overcoming operational challenges of investing in india and china mark j. riedy partner, andrews...
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Overcoming Operational Challenges of Investing
in India and China
Mark J. RiedyPartner, Andrews Kurth LLP1350 I Street, NWSuite 1100Washington, DC 20005 P: 202.662.2756F: 202.662.2739C: [email protected]
I. INDIA VERSUS CHINA
IndiaA. 1991 –
Liberalization begins.
B. 1992 - FDI inflow US$2 Billion.
C. 2003 – FDI inflow US$5.6 Billion.
D. 2005 - FDI inflow US$11 Billion.
ChinaA. 1978 –
Liberalization begins.
B. 1992 – FDI inflow US$11 Billion.
C. 2003 – FDI inflow US$53.5 Billion.
D. 2005 – FDI inflow $50 Billion.
Indian economy grew 9.3% in the quarter ended on March 31, 2006 marking a display of momentum on par with China’s growth of 9.9% in 2005.
II. TIMELINE OF ECONOMIC REFORM
1947: India achieves independence from Britain; embarks on socialist economic policies.
1991: Foreign currency crisis, prompted by rising oil prices, forces India to open up to foreign trade & investment.
1998: India tests nuclear weapons; U.S. and other nations introduce economic sanctions.
2001: U.S. lifts economic sanctions.2004: Congress Party wins a surprise victory in
national election. 2005: U.S. and India sign framework agreement for
civilian nuclear cooperation.
III. INDIA’S ECONOMY IN A NUTSHELL
A. India’s foreign exchange reserves stand at US$160.677 Billion.
B. Sectors with least regulation have grown the fastest.
1. Film production (largest film industry in the world).2. Cable TV distribution (over 70 Million homes with
cable).3. IT/ IT services (US$17 Billion in exports in ’05).4. Pharmaceuticals (9th largest in the world).5. Informal retail - Mom & Pop Shops (informal retail
accounts for 97% of retail sales).C. India is trying to balance the desire to regulate
the unregulated (e.g. Film, Cable TV, IT/IT Services, Pharmaceuticals, Information Retail) sectors, while de-regulating other sectors.
INDIA’S ECONOMY IN A NUTSHELL CONT.
D. India ranks as a top investment destination:1. Top destination for retailers in AT Kearney’s
Global Retail Development Strategy.2. Second most attractive destination for
manufacturing investors as per AT Kearney’s latest FDI confidence ranking.
3. Leading destination for IT and IT enabled services with revenues of US$ 28.2 Billion in 2004-2005.
4. Attracted more than 3 times foreign investment at US$7.96 Billion during the first half of 2005-2006 compared to US$2.38 Billion during corresponding period of 2004-2005.
E. More than 50% of US Fortune 500 companies are outsourcing to India.
IV. INDIA’S GDP GROWTH RATE: 1998-2006
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
1998-1999
1999-2000
2000-2001
20001-2002
2002-2003
2003-2004
2004-2005
2005-2006
V. GROWTH OF U.S.-INDIA TRADE: 2001-2006
Growth of U.S.-India Bilateral Trade 2001-2006
-
5.00
10.00
15.00
20.00
25.00
30.00
2001 2002 2003 2005 2005
US$ billions
VI. SKILLED MANAGEMENT BASE
A. Over 150 Million English speakers.B. World-class educational institutions.
1. Indian Institutes of Technology.2. Indian Institutes of Management.
C. Salary for Indian employee with MBA approx. ¼ that of a comparable U.S. employee.
D. Salary for Indian IT employee approx 1/8 that of a comparable U.S. employee.
VII. NAVIGATING INDIA’S LEGAL SYSTEM
A. General1. Based on English Common Law.2. Unitary court system – However substantial
backlog/delays in cases: If no new cases were filed, it would take approximately 350 years to clear current court case backlog (not including administrative judicial and quasi-judicial case backlogs).
3. Administrative judicial bodies.4. Quasi-administrative/judicial bodies.
a. Income Appellate Tax Tribunal (tax appeal matters).
b. Advance Authority for Rulings (advance clarifications on tax issues).
c. Dispute Resolution Tribunal (mediation).d. Debt Recovery Tribunal (used primarily by
banks/financial institutions to recover debt).
NAVIGATING INDIA’S LEGAL SYSTEM CONT.
B. Tax & Corporate Structuring Issues for Investors
1. Double Taxation Avoidance treaties (U.S., Mauritius, Singapore, Cypress, UAE).
2. Reduction of tax and non-tax liabilities through limited liability vehicles/firewalls.
3. Use of bilateral investment treaties/ agreements4. Treaties based on a combination of OECD and UN
model conventions.5. No anti-treaty shopping provisions in most
treaties makes for better investment structuring.
