taxation nightmares spook investors - dfdl...votes or facebook likes’ a timely reminder from...

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September 2013Volume 7, Issue 3

Drilling into oil and gas contractsEvaluating India’s new Companies Act

The changing face of outbound investmentPlus: expert advice from correspondent law firms


Horror storiesTaxation nightmares spook investors

Contents

India Business Law Journal 1September 2013

36 Antitrust & competition Udwadia Udeshi & Argus Partners

37 Canada-India trade & investment Bennett Jones

38 Corporate & commercial law RRG & Associates

39 Dispute resolution Bharucha & Partners

40 Foreign direct investment OP Khaitan & Co

41 Healthcare & life sciences Krishna & Saurastri

42 Infrastructure & energy Trilegal

43 Intellectual property Singh & Associates

44 Media & entertainment Saikrishna & Associates

45 Mergers & acquisitions Amarchand Mangaldas

46 Private equity & venture capital Khaitan & Co

47 Regulatory developments Phoenix Legal

48 Taxation & transfer pricing Economic Laws Practice

36 Correspondents Expert advice from India Business Law Journal’s correspondent law firms

15

India’s complex and unpredictable tax regime continues to spook investors

3 LeaderReducing the trust deficit

4 Inbox

5 News Bhasin celebrates 50 years of lawyeringGreen light for foreign universitiesMukherjee bids farewell to LuthraUttar Pradesh to develop IT parkTop honours for women lawyersELP opens doors in Bangalore

11 The wrapLegislative & regulatory update: page 11Court judgments: page 13

15 Cover storyHorror stories

20 Vantage pointTaxation bluesAmbiguities and inconsistencies make effective tax planning impossible, laments Rajinder Sharma of DuPont India

21 Spotlight Playing by new rules

24 What’s the deal?Drilling into oil and gas contractsThe legal ins and outs of hydrocarbon

exploration and production in India

29 Intelligence report

A new world order

Horrorstories

Playing by new rules

21

29

Indebted and weakened by a falling rupee, Indian companies are taking a more strategic approach to outbound investment

A new world order

While in many respects India’s new Companies Act has come up trumps, doubts remain over its implementation

Editorial board

India Business Law Journal2 September 2013

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India Business Law Journal


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EditorVandana Chatlani

Deputy editorRebecca AbrahamConsultant editor

Simmie MagidSub-editors

James Kelly, Jennifer LeeContributors

Aparajit BhattacharyaRajdeep ChoudhuryNandini LakshmanRajinder SharmaHarvinder Singh

Production editorPun Tak Shu

Head of marketingBilly Chung

Associate publisherTina TuckerPublisher

James Burden

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DirectorsJames Burden, Kelley Fong

Disclaimer & conditions of saleVantage Asia Publishing Limited retains the copyright of all material published in this magazine. No part of this magazine may be reproduced or stored in a retrieval system without the prior written permission of the publisher. The views expressed in this magazine do not necessarily reflect the views of the publisher, its staff or members of the editorial board. The material in this magazine is not offered as advice and no liability is assumed in relation thereto. The publisher, staff and all other contributors to India Business Law Journal disclaim any liability for the consequences of any action taken or not taken as a result of any material published in this magazine.

© Vantage Asia Publishing Ltd, 2013

Vijaya SampathAdviser to the Chairman & Group CEO

Bharti Enterprises

Pravin AnandManaging PartnerAnand and Anand

Ashok SharmaFounder PresidentIndian Corporate

Counsel Association

Rohan WeerasingheGeneral Counsel &

Company SecretaryCitigroup

Amit Anant MoghayGeneral Counsel

HSBC

Amarjit SinghManaging Partner

Amarjit & Associates

Mysore R PrasannaIndependent Consultant

Pallavi ShroffManaging Partner

Amarchand Mangaldas

Premnath RaiFounding PartnerPRA Law Offices

Shardul ThackerPartner

Mulla & Mulla & Craigie Blunt & Caroe

Shruti Dvivedi SodhiDirector - Legal

Colt Technologies

Bhavna ThakurDirector & Head of

Equity Capital MarketsCitigroup

Shamnad BasheerProfessor in IP Law

National University of Juridical Sciences

Lalit BhasinManaging Partner

Bhasin & Co

Himavat ChaudhuriExecutive Director & Senior CounselTurner General

Entertainment Networks

Sumes DewanPartner

Desai & Diwanji

Fali S NarimanSenior Counsel

Toby GreenburyConsultant

Khaitan & Co

Manik KaranjawalaPartner

Karanjawala & Co

Martin RogersPartner

Davis Polk & Wardwell

Jagannadham Thunuguntla

Strategist & Head of Research

SMC Global Securities

Jane NivenRegional General

CounselJones Lang LaSalle

Sunil SethSenior PartnerSeth Dua & Associates

Girish GokhalePresident - Legal & Group General

CounselJSW

Amarchand & Mangaldas •& Suresh A Shroff & Co

Bennett Jones•

Bharucha & Partners•

DH Law Associates•

Economic Laws Practice•

Khaitan & Co•

Krishna & Saurastri•

OP Khaitan & Co•

Phoenix Legal•

RRG & Associates•

Saikrishna & Associates•

Singh & Associates•

Trilegal•

Tyabji Dayabhai•

Udwadia Udeshi & Argus Partners•

Correspondent law firms

Leader

India Business Law Journal 3

Opinion

September 2013

‘The governorship of the central bank is not meant to win ... votes or Facebook likes’

A timely reminder from Raghuram Rajan, the new governor of the Reserve Bank of India (RBI), on his first day in office. In cautioning that some of his

actions would not be popular, Rajan signaled there were tough times ahead for India.

While there is no doubt about Rajan’s resolve to do the right thing, there is little that he or any regulator can achieve without having invested in a relationship of trust with the masses. Rajan clearly understands this. His widely publicized speech referred to the importance of transparency and predict-ability and of the RBI becoming a “bea-con of stability”.

Impressive rhetoric, but can Rajan be expected to walk the talk?

While a change of guard at the RBI has left observers hopeful of more coherent and practical policymaking from India’s central bank, there is little expectation that it is anything other than business as usual at most other branches of the Indian establishment.

This month’s Cover story (page 15) focuses on an area where a radical shakeup would go a long way towards improving the country’s reputation as a business-friendly jurisdiction: India’s inevitably problematic taxation regime.

The problems faced by companies – both within India and outside – that find themselves embroiled in disputes with India’s tax man are legendary. And with little being done to overhaul the system, not only is there a “trust deficit”, as Ravishankar Raghavan at Majmudar & Partners calls it, but it also seems that some investors are running out of patience. Samsuddha Majumder, a counsel at Trilegal, observes that “in some cases [the fear of tax litigation] could be the basis of decisions on whether to invest in India or not”. He adds that this “was not so before 2012”, when Vodafone became embroiled in its now-infamous dispute with India’s tax authorities.

A lot has changed since the Vodafone dispute flared up; there is now much greater vigilance when it comes to matters of taxation and most companies understand that they can’t afford anything less than an extremely robust tax compliance system. Yet writing in this month’s Vantage point (page 20) Rajinder Sharma, the general counsel for South Asia at DuPont India, says that “even the best-made tax plans can fall apart when tax officials use a fine-tooth comb to find every opportunity to gener-ate additional revenue for the exchequer”.

While generating revenue is critical for the government and the country, there needs to be a realization in the

corridors of power in New Delhi that businesses require high levels of clarity and certainty. If these cannot be pro-vided and investors continue to be spooked by the poten-tial of running into unforeseen tax disputes, the damage to India could be immense.

In this month’s Spotlight (page 21) we turn our attention to India’s new Companies Act, which seeks to ensure that the legal infrastructure for companies operating in India is fit for purpose. The act introduces several new concepts: one person companies, mandatory corporate social responsibility obligations and at least one woman direc-tor for certain classes of companies. But as our coverage reveals, there are still many grey areas, and since the sup-porting rules are yet to be notified, a complete picture of how the new act will impact companies operating in India

is yet to emerge.Another area in which change is afoot

is in the legal infrastructure surrounding hydrocarbon exploration and produc-tion in India. In What’s the deal? (page 24) we provide an in-depth look at new revenue sharing contracts that are set to replace the production sharing contracts that have been used so far.

The new contracts aim to address the chronically low success rates that plague exploration projects in India, and our coverage examines how the changes will affect companies operating in the sec-tor. As it stands, India is dependent on imported hydrocarbons and only time will tell if the restructuring of these contracts will assist the country in its drive towards self-sufficiency on this front.

This month’s Intelligence report (page 29) provides a detailed analysis of the current trends in outbound invest-

ment from India. Just a few years ago, cash-rich Indian companies embarked on a bold global shopping spree, snapping up distressed companies that had fallen victim to the global financial crisis. But now the nature of out-bound investment is markedly different.

Indebted, and weakened by the rupee’s tumble, India Inc has been forced to adopt a more cautious approach. The deals are still flowing, but they are smaller in size and no longer motivated primarily by rock-bottom valuations.

“Given the current state of the market, Indian compa-nies are making small but strategic investments by either purchasing assets or companies from liquidators or com-panies that have the relevant technology or intellectual property,” explains Nipun Gupta, a partner at Bird & Bird.

Russell Holden at Taylor Wessing in the UK, mean-while, reports that the “more challenging outlook” for the Indian economy has led many companies “to focus on their existing Indian businesses and to ‘get their house in order’ at home before looking to expand abroad”.

Be that as it may, there is no stopping the flow of out-bound investment. This is good news for lawyers, both inside India and elsewhere. g

India Business Law JournalYour partner in legal intelligence

www.indilaw.com


Drilling into oil and gas contractsEvaluating India’s new Companies Act

The changing face of outbound investmentPlus: expert advice from correspondent law firms


Horror storiesTaxation nightmares spook investors

Reducing the trust deficit

Inbox Letters to the editor


Dispute resolution

Disclosing self interest

Dear Editor,

I refer to the article titled The sky-scraper debacle: Rul ing on Palais Royale, published in the June issue of India Business Law Journal. The article attempts to examine the facts of the case in Janhit Manch and another v State of Maharashtra and others and also comments on the Bombay High Court’s judgment in this case. We are rather surprised at the contents of the article, which not only attempt to disparage the judgment delivered by the court, but also seek to malign our reputation by suggesting that work has been conducted in the absence of requisite approvals. This is in spite of a standing judgment from Bombay High Court.

Furthermore, the authors of this arti-cle, Mr Vivek Vashi and Ms Prakritee Yonzon have failed to disclose their own in terest in the abovemen-tioned case – the fact that their firm, Bharucha & Partners, are advocates for the petitioners, Janhit Manch.

We believe that India Business Law Journal is a publication of the highest journalistic and ethical standards and would certainly not condone such conduct.

In keeping with ethical and profes-sional norms, we believe all authors of articles should disclose their inter-est in the subject matter of any article that they may write.

We appreciate your cognizance of the ethical and professional issues this matter brings to light.

Vikas S KasliwalVice-Chairman

Shree Ram Urban InfrastructureMumbai

Opinions? Observations?

Feedback?We want to hear from you.

India Business Law Journal welcomes your letters.

Please write to the editor at [email protected].

Letters may be edited for style, readability and length, but not for substance.

Due to the quantity of letters we receive, it is not always possible

to publish all of them.

Correction

In the July/August issue of India Business Law Journal, it was stated that HSA Advocates was launched in 1993. The firm was actually established in 2003. We apologize for the error.

Editor’s note: The authors of The skyscraper debacle: Ruling on Palais Royale were invited to respond to the letter from Shree Ram Urban Infrastructure. The response appears below.

A simple analysis

Dear Editor,

Neither of the authors were in any manner privy to and/or a part of the Janhit Manch matter.

The article was merely an anal-ysis of the decision and nothing further.

Vivek Vashi

PartnerBharucha & Partners

Mumbai


News

September 2013

O ver 350 people gathered at the Hyatt Hotel in New Delhi on 18 September to celebrate Lalit

Bhasin’s contribution to India’s legal profession. Bhasin, who is the man-aging partner of Bhasin & Co and the president of the Society of Indian Law Firms, completed 50 years of service as a lawyer this year.

The event was attended by business leaders, former and present judges, senior advocates, bureaucrats and other dignitaries. A plaque of honour was presented to Bhasin by senior counsel Fali Nariman, Luthra & Luthra managing partner Rajiv Luthra, RNC Legal managing partner Ravi Nath, Karanjawala & Co managing part-ner Raian Karanjawala, National Law School of India University founder and professor NR Madhava Menon, senior counsel RPK Shankardass, and oth-ers. Bhasin was acknowledged for his “impeccable professional service and exceptional contribution to the legal fraternity”.

The event also included a perform-ance by stand-up comedian Papa CJ.

Asked about his feelings on complet-ing 50 years as a lawyer, Bhasin said: “One gets into the second season or playing a second innings with the same zeal, strength and vigour. My role as a lawyer has not been just lawyering. I try to do something for the society in terms of improving the image of the Indian legal profession worldwide and doing work in the field of human rights and legal education.”

Bhasin said his proudest moment over the past five decades was when the government “recognized me and honoured me as the most honest tax-payer in the country” among lawyers.

Assessing the vast strides made by the legal profession over the years, Bhasin said that a greater use of tech-nology and a stronger emphasis on research were commendable. He added, however, that these improve-ments were confined to India’s bigger cities and that more needed to be done to increase access to technology in other parts of the country. “90% of India’s legal population of one million is

still handcuffed with an old and obso-lete system of administration of jus-tice with no use of, or for, technology,” he told India Business Law Journal.

The general infrastructure of courts is another cause for concern. “We have at the lower judiciary and at the level of tri-bunals wholly ill-equipped courtrooms, inadequate support staff, and above all, vacant positions in the judiciary and in the tribunals,” lamented Bhasin.

He also called for better legal edu-cation which could be compared with international standards. “There are very few good law schools in the country,” he said.

eDucation

Green light for foreign universities

India’s Ministry of Human Resource Development has submitted propos-als to the Department of Industrial Policy and Promotion (DIPP) and the Department of Economic Affairs (DEA) to permit foreign universities to open their campuses in the country without the need for a local partner.

The ministry has put forward the pro-posal that foreign universities should be permitted to enter India as compa-nies under the new Companies Act.

The government is empowered to introduce rules under the Universities Grants Commissions (UGC) Act in order to finalize the UGC (Established and Operation of Campuses of Foreign Educational Institutions) Rules, which will enable foreign universities to set up campuses in India and award foreign degrees. Parliament’s slow progress relating to the passing of the Foreign Educational Institutions (Regulation and Entry and Operations) Bill 2010 and other pending bills has been a catalyst for this move.

Both the DIPP and DEA have sup-ported the ministry’s proposal.

In order to set up campuses in India, foreign educational institutions (FEIs) are required to be not-for-profit legal

entities that have been in operation for at least 20 years. In addition, they must be accredited by an accrediting agency in their country of origin, or by an inter-nationally accepted system of accredi-tation. They must also be ranked among the top 400 universities in the world according to rankings published by the Times Higher Education, Quacquarelli Symonds or the Academic Ranking of World Universities by Shanghai Jiao Tong University.

FEIs are also expected to maintain a minimum corpus of `250 million (US$4 million).

Under the proposed rules, FEIs can set up campuses in India once they have been notified as Foreign Education Provider (FEPs) by the UGC. FEPs must

Bhasin celebrates 50 years of lawyering

Left to right: Rajiv Luthra, Anil Divan, Ravi Nath, Nina Bhasin, Lalit Bhasin and Fali Nariman

News


also be registered under section 25 of the Companies Act, 1956, (section 8 of the Companies Act, 2013).

Although the steps toward welcom-ing greater foreign participation are seen as positive, Seema Jhingan, a partner at LexCounsel, believes they “might not stir much interest in the elite foreign educational institutions”.

“Stringent entry barriers, building of the investment corpus, the non-for profit structure and inability to repatri-ate funds abroad make the proposed rules somewhat unattractive for the FEIs,” Jhingan told India Business Law Journal. She said her discus-sions with the representatives of some FEIs revealed that they “were not very excited with the proposals of the gov-ernment of India”.

Other difficulties FEIs may face include bureaucratic delays, acquiring land in the appropriate places and a lack of clarity in higher education regu-lations, adds Jhingan. “Establishing greenfield campuses will be an uphill task for FEIs, as it will require locating areas and land and huge investments in terms of creating infrastructure,” she says. High land prices in prime locations near major cities may force these institutions to “target tier-two cit-ies in India, or within 100km of tier-one cities”.

Legislative and political uncertainty may see interested institutions using the next 12 months to scope out busi-ness partners, survey opportunities on the ground and explore funding options before committing to enter the

country. “In the interim, a lot of these people may look at setting up liaison or representative offices, have people come down to start prospecting and evaluating whether they need a part-ner,” Akil Hirani, the managing partner of Majmudar & Partners, told India Business Law Journal. “They may also want to identify players and establish relationships with Indian entrepreneurs, promoters or companies and even in many cases private equity funds, because there are a lot of education-focused private equity funds. Private equity has been very keen on educa-tion from kindergarten to high school.”

Hirani points out that the nature of the institution may also mean more approv-als are required. Technical universities,

for example, have a separate set of All India Council for Technical Education regulations that must be complied with.

Efforts to allow foreign universities into India are part of the government’s wider push towards reforms as the country’s elections loom. The Indian parliament recently passed the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Bill, 2013; the Pension Fund Regulatory and Development Authority Bill (which allows foreign investors to hold up to 26% in pen-sion fund companies); and the Food Security Bill, which seeks to provide subsidized food to roughly two-thirds of India’s population.

NLU Jodhpur wins South Asia moot

A team of students from National Law University (NLU) Jodhpur has won the first South Asia regional round of the Foreign Direct Investment (FDI) International Arbitration Moot Court Competition. The FDI moot is a compe-tition on investment arbitration organ-ized by the Centre for Legal Studies (CILS) in Austria with support from US law firm Skadden, Suffolk University Law School (Boston), Pepperdine University Law School, the German Institution of Arbitration and the Centre of European Law at King’s College London.

The first FDI moot was held in 2006. The global rounds are held every year

on rotation between Boston, Frankfurt, Los Angeles and London. Suffolk University in Boston hosted last year’s competition, where a team from the University of Ottawa’s faculty of law claimed first prize. This year the global rounds will take place in Frankfurt.

Indian universities have partici-pated in the global rounds in previ-ous years, but this is the first time a South Asia regional round has been conducted. Kachwaha & Partners organized the event in Delhi, which took place from August 30 to 1 September. 10 teams participated in the competition: NLU Jodhpur; NLU Delhi; Gujarat National Law University (GNLU); National Academy of Legal Studies and Research (NALSAR) Hyderabad; National Law Institute University, Bhopal; Guru Gobind Singh Indraprastha University,

Delhi; Ram Manohar Lohiya National Law University, Lucknow; National University of Juridical Sciences, Kolkata; University of Petroleum and Energy Studies, Dehradun; and Masaryk University, Czech Republic.

The Czech Republic team had already qualified for the global rounds and par-ticipated in the South Asia round as a preparation exercise for the finals. However, they were not evaluated for the semis or finals since they had already made it to the global rounds.

The competing teams had to address a problem involving a foreign investor suing the host state for loss suffered while pursuing its business activities in that state.

The team from NLU Jodhpur tri-umphed in the final round of the com-petition, defeating NLU Delhi. The round was judged by senior advocates Fali


News

September 2013

Nariman and Neeraj Kishan Kaul, and Justice Ravindra Bhatt of Delhi High Court. Aditya Singha of NLU Delhi took away the prize for best speaker. Nish Shetty, a partner at Clifford Chance in Singapore; Elodie Dulac, a part-ner at King & Spalding in Singapore; and Rajshekhar Rao, a counsel at the Supreme Court of India, judged the battle for third and fourth place. GNLU came third, while NALSAR Hyderabad came fourth, winning the best memo-rial prize.

