirect transfer of shares.

One of the underlying themes in this year’s budget was to provide certainty and clarity in this budget and most of the issues on indirect transfer of shares have been clarified.

For example, they clarified what they mean by ‘indirect transfer of shares’ and clarified the meaning of ‘gains arising from a transfer of shares of an offshore company where the shares derive value substantially from assets located in India.’ They have said the transaction will only be taxable in India if 50 per cent or more of the total value of the assets of the foreign company is located in India; and global mergers and demergers are exempt, subject to conditions. Small transactions are outside the tax net. There has been no roll back on retrospective taxes on any overseas transaction by foreign firms involving an Indian asset dating back 50 years but at least they have clarified matters for the future.

If you look around the world there are similar regulations everywhere but what India has done differently is to make it retrospective but I don’t think any companies have issues with the rules per se, they just want to know whether they will be taxed so they can factor it into their business transactions. Business are looking for stability in the Indian tax regime and I think that has been achieved to some extent but there will always be murmurs here and there because of the retrospective tax. What you have to remember is that Vodafone and Shell both won their cases in the High Court on equity infusion into their Indian subsidiaries and the Government did not appeal even though it could have taken it to the Supreme Court.

There has been lot of talk about India introducing a comprehensive Goods and Services Tax (GST) (a single tax, similar to VAT in the UK, to be levied on purchases of goods and services, to replace the current layers of state and national taxes.) Are there any indicators in the Union Budget about the Government’s resolve to introduce GST and what rate it would be set at?

No percentage rate has been fixed yet but there are talks going round that it could be 20 to 24 per cent. The revenues gained will be split 50/50 between the state and centre and it will replace all the current indirect taxes that exist. Petroleum and alcohol are not included however and it looks like they will continue with their current tax regime. I don’t know how much revenue GST will bring but the GDP of India is forecast to go up by at least one per cent as a result, as businesses that are currently not operating in the mainstream will come into it – and they will want to come into it. Arun Jaitley did not say when it would be implemented but he indicated it would be 1st April 2016. The public wants it as it will create one tax across the country. A lot of the ground work on GST has been done by the Government and the Constitutional Amendment Bill is now before the Parliament. The Central Government has addressed most of the concerns of the State Governments, in particular assuring them that the state will not lose out on revenues.  In this budget the service tax was increased from 12.36 per cent to 14 per cent ready for the roll out of GST.

The Government announced it would reduce corporate tax rates from 30 per cent to 25 per cent over the next four years and also do away with the corporate tax concessions in a phased manner. What are your views of that?

This will create a flat rate with no deductions and no retrospective element. It will take four years to bring it down and remove all the concession and reduce disputes.  Once that is done everyone will know they are paying a flat rate and it compares very well with global tax rates in the rest of the world including in ASEAN. This will only improve the landscape of India as an investment destination. This is a very positive message. It clearly shows the Government’s resolve to create a business-friendly environment and encourage both domestic and foreign companies.

What are your thoughts on the postponement of General Anti Avoidance Rules (GAAR) by two years?

The Government has said that the Indian environment is not ready for GAAR (an anti-tax avoidance regulation introduced by former Finance Minister Pranab Mukherjee) at the moment. They want to build some safeguards first, defer it by two years, then assess public opinion and bring it out after that. This clearly shows that the Government is listening to the concerns of foreign investors and addressing their issues. During the next two years any underlying issues will be reviewed and addressed. GAAR is about investigating deals that have been structured to avoid tax. Whenever it will be introduced it will be introduced from a prospective and not retrospective effect.  This is a great move as it means all existing investment structures and transactions up to the date GAAR is implemented will be respected.

Modi has previously spoken about building 100 smart cities. Do you see this as an opportunity for UK companies to participate in the infra story in India.

The Delhi-Mumbai freight corridor should be ready by 2017 or 2018 and smart cities are being created along that corridor. A lot of work has happened.

Infrastructure is the key to India’s growth. The Government is looking at infrastructure funds to be set up under the PPP model. The US is adopting three smart cities. They are also looking at setting up tax-free infra bonds that people can buy with a return of say seven per cent. KPMG has proposed to the Government about setting up a development infrastructure bank. When David Cameron came to India on his last visit he committed to spending US$1.5 billion on the Bangalore-Mumbai Corridor and I think there is a lot of work British companies can do if they work with DFID (the Department for International Development.)

I think British contractors can come and do work on this corridor and bring high-tech engineering and other skills to India. Britain has many skills that could be useful to Indian companies. Now with royalties and FTS coming down they can benefit even more. Each project requires multi-billion dollar investments so there are opportunities for financial services.

The RBI has made two surprise cuts in the repo rate in a short space of time this year. Can you comment on that?

India has fared well with recent macroeconomics and the drop in price of oil so inflation is under control and the RBI has been able to cut interest rates, which is better for people needing loans, if commercial banks follow suit. Having said that, tomorrow it could all change.

India’s GDP is expected to grow between 8.1 and 8.5 per cent in 2015-16, as against 7.4 per cent in the current year. Fiscal deficit is projected to decline to 3.9 per cent of GDP in 2015-16 (not the 3.6 per cent target set by Arun Jaitley’s predecessor) from 4.1 per cent in the previous year.  There has been a surge in the country’s foreign exchange reserves, stability in the rupee-dollar exchange rate, and a sharp narrowing of the Current Account Deficit. What is your assessment of the outlook for the Indian economy? 

India is at a unique stage in its journey where it could achieve more than eight per cent year-on-year growth with good policies and clear direction. Foreign investors are again looking at India as a good investment destination. This year’s budget again lays the roadmap for a sustained economic growth and has avoided populist measures.

I think the atmosphere is very positive in India now.  The only issue we have is that investments in many projects have dried up and those projects need to be kickstarted again. It will take one or two years to see real results to the economy. A lot of it will be kickstarted by the Government through infrastructure investments.  Japanese companies are looking at India very positively.

The Government is finally changing processes and making it easier to do business in India. I think British companies need to see the opportunities in India. I think it is high time that British mid-tier companies looked at India. There are so many opportunities and they can get paid royalties for bringing technology here.  Now is the time to look at India as a manufacturing base and take advantage of this emerging middle-class consumer population. Do not underestimate the impact of Direct Benefit Transfers once they reach the hands of the people and the amount of consumption it will spur.

naomi.canton@asiahouse.co.uk

Richard Rekhy and Sanjeev Sanyal, Global Strategist & Managing Director, Deutsche Bank, recently gave a briefing to Asia House corporate members on Modi’s first full year Union Budget. To read about that click here. 

To read an interview that KPMG India CEO Richard Rekhy gave analysing Narendra Modi’s July 2014 maiden budget click here.