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Brit businesses prefer India, despite concerns: KPMG Survey
October, 04th 2011

he strong association between Britain and India goes back a long time in history. Current statistics however show Britain having been relegated out of the top tier league of Indias trading partners.

Whilst the trade figures may not be encouraging, cross border investment between the two countries has picked up in the last few years Tatas followed up their earlier British acquisition of Tetley with that of Corus and Jaguar Land Rover Vodafone bought into Hutchison
in India.

KPMG India conducted a survey involving respondents from various British companies operating in India to assess their level of satisfaction with the local opportunity, business environment and regulation.

Besides understanding the general British perspective on the drivers and challenges in the India opportunity, the survey sought insights on investors preferences among a number of competing emerging markets.

Drivers for investment:

A large forty one percent of respondents considered the growing Indian market as the primary driver for investment. The steady economic growth coupled with a young population has translated into growing aspirations and consequently a large consuming middle-class in India. That in turn is fuelling the demand for different customer related services like banking, insurance, retail and education.

Given the natural alignment of these sectors with British usinesses, the Indian opportunity is quite attractive from the UK perspective. The upward spiral in demand is spilling into niche business segments such as training, architecture, facility management etc, that are typically served by smaller British businesses, also helping create their interest in India.

Challenges for investment:

Thirty two percent of respondents perceived weak governance and bureaucracy as a primary challenge for investing in India. They are frustrated with the time taken to get approvals and clearances particularly at the state and local government departments. Whilst there appears to be visible steps to control corruption, it seems to continue unabated especially among the smaller government offices and departments.

Investors would prefer to be provided with a clear roadmap of what a particular application or approval process involves rather than having to mindlessly struggle for want of clarity.

Preferences for investment destinations:

Large companies are increasingly investing in emerging markets. British companies however prefer investing in India over other competing destinations for a variety of reasons:

Legacy of language, bureaucracy and judiciary lends the desired level of comfort
Complementary political systems - one the oldest and the other the largest democracy
Complementary sector profiles Britain can help develop most of the weak Indian sectors infrastructure, education, defence, innovation, retail, banking, insurance
India has the benefit of a large domestic private market and unlike other emerging markets that are driven by government programs or exports
Indian manufacturing especially in high-technology items has improved notably automotive, pharmaceuticals, centre of excellence

Developments in tax legislation:

The respondents had mixed views on the state of tax legislation and its impact on foreign investment in India. The frequent changes in regulation and a lack of clarity on certain issues is a sore point. The judicial view is divided on issues such as software taxation, permanent establishment, transfer pricing, attribution of profits, deputation of employees etc. with
inconsistent views emerging from various levels of judiciary. Further, the practice of retrospective amendments in law disturbs the well settled position adopted by tax payers and increases the tax costs of doing business in India.

This uncertainty coupled with weak tax administration is a matter of serious concern as it hampers the effective implementation of investment plans. Small and medium enterprises feel intimidated by varied tax regulations and
lack of clarity in implementation by the authorities. Some respondents however felt that the regulatory conditions in India are much better in comparison with some other developing countries.

Proposed tax reforms - Direct Tax Code (DTC) and Goods & Services Tax (GST)

Most of the participants were of the view that India is heading in the right direction with DTC and GST. The primary objective of DTC and GST is to simplify the tax legislation and its administration, eliminate distortions in the tax structure and reduce litigation. This move promises to lend the required level of transparency and clarity to processes.

GST is expected to rationalize the indirect taxes in India by reducing the cascading effect and simplifying procedures. While the objective of both legislations is well received, there are concerns around its implementation including timeliness for its roll out and addressing critical issues in the draft law before being enacted.

Concerns with cross-border M&A transactions

A majority of respondents had serious concerns over recent developments concerning cross border M&A transactions. The action of the tax authorities to tax income arising from jurisdiction outside India has triggered a debate that is likely to persist. Most companies perceived the developments as destabilizing established laws and tax administration. The issues under
the ongoing litigation are unique and unprecedented and its final outcome will have a significant impact on global mergers and acquisitions involving Indian businesses.

The investors are also keeping a close watch on how the interpretation of the new provisions under the DTC will evolve to tax similar transactions.

Complexity of ownership structures

A lot of respondents said that the complexity of ownership structures associated with sectors like defence, education and retail was a key impediment to investing in India. British companies are well placed to work with Indian partners in driving these Indian sectors.

Whilst the respondents appreciated the cap on foreign holding in some critical sectors, they said that, restrictive regulations in some others only hampers Indias pursuit of development and self-sufficiency. The defence offsets policy has been lauded by foreign investors. However, the decision to introduce a ceiling on holding in local joint ventures is considered to be disruptive. The feeling is that, a minority holding in a high-technology defence joint venture cannot encourage the foreign partner to offer any leading edge technology, and may work to the detriment of India interests at indigenising its defence capabilities.

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