The top four teams will fly to Frankfurt to compete in the global rounds, with NLU Jodhpur and NLU Delhi win-ning sponsorships from CILS as the regional round winners. The contend-ers will have to address a problem that includes issues relating to investment planning; tension between a state’s power to introduce new measures to protect public health and its bilat-eral investment treaty obligations; and damages recoverable by the investor. The global finals will take place on 24-26 October.

law firms

Anand marks 90th anniversary

Anand and Anand, one of India’s lead-ing intellectual property law firms, cel-ebrated its 90th anniversary in August.

Although the modern-day firm was formally established in 1979, it traces its lineage back to a practice started in Delhi by RP Anand, the grandfather of the current managing partner Pravin Anand, in 1923.

A moot court competition, hosted by Anand and Anand on 31 August and 1 September, was one of the events held to mark the occasion. Arun Jaitley, a

senior advocate, member of parliament and a former minister of law and justice inaugurated the competition. Teams from 15 law schools participated.

The firm has also instituted a gold medal on intellectual property at the National Law University in New Delhi and set up an in-house legal training programme as part of its anniversary celebrations.

Anand and Anand, which prides itself as acting for innovator companies, has in recent years represented several high-profile clients including Tata Sons, Novartis and Samsung.

Looking back over the 34 years he has spent at the firm, Pravin Anand told India Business Law Journal that the firm’s achievements have included “pioneering the development of the law [in India] with various firsts”, includ-ing Anton Piller orders and Mareva injunctions. Anand also takes pride in “playing a crucial role in developing an interface between lawyers and engi-neers so that technology issues could be comfortably addressed in high tech litigation”.

Outlining his vision for the next decade, Anand told India Business Law Journal that the firm “does not focus on an increase of lawyers or revenue as much as it does on playing our role in the creation of the right intellectual property environment in the country”.

Arun Jaitley and Pravin Anand

News


AZB lawyer splits to start Aarna

Shreyas Jayasimha, a former part-ner at AZB & Partners in Bangalore, has gone solo to launch his own firm, Aarna Law.

Jayasimha spent almost five years with AZB. He began his career at the chambers of S Muralidhar, (now a judge in Delhi High Court) and also worked at Jayaram & Jayaram before setting up his own law firm, Jayasimha Law Chambers, which ran for five years before he joined AZB.

He established Jayasimha Law Chambers in 2003 after receiving a brief, which saw the opposite side engage his senior at the time. “It was a matter of circumstance that launched me to be on my own quite early in life,” he said.

In 2008, Jayasimha studied at Oxford University for a diploma in interna-tional commercial arbitration, which he said “opened his eyes to the pos-sibility of leveraging his skills as a trial lawyer in the Indian courts and in an international setting”. He helped to build AZB’s south India practice as well as their disputes practice across India. At the time, the firm had just inked a best-friends agreement with Clifford Chance, allowing Jayasimha to travel extensively and push AZB’s disputes practice overseas.

Although his experience with AZB was successful and fruitful, Jayasimha felt a desire to pursue his entrepreneurial goals. “I realized that if I were to build on my practice as a counsel, also potentially sit as arbitrator and be involved in mediation then I could encounter a conflict of interest, particularly with a large firm like AZB,” he told India Business Law Journal. “So I wanted to leave when the going was great. It just seemed like a logical next step.”

Aarna Law offers expertise on corporate advisory matters, commercial and corporate litigation, arbitration and mediation, technology law and regu-latory investigative work. The firm currently has four lawyers in addition to Jayasimha. He is keen to ensure that the firm attracts a broad spectrum of India-related work, whether it is within India or outside it, and is especially excited about focusing on dispute resolution and nurturing his own skills as a counsel.

“Aarna” in Hebrew means “mountain of strength and wisdom”. In Sanskrit it refers to the goddess Lakshmi, the presiding deity of prosperity, “and not just monetarily but in a holistic sense”, Jayasimha said. “I decided it would be best not to use my own name this time in order to attract the right talent and keep the focus on merit and professionalism,” he added.

“I have only good things to say about my time at AZB,” said Jayasimha. “I would like to thank in particular, Zia Mody and Ajay Bahl for the exposure and the opportunities they had given me.”

Shreyas Jayasimha

Mukherjee bids farewell to Luthra

Madhurima Mukherjee, the head of Luthra & Luthra’s capital markets practice, left the firm on 22 August. She said her departure would enable her to “move on and explore other opportunities and other platforms”.

A capital markets and corporate finance specialist, Mukherjee is cred-ited with building Luthra’s robust cap-ital markets practice. She spent seven years with the firm, prior to which she worked at Amarchand Mangaldas.

Mukherjee now plans to “give back” through engagements in academia and policy work. She is currently working on the Increasing Diversity by Increasing Access (IDIA) scholar-ship initiative, a project conceptual-ized by Shamnad Basheer, the chair professor of intellectual property at the National University of Juridical Sciences in Kolkata. The IDIA project reaches out to marginal ized and under-represented groups, raising awareness and offering training on law as a career option and help-ing students gain admission to law schools.

“I was very keen to help Shamnad with the IDIA scholarship because that’s something I truly believe will change the landscape of the Indian legal profession going forward,” Mukherjee told India Business Law Journal. “Rather than turning law schools into elitist institutions, we need to take legal education to the

people moves

Madhurima Mukherjee

grassroots so we can grant access to a lot more people and thereby make the profession more inclusive.”

Mukherjee intends to take a six-month break before making a deci-sion about her next work assignment. “I have no concrete plans for now,” she said. “I am essentially a capital markets, corporate finance and secu-rities lawyer and I will always remain as that. I don’t think I see myself

doing something dramatically differ-ent.” She does, however, want to take on more responsibility as a senior lawyer.

Mukherjee is the latest in a line of lawyers that have left Luthra & Luthra for both personal and professional reasons. Other partners that have left in recent months include Ajit Warrier, Nivedita Tiwari, Moushami Joshi, Shweta Hingorani and SR Patnaik.


News

September 2013

ELP opens doors in Bangalore

Economic Laws Practice (ELP) has opened its first office in Bangalore in a bid to cater to clients in south India.

Nishant Shah, a tax partner at the firm, will coordinate all matters in Bangalore where five professionals are currently based. The firm hopes to recruit more talent as it grows its client base.

The Bangalore office is ELP’s sixth in India. Its headquarters are in Mumbai and it has a presence in Ahmedabad, Chennai, New Delhi and Pune.

The firm has no immediate plans to open any more offices in India, but intends to expand through offices out-side the country.

IC Legal poaches partner from JSA

Shiraj Salelkar has left J Sagar Associates to join IC Legal as an equity partner. Salelkar has practiced law for 19 years, of which eight were spent at

Pillai crosses over to Clyde

Prakash Pillai, the former head of South Asia at Rajah & Tann, has joined Clyde & Co Clasis Singapore as a partner.

Clyde & Co Clasis Singapore is a joint law venture between Clyde & Co and Singaporean law firm Clasis LLC that has been operational since 1 August.

Pillai brings extensive experience on international commercial arbitration matters and commercial litigation. His primary focus is India and South Asia, and he is particularly interested in the interplay between India and other inter-national jurisdictions. He has handled matters in a variety of sectors including

Prakash Pillai

professional recognition

Top honours for women lawyers

Delhi-based lawyers Pallavi Shroff and Madhurima Mukherjee have been recognized as among the 33 Most Powerful Women in Indian Business 2013 by Business Today. Shroff is head of the competition law prac-tice at Amarchand Mangaldas and Mukherjee is a former partner at Luthra & Luthra.

Shroff said “I have probably been lucky … not everyone supports a woman who is going up the [career] ladder”.

Mukherjee stated that she enjoyed tackling legal challenges. “If I resolve a complex legal issue, after all these years, I still get a heady feeling,” she said. “Quite like a kid with her first toy.”

Other women featured on the list include Vinita Bali, the managing director of Britannia Industries; Vanita Narayanan, the managing director of IBM India; Shubhalakshmi Panse,

Dhir recruits principal associate

Sumit Phatela has joined Dhir & Dhir as principal associate in the firm’s corporate advisory practice.

Phatela has more than nine years’ experience in general corporate and commercial law, having worked on private equity deals, joint ventures and banking and structured finance mandates. He previously worked with SNG Partners, Vaish Associates and Suri & Co.

Dhir & Dhir is keen to increase the clout of its corporate and commercial advisory team. Its practice covers the full cycle of investments from fund formation to exits. The corporate team consists of more than 20 members with varied specialties. The firm is also looking to recruit professionals with restructuring, insolvency and litigation expertise.

Phatela’s appointment takes the firm to 13 partners and 60 associates.

aviation, automotive, financial services, engineering, projects and construction, IT and telecommunications, and real estate.

Pillai spent seven years at Rajah & Tann. Prior to this, he practised law at Allen & Gledhill for five years and WongPartnership for three years.

Pillai said that given the increasing popularity of Singapore as a seat for international arbitration Clyde & Co is ideally positioned to “address the com-plex arbitration and litigation issues of international clients across the region”. He added that the firm’s international network provides “an excellent plat-form for me to continue my personal focus on India and South Asia”.

Steven Lim, a partner at Clyde & Co Clasis Singapore, said statistics “con-sistently place India as one of the big-gest users of the Singapore International Arbitration Centre. Prakash has devel-oped a leading India and South Asia practice focusing on international arbi-tration … and he brings strong syner-gies to the practice.”

Speaking to India Business Law Journal, Pillai said he expected to see an increase in disputes work “given the falling value of the rupee and general poor economic performance of the market, which are the usual conditions for contractual defaults”.

JSA. Before this he worked at Crawford Bayley & Co, Mahimtura & Co and Gagrats.

As a dispute resolution specialist, Salelkar has extensive experience in dealing with domestic and international arbitration as well as litigation in various courts in India. He has also handled corporate and commercial matters relating to contracts, foreign invest-ment, private equity and real estate.

The new hire takes IC Legal to a total of 18 lawyers.

News


the managing director of Allahabad Bank; Ritu Dalmia, the co-founder of Riga Food; Sumithra Gomatam, the senior vice president of Cognizant; Asha Gupta, the managing director of Tupperware India; Shanti Ekambaram, the president of corporate and invest-ment banking at Kotak Mahindra Bank; Nina Lath Gupta, the managing

director of National Film Development Corporation; Anupama Ahluwalia, the vice president of marketing for India and South West Asia at the Coca-Cola Company; and Kirthiga Reddy, Facebook’s first employee in India and vice chairman of the Internet and Mobile Association of India.

Panse commented: “Being a woman

was not an issue – until I became gen-eral manager. Women are then looked down upon. Not much is expected of them”.

Another woman recognized for her excellence – Anjali Bansal, the man-aging director of Spencerstuart India – pointed out that, “we cannot talk about a gender-related glass ceiling alone. It is also relevant to nationality and ethnicity”.

Others offered a different viewpoint. “[The] glass ceiling does not exist in India Inc,” said Archana Hingorani, the CEO and executive director at IL&FS Investment Managers, who also appeared on the list. “As one gets into senior management posi-tions it’s not about the glass ceiling that one has to worry about but the lack of mentorship. You need people to guide you and take you to the next level.”

Leena Nair, the senior vice presi-dent of leadership and organization development at Unilever, added that there are broader issues beyond men who perceive women as a threat. “It’s like a game of snakes and lad-ders,” she said. “It’s up to the women to navigate and find a way through the barriers in their career and move ahead. The snakes can vary – it could be work-life balance being affected or organizations inherently unfriendly to women.”

Uttar Pradesh to develop IT park

The UP Electronics Corporation (an Uttar Pradesh government undertak-ing) has engaged Dhir & Dhir and Ernst & Young to prepare model documents for the development of a 100-acre IT park. The development, which will cost approximately US$300 million, will be done on a design-build-finance-oper-ate-transfer basis.

The two advisers were selected th rough a compet i t i ve b idd ing process.

This is thought to be the first initiative by a state government in India to create a framework for such a project.

Santosh Panday, an associate part-ner at Dhir & Dhir, led the firm’s team in helping prepare the model documents

for the developer and consultant as well as the guidelines to develop the project. Dhir & Dhir senior associate Meghna Rao assisted on the matter. Adil Zaidi,

an associate director, and Amit Goel, an associate in the transaction advisory services group at Ernst & Young, were the other advisers.

it & infrastructure


The wrap

September 2013

corporate law

India brings into force new Companies Act

India has enacted the Companies Act, 2013, which will replace the exist-ing Companies Act, 1956. The provi-sions of the new act will be brought into effect in phases.

Some of the key features of the new act are:

One person company: The act intro-duces a new category of company called “one person company” (OPC) i.e. a company with a single member.

Compulsory appointment of one res-ident director: The act provides that at least one of the company’s directors must be a person who has stayed in India for at least 182 days in the previ-ous calendar year.

Independent directors: The act con-tains express provisions relating to the powers and duties of independent directors alongside provisions aimed to ensure the independence of such directors.

Outbound mergers: The act allows for the merger of an Indian company with a foreign company of a specified jurisdiction.

Class action proceedings: The act per-mits class action suits, allowing certain members or depositors to initiate action on behalf of the other members or depos-itors against the company, its directors, auditors and/or advisers, experts or con-sultants. Those initiating action may seek a variety of reliefs including damages.

Corporate social responsibility: The act incorporates provisions regarding corporate social responsibility (CSR), owing to which certain companies may be required to set up CSR committees and take efforts to spend specified amounts on CSR activities and policies.

Insider trading: The act prohib-its insider trading of securities by a

director or key managerial personnel. Non-compliance with these provisions could be a criminal offence.

The act grants the central govern-ment wide ranging powers by allowing it to administer the provisions of the act through the enactment of rules framed by it.

In addition to the above, the act has also introduced new definitions for terms such as “control”, “finan-cial year”, “listed company”, “small company”, “private company”, “pro-moter”, “related party”, and “officer in default”; elaborated upon the role of a director; enhanced the roles and

responsibilities of various statutory authorities (such as the Competition Commission of India, Reserve Bank of India, and Securities and Exchange Board of India); introduced new provi-sions with respect to (i) mergers and amalgamations, (ii) revival and rehabili-tation of sick companies, and (iii) wind-ing up of companies; made changes to the existing framework of inter-corpo-rate investment and loans; permitted the issuance of shares with differential voting rights; and limited the issuance of shares at a discount.

For more information and analysis of the new Companies Act, see Playing by new rules, page 21.

Legislative and regulatory update

The wrap


insurance

Insurers allowed greater investment coverage

The Insurance Regulatory and Development Authority (IRDA) released a circular on 23 August concerning investments in alternative invest-ment funds (AIF) registered with the Securities and Exchange Board of India (SEBI) under the SEBI (Alternative Investment Funds) Regulations, 2012.

Subject to exposure limits speci-fied in the following table, the circular allows insurers to invest in Category I AIFs and those Category II AIFs that have an investment strategy which mandates them to invest at least 51% of their investible corpus in entities that are in the nature of venture capi-tal undertakings, small and medium

Type of insurer

Overall exposure limits to venture capital funds (VCFs) and eligible alternative investment funds (AIFs)

Exposure limits

(a) (b) (c)

Life insurance company

3% of the fund value Lower of: (i) 10% (20% in case of Infrastructure Fund) of the corpus of the eligible AIF/VCF, or (ii) 20% of overall exposure as per column (b)

General insurance company

5% of investment assets. “Investment assets” means investments made out of shareholders’ funds representing solvency margins and policyholders funds at their carrying value as shown in its balance sheets drawn up in line with the IRDA (Preparation of Financial Statements and Auditors’ Report of Insurance Companies) Regulations, 2000, but excluding items under “miscellaneous expenditure”

exchange control norms

RBI cuts overseas investment limits to protect rupee

Through a series of circulars released in August, the Reserve Bank of India (RBI) has substantially limited the abil-ity of Indian companies and resident individuals to invest and remit funds overseas.

The circulars issued by the RBI have introduced amendments to the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (ODI Regulations) and the liberalized remittance scheme (LRS).

Restricting overseas investments

Overseas direct investments (ODIs) by Indian parties are regulated by the RBI under the ODI regulations. As per the RBI’s recent circulars, the total financial commitment by Indian parties for the purposes of ODI has been reduced from 400% of net worth to 100%. Thus, any Indian party that intends to set up or invest in an overseas joint venture or wholly owned subsidiary, or enhance its foreign holdings beyond 100% of its net worth, must now seek prior RBI approval. The RBI has, however, clari-fied that this limit will not apply to the financial commitments funded out of the Indian party’s exchange earner’s foreign currency account or out of funds raised through American depositary receipts or global depositary receipts.

This restriction also applies to Indian companies investing in overseas unin-corporated entities in the energy and natural resources sectors. These limita-tions, however, will not apply to ODIs by certain public sector companies.

The changes will apply prospectively to all fresh ODI proposals, and should not impact existing joint ventures or wholly owned subsidiaries outside India.

Restrictions under LRS

LRS was introduced in 2004 as a step towards s impl i fy ing and

diversifying foreign exchange facili-ties for resident Indian individuals.

The recent series of circulars issued by the RBI have brought about the following changes to the LRS regime, all of which will take effect prospectively:

Reduction in l imit: The RBI has reduced the existing limit on remit-tances sent outside India by resident Indian individuals from US$200,000 to US$75,000 per financial year for any permitted current account, capital account or combination transaction, including any gifts or loans.

Prohibition on acquisition of immov-able property: It has been further clar-ified that LRS cannot be used by resident Indian individuals to acquire immovable property, whether directly or indirectly, outside of India.

Setting up of joint ventures/wholly owned subsidiaries: The LRS circu-lar has clarified that resident Indian individuals may set up joint ventures or wholly owned subsidiaries over-seas within the investment limit of US$75,000.

enterprises, or which are engaged in social ventures or infrastructure.

The circular revises the earlier posi-tion whereby insurers could invest only in Category I AIFs that were engaged

in infrastructure investments and medium, small and micro enterprise-related investments.

The circular provides the following exposure limits:

The legislative and regulatory update is com-piled by Nishith Desai Associates, a Mum-bai-based law firm. The authors can be con-tacted at [email protected]. Readers should not act on the basis of this information without seeking professional legal advice.


The wrap

September 2013

Court judgments

taxation

Excise duty decided by whether key use is for cure or care

D i s m i s s i n g a n a p p e a l i n Commiss ioner of Centra l Exc ise, Mumbai IV v M/s Ciens Laboratories, Mumbai, & Anr, the Supreme Court recently held that “a product that is used mainly in curing or treating ailments or diseases and contains curative ingredients even in small quantit ies is to be branded as a medicament”.

As such, the court held that two tribunals – the Customs, Excise and Gold (Control) Appellate Tribunal, and the Customs, Excise and Service Tax Appellate Tribunal – had rightly held that a cream used for the cure of cer-tain skin diseases, produced by Ciens Laboratories, is a medicament and was to be taxed accordingly.

The classification is significant as the Central Excise Tariff Act, 1985, provides that if such a product is a medicament the rate of excise duty on it is 15%, and if not it is 70%.

The Commissioner of Central Excise had argued that the product was to be classified as a cosmetic or toiletry preparation as it is mainly used for the care of the skin, sold over the coun-ter, and can be purchased without the prescription of a medical practitioner.

Rejecting these arguments, a two-judge bench of the Supreme Court held that “when a product contains pharmaceutical ingredients that have therapeutic or prophylactic or cura-tive properties, the proportion of such ingredients is not invariably decisive. What is of importance is the curative attributes of such ingredients that

render the product a medicament and not a cosmetic … If a product’s pri-mary function is ‘care’ and not ‘cure’, it is not a medicament. Cosmetic products are used in enhancing or improving a person’s appearance or beauty, whereas medicinal products are used to treat or cure some medical condition.”

Excise dues payable only on sale of a going concern

Is a person who buys the land, building and plant and machinery of an industrial unit without any encum-brances and in an open auction liable for the excise duty incurred by a previ-ous owner of the unit?

Ruling in M/s Rana Girders Ltd v Union of India & Ors, the Supreme Court held that “only in those cases where the buyer had purchased the

entire unit i.e. the entire business itself” would the new owner be liable for excise duties payable by an erst-while owner of an industrial unit.