NAVIGATING INDIA’S LEGAL SYSTEM CONT.
C. Changing Regulatory Environment1. Independent Regulators Set Up For:
a. Insurance (IRDA).b. Telecom & Media (TRAI).c. Financial Markets (SEBI, RBI).d. Power Generation & Distribution (Central
Electricity Regulatory Commission and State Electricity Regulatory Commissions as power has concurrent jurisdiction and oversight).
e. Pension Fund Managers (PFRDA).
NAVIGATING INDIA’S LEGAL SYSTEM CONT.
D. Expected Regulatory ChangesChanges expected to be seen in the following 12 months include:
1. Opening FDI investments into multi-brand retail trade (as the sector is currently limited to single-brand retail at 51% FDI).
2. Increasing the FDI cap for insurance to 49% (from 26%) which is the only sector requiring legislation in lieu of a simple GOI Cabinet approval.
3. Amending the IT Act to strengthen cyber security laws. 4. Introducing a new content regulator for television. 5. Developing new pension fund management regulations.6. Further liberalization of foreign investment in real estate
(which presently allows 100% FDI in undeveloped non-agricultural real estate exceeding 25 acres or 50,000 square meters, with a US$10 Million capital investment requirement locked-in for 3 years).
7. Banking FDI moving up to 74%; awaiting final implementing regulations.
VIII. PROTECTING INTELLECTUAL PROPERTY
A. Patents 1. General
a. Until 2005, India did not grant product patents for Pharmaceutical products, Agrochemical Products, and Food Products.
Only processes were protected by patent. Patented products could be “reverse
engineered” without incurring legal liability.
b. January 2005 – Trade Related Aspects of Intellectual Property Rights Agreement (TRIPS) obligated India to provide IP protection for product patents in all fields of technology.
PROTECTING INTELLECTUAL
PROPERTY CONT.
Patents cont.2. Areas of Major Concern:
a. Pre- and Post-grant opposition at the patent examiner level. No standing requirements.
No necessary relationship to the matter at issue.
No need for the challenger to demonstrate harm.
Anyone may challenge a patent application. Anyone may challenge a granted patent. Actual Impact – prejudices innovators –
introduces additional and continuous delay and uncertainty.
PROTECTING INTELLECTUAL
PROPERTY CONT. Patents: Areas of Major Concern, cont.:
b. Mashelkar Commission Established by the Government of India in
1995. Presently exploring whether India may limit
protection to new molecular entities. Would essentially limit protection to
“blockbusters” or entirely new classes of drugs.
Would not protect incremental or “follow on” innovation - the lifeblood of the pharmaceutical industry (i.e., new drug delivery systems, salts, esters, etc.).
PROTECTING INTELLECTUAL PROPERTY CONT.Patents Cont.
3. Data Exclusivity/Protectiona. Applies to Pharmaceutical and Agrochemical
Products. b. Protects valuable data such as clinical trial data.
– Required Under Article 39.3 of WTO TRIPS agreement. Data submitted as a condition for obtaining
marketing approval cannot be disclosed to or relied upon by competitors for a set period of time.
Obligates member countries to protect such commercially valuable data from: 1) unfair commercial use and 2) disclosure.
c. India’s current practice is to grant marketing approval to competitors based upon approvals granted to innovators in other countries. Competitors need not submit their own clinical trial or test data.
d. This practice is not in compliance with India’s obligations under Article 39.3.
PROTECTING INTELLECTUAL PROPERTY
CONT.B. Trademarks and Copyrights
1. Laws Largely in Place – Administrative enforcement is the issue – However, Indian courts have ruled regularly in favor of IP rights holders.
2. Exception:a. India does not regulate the production of
optical discs (e.g., DVDs, CDs, Software). Seized discs are difficult to trace. Licensees can engage in
“overproduction”. Production equipment can be moved to
various locations.
PROTECTING INTELLECTUAL PROPERTY CONT.
C. Non-tariff Barriersa. Depress supply of legitimate goods
Example: Retail did not open to FDI until 2006 Even now, it is not open to multi-brand
retailers Only single-brand retailers with FDI limited
to 51% are allowed to operate in India
b. Prevents development of legitimate markets, implementation of best practices in logistics and secure supply chains
PROTECTING INTELLECTUAL PROPERTY CONT.
