Introduction

India’s recently announced budget for 2016-2017 (the “Budget”) sets out a number of structural reforms which further those set out in the preceding 2015-2016 budget. In contrast to budgets of previous years, some of which contained substantive provisions to enhance inflows of foreign direct investment, the Budget is notably more inward looking. As part of the ‘Transform India’ initiative, it concentrates on improvements to traditional areas such as agriculture and the rural population, infrastructure, taxation policy and reform of the banking and insurance sectors. Emphasis has also been placed on innovation, with tax incentives and employment generating initiatives being made available to new enterprises. No firm commitments were made on the introduction of a promised Goods and Services Tax. 

Despite the India centric nature of the Budget, some outward looking measures have been incorporated, with changes being made to foreign direct investment policies as the country looks to promote higher investment for higher growth. 

We set out below a summary of the key initiatives from the Budget, which are expected to be of interest to foreign investors.

A background of strong economic growth and investment

Forming part of the background to the Budget, the International Monetary Fund (“IMF”), in its March 2016 Consultation report with India (the “IMF Report”), predicted that the Indian economic growth will increase to 7.5% in 2016-2017 from a projected 7.3% in the equivalent 2015-2016 financial year, partly as a result of India’s relative insulation from global economic pressures. 

There has been a reduction in inflation which has had a knock on impact on the potential for growth. This has proved attractive for foreign investors, with a strong inflow of investment in 2015. 50% of respondents to the CMS European M&A Outlook for 2015 (“CMS M&A Outlook”) anticipated that the most active target region for European acquirers in 2016 would be Asia, pointing specifically to India as a popular destination for investment.

For a copy of the IMF report, click here and for a copy of the CMS M&A Outlook, click here.

Taxation policy: an impact on trade and investment

The IMF Report outlined the need for improvements in the efficiency of taxation in order for India to meet fiscal targets. The Budget aims to deliver a more simple and reliable taxation regime, with increased penalties to be put in place for underreporting and misreporting income. 

In terms of international trade, changes have been made in taxation to introduce a customs ‘Single Window Project’ which be implemented at specified ports and airports for certain imported goods in order to facilitate trade. In addition to this, the duty drawback scheme will be widened to include more products and countries to act as an encouragement to the import/export market.

As part of tax based measures to boost growth, the government has reiterated its commitment to introduce the general anti-avoidance rules (“GAAR”) which were introduced by the Finance Act 2013 but will be deferred until 1 April 2017. The enactment of the GAAR may be a concern for Indian and international tax payers because of the likely increase in red-tape.

Similarly, as part of measures to increase tax revenue generation, the 2014-2015 budget proposed to amend the definition of a company considered resident in India for tax purposes to a company with its ‘place of effective management’ (“POEM”) at any time in the relevant year in India. This is in contrast with the prevailing position under the Income Tax Act 1961 whereby a company is considered to be tax resident in India if the control and management of its affairs is situated ‘wholly’ in India. When first proposed, the POEM reform raised concern for foreign companies with a presence in the Indian market which would be subject to increased tax burdens as India improves its revenue generation. Allaying these concerns, the Budget defers the POEM reform for a further year.

Banking and insurance: reform and increased transparency

Continued focus was placed on the legal reform programme to repair the corporate banking industry, as concern was raised over the quality of assets in public banks which have been criticised as ‘visibly stressed’. The Government wants to recapitalise banks, with a focus on ensuring macro-economic stability. As part of this, asset reconstruction companies will be opened up to foreign investors in order to respond to the prevalence of India’s bad loans with foreign direct investment of up to 100% permitted under the automatic route. Transparency will be increased via legislation to deal with illicit deposit taking schemes and a Code on the Resolution of Financial Firms will be enacted to regulate bankruptcy situations in banks, insurance firms and financial entities.

In an effort to improve transparency, Government-owned general insurance companies will be listed on the stock exchange. The foreign investment limit in the insurance and pensions sectors will also be raised to 49% via the automatic route. In order to improve the global footing of India’s stock market, the investment limit for foreign entities in stock exchanges will be raised to 15% though there is no similar increase for power or commodity exchanges.

Infrastructure investment: improved efficiency for business and opportunities for foreign investment

The minister presenting the Budget discussed the need to prioritise expenditure in the infrastructure sector in order to improve efficiency. The provision of funding for road works, improvements to airports and major ports will facilitate India’s connectivity and the ease of conducting business in the country.

Infrastructure developments are expected to galvanise public private investment, with a plan drawn up to enhance investment in the generation of nuclear power and steps outlined to improve public private partnerships, including the introduction of a Public Utility (Resolution of Disputes) Bill to streamline dispute resolution in infrastructure contracts and guidelines for the renegotiation of public private partnership concession agreements. In terms of foreign investment, the infrastructure reforms coincide with the liberalisation of limitations on foreign direct investment.

Agriculture revitalisation: opening the way for foreign retail

A number of reforms have been put forward in the agricultural sector which is experiencing low growth rates of around 1.1% and a fall in exports and imports. A number of the measures involve sustainability improvements such as the promotion of organic farming whilst others centre on providing fiscal support for farmers by reducing the burden of loan repayments and promoting the availability of credit.

India’s vulnerability to climate change and its reliance on the domestic agricultural sector makes sustainability projects of key importance to development goals. Despite the domestic focus, measures have been implemented in the Budget to allow 100% foreign direct investment in the marketing of Indian food products in order to stimulate the food processing industry.

Healthcare and innovation: demand for drugs and enterprise incentives

For a number of years emphasis has been placed on the need to improve the Indian healthcare sector. The Budget responds to public concern by enacting a new health protection scheme which will cover hospitalisation expenditure for around a third of the Indian population, alongside acknowledging the difficulties that India has faced with the provision of affordable drugs. This has the potential to impact the international lifesciences sector as demand will be increased for low cost generic drugs and other resources.

The Budget also focuses on employment generation which links the recently initiated ‘Start-up India, Stand-up India’ scheme, providing incentives to fledgling businesses. Progress has been made in terms of supporting innovation via the provision of tax incentives for fledgling companies including allowing deductions of 100% of profits and gains for certain innovative enterprises, and those with new products driven by technology and IP. It is likely that such initiatives will have an impact on India’s quickly developing start-up community, making it more attractive to investors. New manufacturing companies will be able to choose to be taxed at a rate of around 25% provided they meet certain conditions and reductions will be made in 2016-2017 in the corporate tax rate for small enterprises. Amendments to the Companies Act 2006 and the removal of red-tape to allow for one day company registration is set to provide a more supportive environment for start-up companies in order to bring India in line with international standards.