Rana Girders had successfully bid for an industrial unit which was in the possession of the Uttar Pradesh Financial Corporation. The land and building were transferred through a sale deed and the plant and machinery through an agreement of sale. Both the deed and the agreement stated that while the asset in question was free from all encumbrances, the statu-tory liabilities arising from it were to be borne by the purchaser.

Subsequently, the Commissioner

The wrap


The update of court judgments is compiled by Bhasin & Co, Advocates, a corporate law firm based in New Delhi. The authors can be contacted at [email protected] or [email protected]. Readers should not act on the basis of this information without seeking professional legal advice.

employment law

Termination of fixed term contract not retrenchment

Ruling in Bhavnagar Municipal Corporation v Salimbhai Umarbhai Mansuri, a two-judge bench of the Supreme Court held that when the termination of the services of a worker is as a result of non-renewal of the contract between the worker and an employer, it would not constitute retrenchment.

In 1988, Salimbhai Umarbhai Mansuri had been appointed on daily wages by the Bhavnagar Municipal Corporation (BMC) for two fixed peri-ods and under two separate contracts. Mansuri’s services were automati-cally terminated on the expiry of the second contract. He had worked a total of 54 days.

Mansuri disputed his termination in 1989, and the case was referred to a labour court. In 2003, the labour court held that the BMC had violated the provisions of sections 25G and 25H of the Industrial Disputes Act, 1948, by not calling Mansuri for work before appointing new workers. The BMC was directed to reinstate Mansuri with continuity in service and consequential benefits. Appeals before a single judge and division bench of Gujarat High Court went against the BMC.

Stating that it was “sorry to note” that the labour court, the single judge and the division bench had not “properly appreciated the factual and legal position in this case”, the Supreme Court held that as Mansuri’s services had been terminated on expiry of the second term, his service stood automati-cally terminated in accord-ance with the terms of his contract of appoint-ment. The court said that the contract, consciously entered into by Mansuri and the employer, indi-cated that the employ-ment was short-lived and liable to termination and thus this was not a case of retrenchment. “Mere fact that the appointment orders used the expres-sion ‘daily wages’ does not make the appoint-ment ‘casual’ because it is the substance that matters, not the form.”

of Customs and Central Excise, Meerut-I, demanded that Rana Girders discharge its liability for excise duty owed as purchaser and successor-in-interest of the borrower. This triggered a writ petition in Allahabad High Court where it was held that in view of the covenants in the sale deed and the agreement, the current owner was liable to pay the excise duty.

Clarifying that Rana Girders had to

discharge only the statutory liability that arose out of the land, building, plant and machinery, the Supreme Court said: “The dues of the Excise Department became payable on the manufacturing of excisable items by the erstwhile owner, therefore, these statutory dues are in respect of those items produced and not the plant and machinery which was used for the purposes of manufacture.”

securities law

SCRA regulates transfer of shares of unlisted company

I n B h a g w a t i D e v e l o p e r s P v t Ltd v Peerless General Finance & Investment Company Ltd and Anr, the Supreme Court held that the provi-sions of the Securities Contracts (Regu la t ion ) Act , 1956, (SCRA) cover unlisted securities of a public limited company.

The dispute in the case centred on the refusal of Peerless to reg-ister shares received by Bhagwati Developers from a person to whom it had lent money, on the grounds that the transfer of the shares was in vio-lation of the SCRA, partly because it was not a spot delivery contract.

Through powers conferred on the government under section 16 of the SCRA only spot delivery contracts are permitted for the sale or purchase of securities.

In appeals to the Company Law Board and Calcutta High Court, Bhagwati Developers argued that as the shares of Peerless, a public limited company, were not listed on any recognized stock exchange, the shares do not come within the defini-tion of securities under section 2(h)(i) of the SCRA.

Holding that the definition of secu-rities under the SCRA does not make any distinction between listed and unl isted secur i t ies, a two-judge bench of the Supreme Court held that a share would be considered a security under the SCRA if the share is capable of being bought and sold. The court said that the size of the market is of no consequence and the number of persons willing to purchase such shares would not be decisive. “One cannot lose sight of the fact that there may not be any purchaser even for the listed shares … what is required is free transferability”.


Cover storyTaxation

September 2013

Horror stories

India’s complex and unpredictable tax regime continues to spook investors. Rebecca Abraham recalls some of the nightmares and

asks how domestic and foreign companies can reduce the uncertainties surrounding taxation

I n November 2006, Mérieux Alliance, a French company that traces its roots to an entity set up in 1897 by a stu-dent of Louis Pasteur, acquired a 61.4% share in Shantha

Biotechnics, a 13-year-old biotechnology company based in Hyderabad. The acquisition was made through ShanH, a company registered and resident in France that Mérieux Alliance had recently set up for the purpose. Subsequently, Groupe Industriel Marcel Dassault, a French conglomerate with interests ranging from aviation and newspapers to wine, took on a 20% interest in ShanH.

In August 2009, Sanofi Pasteur acquired the entire share capital of ShanH, which by that time held a little over 80% of the share capital and voting rights of Shantha Biotechnics. As a result, majority ownership of the Indian company moved from one French company to another.

As far as the French entities were concerned, there was little that could attract the attention of the Indian tax authorities, more so as there is a double tax avoidance agreement (DTAA) between France and India. However, this was not to be.

Cover story

India Business Law Journal16

Taxation

September 2013

Accepting the inevitable

“Tax litigation in some form is inevitable once you have a business of significant size in India,” says Rohan Shah, the managing partner of Economic Laws Practice, who leads the firm’s tax practice. He also warns that when they arise, tax disputes in India can be much harder to resolve than they are elsewhere. “In other countries it is possible to sit with the tax officer and reach a settlement – not so in India,” he says.

Ashok Dhingra, a partner at J Sagar Associates, agrees: “The tax authorities create a large number of demands on account of revenue bias, which [the authorities] lose at higher appellate forums,” he says. “Companies also either don’t get proper advice or take high risk positions, which lead to litigation.” As a result, “tax litigation is inevitable”.

Companies face a complex plethora of taxes levied by both the central and state governments, and with a lack of clarity about liability, confrontations with the tax authorities are routine. And with India’s tax authori-ties attempting to lift the corporate veil on cross-border transactions undertaken by international companies with Indian subsidiaries, there was little chance that Sanofi’s acquisition of ShanH would go unnoticed.

And so, in May 2010, Sanofi received a tax demand notice on account of tax payable on the capital gains made by the sellers of ShanH. Disputing the demand for a little over `10 billion (US$160 million), Sanofi argued that it is not liable for tax in India for several reasons, includ-ing that India’s tax laws have no extraterritorial operation, that the tax authorities cannot require a non-resident to deduct tax in respect of payments made outside India, and that as a result of the DTAA, the transaction would be taxed in France and not in India.

However, the Authority for Advance Rulings (AAR), which rules on questions of law or fact arising from con-cluded or proposed transactions, decided that capital gains tax was payable in India. The AAR held that the sequence of events that led up to the sale of ShanH to Sanofi was a façade and amounted to a tax-avoidance scheme.

With almost no chance of a negotiated settlement, the matter was passed on to the courts.

Andhra Pradesh High Court ruled in favour of Sanofi,

but the matter is now under appeal at the Supreme Court. Andhra Pradesh High Court had held that arguments put forward by the tax authorities were “premised on a fundamentally erroneous factual substratum, fallacious and misconceived” and there is little expectation that the Supreme Court will disagree.

However, it is by no means certain that the Supreme Court’s decision will be the end of the matter. In the now-infamous Vodafone ruling of January 2012, the Supreme Court ruled in Vodafone’s favour and overturned a US$2.5 billion tax bill that the UK-based company received fol-lowing its indirect acquisition of a majority stake in Hutchinson Essar. Yet subsequent amendments to India’s tax legislation, which have a retroactive effect, could still result in Vodafone having to pay a hefty tax bill.

The Vodafone case is far from resolved, and with the high level of uncertainty that surrounds the interpreta-tion and enforcement of India’s tax regulations in the spotlight – not to mention the government’s willingness to pass retrospective amendments – would-be investors have the jitters.

“The [tax] assessee believes that there is no certainty,” laments Ravishankar Raghavan, the principal of the tax group at Mumbai-based Majmudar & Partners. “There is a trust deficit.”

“There is a feeling among the international commu-nity that India is an extremely litigious country as far as taxation is concerned,” adds Samsuddha Majumder, a counsel in the New Delhi office of Trilegal, who is part of the firm’s tax advisory team. “Of late we have noticed that in some cases this could be the basis of decisions on whether to invest in India or not, but that was not so before 2012”.

Transfer pricing in the spotlight

Disputes over tax demands on cross-border invest-ments, such as that involving Sanofi, are just one of several areas where confrontations routinely occur. Other problem areas include questions related to permanent establishment in India, withholding tax and the lack of a permanent account number by international companies receiving payments from India.

But the largest volume of disputes centre on the pricing of transactions that take place between related parties in India and outside – transfer pricing matters. Companies that have been caught up in such disputes in India report-edly include Shell, Microsoft, Gillette India and IBM.

In other countries it is possible to sit with the tax officer and reach a settlement – not so in India Rohan ShahManaging PartnerEconomic Laws Practice

There is a trust deficit Ravishankar RaghavanPrincipal, Tax GroupMajmudar & Partners

Cover story


Taxation

September 2013

“There is on an average one transfer pricing ruling every week by a bench of the Income Tax Appellate Tribunal (ITAT),” says Sanjay Sanghvi, a Mumbai-based partner at Khaitan & Co.

“Transfer pricing disputes can be avoided only if you have proper documentation, proper transfer pricing studies and if you have adequate reason to substantiate your arm’s length price,” says Raghavan at Majmudar & Partners.

As it stands it is the taxpayer who has to prove that international transactions have been recorded at an arm’s length price, which is the price a company would charge an unrelated party, and that the Indian entity has not deliberately recorded lower profits. This can be a challenge as the tax authorities and the taxpayer often disagree on what the appropriate arm’s length price should be.

A ruling earlier this year by a special bench of the ITAT on the taxability of advertising, marketing and sales pro-motion (AMP) expenses incurred by LG Electronics India

(in the assessment year 2007-2008), was of particular concern to international companies with subsidiaries in India. Indeed, fourteen such companies took part in the proceedings at the ITAT as interveners on the matter.

In the case, the ITAT ruled that the transfer pricing officer was justified in requiring that LG Electronics India be compensated by its South Korean parent for AMP expenses incurred that were in excess of similar expendi-ture by a comparable company in India. While AMP expenses at LG Electronics India were at 3.85% of sales, tax authorities concluded that the same expenses at a comparable company in India were only 1.39% of sales.

Ghosts from the past

Aseem Chawla, a partner at New Delhi-based MPC Legal, points out that most of the current litigation, including the LG Electronics case, “is somewhat historic” and has been triggered by “shortcomings of tax plan-ning” in years gone by.

Rohan Shah, managing partner, Economic Laws Practice:

Plan well and while doing so be prepared for a •challenge from an aggressive tax authority.Before undertaking a big strategic tax structure, seek •out the regulator and obtain their input.Be scrupulous about following tax planning as in •reality there are often big gaps between tax planning and the execution of it.

Dinesh Agrawal, executive director, Khaitan & Co:The penalty imposed in disputes over indirect tax can •be reduced and the liability can be frozen if a pre-deposit of the disputed duty with interest is made within a prescribed time period. Under the service tax law, when a penalty is levied, the amount imposed can be reduced to 25% from 100% if payment of the service tax, interest and penalty is made within 30 days from the date of communication of the order by the central excise officer. The penalty under excise and customs also gets reduced to 25% if it is paid (along with such excise duty/customs duty and interest) within 30 days from the date of communication of order of the central excise officer or the customs officer.

Ravishankar Raghavan, principal of the tax group, Majmudar & Partners:

To mitigate the risk of disputes from a transfer pricing •perspective and as requests for higher levels of documentation become routine, proper paper work is vital. In addition, transfer pricing studies are required under section 92D of the Income Tax Act. From a withholding tax perspective, do not leave •

withholding tax issues for a later date. When drafting agreements be very clear what withholding tax will apply.From a permanent establishment perspective, study •and analyze the facts before deciding if there is a possible risk.To reduce the risk of disputes over valuation of shares, •ensure that valuation is done as per the discounted free cash flow method.In case income tax authorities raise any questions, •do not try to question their jurisdiction. Answer them politely and provide them with the information that they want.

Aseem Chawla, partner, MPC Legal: Use focused teams to handle different facets of •taxation. As such, tax audits should be carried out with the help of people who have their ear to the ground and excellent grass-roots knowledge. Similarly, while appeals should be handled by people with experience in this area, tax planning should be handled by those with a more macro view and knowledge.

Samsuddha Majumder, counsel, Trilegal:Be well advised as to recent trends in taxation. •Courts and tribunals are pretty independent and often give the benefit of the doubt to the taxpayer. Track developments and keep your ear to the ground. While tax structuring is welcome and nobody would •do business without it, take a view that will last the test of time. “There are loopholes [in the law] but the danger of using it is that it can be plugged and with retrospective effect.”

Top tax tipsExpert advice on staying on the right

side of India’s tax authorities

Cover story


Taxation

September 2013

Since the Vodafone case the world has changed and Indian and international companies alike have become far more vigilant with their India-related tax affairs. “The lessons of Vodafone have made everybody revisit their [tax] competencies,” says Chawla.

Moving forward, new safe harbour rules for transfer pricing, announced on 19 September, have been broadly welcomed. An initial draft of the new rules sparked fear among companies because the benchmarks were seen as being too high. However, while finalizing the rules, the finance ministry reduced the margins and lifted ceilings to the relief of many observers.

The rules prescribe the limit and conditions within which cross-border transactions between related com-panies are not to be questioned by tax authorities. They will be applicable for five years beginning from the assessment year 2013-14.

Indirect taxation

While corporate horror stories stemming from the inter-pretation and implementation of India’s direct tax regime grab headlines around the world, it is disputes triggered by the complexity of India’s indirect tax regime that clog up the courts at home. A particular problem is the overlap of levies, made worse by the fact that it is very difficult to segregate what constitutes goods and services.

The service tax regime is particularly problematic, despite the introduction of a new system for the taxation of services on 1 July. Under the new system all services except those on a negative list are taxed. The standard rate of service tax is currently 12.36%, up from 5% when it was introduced in 1994 as a modest tax covering just a few specified services.

However, the system continues to be riddled with problems and inconsistencies. Raghavan at Majmudar & Partners points out that while a service tax would nor-mally be paid by the provider of a service, in cases where the service provider is outside India and the recipient of the service is inside India, the tax is still applied, but paid by the recipient.

“All issues of service tax are pretty much open,” says Chawla at MPC Legal, adding that questions over what constitutes an export or import of a service are totally unclear. “The challenge of characterization and correct

appreciation of law is still an issue”.A new goods and service tax (GST), which has been in

the pipeline for some time now, offers the hope of greater clarity. However, its introduction has been plagued by political differences between states and between the central and state governments.

The benefits of the new regime are there for all to see. “The GST will help in at least taking over the whole med-ley of taxes and the overlaps will certainly reduce,” says Chawla.

Commenting on the timeframe of its introduction, Dhingra at J Sagar Associates predicts that “GST is likely to happen in next two to three years”. Meanwhile “changes in other indirect tax laws, in particular service tax laws, are also likely to happen”.

Using tax revenue to fight taxpayers

A common complaint about India’s tax regime is that appeals by the tax authorities seem to happen as a mat-ter of routine.

For this reason, Shah at Economic Laws Practice cau-tions that while good tax planning is vital, tax assessors should always be “prepared for a challenge from an aggressive tax authority”.

The tax authorities “are not accountable to anybody,” laments Dinesh Agrawal, the executive director of the indirect tax practice at Khaitan & Co. “The government is using taxpayers’ money to defeat the taxpayer.”

A casualty of such aggressive action is the AAR, which was introduced in an attempt to ensure certainty and pre-dictability in matters of direct and indirect tax. But with tax authorities persistently seeking to overturn the AAR’s rulings, its authority has waned.

“The certainty or sanctity that was there behind AAR rulings is practically not there any longer,” says Agrawal.

There are indications that the government may be about to act to curb repeated appeals by the tax authori-ties. With dispute resolution seen as a key factor in improving business confidence, Montek Singh Ahluwalia, the deputy chairman of the planning commission, said earlier this year that “the government needs to set up an internal mechanism to ensure that it does not appeal a case all the way up to the Supreme Court.

In some cases [the fear of tax litigation] could be the basis of decisions on whether to invest in India or notSamsuddha MajumderCounsel Trilegal

The lessons of Vodafone have made everybody revisit their [tax] competenciesAseem ChawlaPartnerMPC Legal

Cover story


Taxation

September 2013

“At some point, we have to decide we will not appeal further,” Ahluwalia said. “We are working on this”.

Uncertainty prevails

A further problem is the apparent disjoint between the makers of tax policy and those who administer it.

“There are two mindsets … and the taxpayer is caught in between,” says Chawla at MPC Legal. “If the finance ministry does nothing but undertake practical measures to improve tax administration for the next five to seven years … this will be good tax policy”.

“What we really need is a more taxpayer friendly administration,” says Sanjay Sanghvi, a partner at Khaitan & Co.

Here too there are indications that some change may be in the offing. At the end of August, the government announced the setting up of a seven-member tax admin-istration reform commission headed by Parthasarathi Shome, an adviser to the finance minister.

Shome has already proved himself to have some clout. In September 2012, while head of an expert committee set up to address foreign investor concerns over the introduction of General Anti-Avoidance Rules (GAAR), he recommended delaying the rules by three years. Subsequently the government announced in January that the implementation of GAAR would not happen before April 2016.

But while Shome’s new commission, coupled with

other recent developments, offer a glimmer of hope to beleaguered taxpayers, the reality is that suspicion and uncertainty over India’s tax policy is frustrating and deter-ring investors.

“What happens is that a person who wants to fol-low the law is not sure if he has followed the law,” says Majumder at Trilegal. “That is probably the single most dangerous thing about being in India, and is true not only for tax.” g

The government is using taxpayers’ money to defeat the taxpayerDinesh AgrawalExecutive Director Khaitan & Co

Vantage point Opinion


E very taxation system has its inherent contradictions. While the tax authorities look for ways to increase revenues, taxpayers – both companies and individu-

als – seek out ways to reduce their tax outgoings. As such, while tax authorities have targets for generating revenue, companies and individuals alike set targets for achieving tax efficiencies.

It is against this backdrop that in-house counsel and tax managers undertake tax planning. But even the best-made tax plans can fall apart when tax officials use a fine-tooth comb to find every opportunity to generate additional rev-enue for the exchequer. For evidence of this, look no further than Vodafone!

A key problem faced by tax planners in India is that the country’s tax regulations are plagued by inconsistencies and grey areas related to the classification of goods. In the 1980s, these grey areas included goods classified under tariff item 68 of the then-existing excise tariffs in the Central Excise Act. This tariff item was a general catch-all for goods not “elsewhere specified” in earlier items of the excise tariff.

When the Harmonized Commodity Description and Coding System of Tariff Nomenclature was introduced in India in 1986 through the Central Excise Tariff Act, 1985, we thought that such issues would no longer trouble us. However, out hopes were misplaced and classification issues persist even today. This happens because a product can often be classified under more than one chapter head-ing. And while companies go about using the classification that is most attractive from a tax point of view, the tax authorities would want them to use the classification that generates the most revenue.

A further problem facing in-house counsel in India has to do with the lack of professionalism in the disposition of adjudications. Here too there are grey areas. For example, those involved in the business of growing seeds struggle as there is uncertainty over whether revenue obtained from the growing of seeds is classified as business income or agri-cultural income, as both are taxed differently. Why is this question still unanswered when companies in India have been in the business of growing seeds for more than three decades? A study was done on this very issue almost 15 years ago by the Ministry of Finance and the Income Tax Department, yet the tax authorities have not been able to rationalize the system and so clear up such ambiguities.

Another example is the classification of coal as thermal coke (coal cake) or metallurgical coal. Due to advances in thermal power generation and blast furnace technology both can be used interchangeably in power generation or

steel making. Yet the Central Board of Excise and Customs uses the visual caking properties of coal to classify it. Coal used for power generation is taxed at a lower rate than that used in steel making, even though the actual coal can be identical. Why can’t this be rationalized?