D. Enforcementa. Court System Plagued by intractable delays.b. Lack of judicial and legal capacity.
Few judges and lawyers trained in IP law. New & complex cases set to enter system (i.e., product patents).
c. Serious “pirates” are not deterred by insufficient criminal and civil penalties – In criminal cases:
Enforcement is Conducted at the State, and not the GOI, Level.
Sporadic State Government efforts - Lack of will - Lack of enforcement capacity.
d. Attitudes may be changing: Recent case involving Time magazine in which infringer was
ordered to pay plaintiff’s costs and damages. Recent precedent-setting case in Delhi High Court, where sole
proprietor of law firm was granted a permanent injunction against the use by an erstwhile employee of documents created while in employment, on the theory that the copyright vested in the proprietor of law firm, since the documents were “works” created in the course of a contract-for-service.
PROTECTING INTELLECTUAL PROPERTY CONT.E. Recent Developments:
1. Separate IP Tribunal may be established.a. Few details known thus far.
Unknown as to whether this expected new tribunal would have civil and/or criminal jurisdiction.
b. However, it represents a step in the right direction- Demonstrates a growing understanding of the impact of counterfeiting and piracy on such areas as tax revenue, innovation, and linkage to other criminality/ statutory violations.
IX. PROTECTING YOUR INVESTMENTA. General
1. Engage Qualified Counsel, Accountants and Consultants at the Outset.
2. Need for Upfront & Well-Considered Tax and Corporate Structuring.
3. Due Diligence is Key.a. Ensure that your partner is trustworthy and has
the financial ability to implement the investment.
b. Enshrine IP protection in all contracts.4. Contracts Require Certain Protective Clauses.
a. Neutral-country arbitration is a must. if pressed into arbitration in India, bifurcate
the arbitration clause so smaller disputes are arbitrated in India and larger ones are arbitrated in a neutral country.
PROTECTING YOUR INVESTMENT CONT.General: Contracts to Have Certain Protective Clauses
cont.
b. Strong indemnification clauses.c. Force majeure – this provision permits suspension of
contractual obligations under certain circumstances.d. Compliance with U.S. Foreign Corrupt Practices Act (FCPA)
and Indian anti-bribery laws – accusations particularly can adversely affect public company stock.
5. Need for insurance requirements to protect transactions, such as political risk insurance against expropriation, etc.
6. Need for transfer pricing protective provisions particularly in related party (parent-subsidiary) transactions (e.g. outsourcing).
a. The Government Of India (GOI) is aggressive on transfer pricing requiring mandatory tax audits, if the annual aggregated contract amounts between related parties exceed a very low US$1.1 Million threshold.
b. The GOI imposes the largest transfer pricing penalties in the world ranging between 100%-300% and without any benchmarks on applying this range.
PROTECTING YOUR INVESTMENT CONT.B. Investment Risks
1. Taxation issues a. India dramatically changes core tax rules regularly- usually not
to the benefit of foreign investors.b. GOI “virtual” permanent establishment (PE) cases (100%
penalties and interest, plus an additional 8% (originally 18%) annual compounded interest if payments are not made to the GOI before contesting the assessment). The GOI attempts to assert tax jurisdiction over income, where the assessee does not have a demonstrated physical presence in India.
c. GOI’s new set of PE cases markedly have increased – recently a US$37 Million tax charge was imposed on one company for one assessment year (5 years ago) plus 100% penalties and interest measured from 5 years back. The GOI is going after the company’s world—wide income. It also could be hit in each of the next 4 assessment years since the original charge in a similar fashion. The total sum could be staggering and will require years of litigation to resolve.
d. GOI is increasingly become more aggressive in transfer pricing cases.
e. Andrews Kurth recently won the largest tax award case in Indian history at the Income Tax Appellate Tribunal level. Wins at this level virtually never happen. It took 9 years to reach this victory.
PROTECTING YOUR INVESTMENT CONT.
Investment Risks cont.
2. India only has 15 years’ experience in opening markets. The regulatory environment still evolving rapidly- expect change.
3. Corruption is still rampant in India- not so much top-level corruption (e.g. receipt of project permits as permit requirements are reduced), but “frictional” corruption across the lower levels - inspectors, meter readers, etc.
4. Choose your states wisely. Each has different level of development and different levels of market-friendliness.
5. Relations with key neighbors- China & Pakistan- as good as ever, but a positive course not set in stone.
6. Potential for radicalization of India’s government exists should economic reform program backfire.
7. India has a growing Maoist movement- Naxalites- along eastern part of country. Appears to be growing.
8. State elections rarely are good for the incumbents. Expect political instability every 5 years.
9. India still has antiquated labor laws, making it difficult to hire short-term workers or to lay off employees.
10. Contract sanctity remains a major stumbling block.
PROTECTING YOUR INVESTMENT CONT.
