26 May 2016

Financial sector reforms: Move faster, sooner - Economic Times

I have a piece in today's Economic Times on the financial sector reforms in the two years of Modi rule and the way forward for the balance three years. Posted below is the full piece and here is the link to the original.

Financial sector reforms: Move faster, sooner

India’s financial sector and its regulators have much to be pleased about, though not enough to be complacent about. To start with, the RBI has always had a formidable reputation as a central banker. On the Sebi front, a World Bank ease of doing business study placed India at the 8th rank on investor protection. Incidentally, that was the only metric on which India performed in the top ten.
Archimedes said “give me a lever long enough and a fulcrum on which to place it, and I shall move the world”. The financial sector can be India’s lever and the regulators the fulcrum to improve the Indian economy by providing easier capital resulting in a Cambrian explosion of productivity and growth. The past two years have seen some significant changes in the financial regulatory structure.
The most dramatic of the changes, which will cast long shadows was the merger of the forward commodities futures regulator, with the securities regulator, Sebi. The merger has brought about significant improvements in the quality of regulation. The government should push for a more unified regulator with insurance, pension and even banking, falling under Sebi’s domain. This will prevent Sahara like problems arising out of regulatory gaps or turf fights like those seen between Sebi and the insurance regulator.
Significant reforms have been carried out in liberalising limits of foreign investments in areas such as insurance, defence, and railways. The FIPB is sought to be abolished.
The move would reduce pointless bureaucratic hurdles in foreign investments and unnecessary movement of files between three ministries and one or more financial regulators. More liberalisation in sectors would be key to further investments and draining the swamp of unnecessary procedure and multiple bodies should be the next important step.
The Jan Dhan Yojana has been a significant and impactful first step in financial inclusion. The objective to bank more people can be furthered with a removal of the requirement of ‘address proof’ which unnecessarily bars mobile citizens from opening bank accounts even though they have identity proofs. When I first moved to Ahmedabad to teach at IIM, I was unable to open a bank account for this reason. Imagine the plight of the uneducated and the poor.
The recent efforts to do away with tax havens and double nontax treaties is a tough step, which was long overdue and will end the apartheid against domestic investors. This should be carried to its logical conclusion and all investors, foreign or domestic should be treated fairly.
We need to improve the markets of corporate debt, securitisation, real estate trusts, infrastructure trusts for the development of India’s infrastructure. Similarly, developing the alternative investment fund market, currently pygmy-sized, would develop domestic investment of money which will go into productive use. Nearly 99% of the problems in all these areas relate to direct taxes or stamp duty.
The recent Narayana Murthy report constituted by Sebi hardly had any reform suggestions for the regulator — they were nearly all tax issues.
Finally, being able to raise capital is no good unless that capital is well deployed and the ease of doing business is improved with fewer permissions, forms and bureaucracy. That includes the modern ‘right to die’ for companies sought to be introduced by the new bankruptcy code.

12 May 2016

Mauritius tax treaty: A right move at an appropriate time

I have an opinion piece in today's Mint newspaper on how the use of tax treaties to skip taxes needed to go and how this government introduced the 'protocol' amending the old treaty with the right words, a smooth non disruptive transition and the best time in recent times for introducing it. Not only is the move right, it has virtually not moved the market (based on of course a two day record). I argue that capital importing countries tax source income while capital exporting countries tax global income of residents. Both are designed to maximise tax and India will be wrong to copy the western model. In fact I point out that even the western countries, though usually adopting the residency model, opportunistically switch to the source based model for real estate deals by foreigners. This is because foreigners often buy real estate in London, New York and Paris and these countries again act rationally in their self interest. I conclude by saying that the effective repeal of abusive treaties should be welcome by even foreign investors who will see better investments in infrastructure through their tax dollars. Here is the link to the original piece and pasted below is the full article:

"My first class on taxes in the early 1990s started with the professor telling the class “there is no equity in tax, there is no logic in tax, do not seek either”. I was not convinced, I’m not convinced still. The fundamentals of fairness and equity surround the entire ecology of rule of law and there is no reason taxation principles should live wholly outside that.
The power to tax, based on the legislative process, is an expression of national sovereignty. Two forms of taxation exist worldwide for income based in another country. The first is the “residence-based taxation”. Countries applying such a principle tax their residents on their worldwide income, wherever derived. The second is “source-based taxation” where tax income is derived from sources in their territory, regardless of the residence of the person deriving the income. Most countries apply a combination of residence-based and source-based taxation.
According to a UN paper (UNCTAD), double taxation most often occurs when both the source country and the country of residence concurrently exercise their taxing right without providing full relief for the other country’s tax. Countries enter into double tax treaties to minimize the double taxation arising out of this intersection and the resulting unfairness.
In this world, view of minimizing unfairness out of overtaxing, there is really no space for maximizing unfairness which arises out of use of tax havens to pay no tax anywhere. Secondly, in the world where Indians pay tax on capital gains, given that we are primarily a source-based tax system, it is apartheid for foreign residents to pay no taxes.
Thirdly, the gain occurs primarily in dubious cases. Where a resident, for example of the US, invests in India via Mauritius, the resident ends up paying zero tax in India but up to 50% tax in the US. If Mauritius were not placed between the countries, the Indo-US tax treaty would more evenly divide the tax between India and US.
In other words, Mauritius is a route for transferring India taxpayer money to the US government. These are the non-dubious cases. Dubious cases are where the profit is milked in the tax haven and the beneficiary is a resident of another tax haven. In other words, the profits are all secreted out and neither India nor US will get to tax. Fourth, the opacity of using tax havens means they are a breeding ground for parking bribe money, circulating money laundering proceeds or other movements of international crime money. Panama.
Most Western countries are capital exporting countries and therefore they maximize their revenues by charging their residents for global income rather than bothering about the source income. However, they impose source-based tax on sale of real estate as foreign investors often end up buying local real estate. So foreign investors in their shares, though not in property, are typically exempt. They use the residence test in their self interest, except when it doesn’t suit them.
Conversely, capital hungry countries like India do not deploy much money overseas and rather attract foreign capital. We use source-based income test as it will maximize our sovereign tax collections. Indeed, there are several countries in the West which tax source-based income of gains in their territory, for instance Spain and Israel. This is rational self-interest of India and there is no use copying Western countries which are doing what is in their self-interest.
No matter which way you cut it, unfairness of double taxation is never an excuse for encouraging tax havens. The provision of an anti-abuse provision has been in the works for many years and has been sought to be implemented with effect from 2017. This information of Mauritius going away as a haven has been in the works for a long time and foreign investors in fact would have seen it coming.
Secondly, in these relatively happy times for India, this is a good time to introduce a small tax (mainly on unlisted securities, as listed securities held for a year are exempt), on the outsized returns foreign investors can expect.
Thirdly, the announcement detracts from a sudden change in taxation and grandfathers all investments made till next year and is an added benefit and a shock absorber rather than an announcement for taking away a benefit.
The anti-apartheid law should be welcomed by all, even foreign investors whose tax will help make the infrastructure to further improve their post-tax return."

03 May 2016

3rd Annual Roundtable of Finsec Law Advisors

Finsec Law Advisors and the Association for Development of Securities Market (ADSM) proudly hosted its third roundtable on the 29th of April 2016. This year the focus was on Institutional Investors.  We were also happy to team up with Institutional Investor Advisory Services India Limited (IiAS) and the event was solely sponsored by BSE Ltd.

Investor protection is as crucial for sophisticated institutional investors as for retail investors. Although the tenets of investor protection may differ in range and tenor, an active and informed institutional investor not only safeguards its interests better but can also contribute towards better corporate governance and shareholder value.

The objective of the Roundtable was to bring together financial market experts and
decision makers within the industry and academia for an active, face-to-face discussion on key issues faced by institutional investors in the Indian capital market. The Roundtable, though moderated, took place without a centre of gravity and the wisdom from the discussions will result in an approach papers on issues discussed, which will be shared with policy makers.

01 March 2016

Budget 2016: Financial sector reforms – another day

I have a piece in today's Financial Express on the missed opportunities for capital formation and investment in the budget 2016-17. Attached below is the full piece:

The Budget 2016-17 charts out an ambitious goal as far as farm support and decentralisation up to the panchayat level. The results of that would only be visible only if the various schemes are implemented without excessive leakages.
What is disappointing is the treatment of investments and capital in the Budget. This Budget is unlikely to unleash the powerful and beneficial forces of capital raising and entrepreneurship. So, what are the five areas of concern from the perspective of capital formation?
First is the long-awaited reform in the taxation of alternative investment funds that invest in listed securities. Currently, they neither get the benefit of a passthrough nor do they get the benefit of long-term capital gains available to an investor who invests directly in listed securities. The illogical lack of such benefit means that a person investing in Infosys or other listed stock will pay 0% capital gains tax if held for a year, but if the same investor were to invest through the Sebi-registered AIF, he would pay upwards of 35% tax and harassment for paying even more. This could have been a major source of investment from domestic savers who underinvest.
Second, people were expecting a reform to foreign investment in stock exchanges, which has increased from 5% cap per investor to a 15% cap. From a control perspective, foreign investors would not be interested in such an increase, which raises their capital investment but restricts their ability to control the domestic exchange any further. A 5% control is quite similar to a 15% control in terms of ability to change management. So increasing investment will not look inviting.
Third, the concept of taking away the double taxation for dividend for high net worth investors and promoters means that there is now triple taxation. One, when the company pays corporate tax, two when the company pays dividend distribution tax and three when the investor pays tax. This may be sound rich bashing, but is poor policy for capital formation and investment.
Fourth, public banks are to be capitalised by only Rs 25,000 crore. The NPAs, the real quantum of which is a matter of conjecture, but by all estimates well in excess of that figure will restrict the ability of banks to lend purposefully. Particularly to the infrastructure sector and to the corporate sector in general.
Finally, the many recommendations of the Justice Srikrishna financial sector committee, with two exceptions, have not been announced for implementation. The two sought to be implemented on resolution of financial firms and monetary policy committee were both opposed by many.

22 February 2016

Alternate exchanges

I appeared on The Firm show of CNBC, India discussing the area of alternate exchanges. Here is the link to the show.

17 February 2016

10 December 2015

Exit option to shareholders on change of objects of fund raising in IPO

I have a piece on the Firm website where I discuss the consultation paper on exit being provided to dissenting shareholders where public offer proceeds have not been applied towards the disclosed object. I argue that the Companies Act provision which provide an exit option to shareholders where objects are modified is unwholesome in its application and is wholly wealth destructive for genuine shareholders. Some punters may make some money in the short term in some cases, but broadly everyone loses. Below if the full piece and here is the link to the original article:

"Punters versus The Real Economy
SEBI has come out with a consultation paper on exit being provided to dissenting shareholders where public offer proceeds have not been applied towards the disclosed object.

To provide a brief context, sections 13 and 27 of the Companies Act, 2013 provide that where a company has raised money from the public, and wishes to use part of the funds towards an object not originally stated in the prospectus, then such change of object must be permitted by shareholders by way of a special resolution. In addition, dissenting shareholders are to be provided an exit by the promoters of the company in terms of regulations of SEBI.

The basic premise of the Companies Act in the two sections is that a change of objects for use of funds raised is by itself a dubious activity. It also seems to protect shareholders from such a change by guaranteeing them money back. On the face of it, this does not sound wrong at all. If a company has raised money for a purpose, it must use it for that purpose. But the reality is quite different from the optics.

The world of economics and the competitive landscape for almost every company is a slippery slope. Oil at $100 a barrel versus oil at $37 in a matter of just over a year can make entire industries highly uncompetitive, where they were previously profitable. And of course conversely, many companies would find the dip in oil prices a big bonanza, so that they would like to enter into a business which was previously unattractive. For a company, the price of oil is merely one of the hundreds of variables which make their business viable or unviable. The reality is that these variables, much as we like predictability, vary on a daily basis. Whether it is input costs, change of regulations, number of competitors or many other unforeseen factors.

Now imagine a company which had raised funds for a particular project, say deep sea oil discovery in 2013 or a beer factory in Kerala in 2014. Now imagine what such a company would be looking at in 2015. Funds were raised for a project which has now become unviable because of change in competitive features or regulatory changes. If the oil drilling is done the cost of extraction (say) would exceed the sale price by 30% and in the second case sale of beer locally would be banned and transport costs would ensure that sale outside the state would be unviable.

Now imagine what the promoters of the company would do with the funds raised, assuming that only a small part of the funds raised had actually been invested in the two projects. They can do one of the two things a) continue with the projects and watch the shareholder money go down a certain black hole, but with no liability on the promoters/managers. b) discontinue the project and attempt to invest in a viable sector, but seek shareholder approval and give them an exit option out of the personal funds of the promoters. Clearly, the incentive will be to take the first option given the new Companies Act. Equally clearly, this is a bad outcome for the company, the shareholders and for economy.

While the SEBI discussion paper seems to understand some of the issues, it only subtly talks about them and recommends statutory change. SEBI as a creation of the statute of course rightly does not challenge the statute itself. But, someone ought to- in the national interest. This law is unwholesome in its application and is wholly wealth destructive for genuine shareholders. Some punters may make some money in the short term in some cases, but broadly everyone loses. We really need a discussion paper on the existence of the statutory provisions more than a discussion paper on the logistics of the SEBI norms for providing the exit option to dissenting shareholders."

(Attached is SEBI’s Discussion Paper on “Exit Offer to Dissenting Shareholders)