As I see it, rationalization exercises undertaken by the tax authorities are neither thorough, nor are they suffi-ciently futuristic. It is clear to all that technology is changing rapidly, but the tax authorities don’t appear to take these potential changes into consideration while undertaking rationalization exercises. Are they oblivious to the chang-ing times?

A larger problem in India has to do with the tax breaks granted to certain sectors, such as small-scale industry, ostensibly for their protection. These tax exemptions and benefits are often based on little more than political con-siderations. If such benefits were really provided to specific sectors on the basis of their genuine needs, one could expect companies in such sectors to grow into large-scale enterprises and subsequently contribute more revenue to the exchequer at a later date. But in reality this rarely hap-pens, not least because the tax breaks are given without much scientific reason.

Today only 3% of Indian’s population pays income tax. Yet we do not have a mechanism or a methodology to increase the tax coverage. This is a serious problem as the absence of a transparent tax system is turning increasing numbers of people towards non-payment of taxes. The los-ers are people who receive salaries – the salaried classes – who I am sure comprise the majority of the 3% of the population that does pay income tax.

As it stands, India’s tax system has little respect or rec-ognition for high net worth individuals (those who make more than `200,000 (US$4,000) each month) who pay the lion’s share of the income tax collected. The tax authorities deal with such people in the same manner as someone who pays `100 as tax each month. Even the banks, hotels, airlines and small shopkeepers up and down this vast country recognize their regular and larger patrons. Isn’t it time the tax authorities did the same?

There have been some improvements to the tax systems and structures in recent times. However, the fact is that the speed at which the inconsistencies and ambiguities within the system are being removed is not sufficient to keep pace with the needs of a growing India. g

Ambiguities and inconsistencies make effective tax planning impossible, laments Rajinder Sharma the general counsel of DuPont India

Taxation blues

Rajinder Sharma is the director of corporate affairs and general counsel for South Asia at DuPont India.

Spotlight


Company law

September 2013

C ompanies operating in India can expect a greater focus on increased regulations and corporate accountability. Governance is at the heart of the

Companies Act, 2013, which was notified in the Gazette of India on 30 August. The act appears to keep pace with the changes in the Indian economy and effectively frames dynamic, abstract concepts into concise and crisply worded legislation.

The act is an umbrella legislation, as it largely relies on subordinate rules for the implementation of its provisions and for day-to-day governance. The subordinate rules are being framed and are being made available; as yet there is no timeline for this. As a result, a complete picture of the impact of the new act would only be available when the

Ministry of Corporate Affairs publishes the subordinate rules. In the meanwhile, two sets of draft rules that cover 24 chapters have been issued.

A fair hand

In a bid to create a robust corporate law framework while strengthening existing concepts, the act introduces several new concepts. These include a one person com-pany (OPC), provisions for corporate social responsibil-ity (CSR) for certain classes of companies that will be measured and evaluated, and the mandating of at least one woman director for certain classes of companies, as well as one resident director for all companies.

Playing by new rulesWhile in many respects India’s new Companies Act has come up

trumps, doubts remain over its implementation

Aparajit Bhattacharya and Harvinder Singh report

Spotlight


Company law

September 2013

The act also places strong emphasis on accountabil-ity, with mandatory provisions regarding the rotation of auditors, strengthening the independence of independ-ent directors and highlighting the relevance of minority shareholders in related party transactions.

Innovative laws

Several jurisdictions, including the UK, the EU, Singapore and certain countries in the Gulf, have already adopted the concept of a single member company, with the intention of simplifying the procedural aspects of incorporating a company. With the introduction of the concept of an OPC, it will now be possible to incorporate a similar entity in India.

However, there are grey areas with regard to OPCs. While the act is unclear about whether a body corporate can become the sole member of the OPC, a deterring factor in relation to the incorporation of an OPC will be the inci-dence of a 30% corporate tax (plus surcharge) under the present tax regime. As such, unless the Income Tax Act, 1961, is amended, a single person entity that is structured as an OPC would pay higher tax than a sole proprietorship, which under slab rates pays tax at rates ranging from 10% to 30%. In addition, sole proprietorships are not liable for any minimum alternate tax and dividend distribution tax.

Limiting structures

The act also places restric-tions on the making of down-stream investment. As a result, such investments can be made through a maximum of only two layers of investment compa-nies. However, there are mul-tiple areas in relation to the concept of two layers of invest-ment companies that are not addressed in the act.

A restriction on investment layers may potentially have a negative impact on the ability of companies to undertake inno-vative business and corporate structuring. In addition, while the stated intention of limiting multi-tiered structures is to pre-vent the diversion of funds and to bring in more transparency in the utilization of funds, it is unclear how this can be achieved by l imit ing corporate struc-tures. Meeting transparency requirements could have been achieved through enhanced disclosure requirements rather than by restricting corporate structuring opportunities.

As regards M&A activity, it will now be permissible for an Indian company to merge with a foreign company in certain jurisdictions, which are yet to be announced. This will make c ross-border mergers and

acquisitions easier. The new law also simplifies merg-ers between two or more small companies (with a paid up share capital less than 5 million or turnover less than `20 million) or between a holding company and its wholly owned subsidiaries, which will now need no court intervention.

More changes necessary

However, other regulations will have to be amended in order for other laws that affect companies to be consist-ent. These include the Foreign Exchange Management Act, 1999, and the Income Tax Act, 1961, which currently do not recognize cross-border mergers, but will need to be amended to be consistent with the changes brought about in the new Companies Act.

Private equity, angel and strategic investors will be relieved now that the ambiguity on the enforceability of certain protective covenants, such as on the transferabil-ity of shares, tag along, drag along and the right of first offer and refusal rights, has been removed.

Certain conflicting judicial precedents regarding trans-fer of securities have also been laid to rest, as the act provides that any contract or arrangement for transfer between two or more persons shall be enforceable. Further, an investor who is in control of the company i.e.

Solo miSSion: The Companies Act, 2013, offers Indian businesses the chance to set up a one-person company.

Spotlight


Company law

September 2013

has the right to appoint the majority of the directors or has the right to control the management or policy deci-sions, by virtue of shareholding or management rights or shareholders agreements or voting agreements irrespec-tive of its actual shareholding in the company, will qualify as a promoter. This will entail greater accountability.

Showing you care

The provision for mandatory CSR spending introduced in the act is radical and may also be the first of its kind in the world. Companies that have a net worth of at least `5 billion, or turnover of at least `100 billion, or net profit of at least `50 million during any financial year will now be obliged to spend 2% of their average net profits made during the three immediately preceding financial years towards CSR activities. However, the act does not provide penalties for non-compliance and companies are only required to provide a disclosure of the reasons for non-compliance in their annual report.

In addition, the act does not define specific CSR activi-ties. The only obligation it imposes is for companies to earmark the funds, form a committee, formulate a CSR policy, and spend the cash. As such, it appears to be a benign provision, which will allay the initial fears that had been expressed by the corporate world.

Fixing flaws

Various scams and frauds – including that at Satyam in 2009 – that rocked the corporate world showed that the Companies Act, 1956, was inherently flawed in relation to the audit provisions. Not only was an overhaul of the entire auditing standards and systems necessary, but

there was also need for greater accountability on the part of the auditors.

The act provides for appointment of auditors for five years, although there are requirements that the share-holders ratify their appointment at the annual general meeting. In addition, shareholders have the power to rotate an auditor partner and his team at such intervals as desired by the shareholders. This will ensure that every five years there will be a new watchdog to look at a company’s records. This should minimize any chance for collusion between the auditor and the management.

Power to shareholders

The act focuses on the protection of shareholders’ rights and interests. It includes provisions for class-action suits, which were to-date unheard of in India. It gives the shareholders and depositors of a company the right to claim damages or compensation from the company, its directors, auditors and experts or consult-ants. Damages can be claimed from directors, auditors or experts for any fraudulent, unlawful or wrongful act or omission or conduct, including for any improper or misleading statement made in the audit report. Liability under such suits will be unlimited.

These provisions re-emphasize the fact that the core construct of the act is to increase accountability and allocate responsibility. While the benefits of such provi-sions are clear, it will play an important role in introduc-ing sufficient checks and balances to ensure that only genuine actions are entertained by a National Company Law Tribunal (NCLT), which will replace the Company Law Board.

The NCLT is expected to also assume the jurisdiction of the high court in relation to restructuring, mergers, amalgamations and windings up. The idea of the NCLT was first introduced in 2002 as part of an amendment to the Companies Act, 1956, but never made operational. Presumably the NCLT will now become a reality as it has a significant role to play in the new act.

On 12 September, as a first step towards implementa-tion of the new Companies Act, the Ministry of Corporate Affairs notified 98 of the act’s 470 sections. These are sections that can be implemented without the support of any subordinate rules.

Although the new act poses some implementation chal-lenges, it is undoubtedly expected to usher in sweeping changes with regard to the future governance, audit and accountability of corporations in India. The strong emphasis on increased regulation, increased account-ability and clear allocation of responsibility appears to be aligned not only with evolving global trends, but also with the demanding requirements of the current dynamic domestic economic environment.

Companies looking to get to grips with the new Companies Act will do well to heed the words of Pope John Paul II, who said: “the future starts today, not tomorrow”. g

Aparajit Bhattacharya is a partner at HSA Advocates in New Delhi where he heads its corporate M&A practice. Harvinder Singh is a part-ner at the firm. The authors would like to thank Sumedha Dutta, a senior associate, and Rohan Dang, an associate at the firm, for their contribu-tions to this article.

Urgent repairS: Corporate scams such as that at Satyam revealed the inherent flaws of the previous Companies Act.

What’s the deal?


Oil and gas contracts

September 2013

I n 2012, India was the world’s fourth largest consumer of crude oil and petroleum products, with crude oil demand at 3.59 million barrels per day (mb/d) and demand for

natural gas at 254 million standard cubic metres per day (mmscmd). Due to the relatively low level of domestic pro-duction, approximately 80% of crude oil demand is met through imports. There is an acute mismatch between the supply and demand of natural gas, with only 166 mmscmd of demand satisfied in 2012. Of the volume of natural gas supplied, 65% was satisfied by domestic production, and 35% from imports in the form of liquefied natural gas.

Production from maturing gas fields is stagnating. The prognosis for domestic natural gas production is poor until at least the end of the 12th five-year plan (financial year 2016/17). This is due largely to the former darling of the industry (Reliance Industries’ supposedly prolific D6 block in the Krishna-Godavari Basin) grappling with declining production, due ostensibly to geological factors.

Projections indicate a continued rise in the mismatch of demand and domestic natural gas supply, with offi-cial estimates pegging demand at 272 mmscmd for the 2014/15 financial year against domestic supply of 111

Drilling into oil and gas contracts

Rajdeep Choudhury explains the legal ins and outs of hydrocarbon exploration and production in India

What’s the deal?



September 2013

mmscmd. If rising demand for hydrocarbons is to be satisfied through imports, this will increase the financial burden on the exchequer and account for a dispropor-tionately high share of India’s burgeoning current account deficit.

But this is not how it has to be. Countries such as Brazil and Colombia have brought about significant increases in domestic production and reserves through major changes in their fiscal and policy frameworks. Comments by India’s minister of petroleum and natural gas in January 2013 that India aims to reduce crude oil imports by 50% by 2020, by 75% by 2025 and eventually achieve self-sufficiency by 2030 demonstrate political intent to reduce the country’s over-dependence on imported hydrocarbons.

The New Exploration Licensing Policy

The New Exploration Licensing Policy (NELP) was notified by the Indian government in 1999. The purpose of overhauling the previous exploration regime was to allow for direct competition between national oil com-panies (NOCs) such as ONGC and Oil India, and private sector participants in the exploration and production of hydrocarbons. Prior to NELP, the right to explore for and produce hydrocarbons was awarded to NOCs on a nomi-nation basis.

Under NELP, exploration blocks are awarded through international competitive bidding, with 100% foreign and private participation permitted. Nine rounds of bidding have been held since 1999, with 254 of the 360 blocks on offer awarded. Approximately 12% of the total acreage on offer has been awarded to major international oil and gas companies (IOCs). There was no foreign participation, however, among the bidders that were awarded 19 blocks out of the 34 on offer in the latest round.

The relative success of the early rounds of bidding is attributed to IOCs clamouring to enter the Indian market, enthused by visions of hydrocarbon riches. The noticea-ble reduction in participation by IOCs after the sixth round may be indicative of waning interest in India’s exploration and production sector, and a signal that reform of the country’s fiscal and policy regime may be overdue.

Domestic production of crude oil has grown anaemically from 0.7 mb/d in 1990 to 0.89 mb/d in 2011 at a compound annual growth rate of 1%. This is due to declining produc-tion from mature oil wells and insufficient production from new fields to offset the shortfall. The Ministry of Petroleum and Natural Gas is reported to be preparing to invite bids for the 10th NELP round of auctions in 2013/14, comprising deepwater, shallow water and onland blocks.

Production sharing contracts

The principal instrument through which an oil and gas company engages in the exploration and production of hydrocarbons is the production sharing contract (PSC). By adopting the PSC regime instead of a concession-based regime, a government maintains, in principle, greater sovereignty over its natural resources as the con-tractor is effectively appointed a service provider. In the notice inviting offers issued by the Indian government, the principal features of the model PSC (MPSC) are set out.

The MPSC has evolved over the course of NELP bidding rounds as the Indian government has sought to structure the fiscal and policy regime in line with its objectives. The

MPSC offered during the latest round of bidding sought to pique interest by offering the following terms, among others:

Exploration phase of seven years for onland and •shallow water blocks, and eight years for deepwater and frontier area blocks;Production phase of 20 years, with provision for •extension;No signature, discovery and production bonus;•No carried interest from NOCs;•Income tax holiday for seven years from the start of •commercial production;Exemption from customs duty for goods imported for •deployment in petroleum operations;Cost recovery limit of up to 100% with allowance for •carry-forward;Fixed rate of royalty levied on an ad valorem basis, with •the rate dependent on the type of field; andSharing of “profit petroleum” based on a pre-tax •investment multiple (PTIM) as bid by the contractor (profit petroleum being the volume of petroleum left after deduction of “cost petroleum” from gross production for recovery of certain recoverable costs which in India includes royalty).

Comptroller and auditor general

The recent controversy over the PSC regime began in November 2007. It was symptomatic of the atmosphere of mutual mistrust and suspicion between the Indian govern-ment and contractors, with the Ministry of Petroleum and Natural Gas asking the comptroller and auditor general (CAG) to audit PSCs subsisting in certain blocks. The request was made to address concerns over the capital expenditure being incurred by contractors in the develop-ment of hydrocarbon assets awarded under NELP.

The main objectives of the audit were to determine whether: (a) the systems and procedures of the petroleum ministry and the Directorate General of Hydrocarbons to monitor and ensure compliance by the contractors with the terms of their respective PSCs were adequate and effec-tive; and (b) the revenue interests (including royalty and profit petroleum) of the Indian government were properly protected.

To that end, the CAG sought to verify whether:Capital expenditure, operating expenditure and net •cash income were accurately and reliably reflected, and whether the financial data was corroborated by adequate documentation;The details of the individual items of the capital •expenditure and the operating expenditure were reasonable, and commensurate with the original and revised budgets, plans, feasibility reports and other documents; and There was collateral evidence of the authenticity of •goods and services procured in furtherance of the performance of the PSC.

The CAG’s audit, issued on 24 August 2011, was critical of the prevailing PSC and suggested improvements in the management of hydrocarbon exploration and production.

The principal recommendations related to cost recovery and the sharing of profit petroleum provisions of the MPSC. It appears that the CAG used the terms “profit sharing” and “profit petroleum” interchangeably and although their

What’s the deal?



September 2013

meanings differ, it is prudent to assume that the CAG intended to use only the term “profit petro-leum”, as defined above.

The sharing of profit petroleum is based on the respective PTIM slab where the then prevailing PTIM ratio falls. The PTIM ratio is calculated by dividing the contractor’s net income by the investment made by the contrac-tor. The proportion in which profit petroleum will be shared for each of the slabs is subject to bidding. Under the sliding scale system, the Indian government’s propor-tion of profit petroleum tends to rise with the increase in the PTIM ratio.

The CAG believed that since the Indian government’s share of profit petroleum was based on the PTIM ratio, which was a function of net income and investment, there existed a perverse incen-tive on the contractor to incur abnormal capital expenditure and operating expenditure in order to disentitle the government to its fair share of the profit petroleum. In fact, such are the vagaries of the mechanism used to calcu-late the sharing of profit petro-leum, that in certain scenarios, an increase in capital expenditure could result in an increase in the contractor’s share and a reduc-tion in the Indian government’s share of profit petroleum in spite of a reduction in the total profit petroleum.

The CAG conceded that PTIM is not conceptually flawed, but recommended that it be replaced on the basis that a key component of the formula for calculating it – expenditure incurred – is vulnerable to manipulation. The CAG supported substituting a profit petroleum shar-ing formula based on a single percentage that would be open to bidding. This would purportedly reduce the incen-tive for untimely and excessive capital (and operating) expenditure.

The findings and recommendations of the CAG report irked private sector exploration and production companies. Among other disagreements, they rejected the accusation that excessive capital and operating expenditure was being incurred, or that true capital and operating expenditure was being misrepresented for the purpose of enhancing the contractor’s entitlement and reducing the Indian govern-ment’s entitlement to profit petroleum.

A step in the right direction?

The Rangarajan Committee, which was constituted to review the profit sharing mechanism and PSCs, submitted its report in December 2012. The committee was given liberty to carry out a wholesale review of the PSC regime

and recommend new guidelines to determine the price of domestically produced natural gas.

The report echoes the sentiments of the CAG report regarding cost recovery and sharing of profit petroleum. It reiterates the principal objection: the MPSC’s focus on the recovery of capital and operating expenditure incurred through exploration, development and production opera-tions before sharing of production with the Indian govern-ment acts as a constraint on the government’s goal of maximizing economic rent and its share of profit petro-leum. The report goes on to say that the “liberal cost recovery provisions” coupled with “creative” use of costs and investments by contractors result in delays in the Indian government receiving its economic rent and share of profit petroleum.

The report recommends the introduction of a new con-tractual structure based on revenue sharing containing the following new features:

There will be no direct cost recovery provisions;•Fixed royalty on an ad valorem basis as prevalent in the •MPSC will be levied on gross revenue;From the commencement of commercial production, •revenue, after payment of royalty, will be shared based on the average daily production over the course of

Sticky SitUation: Low levels of domestic production mean that approximately 80% of crude oil demand is met through imports.

What’s the deal?



September 2013

a year or a quarter, using a sliding scale, where the contractor will bid the percentage payable to the Indian government on the basis of each price bracket and production bracket set out in a matrix;Income tax holiday for a period of 10 years from the •commencement of commercial production for ultra deepwater blocks (over 1,500 metres); andDomestic market obligation will be withdrawn, allowing •the contractor to sell the petroleum in the international market.

It is expected that bidding for the price and produc-tion brackets will be progressive: the government’s take will rise in step with increases in production and price. In addition, the new regime will allow the government to reap the benefit of surges in the price of hydrocarbons, and upward revisions in recoverable reserves. The net present value of the government’s share in revenue using benchmarked production profiles will be one of the key criteria when evaluating bids.

Despite efforts to paint the above revised contractual

structure as a panacea, shortcomings are evident. The levy of royalty, absence of direct cost recovery and shar-ing of revenue mean that the dynamics of the proposed fiscal and policy regime will be somewhat similar to the concession-based system prevalent in the Gulf of Mexico, Brazil and Colombia even though the regulatory and prospectivity know-how ecosystem in India has not matured to the requisite degree. Royalties impose upfront costs on contractors without taking into account capital and operating expenditures or the prospectivity of the field. They have a significant impact on the project’s net present value, and every effort should be made to remove them.