C.Mitigating Investment Risks
1. Use India’s tax treaty country partners as pass-through (Mauritius & Singapore).
2. Encourage corporate culture of saying “no” to corruption. Once a company is recognized as clean, attempts to collect payoffs will drop.
3. Join trade associations/ find sources of information to learn about and influence potential regulatory changes.
4. Do not “dip your toe in the water”. If you decide to enter India, it requires attention and commitment. In nearly every industry, foreign companies compete effectively and profitably.
5. Obtain political risk insurance from U.S. OPIC – a must for infrastructure projects.
X. PROBLEM AREAS FOR INVESTORS
A. Restricted sectors or Low FDI caps - multi-brand retail trade (banned), insurance (26%), print news media (26%).
B. Power investments - contract sanctityC. Purchase Preference Policy- gives state and
GOI-owned companies a 10% bid amount preference in government contracts.
D. Television carriage regulations favor distributors (i.e. cable companies), not content providers (i.e. companies that provide the channels).
1. Content providers are required to provide content to all distributors irrespective of price.
PROBLEM AREAS FOR INVESTORS CONT.
E. Foreign investors cannot invest in existing real estate assets, but can invest in undeveloped real estate.
1. Need for an independent real estate regulatory body.2. Single window clearance should be introduced.3. The Reserve Bank of India (RBI) is holding up the issuance by
the GOI Securities & Exchange Board of India (SEBI) of the required Foreign Venture Capital Registrations (FVCIs) necessary for FDI real estate investments from foreign funds. Such FIPB approval is markedly-less beneficial for foreigner investors, as those investors will encounter onerous GOI share pricing compliance and other problems at investment exit.
F. Need for independent regulator for oil & gas distribution.1. Administrative Price Mechanism presently distorts the market
and makes private distribution uneconomical.G. Increase the default limit for FII investments - 24% equity
now – seek to be in-line with sector FDI caps.1. An FII can only invest up to 24% in an Indian company, except
for special approval from GOI & RBI.
PROBLEM AREAS FOR INVESTORS CONT.
H. Stabilize tax environment- tax regulations change frequently, with tax incentives regularly added and dropped.
I. Heavy regulation of labor- difficult to scale down during economically-depressed times.
1. Difficult to attract contract labor for short-term projects.2. If more than 100 employees then need express approval
from Ministry of Labor.J. Requirement for No Objection Letter from a previous JV
partner where subsequent investment is in the same field – potential for abuse.
K. Poor Infrastructure acts as deterrent to foreign investment in manufacturing sector – must privatize government-owned enterprises to attract substantial necessary foreign capital.
L. High Tariffs – must lower tariffs on raw materials & imported goods, cover IT & telecom products into zero duty scheme – India continues to have the highest customs duty rates in Asia.
PROBLEM AREAS FOR INVESTORS CONT.
M. Must rationalize complex transfer pricing rules & reduce penalties – increase the low US$1.1 Million level of permitted transfer pricing before a mandatory audit is initiated.
N. Expiration of the Software Technology Park 10-year tax exemption in 2009 unless extended. Moving the existing new IT companies at the end of the tax holiday into a Special Economic Zone (SEZ) to obtain the benefit of the full SEZ 10-year holiday is not achievable under the current SEZ statute.
O. Must rationalize GOI procurement processes and licenses – ending the 10% state and GOI-owned company purchase preference agreement and adoption of international best practices.
P. Foreign Banks must be allowed greater market participation to augment the development of the banking market and introduction of new products and services.
Q. Unregulated IT/BPO sector.1. additional training for criminal investigators, judges and lawyers.2. improvement in tax environment.3. inflexible labor regulations must be made flexible.
XI. CONCLUSIONIn nearly every sector of the
economy, there are examples of foreign investors who have had
success in India.
Don’t be deterred by initial problems. Plan your investment well. Remain committed. And be prepared for an exciting time.
Contact Info: Mark J. Riedy
PartnerAndrews Kurth LLP1350 I Street, NWSuite 1100Washington, DC 20005
P: 202.662.2756F: 202.662.2739C: 703.201.6677
USIBC1615 H Street, NWWashington, DC 20062
P: 202.463.5679F: 202.463.3173
www.usibc.com