The fiscal and policy regime to be adopted is a func-tion of the objectives that the Indian government should follow, which in turn depend on the macroeconomic situ-ation, prospectivity and reliance on imports. The regime should act as a catalyst for competition among contrac-tors, which will drive the overall level of exploration activ-ity. Given the stunted growth in domestic hydrocarbon production and over-dependence on imports, the aim of

the Indian government should be to maxi-mize hydrocarbon reserves, production and acreage utilization by deploying indus-try-leading technology and operational expertise rather than seeking to extract the highest economic rent.

A major feature of the proposed model being touted is the incentive on contrac-tors to minimize their expenditure. Under the PSC structure, the contractor bears all financial risks associated with exploration efforts, the overwhelming majority of which are unsuccessful. In the event hydrocar-bon is not discovered, the contractor does not recover its exploration investment, and must bear the loss.

With India’s relatively low exploration success rate and uncertain level of pro-spectivity, contractors look to cost recov-ery provisions in PSCs to recover their significant investment before sharing any petroleum with the host government. In the absence of direct cost recovery in the proposed structure, contractors will have to look to their share of gross revenue to recover the investment.

The quality of data on the prospectiv-ity of Indian sedimentary basins will be a significant factor in attracting interest from contractors, who will proceed with utmost caution before committing billions of US dollars in exploration activities without having first right of recourse to project revenues for recovering the investment. Contractors will be particularly interested in evaluating the reliability of prospectivity data.

Contractors wil l quietly appreciate escaping the intrusive scrutiny of the Indian government that came with cost recovery provisions. The administrative responsi-bilities of the Indian government and the management committee set up under PSCs will be curtailed with the government

room for improvement: Royalties in the revised contractual structure impose upfront costs on contractors without taking into account capital and operating expenditures or the prospectivity of the field.

What’s the deal?



September 2013

A new world order

no longer engaged in conducting audits of petroleum operations, and the committee no longer responsible for approving investments for development and production operations. The management committee can perhaps be involved in matters pertaining to health and safety, optimi-zation of field development plans, reservoir management, and other technical issues.

Contractors will welcome the operational flexibility that the proposed structure will afford them. In recent times, the Indian government, through its nominees who make up 50% of the members of the management commit-tee, has sought to leverage its powers under the MPSC by withholding approval of expenditures incurred. The power to withhold approval has become a negotiating tool when the Indian government has suspected contractors of seeking inflated cost recovery. Without the approval, the contractor is unable to recover the total investment from cost petroleum, thereby significantly impairing its revenue.

Additional measures required

To encourage the development of fields with declining production, service companies should be engaged, and remunerated by fixed fees along with a percentage of any production increase.

Contrary to assertions made in the report, the proposed regime is unlikely to usher in development of smaller and marginal fields. The levy of royalty and absence of direct cost recovery will discourage such development. Royalties make small and marginal fields less attractive, and render their development uneconomical. To counter the unacceptably high risk-reward trade-off, royalties in such fields should be eliminated. Also, the provision allowing the contractor to deduct unsuccessful explora-tion costs incurred in other contract areas from its profit petroleum for the purpose of computing its income tax liability should be retained as this will encourage contrac-tors to pursue exploration of marginal fields.

The technology intensive nature of hydrocarbon explo-ration requires the expertise of global service providers. The uncertainty over whether the presumptive taxation regime or tax on fees for technical services regime should be applied to foreign oilfield service companies needs to be settled by way of legislation in favour of the pre-sumptive taxation regime. The administrative burden and computation mechanism to determine characterization of income eligible for the presumptive taxation regime should be simplified. Furthermore, to contain cost infla-tion in exploration activities, oilfield services provided by Indian companies should be granted exemption from service tax.

The current provision in the MPSC relating to adapta-tion is woefully inadequate since the triggering event is limited to the levying of tax on petroleum which results in a material change to the expected economic benefits accruing to any of the parties. This restrictive trigger should be replaced by the principle of “change of cir-cumstances”, which is unforeseeable and not within the control of the party invoking the provision to obtain relief. In addition, indemnity obligations should be incorporated whereby the Indian government will be required to indem-nify the contractor for any loss or damages ensuing from the change of circumstances.

If the contractor and the Indian government agree that

there has been material change to the expected economic benefits to the parties, but are unable to agree on neces-sary revisions in the PSC to maintain the benefits after consultations carried out in good faith, the PSC should expressly confer on an arbitrator the power to adapt the terms of the PSC.

With regard to dispute resolution in the MPSC, the Indian government may be persuaded to adopt an addi-tional measure to instill greater confidence among IOCs in a stable, neutral and predictable dispute resolution mech-anism. Disputes arising under PSCs should be resolved by arbitration at a neutral seat and venue. Arbitration conducted under the arbitral rules of the Singapore International Arbitration Centre is a viable alternative. This would build on the generally well-received judgment of the Supreme Court of India in Bharat Aluminium Co v Kaiser Aluminium Technical Services Inc (2012), which has laid down the foundation for a less interventionist approach by the Indian courts.

The transition to an open acreage licensing policy should be the long-term goal, although its success will depend on the quality of data available on the prospec-tivity of Indian sedimentary basins. The government’s setting up of the National Data Repository is a step in the right direction, although the volume of data needs to be comprehensive and policies regarding the use of data must be firmed up. In addition, communications with the industry must improve.

Kelkar Committee

Another committee was recently formed by the petro-leum ministry, under the stewardship of Dr Vijay Kelkar, a veteran technocrat. The Kelkar Committee has been given a wide and ambitious remit, including the task of recommending policies to enhance domestic production in hydrocarbons and reviewing institutional mechanisms for acquiring hydrocarbon assets abroad.

The terms of reference were expanded to invite the Kelkar Committee’s recommendations for the transition to market-determined pricing of natural gas by the end of the 2016/17 financial year, and its views on the rec-ommendations set out in the report of the Rangarajan Committee for migrating from the PSC model to a revenue sharing contract model.

Changes ahead?

The baton for reforming the fiscal and policy regime governing the domestic production of hydrocarbons has been passed to the Kelkar Committee. It will be interest-ing to see if this committee can build on the work of the Rangarajan Committee, and recommend meaningful additional reforms for transforming the regime. The oil and gas industry awaits the introduction of the model revenue sharing contract for the next round of bidding. The details of the contract will determine whether the beginning of the end of India’s over-dependence on imported hydrocarbons is nigh, and whether the petroleum minister’s comments earlier this year about increasing self-sufficiency will prove to be prophetic. g

Rajdeep Choudhury is a project development and finance lawyer based in Mumbai. He can be contacted at [email protected].

Intelligence report


Outbound investment

September 2013

A new world order

Indebted and weakened by a falling rupee, Indian companies have taken a more strategic approach to outbound investment

Nandini Lakshman reports from Mumbai

Intelligence report


Outbound investment

September 2013

Afew years ago, corporate India embarked on a global acquisition spree, buying up pretty much whatever was available. The global financial crisis meant that bargains were in abundance and Indian companies snapped them up with

glee. In many cases the acquisitions were driven primarily by rock-bottom valuations and there was scant regard for the strategic fit between target and the acquirer.

Today, as major world economies begin to show signs of recovery, Indian companies are not in such a hurry to buy overseas assets. Although it is still a good time to purchase undervalued companies, India Inc is acting with caution while jostling for position in the global marketplace. Strategy has overtaken affordability as the primary driver of overseas acquisitions.

“The focus on outbound investment clearly remains to drive the growth agenda for Indian companies,” says Raja Lahiri, a partner in transaction advisory services at Grant Thornton. “The associated drivers include new products, services and customers and not just the acquisition of dis-tressed assets.”

Lahiri points to the US$2.6 billion in outbound invest-ments by ONGC in overseas oil-fields, and Apollo Tyres’ recent US$2.5 billion acquisition of Cooper Tyres in the US as examples of this trend.

Today, the rationale for outbound investment is three-fold: entering new markets to drive growth; monetizing assets to retire debt; and exiting businesses which are a financial drain. Natural resources such as oil, gas and coal may be the need of the hour (see Searching for coal in Australia, page 31), but other popular sectors this year have included information technology and services, auto components, engineering goods and healthcare.

Measured optimism

Surprisingly, although deal sizes are getting smaller, corporate cautiousness has not dented outbound invest-ment numbers. Data from the Reserve Bank of India (RBI) show that India Inc spent US$36.52 billion on outbound investments from August 2012 until July 2013, up from

US$27.3 billion the previous year. In the first five months of the current fiscal year, beginning 1 April, Indian companies invested US$16.4 billion in global assets, compared to just US$13.2 billion in the same period last year.

More importantly, India is emerging as a key player in major western markets such as the US and the UK. According to UK Trade and Investment figures, India is now the second largest investor in Britain. A wave of Indian investment flowed into the country following the 2012 Olympic Games in London, and more is on its way. Tata Motors has announced plans to increase its investment in its UK engine plant in Wolverhampton, and Tata Steel, which bought British steel giant Corus in 2007, has said it will spend an additional US$1.2 billion at its Welsh steel plant in Port Talbot over the next five years. Axis Bank, meanwhile, opened its doors in London in July.

Other European dealmakers include cash-rich Infosys, which shed its conservative image by acquiring Zurich-based Lodestone Holdings for around US$350 million in September 2012. The deal gives Infosys a presence in Europe, the Middle East and Africa.

Indian companies are also inking deals in Italy, where they are “trying to use Italian acquired targets as vehicles to expand globally,” says Arianna Carlotti, the head of the

The focus on outbound investment clearly remains to drive the growth agenda for Indian companiesRaja LahiriPartner, Transaction Advisory Services Grant Thornton

The IT sector has experienced considerable interest in the last yearCarlos Roberto Siqueira CastroSenior Partner Siqueira Castro Advogados

Indian companies today are showing a great interest in multiple outbound investment activities Vinay AhujaPartner and Head of India DeskDFDL Legal

Intelligence report


Outbound investment

September 2013

India desk at Pirola Pennuto Zei & Associates in Rome. Carlotti says investors may encounter difficulties with labour and tax laws in Italy, but that they may be resolved by drafting detailed business plans, conducting thorough due diligence and seeking advice from Italian advisers.

Latin America is also seeing some Indian interest, par-ticularly in the IT, telemarketing and energy sectors. Wind power generator Suzlon has invested in wind farms in the region, while according to Carlos Roberto Siqueira Castro, a senior partner at Siqueira Castro Advogados in Brazil, “the IT sector has experienced considerable interest in the last year”.

In other parts of the continent, such as Argentina, Indian activity has been more subdued. “Due to an economic and financial crisis, the government was obliged to impose a series of restrictions on the repatriation of capital and dis-tribution of dividends abroad, import of goods, and foreign exchange,” says Carlos Alfaro, the managing partner at Alfaro Abogados in Buenos Aires. “These policies were pegged with price controls and a substitution of imports policies.”

In Asia, lawyers report steady levels of outbound invest-ment by Indian companies.

“Indian companies today are showing a great interest in multiple outbound investment activities and have become extremely active in global markets with a focus to achieve the next level of growth,” says Vinay Ahuja, a partner who heads the India desk at DFDL Legal in Laos. “They are searching to enter markets where there are achievable growth opportunities.” DFDL’s deals in the last year include assisting Tata International to expand its footprint in Laos and Cambodia; advising the Export Import Bank of India on a US$2 million loan to a Vietnamese coffee manufac-turer; and counselling Nav Bharat Ventures on setting up a 108MW hydro power project in Laos.

Calculated moves

Indian companies borrowed heavily to fund earlier rounds of acquisitions and many are now overleveraged as a result. “The question now is about financing and liquidity,” says Sameer Tapia, a senior partner, at ALMT Legal. Government statistics peg external commercial borrowings (ECBs) at US$85.3 billion and foreign currency convertible bonds around US$7 billion, some of which are due to mature shortly. As a result, many of the current wave of outbound

Indian companies are facing difficulty in accessing capital due to tight liquidity in the Indian financial markets Yash Rana Partner and Asia Chairman of Goodwin Procter in Hong Kong

Philip Catania, a partner at Australian law firm Corrs Chambers Westgarth, notes that there has been a slow-down in Indian investment in overseas coal assets in the last 12 to 18 months. “We believe that this slowdown is partly due to the difficult market circumstances that currently exist,” says Catania. He suspects that Indian companies interested in Australia are waiting and watch-ing how two acquirers – Adani and GVK – which have invested in coal mines, progress in developing their projects.

One reason for the lull in demand following the initial burst of interest from Indian companies in coal resources in Africa and Australia is that imported coal is expensive and the Indian government hadn’t allowed producers to pass on the extra costs to consumers. But with a serious power shortage to contend with – a quarter of India’s population has no access to electricity and there is a power deficit of 8-12% during peak hours – India has to almost double its generation capacity over the next dec-ade. Imported coal may be the only way to achieve this.

As such, in June the government finally bowed to industry pressure and said that producers could pass

on the cost of imported coal to customers. “As previous power price restrictions made imported coal an unfeasi-ble option for many power companies, we believe that this announcement will provide the impetus for renewed demand for Australian coal,” says Catania. “In addition, we believe that Indian companies are beginning to see the lower coal prices as an opportunity to invest in, or acquire, Australian coal projects at a lower cost, and we believe that M&A activity in the mining sector will begin to increase steadily.”

Other sectors of Australia’s economy are also attract-ing Indian investments. Tata Motors, the maker of the world’s cheapest car, the Nano, announced plans in July to enter the Australian market with a range of light com-mercial vehicles.

In July, Indian waste management company Ramky bought Enviropacific for US$40 million, while Punj Lloyd bid for Australian mining and construction company Macmahon. “These deals confirm that there is more to Indian investment in Australia than just coal,” says Richard Gubbins, a partner and head of the India busi-ness group at Ashurst’s London office.

Searching for coal in AustraliaFollowing a lull, outbound investment in mining may be set to rebound

Intelligence report


Outbound investment

September 2013

Mozambique welcomes Indian investors. The country has established a framework for ventures that involve state or private foreign direct investment (FDI) and foreign invest-ment is allowed in all economic sectors, except for those reserved for domestic companies.

The country has a well-developed arbitration system that enables effective dispute resolution through: (i) Arbitration through the International Centre for the Settlement of Investment Disputes (ICSID) under the Washington Convention of 15 March 1965; (ii) ICSID arbitration under the ICSID Additional Facility Rules, where the investor is a national of a state that is not a signatory to the ICSID Convention; and (iii) Rules of the International Chamber of Commerce.

The key laws governing FDI into Mozambique include: The Law on Investment (LI); the Regulation of the Investment Law (RIL), 2009; the Code of Fiscal Benefits for Investments (CFBI), 2009; and the CFBI’s accompanying regulations.

To qualify for an investment authorization, a company must hold at least US$100,000 in (i) freely convertible cur-rency; (ii) equipment and relevant spare parts, materials and other imported goods; and/or (iii) the transfer of land usage rights, patented technologies or registered trade-marks, for which remuneration is limited to the participation in the distribution of profits resulting from the activity in which such rights, technologies or trademarks have been, or will be, used.

The LI, RIL and CFBI guarantee the security and legal protection of goods and rights, including industrial prop-erty rights, in investments that comply with the LI and its regulation. The Mozambican government, in line with conditions set out in relevant legislation, guarantees the remittance of funds in connection with: (i) exportable prof-its resulting from investments eligible for export of profits under the provisions of RIL; (ii) royalties or other payments for remuneration of indirect investment linked to the trans-fer of technology; (iii) amortization of loans and payment of interest on loans contracted in the international financial market and applied in investment projects in the country; (iv) proceeds of any compensation by the government; and (v) invested and re-exportable foreign capital, independent of eligibility, if the investment project is to export profits under RIL.

Tax benefits

Foreign investors in Mozambique can enjoy a number of fiscal benefits and incentives, including exemption from import duties and value added tax (VAT) for imported goods that are classified as “class K” of the Customs Tariff Table, (subject to certain restrictions). They may also enjoy

tax credits for investment equal to 5% of the total investment realized for a period of five tax years from the beginning of their investment. This tax credit will be deductible from the corporate income tax assessed up to the total amount of the tax assessment. The tax credit will be between 10-15%, depending on the province in which investments have been made.

Such tax credits are not available on investments in cor-poreal assets resulting from the construction, acquisition, reparation and extension of buildings; non–commercial vehicles; furniture and articles of comfort or decoration; social equipment; specialized equipment seen as state-of-the-art technology; other equipment not directly related to and associated with the productive activity of the project.

Accelerated appreciation is permitted for new immov-able assets used towards an investment authorized under the IL. Accelerated depreciation at twice the normal rate set by law to calculate the depreciation that is treated as a deduction is also permitted for rehabilitated immovable assets, machinery and equipment used in industrial and agro–industrial activities.

Furthermore, Mozambique offers tax deductions of up to 5% on investment expenditure used for the professional training of Mozambican workers.

The regime established under IL and its associated regu-lations does not apply to petroleum operations. A different fiscal incentives package has been developed for projects in the oil and gas sector.

Opportunities

Infrastructure shortages in Mozambique are creating a bottleneck in the production and export of coal, which has the potential to be a pillar of economic growth. At least US$50 billion in infrastructure investment is needed to sup-port Mozambique’s coal and gas sectors alone.

Agribusiness is another untapped investment opportu-nity: 57% of land in Mozambique is arable, yet the country still relies on imports of fresh produce and no big interna-tional players are active in the sector.

Recent discoveries of 100 trillion cubic feet of gas reserves, combined with a proposed LNG plant with capacity of 10MTpa, have the potential to transform the country’s economy. They also present extremely attractive opportunities for investors from India.

Moving into MozambiqueFaizal Jusob explains how the African country is attempting to entice Indian investors

Practitioner’s perspective

Faizal Jusob ([email protected]) is a partner at CGA in Mozambique..

Faizal Jusob

Intelligence report


Outbound investment

September 2013

investment deals are motivated by the desire to consolidate existing business interests. “The tightening of debt availabil-ity has resulted in caution with large outbound investments,” says Lahiri at Grant Thornton.

The home turf too has become a cause for concern. As Indian prime minister Manmohan Singh tried to assuage investors’ fears about economic growth, which slid to 4.4% in the first quarter of this fiscal year compared to 4.8% in the previous quarter, business sentiment took a beating. In addition, rising inflation, policy inertia, a bulging fiscal deficit and a volatile rupee – which briefly touched a record low of `69 to the dollar – have all conspired to haunt debt ridden companies.

The rupee’s fall has made markets such as the US and the UK more expensive, increasing the cost of acquisitions and decreasing the value of available funds. “The volume of transactions by India into the US has slowed down with the weakening of the rupee. Indian companies are facing difficulty in accessing capital due to tight liquidity in the Indian financial markets,” says Yash Rana, a partner and

Asia chairman of Goodwin Procter in Hong Kong. “The more challenging outlook for the Indian economy

has led many companies to focus on their existing Indian businesses and to ‘get their house in order’ at home before looking to expand abroad,” says Russell Holden, a partner in the India group at Taylor Wessing in the UK. The firm is working on several refinancing arrangements for Indian companies, where it is putting foreign currency loans in place or issuing bonds in overseas markets such as Singapore.

Ambition and restraint

Some highly leveraged Indian companies are actu-ally selling their overseas assets in an attempt to reduce their debt burdens. In May, Apollo Tyres, India’s largest tyre maker, sold its South African business to Japan’s Sumitomo Rubber Industries for US$60 million.

Bangalore-based GMR Infrastructure, meanwhile, has unlocked US$258 million by shedding its 70% stake in a gas-fired power project in Singapore. It has also sold its 50% stake in Intergen, given up its holding in South African coal mines, and backed out of two domestic road projects. There is speculation that GMR will also pull back its 40% stake in Istanbul’s Sabiha Gokcen International Airport in Turkey.

The new era of corporate restraint is reflected in deal sizes. The big mergers and acquisitions of five years ago – when Tata Motors bought Jaguar Land Rover, Tata Steel snapped up Corus and the Birla group acquired Novelis – have made way for more modest deals. “Given the current state of the market, Indian companies are making small but strategic investments by either purchasing assets or companies from liquidators or companies that have the relevant technology or intellectual property,” says Nipun Gupta, a partner at Bird & Bird. Adds Suresh Talwar, a partner at Talwar Thakore & Associates: “Large acquisi-tions cannot take place as many companies have no cash flow and they are unable to even borrow funds.”

Indicative of this new breed of strategic and measured outbound investments is Mahindra & Mahindra’s recent

Indian investors are slowly approaching Spain, focusing on several areas but, above all, automobiles and pharmaceuticalsSergio Sanchez SolePartner Garrigues Abogados

Indian companies are making small but strategic investments … purchasing assets … or companies that have the relevant technology or intellectual propertyNipun GuptaPartner Bird & Bird

[The Indian economy has led] many companies to … ‘get their house in order’ at home before looking to expand abroadRussell HoldenPartner, India Group Taylor Wessing

Intelligence report


Outbound investment

September 2013

foray into Spain. In June, in an attempt to gain access to new markets and supply chains, Mahindra & Mahindra’s auto components and forgings businesses entered into a merger and share swap with Spain’s CIE Automotive SA. The new entity – christened Mahindra CIE Automotive – is 51% owned by CIE, with Mahindra holding a stake of around 20%. “We do achieve consolidation of our own entities which has been on the cards for a while ... we also create a global entity simply by this alliance with CIE,” Anand Mahindra, the chairman of the Mahindra group, told reporters in Mumbai.

The Mahindra deal is not the only Indian activity in Spain. “Indian investors are slowly approaching Spain, focusing on several areas but, above all, automobiles and pharma-ceuticals,” says Sergio Sanchez Sole, a partner at Spanish law firm Garrigues Abogados.

Push and pull

If the “pull” of overseas opportunities is driving some outbound investment deals, the “push” of challenges at home is driving others.

Indeed, with New Delhi dragging its feet on key policy decisions, a jittery India Inc is finding the path to domestic growth unappealing. In March, Kumar Mangalam Birla, the head of the US$40 billion Birla group, said he would rather invest overseas – including in the US, Brazil, Thailand and Indonesia – than in India. Speaking to Bloomberg TV, he cited frequent policy changes at home as the reason for his current global push. “We are in 36 countries around

the world,” said Birla. “We haven’t seen such uncertainty and lack of transparency in policy anywhere.”

In its latest outbound excursion, the Birla group is pre-paring to invest US$500 million in Turkey to set up a vis-cose staple fibre plant with a captive power plant in Adana. However, it may find that it runs into exactly the same problems it is trying to escape back at home. “Turkey is a country where laws and regulations frequently change,” explains Orcun Cetinkaya, a partner at Mehmet Gun

& Partners in Istanbul, adding that “it is not possible to give a list of expected changes in the legislation”.

All eyes on the rupee

While Birla’s in-house law-yers will no doubt be keeping one eye on investment regula-tions in Turkey, it’s likely that the other will remain firmly focused on the value of the rupee.

On 14 August, with the rupee continuing its downward spiral, India’s central bank imposed curbs on foreign currency out-flows. Companies could make outbound investments of no more than 100% of their net worth, said the RBI, lowering the earlier limit of 400%. The ensuing brouhaha suggested that India was going back to capital controls. But just three weeks later, in a dramatic u-turn on 4 September, the RBI announced that companies could again invest up to 400% of their net worth on outbound investments, but only if their investments were funded by ECBs.

Such flip flops continue to drive capital out of India. g

There is more to Indian investment in Australia than just coalRichard GubbinsPartner and Head of India Business GroupAshurst

cUrrency forecaSt: The rupee’s tumultuous journey in recent months has led the Reserve Bank of India to impose curbs on foreign currency outflows.

Correspondents


Antitrust & competition

September 2013

CCI takes careful look atnon-compete agreements

Non-compete agreements (NCAs) have become a standard feature of merger and acquisition deals.

Such agreements seek to protect the acquirer of a business by restraining the seller from participating in a similar busi-ness or using know-how related to the business and thereby competing with the acquirer. Acquirers often pay a significant amount for the goodwill of the business and for such non-compete obligations.

NCAs have been scrutinized in India against the backdrop of section 27 of the Indian Contract Act, 1872, which makes an agreement that restrains any-one from exercising a lawful profession, trade, or business of any kind, void. However, as per various judicial pro-nouncements, reasonable restraint is permitted under certain circumstances. Further, as an exception to section 27, a seller of goodwill can agree not to carry on a similar business within the speci-fied local limits, so long as the buyer, or any person deriving title to the goodwill from the buyer, carries on a like busi-ness there, and provided that such limits appear reasonable to the court.

Courts have held that reasonableness of restraint depends on various factors, and any covenant to prevent divulgence of trade secrets or business connections has to be reasonable to ensure adequate protection to the covenantee. Normally negative covenants operative during the term of a contract have been held to be permissible while those operative after the termination of a contract have been held to be in violation of section 27.

Since the coming into effect of the Competition Act, 2002, NCAs are also subject to the scrutiny of the Competition Commission of India (CCI). Two recent CCI decisions – both relat-ing to acquisitions in the pharmaceuti-cal sector – highlight the competition law concerns that may arise out of NCAs.

Hospira/Orchid

Hospira Healthcare India entered into an agreement to acquire two API busi-nesses from Orchid Chemicals and Pharmaceuticals. The agreement con-tained a non-compete clause which cov-ered not only the business transferred, but also restricted research, develop-ment and testing of penem and penicil-lin APIs for injectable formulations. While examining the proposed acquisition, the CCI observed that non-compete obliga-tions should be reasonable, particularly in respect of: (a) the duration over which such restraint is enforceable, and (b) the business activities, geographical areas and persons subject to such restraint, so as to ensure that such obligations do not result in an appreciable adverse effect on competition.

The CCI approved the acquisition only after the parties agreed to modify the terms of the non-compete covenant to: (a) reduce the non-compete obliga-tion to four years in India, and (b) allow Orchid to conduct R&D activities for new penem and penicillin APIs.

Mylan/Agila

NCAs again came up during Mylan’s acquisition of the entire share capital of Agila Specialties. Agila was involved in the business of injectable products and, through a subsidiary, was engaged in R&D and manufacturing of oncology-related pharmaceutical products and other preparations. The NCA restrained the selling promoters from developing, manufacturing, distributing, market-ing or selling any injectable, parenteral, ophthalmic or oncology pharmaceutical products for human use anywhere in the world for six years.

While examining the proposed acqui-sition, the CCI referred to its earlier deci-sion in Hospira/Orchid and observed

that the non-compete covenant sought to impose a blanket restriction covering products which were not even within the scope of the business activities of the target companies. It said the covenant should cover only those products which were either being manufactured or sold or were under development by Agila and its subsidiary.

The CCI approved the acquisition after the parties proposed modifications, including: (a) reducing the duration of the non-compete obligation to four years; (b) restricting the scope only to products which were being manufactured by the target companies or were in the pipeline; and (c) permitting the promoters to under-take R&D activities for new molecules.

The above decisions demonstrate that any non-compete obligation which causes or is likely to cause an appreci-able adverse effect on competition in India would not be valid. However, NCAs are often essential for the success of a combination. To protect the value of the investment the acquirer may require the seller to refrain from competing with the business. If there is a blanket prohibition on such restrictions, then a large part of the economic raison d’être for entering into a deal may be lost.

The CCI has implicitly recognized that business exigencies require the impo-sition of certain restraints. However, these restrictions should be reasonable and directly related to the combination. Therefore, while drafting NCAs a fine balance must be struck, having regard to the duration and scope of the non-compete obligation.

By Adity Chaudhury,Udwadia Udeshi & Argus Partners

Udwadia Udeshi & Argus Partners is a full-service law firm with offices in Mumbai, Delhi, Bangalore, Kolkata and Chennai. Adity Chaudhury is a man-aging associate at the firm. The views expressed by the author are personal and do not reflect the views of the firm.

Udwadia Udeshi & Argus Partners 1st Floor, Elphinstone House

17 Murzban Road, Mumbai - 400 001Tel: +91 22 2200 1400Fax: + 91 22 2200 1411

Other offices: Delhi, Bangalore, Kolkata and ChennaiEmail: [email protected]

Correspondents


Canada-India trade & investment

September 2013

After the recent completion of the eighth round of negotia-tions toward a Comprehensive

Economic Partnership Agreement (CEPA) between India and Canada, the Canadian government announced in July the immediate opening of the Indian market to Canadian eastern spruce lumber. The value of Canadian wood product exports to India has more than tripled in the past five years, to C$9.6 million (US$9.2 million) in 2012.

According to data from Natural Resources Canada, Canada is the world’s second largest exporter of wood products, with approximately C$10 bil-lion exported annually. India is regarded as an important market for Canada and the addition of eastern Canadian spruce to the trade mix is an important step in overall trade discussions between the two countries.

Tripling two-way trade

Two-way trade between India and Canada has remained relatively sta-ble at approximately C$5 billion for the past several years, but both govern-ments have set a target of C$15 billion by the end of 2015, with much focus on the CEPA as a platform for increasing two-way trade. Exploratory discussions regarding the India-Canada CEPA began in January 2009 and negotiations for-mally commenced in November 2010.

Both countries had set a deadline to finalize the agreement by the end of 2013 but it appears unlikely that target will be met. Nonetheless, the Canadian government has reiterated the impor-tance of its partnership with India and progress has been made on several key fronts on the India-Canada trade and investment agenda. For example, this April marked an important step towards full implementation of the India-Canada Nuclear Cooperation Agreement as

India’s Department of Atomic Energy and the Canadian Nuclear Safety Commission announced that they had finalized arrangements allowing for the export of nuclear equipment and fuel from Canada to India for energy use. This opened a new chapter in the rela-tionship between the two countries in this area, which had previously soured when India used Canadian supplied nuclear technology to test-detonate a nuclear device in 1974.

Focus on energy and resources

Both countries recognized that the nuclear energy agenda needed to be sorted out in order to advance trade between India and Canada, not only for historical reasons, but also to help both countries prosper economically. To meet its burgeoning growth, and result-ing energy needs, India has announced plans to establish 12 new nuclear power reactors by 2021. It has been estimated that such an increase in nuclear energy capacity will require some 1,500 addi-tional tonnes of uranium each year. Canada is the world’s second-largest producer of uranium (after Kazakhstan) and produces over 10,000 tonnes of uranium per year.

The broader energy agenda also offers opportunities for the two countries to prosper by working together. India imports approximately 80% of the oil it consumes, while Canada has the world’s second-largest oil reserves, with output from oil sands alone forecast to grow from 1.8 million barrels a day in 2012 to 5.2 million barrels a day by 2030. This explosion in production is accompanied by technological innovation and a desire to build pipelines from Alberta to the eastern (Atlantic) and western (Pacific) coasts, which should enable increased transport of Canadian oil to Asia.

With continuing political uncertainty

in the Middle East, Canada is quickly emerging as an important oil producer with the highest levels of political and social stability.

The food and agriculture sectors are other important areas where partnership between the two countries is important for their mutual success. India’s middle class is growing, both in number and economic prosperity, and is expected to comprise 600 million people by 2020. This will mean heightened demand for food and agricultural products. Canada is already India’s largest supplier of imported lentils and other pulses but there is room for further growth, includ-ing in the fertilizer area. Canada is one of the world’s leading producers of potash, an essential component of industrial fertilizers, and has the capacity to meet the current global potash demand for centuries.

Another important sector is that of “human capital”. With a relatively small population (about 33 million) compared to its vast geographic size, Canada is in perpetual need of skilled workers, particularly in the high technology and energy sectors where Canada contin-ues to see rapid growth. Canadian uni-versities have recognized this need and have been actively courting talented Indian students, including a delega-tion to India at the end of August, in which nine major Canadian universities participated.

As CEPA negotiations advance toward finalization of the agreement, it is encouraging to note the progress that has been made on many fronts in the India-Canada partnership.

Raj Sahni is a partner and chair of the India Busi-ness Group at Bennett Jones LLP, a law firm with offices in Calgary, Toronto, Edmonton, Ottawa, Dubai, Abu Dhabi and Doha, and representative offices in Washington DC and Beijing.

Expansion of wood exports latest step in bilateral trade

By Raj Sahni,Bennett Jones LLP

Suite 3400, 1 First Canadian Place P.O. Box 130

Toronto, Ontario M5X 1A4Fax: +1 416 863 1716

Tel: Raj Sahni, Chair – India Business Group +1 416 777 4804Website: www.bennettjones.com

Correspondents


Corporate & commercial law

September 2013

C-14, Lower Ground FloorChirag Enclave

Greater Kailash-INew Delhi - 110048

Tel: +91 11 4056 3742Fax: +91 11 4100 5046

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Companies Bill to change corporate restructuring

The Companies Bill finally received presidential assent after being passed by the Rajya Sabha on 8

August. The bill designates the National Company Law Tribunal as the authority to decide on matters relating to compro-mise, arrangement and amalgamation (reconstruction) and no longer neces-sitates approval of the high court.

Key changes

Frivolous litigation: The present Companies Act, 1956, does not pro-vide any threshold for raising objec-tions and in the past shareholders with minuscule holdings and creditors with insignificant outstanding debt have objected to schemes for reconstruc-tion on frivolous grounds. Under the bill objections can be raised only by shareholders holding a minimum 10% stake or creditors holding more than 5% of the total outstanding debt as per the latest financials.

Fast-track merger: Under the act, in an amalgamation of a wholly owned subsidiary into a holding company, dis-pensation is sought from the procedure on the basis of judicial precedents. However, the principle is not unan-imously applied and followed by all courts. The bill provides a short and time-bound procedure for the merger of two small companies or between a holding company and its wholly owned subsidiary. The scheme after being approved by 90% in value of the credi-tors will be filed with the central gov-ernment (CG), registrar of companies (ROC) and official liquidator (OL). It will be approved by the CG where no objec-tions are received from the ROC or the OL.

Cross-border merger: The act only permitted merger of a foreign company with an Indian company. The bill in addition permits merger of an Indian

company with a foreign company sub-ject to prior approval by the Reserve Bank of India (RBI).

Treasury shares: Creation of treas-ury shares will no longer be permissible as the bill prohibits the transferee com-pany to hold shares in its own name or under a trust whether on its behalf or on behalf of any of its subsidiary or associate companies.

Merger of listed with unlisted com-pany: In case of merger of a listed transferor company into an unlisted transferee company, the bill provides an option to the transferee company to continue as an unlisted company with an exit offer being made to share-holders at a price that accords with a pre-determined formula/fair value and which is not less than the price arrived at as per Securities and Exchange Board of India (SEBI) regulations.

Purchase of minority sharehold-ing: The bill also offers a window for purchase of minority shareholdings by shareholders holding at least 90% of shares, who must notify their intention of buying out the minority’s shares at a price determined by a registered valuer.

Claim of set-off: The bill permits a transferee company to claim set-off of any fees paid by the transferor com-pany on its authorized capital.

Auditor’s certificate: Under the bill, filing of an auditor’s certificate to the effect that the proposed reconstruction conforms with accounting standards is a precondition for the issuance of the tribunal’s order.

Notice: Under the act, notice of the meeting and relevant documents must be submitted only to the concerned creditors, shareholders or debenture holders. Under the bill, notice must be sent to the CG, income tax authorities, RBI, SEBI, ROC, stock exchanges, OL, Competit ion Commission of India if necessary, and other sectoral

regulators or authorities that are likely to be affected by the reconstruction, to seek representations, failing which no objection will be deemed. Notice must be sent to debenture-holders of the company as well as to members and creditors and must in addition to the terms of reconstruction include a copy of the valuation report and their effect on creditors, key managerial personnel, promoters and non-promoter members and the debenture-holders.

Dispensing with the meeting: Under the bill, the tribunal may dispense with calling of the creditors’ meeting where at least 90% in value of the creditors provide consent by way of an affidavit.

Buy-back offer: The act is silent on whether more than one buy-back offer can be made in one year. The bill speci-fies that in addition to complying with other provisions, no buy-back offer will be made for a period of one year from the date of the preceding buy-back offer.

Other key changes include permitting voting by postal ballot in addition to vot-ing in person or proxy, mandatory disclo-sure of reduction of share capital and any scheme of corporate debt restructuring, stipulating an appointed date from which a scheme will be effective, etc.

Conclusion

The above changes signify the intent of the legislature to adapt to the chang-ing commercial and economic climate of corporate restructuring, providing for a more transparent and robust mecha-nism. Amendments will need to be gradually carried out in related statutes such that harmony in interpretation and practice is ensured.

By Ranjana Roy Gawai and Safeena Mendiratta,RRG & Associates

Ranjana Roy Gawai is the managing partner and Safeena Mendiratta is a senior associate at RRG & Associates.

Correspondents


Dispute resolution

September 2013

Bharucha & Partners Advocates & SolicitorsCecil Court, 4th Floor, MK Bhushan Road

Mumbai-400 039India

Tel: +91-22 2289 9300Fax: +91-22 2282 3900

E-mail: [email protected]

Update on ex parte ordersand exclusive jurisdiction

By Vivek Vashiand Shamika Haldipurkar,Bharucha & Partners

In two recent cases, the Supreme Court of India has rendered impor-tant decisions in the areas of exclu-

sive jurisdiction clauses and ex parte orders.

Exclusive jurisdiction

On 3 July, in M/s Swastik Gases P Ltd v Indian Oil Corp Ltd, the court held that when an agreement provides for the jurisdiction of a certain court, even without using ouster words such as “exclusive”, “only” or “alone”, the designated court will have exclusive jurisdiction over the contract.

In this case, an agreement was exe-cuted in Kolkata, while the cause of action arose in Jaipur. Clause 17 of the agreement provided for arbitration in accordance with the Arbitration and Conciliation Act, 1996, without specify-ing any seat. Clause 18 stated: “The Agreement shall be subject to jurisdic-tion of the Courts at Kolkata.”

The appellant had filed a petition for appointment of a tribunal before Rajasthan High Court, on the basis that the parties were carrying on business in Jaipur, the goods were located in Jaipur, and the agreement was signed in Jaipur. The respondent opposed the petition on the basis of clause 18 of the agreement.

Decision

The Supreme Court held that when a certain jurisdiction is specified in a contract, an intention to exclude all oth-ers from its operation has to be inferred, and that in this case “the maxim expres-sio unius est exclusio alterius [expres-sion of one is the exclusion of another] comes into play as there is nothing to indicate to the contrary”. The parties would not have added the exclusion clause to begin with if they had intended

that all courts where the cause of action had arisen would continue to have juris-diction over the dispute.

In other circumstances, sections 16, 19 and 20 of the Code of Civil Procedure, 1908 (CPC), can help in deciding the jurisdiction in an agree-ment. The court reasoned that the sole purpose of a jurisdiction clause is to specify the territorial jurisdiction of the agreement and avoid the applica-tion of the CPC. The court accordingly dismissed the appeal and upheld the lower court’s order.

In earlier cases (illustratively ABC Laminart v AP Agencies, 1989), parties had to prove to the court the reason and rationale behind choosing to give exclu-sive jurisdiction to a particular court, and courts had refused to grant exclu-sive jurisdiction to the court specified in the jurisdictional clause. Given the past approach of the courts, this deci-sion comes as a forceful thump on the table, and graciously saves parties from proving the exclusivity of any specific jurisdictional clauses in agreements.

Ex parte orders

In the second case, the Supreme Court laid down guidelines for trial courts to follow before passing ex parte orders or decrees.

The appellant, Shantilal Gulachand Mutha, had purchased five Tata diesel vehicles from the respondent, Tata Engineering and Locomotive Company Ltd (Telco), to be paid for in eight instal-ments through the appellant’s banker, the second respondent. Telco filed a suit for the recovery of a part of the agreed purchase price. The appellant entered an appearance but, believing that the entire amount had been paid, did not file a statement of defence. The trial court subsequently decided the matter ex parte in Telco’s favour under

order VIII rule 10 of the CPC, without considering the pleadings in the plaint or any issue involved.

An application by the appellant to set aside the ex parte decree was dis-missed on grounds of maintainability and a subsequent appeal was also dismissed.

The Supreme Court set aside the ex parte decree, permitted the appellant to file a written statement, and remanded the matter for a timely de novo trial, but did not deal with the maintainability of the appellant’s application.

Guidelines

The court relied heavily on its findings in Balraj Taneja v Sunil Madan (1999): (1) the court should not act blindly on averments made in the plaint, merely because the written statement has not been filed; (2) even if no written state-ment has been filed, the burden is on the plaintiff to prove every averment made in the plaint and settle any fac-tual controversy arising; (3) the court should be cautious in passing any judgment under order VIII rule 9 of the CPC; (4) an order under order VIII rule 9 is a judgment and must include the judge’s reasons; (5) the facts giving rise to the plaintiff’s case and the judge’s reasons for passing the order have to be justified even in the absence of a written statement by the defendant; (6) the judge has to apply extra caution in exercising discretion when the defend-ant fails to file a statement or reply; (7) the court must examine the plaintiff’s case on a prima facie basis to see if the relief sought can be granted from the facts on the record.

Vivek Vashi is the mainstay of the litigation team at Bharucha & Partners, where Shamika Haldipurkar is an associate.

Correspondents


Foreign direct investment

September 2013

I ndia’s telecommunication sector has registered phenomenal growth during the past few years. India now has the

world’s second largest telecom network and is one of the most lucrative telecom markets globally. Government policies and the regulatory framework have pro-vided a conducive environment for serv-ice providers. Growth is expected to continue, with penetration in rural areas being a major area of opportunity for the next five years.

The main growth drivers in the sec-tor are: (i) subscriber base, which is expected to rise from 51% currently to 72% by 2016; (ii) mobile value-added service, which is forecast to grow to US$10.8 billion by 2015 especially from semi-urban and rural areas; (iii) mobile number portability; (iv) handsets, with shipment of 208.4 million expected by 2016; (v) new network architectures to deliver high-bandwidth services.

Investment climate

Earlier foreign direct investment (FDI) policy allowed 74% FDI (automatic up to 49% and with government approval for 49%-74%) in specified telecom serv-ices. However, in a bid to attract more investment from telecom giants, India has increased the permitted FDI to 100% (automatic up to 49%, government route above 49%) for all telecom services.

Investments above 49% will still require a go-ahead from the Foreign Investment Promotion Board. The government is also working on a separate preferential market policy, which requires that 65% of the equipment used by a telecom company be manufactured in India.

The change in the FDI policy is a pragmatic one as the increase in FDI is coupled with the removal of some security-related provisions under the previous policy norms. The fresh inflow of money and reduced burden on local

entrepreneurs will help the industry pro-vide better quality services and foster the adoption of the latest technologies. The industry is likely to see further con-solidation with foreign players, who may eye the smaller players in the country.

The decision to allow 100% FDI will also eliminate the need of a foreign player to partner with a local telecom company and is expected to provide much needed increases in cash flows that will enable telecom companies to meet their expansion plans. Further, foreign investors can now think of multi-ple ways to bring fresh capital into their companies, which will expand their abil-ity to raise funds.

Several major players operating in the Indian telecom sector have foreign ownership at or near the previous FDI limit of 74%, for example, Aircel (Maxis, Malaysia), MTS (Sistema, Russia), Uninor (Telenor, Norway) and Vodafone (Vodafone Group, UK). These compa-nies are expected to gain the immediate advantage from this decision as it will give them the option to establish wholly owned subsidiaries in India and embark on an aggressive plan to compete with Indian companies such as Airtel and Reliance.

More measures required

The Indian telecom industry has faced several challenges in the past two years. Although the government has increased the ceiling of FDI in telecom companies to 100% to help the industry raise funds and reduce its financial burden, this measure alone will not suffice.

Additional requirements include clar-ity on merger and acquisition guidelines and a clear roadmap on spectrum re-farming. The National Telecom Policy 2012 aims at promoting efficient use of spectrum but the challenge by govern-ment on the legality of the 3G roaming

agreements between operators contra-dicts this aim.

Retrospective amendments to tax regulations to enable the government to levy tax on past transactions, as in the Vodafone case, have given wrong signals to foreign investors. The policy towards renewal of old licences also needs clarification. For consolidation to happen, as well as to attract new players to the Indian telecom market, a comprehensive framework is required to provide clarity on all regulatory issues.

Conclusions

India is one of the most attractive tel-ecom markets because it is still one of the markets with the lowest penetration. The government is keen on developing rural telecom infrastructure and is also set to roll out next generation or 4G services in the country. Operators are in expansion mode and are investing heavily in telecom infrastructure.

While foreign telecom companies are acquiring considerable stakes in Indian companies, Indian operators abroad are bringing their knowledge and best prac-tices back home, where they can benefit Indian businesses and consumers. For example, Bharti Airtel is gaining opera-tional experience across Africa while Tata and Reliance Communications are doing the same with their international under-sea cable and corporate businesses.

The burgeoning middle class and increasing spending power, together with the government’s thrust on increas-ing rural telecom coverage, a favourable investment climate and positive reforms, will ensure that India’s high potential is indeed realized.

OP Khaitan & Co is a 40-lawyer law firm, based in New Delhi. Gautam Khaitan is the firm’s managing partner and Nidhi Mathur is a junior partner.

Indian telecom industryon a growth trajectory

By Gautam Khaitan and Nidhi Mathur,OP Khaitan & Co

Khaitan HouseB-1, Defence Colony, New Delhi - 110 024, India

Tel: +91 11 4650 1000 Fax: +91 11 2433 7958, 4155 1590

Email: [email protected] [email protected]

Website: www.opkhaitan.com

Correspondents


Healthcare & life sciences

September 2013

Mumbai | Delhi | Bangalore | Pune | AhmedabadHead Office: New Excelsior Building, 7th Floor, Wallace Street,

A.K. Nayak Marg, Fort, Mumbai – 400001 IndiaDr Rachna Bharadwaj, AssociateTel: +91 22 2200 6322 Ext 245

Fax: +91 22 2200 6326 / 66550607Email: [email protected]: www.krishnaandsaurastri.com

Genuine informed consenta challenge in clinical trials

The informed consent docu-ment (ICD) is the most impor-tant document in a clinical trial.

Prospective participants sign the ICD after they have been informed of all the aspects of the trial relevant to their decision, thus allowing them to make an express choice to voluntarily participate in the trial. The principle underlying informed consent is the right to self-determination of every adult of sound mind.

Informed consent is not just a signa-ture on a form but an ongoing process of exchange of information between the investigator and the participant. For a legally effective informed consent by the participant or their legally author-ized representative (LAR), the consent should be freely given and not obtained by coercion, undue influence, fraud, mistake or misrepresentation.

ICD contents

In trials conducted in India, the ICD is set out in the Drugs and Cosmetics Rules, 1945, in Appendix V of Schedule Y, with an ethics committee (EC) or institutional review board (IRB) hav-ing the final authority for ensuring the adequacy of the information in the ICD. In clinical trial studies that are subject to US Food and Drug Administration regulations, the ICDs should meet the requirements of title 21 of the Code of Federal Regulations (CFR) 50.20 and contain the information required by each of the basic elements of 21 CFR 50.20(a) and each of the six elements of 21 CFR 50.20(b) that is appropriate to the study.

The ICD must be signed by the inves-tigator, witness and prospective partici-pant or their LAR after giving the latter a sufficient opportunity to consider whether to participate in the trial. The ICD should be in a language known to

them, avoiding any scientific jargon, and should explicitly mention that the trial involves research, the purpose of the trial, treatment options in trial ran-domization, number of subjects in the study, trial procedures, participants’ responsibilities, known risks, expected benefits, alternative treatment options available and expected duration of the trial.

The trial participant or LAR must also be given information on the proce-dures to be followed, including invasive procedures, and a description of any reasonably foreseeable risks or dis-comforts and any specific appropriate alternative procedures or therapies available to the participant.

Additional requirements

The ICD should describe the extent to which confidentiality of records identifying the participant will be main-tained and who will have access to participants’ medical records. It should not contain any exculpatory language through which the participant or LAR is made to waive or appear to waive any rights, or release or appear to release the investigator, the sponsor, the institution, or its agents from the liability for negligence. Responsibility for ensuring that the informed consent process is adequate lies with the EC or IRB, clinical investigator and research sponsor.

Stating that participation is volun-tary, that the participant can withdraw from the study at any time and that refusal to participate will not involve any penalty or loss of benefit to which the participant is otherwise entitled is also an important aspect of the ICD. When withdrawal from a research study may have deleterious effects on the participant’s health or welfare, the ICD should explain any withdrawal

procedures that are necessary for the participant’s safety and specifically state why they are important to the participant’s welfare.

In exceptional circumstances, how-ever, participation in the study may be terminated by the investigator without regard to the participant’s consent. This may occur in the event that the participant does not follow the inves-tigator’s instructions. If any significant new finding is made during the course of the research which may affect the participant’s willingness to continue participation, the participant or LAR must be notified in a timely manner. The EC or IRB should ensure that a system or a reasonable plan exists to make such notification.

Under recent amendments on injury compensation in the Drugs and Cosmetic Rules, 1945, it is now man-datory to incorporate into the ICD trial injury compensation and name of the beneficiary for compensation in the event of death of the trial participant.

During clinical trials changes may be made in the research protocol depend-ing on the direction of the ongoing trial, which may necessitate informing the trial participant and taking a fresh consent. This may lead to multiplicity of ICDs.

Ensuring that an ICD truly represents the informed consent of illiterate sub-jects is still a challenge. The future is likely to witness video recording of the informed consent process to ensure that the consent is truly informed, affording more transparency to clinical trials. The ICD is a legally binding con-tract and any breach could lead to legal proceedings.

Dr Rachna Bharadwaj is an associate at Krish-na & Saurastri Associates and an advocate registered with the Bar Council of India.

By Dr Rachna Bharadwaj, Krishna & Saurastri Associates

Correspondents


Infrastructure & energy

September 2013

The Gujarat Solar Policy introduced by the government of Gujarat in 2009 and the preferential feed-in

tariff programme for solar power in Gujarat are often credited with kick-starting the solar movement in India. However, of late various regulatory and market developments in Gujarat have shaken investor confidence in the Gujarat solar story.

Some of the features of the regulatory framework governing the solar power sector in Gujarat which investors consider key attributes typically of an investment-grade solar policy have come under challenge and may negatively influence investment decisions.

Waiver of requirements

Until solar power achieves grid parity, an investment grade policy framework for solar energy should ideally provide mandatory renewable energy targets or purchase obligations to create a market. Further, a clear enforcement regime set-ting out penalties or consequences of non-compliance with such targets or obligations is also required.

The Gujarat Electricity Regulatory Commission (GERC), the state electricity regulator for Gujarat, had fixed the mini-mum percentage of renewable energy that must be purchased by distribu-tion licensees in Gujarat in a given year, referred to as renewable purchase obliga-tions (RPO). However, GERC, in what can only be termed as a retrograde step, has waived the renewable energy purchase requirements for distribution licensees in Gujarat for the financial year 2012-13.

GERC’s unwillingness to enforce the RPO in Gujarat could lead to distribution licensees ignoring their RPO in the future and skewing the market for solar power in the state.

Further, in a classic case of backtrack-ing, Gujarat Urja Vikas Nigam Limited

(GUVNL), which is the off-taker from solar projects in Gujarat, had recently approached GERC for a reduction in the feed-in tariff at which power purchase agreements were executed by GUVNL with solar project developers in Gujarat. GUVNL’s move raised questions about the stability of the regulatory regime governing solar projects in Gujarat and its credibility as a leading state for solar project development. GUVNL’s petition also risked setting a precedent for other states to attempt to reduce their expo-sure to “expensive” renewable energy.

India’s Electricity Act, 2003, authorizes state electricity regulatory commissions (such as GERC) to determine tariffs for generation, supply and transmission of electricity for their respective states. In exercise of such powers, GERC had determined a generic feed-in tariff for solar photovoltaic projects in Gujarat. The solar feed-in tariff determined by GERC was based on certain normative assumptions – capital cost, debt-eq-uity ratio, etc. – which were finalized by GERC after conducting public consulta-tions with stakeholders, which included GUVNL.

GUVNL, in its petition before GERC, had argued that the feed-in tariff for solar projects should be reduced as the actual project parameters – such as capital cost (per MW) incurred by the solar power developers, interest on project debt, and debt-equity ratio for solar projects – were lower than the val-ues assumed by GERC in determining the generic feed-in tariff.

Much to the relief of the solar power sector, GERC dismissed this petition early last month. GERC also observed that a state electricity regulator does not have the powers to reopen solar power purchase agreements or the tariff at which a power purchase agreement has been executed unless such pow-ers are specifically granted to the state

electricity regulator under the power pur-chase agreement or the applicable tariff regulations.

Various news reports seem to suggest that GUVNL is planning to approach the Appellate Tribunal for Electricity to appeal the dismissal of its tariff revision petition by GERC. If the Appellate Tribunal for Electricity rules in favour of GUVNL, all affected solar project developers will have to rethink their financial models and long-term revenue projections.

Conclusions

As with most infrastructure projects, solar power projects require high up-front capital investment and have a long payback period. Therefore, confidence that the policy terms will be stable dur-ing the life of the investment and clarity regarding the circumstances that will lead to policy change are important. Within the overall solar policy frame-work, government support or incen-tive mechanisms (such as preferential feed-in tariffs and mandatory renewable energy targets or purchase obligations) is one of the key factors in attracting investment. Therefore, GERC’s decision to waive the RPO in Gujarat and the uncertainty created by GUVNL about the applicable tariff is a setback to the creation of an investment-grade policy framework.

It is important that Gujarat enforces the regulatory framework, based on binding targets or implementation mechanisms, and builds confidence that the tariff regime will be stable and can provide the basis for long-term capital-intensive investment in the solar sector.

Akshay Jaitly is a partner and Avirup Nag is a counsel at Trilegal. Trilegal is a full-service law firm with offices in Delhi, Mumbai, Bangalore and Hyderabad.

New DelhiA-38, Kailash ColonyNew Delhi – 110 048

IndiaTel: +91 11 4163 9393Fax +91 11 4163 9292

E-mail: [email protected]@trilegal.com

Sunshine state: Can Gujarat still live up to the promise?

By Akshay Jaitly and Avirup Nag,Trilegal

Correspondents


Intellectual property

September 2013

I n today’s business environment, where the fortunes of a business empire can depend on a moment

of uncertainty, insurance is a viable option to minimize potential losses. A company’s tangible assets can be insured through various kinds of insur-ance schemes available in the market. Intangible assets such as intellectual property (IP) can also be safeguarded through insurance, which is a recent development in the business environ-ment around the world.

In the past two decades IP insur-ance has become an important strategy to help minimize the monetary risks involved in protecting IP in a situation such as infringement, particularly for companies with a large pool of IP assets. (For example, Samsung owned around 47,855 patents in 2012, according to Statista, an online statistics provider.)

US origins

IP insurance originated in the late 1990s, when Intellectual Property Insurance Services Corporation started selling IP insurance products in the US. Following this, many big insurance companies started selling IP insurance products in the US market.

Research in 2012 by the US Economics and Statistics Administration and the United States Patent and Trademark Office shows that almost the whole US economy relies on some sort of IP. The value of IP-intensive industry was around US$5.6 trillion, or 34.8% of the US GDP. IP merchandise exports totalled around US$750 billion, or 67.8% of US mer-chandise exports. The IP industry directly employed around 27 million people.

The IP market in the US is so huge that taking a proactive approach to IP insur-ance was inevitable. IP insurance plays a particularly instrumental role in estab-lishing start-up technology companies

as such companies have limited funds available if faced with litigation.

Goals of coverage

IP litigation is a lengthy and expen-sive process. For example the ongoing global patent war between Apple and Samsung has so far cost both compa-nies around US$2 billion. IP insurance provides a mechanism to help manage the cost of maintaining IP.

IP insurance can cover: (1) patent, trademark and copyright infringe-ment litigation; (2) patent infringement defence; and (3) legal expenses during an infringement suit (a “pursuit policy”).

Generally a company or an individ-ual insures their IP to take care of the expenses involved in IP litigation, includ-ing damages. In the absence of such a mechanism a company can easily be wrecked financially because of lack of proper management to defend its IP rights.

IP insurance covers the expenses in cases of infringement and also helps to promote research and development by providing protection for such activities at an affordable price.

The situation in India

There is no concept of IP insurance in India. In an interview some years back, CS Rao, former chairman of the country’s Insurance Regulatory and Development Authority, said that no insurance com-pany had even applied for such a prod-uct in India.

According to data released by sev-eral intellectual property agencies, India ranked seventh in the world with 42,291 patent applications in 2012. Though India still lags far behind coun-tries such as the US, Japan and China, which have more than 500,000 pat-ent applications a year, the number of

patent applications is increasing every year in India.

With the rising number of patent appli-cations and growing IP awareness, litiga-tion can be expected to increase drasti-cally in the future. Globalization and liberalization of the Indian economy has allowed the flow of foreign goods and services into India and vice versa. The only way for Indian products to face global competition and survive in the global market is innovation and constant research.

Companies invest massively in research and development in order to compete in the market. The investment in research is a risky affair as the outcome of the research is uncertain. Having a prior claim plays a crucial role in IP enforce-ment and companies’ attempts to claim priority over an invention or a name often leads to litigation.

In the case of Bajaj Auto v TVS Motors, Bajaj Auto obtained an injunction to prevent the launch of TVS Motors’ two-wheeler model TVS Flame, which Bajaj claimed used its patented DTS-i technol-ogy. The case brought heavy financial losses to TVS Motors.

Corporations and even individuals could avoid such losses by insuring their IP.

IP insurance in India is the need of the hour. IP will play a major role in the development of the Indian economy and sooner rather than later the need to pro-tect the risk involved in IP through insur-ance will definitely be felt in the Indian market. India still has a long way to go in the field of research and development and the introduction of IP insurance will provide breathing space for companies and individuals dependent on IP.

Manoj K Singh is the founding partner of Singh & Associates, a full-service international law firm with headquarters in New Delhi.

By Manoj K Singh,Singh & Associates, Advocates & Solicitors

Insurance can help protect intellectual property assets

N-30, Malviya Nagar, New Delhi -110017 IndiaTel: +91 11 4666 5000, 2668 7993, 2668 0331

Fax: +91 11 2668 2883, 4666 5001Email: [email protected]

Website: www.singhassociates.in

Correspondents


Media & entertainment

September 2013

The Telecom Regulatory Authority of India (TRAI) has indicated that it is considering recommending further

restrictions on cross-media ownership in India across TV and radio broadcasting, news print and online sectors. TRAI is mandated to oversee the telecom and broadcasting industry.

TRAI’s consultation paper on “Issues Relating to Media Ownership”, published in February this year, examined the regu-latory contours of ownership in the media sector in India. TRAI had issued a similar consultation paper in 2008 and to further substantiate the recommendations of the 2008 paper, the Ministry of Information and Broadcasting commissioned a research study by the Administrative Staff College of India in 2009.

Based on the study, TRAI’s 2013 consultation paper sought stakeholder comments on several questions raised on cross-media ownership and method-ologies to apply restrictions.

Risk of confusion

The consultation paper raises several important questions critical to the long-term viability of stakeholders, ensur-ing viewership/viewpoint plurality, and regulating ownership in the Indian media sector. From the paper it appears that TRAI has overlooked the possibility of the proposed restrictions/regulations replicating existing regulations. Such regulatory overlaps would not only cause confusion with respect to applicability but also create jurisdictional conflict and thus may defeat the very purpose of the intended regulations.

Restrictions on foreign direct invest-ment (FDI) in different news and non-news media sectors, on cross-equity holdings in broadcasting and distribu-tion companies, and on direct to home service licences already serve to prevent concentration, thus affording “viewpoint

plurality”. Additionally, the Competition Act, 2002, regulates vertical holdings, cross-holdings and other mechanisms that would lead to dominance of enti-ties, thus ensuring pluralism.

The Competition Commission of India (CCI) is already constituted to oversee many of the issues mentioned in the consultation paper. The CCI is vested with the power to eliminate practices having an “adverse effect” on competi-tion, to promote and sustain competition, and to protect consumer interests. The ambit of the Competition Act includes the media sector and any instances of concentration can be adequately addressed by the Competition Act.

The peculiarity of the Indian media market arises largely from its varied spectrum of languages leading to a frag-mented media sector. Further, the FM radio industry has remained fragmented subsequent to privatization more than a decade ago contrary to a general fore-cast of eventual consolidation. Clearly, further restricting FM radio ownership in addition to existing regulations will only assist in further fragmentation.

In the television industry, 300 of the 817 channels have permission to broadcast under the category of “news and current affairs”. Approximately 13 different entities own these 300 channels. Thus, evidently, the television sector does not “suffer” from concentration among a few players.

The absence of concentration in this sector is also a result of various restric-tions on equity holding between broad-casting and distribution companies, restrictions on FDI, etc., thus making the television industry vibrant and competi-tive and ensuring “viewpoint plurality”.

Shortcomings of study

The study commissioned by the Ministry of Information and Broadcasting does not seem to be authoritative on several

counts. Firstly, the value of the media industry increased from `587.4 billion in 2009 to `820.5 billion in 2012. Therefore, the applicability of the study, which has been on the shelf for four years while the impugned industry grew significantly, is questionable. Secondly, the study chose a market sample comprising speak-ers of five languages – Telugu, Tamil, English, Malayalam and Hindi – surpris-ingly excluding Bengali, Marathi and Kannada, thereby completely excluding Kolkata, Mumbai and Bangalore, three of India’s largest metro cities. Thirdly, the reliance on television audience meas-urement data (also known as television rating points) to assess viewership size is contradictory as TRAI has itself issued a consultation paper to address the reli-ability issues of such data.

The proposed restrictions in addition to existing regulations, in the modern con-text in which they operate, would serve to make the situation more complex and would not only potentially induce friction between regulatory bodies but also result in confusion, thus adversely affecting the promotion of viewpoint plurality. The study leaves much to be desired and should not therefore be the basis for TRAI to “assume” that restrictions and regulations on cross-media ownership and control are required. Also, the con-sultation paper appears to have “cherry picked” regulations from different juris-dictions such as the US and UK to fit into the peculiar Indian context. Owing to India’s language diversity and given that television does not operate on a local city level, applying such regulations and restrictions in order to preserve viewpoint plurality may prove to be redundant.

Ameet Datta ([email protected]) is a partner at Saikrishna & Associates, where Subhajit Banerji ([email protected]) is an associate.

A-2E, CMA Tower, 2nd FloorSector -24, NOIDA - 201301National Capital Region, India

Tel: +91 120 4633900 (100 Lines) Fax: +91 120 4633999

Cross-media ownership: Are more rules needed?

By Ameet Datta andSubhajit Banerji,Saikrishna & Associates

Correspondents


Mergers & acquisitions

September 2013

Amarchand Towers 216 Okhla Industrial Estate - Phase III

New Delhi - 110 020 Tel: +91 11 2692 0500 Fax: +91 11 2692 4900

Managing Partner: Shardul ShroffEmail: [email protected]

By Akila Agrawal and Sourav Kanti De Biswas,Amarchand Mangaldas

Foreign investments in the phar-maceutical sector are being heav-ily scrutinized by the Foreign

Investment Promotion Board (FIPB). Until 2011, foreign investment in this sector was permitted up to 100% under the automatic route. In 2011, the gov-ernment amended its policy such that investments in green-field pharma enter-prises are permitted up to 100% under the automatic route and investments in brown-field pharma enterprises require prior approval.

The amendment was triggered by public policy concerns. The govern-ment thought that the acquisition of several Indian pharma companies by foreign entities could impact production levels and prices of essential drugs.

Viable alternative?

Despite the laudable objectives behind the policy change, it is useful to examine whether the twin objectives of availability and affordability of essential medicines could be met through existing regula-tions, without hindering genuine inflows of foreign direct investment (FDI).

Through the Drugs (Prices Control) Order, 2013, issued by the National Pharmaceutical Pricing Authority, the government will be able to regulate prices of essential medicines and has the right to require drug manufacturers to increase production or undertake sales to specific persons in case of emergen-cies. It may be practical to stringently apply and make effective these regula-tions rather than to require approval for all brown-field foreign investments, par-ticularly because the above objectives are applicable irrespective of whether an entity is foreign owned or Indian owned and therefore introducing this provision in the FDI policy seems irrational.

Concerns about research and devel-opment expenditure commitments and

ensuring continuity of production of essential medicines in cases of brown-field investments can always be sepa-rately addressed by imposing condi-tions under the FDI policy, without the need for the FIPB to individually scruti-nize each transaction.

Broad definition

The term “brown field” is not explicitly defined in the FDI policy. The notification in 2011 referred to brown-field invest-ments as investments in existing com-panies. This appears to be the prevailing interpretation of this phrase.

Today, if a 100% foreign-owned pharma company wants to issue further shares to its parent entity to meet working capital requirements, it will have to receive prior approval of the FIPB. Similarly, if such a pharma company makes a rights offer, it will require FIPB approval. Transfer of shares between two non-residents will require FIPB approval even in the case of an internal group restructuring.

The government should create excep-tions from the approval requirements for such cases as they merely add to the delay in bringing investments into India and make doing business in India cum-bersome rather than effectively address any public policy concerns.

The industry also has concerns over medical devices being classified under the pharma sector and thereby facing the same stiff norms applicable to brown-field investments in pharma companies. In our view, while the manufacture of medical equipment that is classified as “drugs” under the Drugs and Cosmetics Act, 1940, may fall under the pharma sector currently, it is debatable whether a company that manufactures medical devices where a small or negligible per-centage are classified as drugs under the act will fall under the pharma sector or the manufacturing sector.

What’s next?

As per news reports, the govern-ment is deliberating on creating a sub-category for medical equipment under the pharma sector which will not attract the stiff FDI conditions as applicable to brown-field investments in the pharma sector. The new Drugs and Cosmetics Bill, 2013, also proposes to bring about a clear distinction between drugs and medical equipment. Early clarification of this matter would be helpful.

In a 2011 meeting chaired by the prime minister it was decided that the FIPB would scrutinize pharma proposals for a short term and subsequently the Competition Commission of India (CCI) would be empowered to decide all cases of mergers and acquisitions in this sector irrespective of any threshold. This deci-sion has not yet been implemented.

Given that one of the key concerns in this sector relates to indiscriminate acquisition of home-grown Indian com-panies by foreign multinational entities, it is fitting for the CCI to be granted the authority to scrutinize transactions that are above a certain threshold.

In light of the objectives that the gov-ernment has set out to achieve through the foreign investment policy in the pharma sector, the existence of regula-tions that can control availability and price of essential drugs, and the cum-bersomeness of the existing FDI regime in genuine investment cases, the gov-ernment should reconsider whether it is necessary for the FIPB to review each individual foreign investment transac-tion in the pharma sector.

Akila Agrawal is a partner and Sourav Kanti De Biswas is a principal associate at Amarchand & Mangaldas & Suresh A Shroff and Co, New Delhi. The views expressed in this article are those of the authors and do not reflect the position of the firm.

Investment policy rethinkneeded for pharma sector

Correspondents


Private equity & venture capital

September 2013

Tax pass through for AIFs:A vexed issue for investors

Ayear ago the Securities and Exchange Board of India (SEBI) introduced the Alternat ive

Investment Funds Regulations, 2012, which replaced the SEBI (Venture Capital Funds) Regulations, 1996. The aim was to bring in regulations that encompassed all forms of private equity and also introduced a regime for the for-mation of alternative investment funds (AIFs) and domestic hedge funds. This step marked the next phase of evolution of the domestic private equity industry in India.

The AIF regulations do not exist in a vacuum and in order to achieve their objectives, synchronization between the AIF regulations and other relevant legislation/regulations is imperative. Section 10(23FB) of the Income Tax Act, 1961, is a case in point, since it affords a “tax pass through” to all venture capital funds (VCFs) registered under the erstwhile VCF regulations, whereas in the case of AIFs the pass through has only been extended to a sub-category of Category I AIFs and that too with additional conditions and riders.

Category I

Category I AIFs are those which invest in start-up or early-stage ven-tures, social ventures, small and medium enterprises (SMEs), infrastruc-ture, or other sectors or areas consid-ered socially and economically desir-able. The sub-categories of Category I AIFs include VCFs (including the sub-category of angel funds), SME funds, social venture funds and infrastructure funds. The AIF regulations clarify that such funds which are formed as trusts or companies will be construed as a venture capital company or a VCF as specified under section 10(23FB) of the act.

Thus, the intent behind the AIF regu-lations is to encourage and provide incentives for Category I AIFs irrespec-tive of their sub-category, as long as they have a positive spillover effect on the economy.

Issues

Given the current wordings, only Category I AIFs that fall under the sub-category of VCFs are eligible for a tax pass through. Thus, Category I AIFs that invest primarily in unlisted securi-ties of startups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property rights-based activities or a new business model are VCFs and eli-gible for a tax pass through. Category I AIFs which are set up as SME funds, social venture funds or infrastruc-ture funds are ineligible for a tax pass through benefit, even though these funds have “positive spillover effects on the economy”.

Another peculiarity of the tax treatment under the act is the requirement that the VCF adhere to additional conditions/restrictions which have seemingly been borrowed from the AIF regulations. Take for instance the requirement that a VCF cannot invest in associated companies. While the AIF regulations contain a similar restriction, it is not an absolute restriction as it is in the act. Thus, an AIF can invest in associated companies after getting the approval of 75% of its investors.

Another example is the requirement that a VCF invest two-thirds of its investi-ble funds in unlisted equity shares or equity-linked instruments. While the AIF regulations contain a similar restriction, they allow for investment into compa-nies listed or proposed to be listed on a SME exchange or the SME segment of an exchange. A further case in point

pertains to the listing of units of an AIF, which is permitted under AIF regulations but prohibited under the act.

While some may argue that a general pass through for taxation purposes can still be claimed under other provi-sions of the act dealing with trusts, a key point to note is that when a fund relies on general pass through provi-sions, the tax liability rests with the trustee in its capacity as a representa-tive assessee of the beneficiaries (i.e. investors). In such a scenario, a trustee can be held liable for non-payment of tax on income earned by the trust even though the income has been distrib-uted to the investors. This often results in a situation where a trustee takes a conservative approach and deducts tax at the highest applicable rate on income distributed, and the individual investors are then faced with an uphill battle to claim a refund.

Conclusion

Tax pass through for AIFs has become a vexed issue for venture capital inves-tors, given the conflicting approach contained in the act and the AIF regula-tions. Given that amendments to the act were made after the AIF regulations came into force, it is surprising that the amendments are not in sync with the letter or spirit of the AIF regulations.

At a time when India urgently needs liberal doses of investment in key sec-tors, the government would do well to ensure that the tax law complements the AIF regulations and helps achieve the purpose behind them, as opposed to being a hindrance.

By Bijal Ajinkya and Abhay Sharma Khaitan & Co

Khaitan & Co One Indiabulls Centre, 13th Floor, Tower 1841 Senapati Bapat Marg Mumbai 400 013, India Tel: +91 22 6636 5000 Fax: +91 22 6636 5050 Email: [email protected]

Bangalore | Kolkata | Mumbai | New Delhi

Bijal Ajinkya is a partner and Abhay Sharma is a principal associate at Khaitan & Co. The views of the authors are personal, and should not be considered as views of Khaitan & Co.

Correspondents


Regulatory developments

September 2013

New DelhiSecond Floor, 254, Okhla Industrial Estate, Phase III, New Delhi-110020IndiaTel +91 11 4983 0000Fax: +91 11 4983 0099Email: [email protected]

EU market regulation: A rude wake-up call?

By Sawant Singh,Aditya Bhargava and Raghuveer Sarathy,Phoenix Legal

New rules in the European Union are forcing European banks in India to reconsider their clearing opera-

tions based out of India. In response to the financial crisis, the EU adopted the European Market Infrastructure Regulation (EMIR) in August 2012 to increase transparency in the “over-the-counter” (OTC) derivatives market and to mitigate systemic risk by reducing operational as well as counterparty credit risk. Once fully implemented, the EMIR will require certain classes of derivatives to be centrally cleared.

The EMIR also prescribes risk-mit-igation techniques to be applied for uncleared OTC derivatives and aims to create reporting obligations for all derivative contracts.

International applicability

To ensure that European banks do not skirt around the EMIR through their foreign branches, the EU has sought to ensure that EMIR-related commitments applica-ble to EU members are implemented in a similar manner by the EU’s international partners. Article 25 of the EMIR requires central clearing parties (CCPs) in other global jurisdictions providing services to EU-registered banks to be approved by the European Securities and Markets Authority (ESMA). This approval depends on whether the ESMA determines the legal framework of a global jurisdiction to be the equivalent of the EU framework. For instance, the ESMA recognizes the clearing framework established under the Dodd-Frank Wall Street Reform and Consumer Protection Act of the US as an equivalent framework.

Once the EMIR comes into force, European banks and their foreign branches will be barred from dealing with any non-recognized CCPs in other global jurisdictions.

On 1 October this year, the ESMA is

due to provide technical advice to the EU on the equivalence of legal frame-works of various jurisdictions (including India). Prior to the determination of such equivalence, non-EU CCPs are required to file an application with the ESMA to be treated as a “qualifying CCP” (QCCP), i.e. a CCP whose jurisdictional legal framework is being examined by the ESMA for “equivalence”.

Filing this application will allow such QCCPs to function for a period not exceeding 180 working days from the date of application, until their juris-dictional legal framework has been assessed by the ESMA.

Third-country provisions

Article 25 of the EMIR has raised some eyebrows in India, with Indian regulators perceiving the EMIR to be a case of ter-ritorial overreach. The Reserve Bank of India has not expressed any intention of applying for equivalence to the ESMA, as it appears to believe that this may result in ceding regulatory ground to an author-ity that is essentially exercising extra-territorial jurisdiction over the activities of Indian CCPs.

Consequently, the Clearing Corporation of India Limited (CCIL), which was expected to have applied for recognition under the EMIR, has not yet filed such an application. Therefore, from 1 October, if the ESMA decides that India’s regime is not “equivalent”, the CCIL will not be considered as a QCCP, thereby depriv-ing European banks of breathing space to plan their India strategy. Starting 1 October, the EMIR could force European banks to abandon any business activities that require clearing in India.

A potential work-around for European banks could be to convert their branches in India into subsidiaries since the EMIR does not apply when EU banking groups access non-EU CCPs through

local subsidiaries. In contrast to local branches, local subsidiaries are not con-sidered as EU clearing members (which have to comply with the EMIR). However, the regulatory hoops which European banks will have to jump through, and the associated costs, to turn branches into subsidiaries make this an unviable alternative.

Moreover, recently issued EU capital requirement regulations, which apply to both bank branches and subsidiar-ies, have led to confusion on whether local subsidiaries of European banks have to provision at a higher rate for exposure to non-EU CCPs/non-QCCPs. Notably, while CCPs from some jurisdic-tions have rushed to submit applications to the ESMA, the Canadian Derivatives Clearing Corporation believes that it does not need to go through the “equiva-lence” process as only subsidiaries of European banks are present on its list of clearing members.

Conclusions

The decision not to submit an applica-tion to the ESMA already appears to be assuming diplomatic overtones. Unless India and the EU work out a mutually beneficially “middle-path”, European banks may eventually be forced to exit from the Indian OTC derivatives market. Given that India does not rank as a sig-nificant jurisdiction for the EU in terms of exposure related to cleared trades and outstanding liabilities, the chances for a compromise to be worked out between the EU and India may be bleak.

European banks with Indian operations are awaiting the effects of the 1 October rules with bated breath.

Sawant Singh is a partner, Aditya Bhargava is a senior associate, and Raghuveer Sarathy is an as-sociate at the Mumbai office of Phoenix Legal.

MumbaiFirst Floor, CS-242, Mathuradas Mill Compound,NM Joshi Marg, Lower Parel Mumbai - 400 013, IndiaTel: +91 22 4340 8500Fax: +91 22 4340 8501Email: [email protected]

Correspondents


Taxation & transfer pricing

September 2013

Recently, the Bangalore Special Bench o f the Income Tax Appellate Tribunal (ITAT), in the

case of M/s Biocon Ltd v DCIT, has held that discount on employee stock option plans (ESOPs) is an allowable expenditure. In the past, various judi-cial precedents have delivered con-flicting views on this subject.

Typically, ESOPs are a mechanism used by companies to provide incen-tives to their employees. Generally, companies issue options to pur-chase stock below the market price in order to motivate and strengthen employees’ trust in the company and increase their interest in the growth of the company. Based on commercial needs, a company devises an ESOP to align the goals of the company with those of its employees.

The ESOPs devised by companies can involve setting up an employee trust, phantom equity schemes, stock appreciation rights, etc.

Taxability of ESOPs

Stock options allotted on and after 1 April 2009 are to be taxed as per-quisite in the hands of the employees at the time of exercise. The difference between the fair market value of shares received and the amount paid is treated as income in the hands of the employ-ees. The employer is required to with-hold taxes on such perquisite under section 192 of the Income Tax Act, 1961, in the year in which the option is exercised. Subsequent appreciation to the value of the shares received on exercise is in the capital stream and any gain on ultimate sale of shares is taxable as a capital gain.

Companies have been facing vari-ous issues in terms of analysing the taxability and calculating the tax in the hands of employees and the quantum

of deduction in relation to the expendi-ture incurred on ESOPs, etc.

Three-step analysis

The Bangalore ITAT’s recent ruling in relation to deduction of discount on ESOPs as expenditure while comput-ing taxable profits of the company issuing ESOPs addresses the question of deductibility of discount on ESOPs in three steps as follows:

First, a deduction of discount on ESOP is an allowable expenditure if: (a) the substance of issuing employee stock options is disbursing compen-sation to employees for their serv-ices, for which the form of issuing stocks at a discounted premium is adopted; and (b) the obligation of issuing stocks at a discounted price on a future date in return for services is an expenditure incurred wholly and exclusively for the purpose of busi-ness so as to be eligible under sec-tion 37(1) of the act.

Second, on the quantum and timing of the deduction, an ESOP discount can be claimed as a deduction over the vesting period at the rate at which there is vesting of options in the hands of the employees.

Third, on whether there can be any subsequent adjustment to the amount of discount, if required, no deduc-tion of discount can be claimed on unvested or lapsed options as there is no employee cost to that extent so an adjustment to that extent would be required to be made.

Considering the above, the ITAT held that while computing the income under the head “profits and gains from business or profession”, an assessee can claim the discount on the ESOPs granted to its employees as a deduct-ible expenditure under section 37(1) of the act.

Key clarifications

Thus, the above ruling has clarified the following major issues: (a) discount on ESOPs is a deductible expenditure since it is in the nature of employee cost; (b) such discount on options under ESOPs is an ascertained liability and not a contingent liability; (c) such discount is deductible over the vesting period on a straight line basis, if the vesting is on a uniform basis; (d) if the vesting is not uniform, then subsequent adjustment to the amount of discount claimed earlier would need to be made at the time of exercise of options; (e) an adjustment to the income is called for at the time of exercise of an option, amounting to the difference between the amount of dis-count calculated with reference to the market price at the time of grant of the option and the market price at the time of exercise of the option.

Conclusion

Although the judicial precedent dis-cussed above has clarified the long-standing issue of whether the discount on ESOPs is an allowable expenditure, computing the eligibility and quantum of deduction during the course of the period of implementing an ESOP will always be a challenge. It is therefore important not only to envisage the pos-sibilities, but to document the scheme such that it not only meets the commer-cial intent of the company but also pro-vides for how the eventualities would be dealt with as all of that would become the basis for claiming deduction.

Economic Laws Practice is a full-service law firm with headquarters in Mumbai and offices in New Delhi, Pune, Ahmedabad, Bangalore and Chen-nai. Pranay Bhatia is a tax partner at the firm and Hardik Choksi is an associate.

Economic Laws Practice1502 A Wing, Dalamal Towers

Free Press Journal RoadNariman Point, Mumbai 400021

IndiaTel: +91 22 6636 7000Fax: +91 22 6636 7172

Email: [email protected]@elp-in.com

ITAT clarifies deductibilityof discount on ESOP

By Pranay Bhatiaand Hardik Choksi,Economic Laws Practice

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