Has India had a worse year in recent memory? The news throughout much of 2012 has been far from good: A stuttering economy, government vacillation over hard decisions, political gridlock, the falling rupee, soaring inflation and corruption scandals to name just a few, capped off almost tragicomically by a massive power cut that kept 600 million people in the northern part of the country in the dark for about three days. The general handwringing that has accompanied all of this has been about how India, not so long ago a darling of foreign investors, and considered a worthy competitor to China in the emergingmarket stakes, had lost its sheen, and was possibly moving in the opposite direction.

But now the smiles are slowly coming back. The past month or two have had positive developments from a variety of quarters. In September, the Indian government announced a slew of policy measures that included permitting foreign direct investment (FDI) in the controversial multibrand retail sector, which means that international retailers like Wal Mart, Tesco and Carrefour can set up and own 51 percent of their retail business in India. The hugely unpopular General Anti Avoidance Rules (GAAR) provisions in the Indian Income Tax Act were referred to an expert committee that clarified in what instances the GAAR provisions should be applied, and also recommended postponing implementation by three years. Then the Supreme Court last week passed a landmark judgment limiting the amount of intervention possible by Indian courts in an international arbitration having its seat outside India. And finally, India’s cabinet last month approved bills to liberalise foreign investment in insurance and pensions, and these now await passage through parliament [see box on page 17].

All these have certainly come as good news to various industry stakeholders, including lawyers. Sridhar Gorthi, a partner at Trilegal, says that the developments aim to put India back on the liberalisation track. “The government has sent a very positive signal; that it is keen to return the country to the path of liberalisation. India’s slowly coming back on the map,” he says. While it’s hard to tell if these measures in themselves will affect a turnaround, Gorthi adds, they are certainly laudable. “There has been a fair amount of stagnation of growth,” he says. “Not all the factors causing this stagnation will be addressed by the economic liberalisation, but some of them will. Particularly in our business, as legal advisers to domestic and international corporations doing business in India, it’s really positive.”

FDI: THE BIG BANG

In less than 24 hours in the middle of September, Indian Prime Minister Manmohan Singh unleashed a slew of economic reforms that stunned the world, including parties in his coalition. Dubbed the “big bang” reforms, these included a hike in diesel prices, disinvestments in four state owned companies, and most eyecatchingly, the introduction of FDI in multibrand retail, aviation and broadcasting.

According to Azmul Haque, partner and cohead of the India practice at Shook Lin & Bok, the introduction of FDI in the retail sector a year after the Indian government had backtracked on plans to open up the supermarket sector, counted as the most exciting of the announced reforms. “The opening up of the retail sector has been eagerly anticipated, and after the ‘aboutface’ on retail policy earlier last year in the face of political opposition, this is probably doubly welcome news,” he says. “Apart from the anticipated benefits in terms of shoring up a decelerating economy, improving supply chain infrastructure and generating employment, the decision itself is a welcome sign that the Indian government can shake off accusations of ‘policy paralysis’ and implement investment reforms when required.” Gorthi agrees. “The reason is that it has been anticipated for so long, and there are so many companies that have lined up their India plans at various stages of preparation,” he says. “We’ve een involved with some of them. So for some of our clients, it’s a very exciting development.”

However, lawyers are worried about a number of conditions and restrictions tied to the liberalisation, including one that allows individual states to decide whether they want to allow FDI in multibrand retail or not. “That’s never happened in any category of FDI before,” he says. “It’s very difficult to predict how that will play out. We’re looking for further information and clarity that will hopefully emerge over the coming few months.” Haque notes that there are some structural hiccups. “Only 10 states have so far agreed to implement the decision, and this will make it difficult for foreign retailers to roll out nationwide operations and a comprehensive supply chain,” he says. “Also, the requirement imposed on multibrand retailers to source 30 percent of their goods from local small and medium sized enterprises may pose challenges for nonF&B retailers in entering the market.”

The immediate impact, Haque says, will be to benefit the foreign single brand retailers. “I expect there will be a few prominent single-brand investments in the apparel and restaurant segment,” he adds.

Additionally, India has allowed foreign airlines to buy stakes of up to 49 percent in local carriers, in a much awaited policy move that provides a potential lifeline to the country's debt laden airlines by opening up a fresh source of funding. “Opening up the aviation sector to investment by foreign airlines was a policy change necessitated by the precarious condition of ailing Indian carriers who have been under severe financial stress,” says Haque. “However, it is unlikely that airlines like (severely debt laden Indian airline) Kingfisher will have many suitors the more likely scenario is that foreign airlines will set up new airlines in India in conjunction with new local partners in the aviation business.” Gorthi adds that there is “nothing ground breaking” about the move. “It’s been on the cards forever. It’s hard to see why this took so long,” he says.

GAAR: ANOTHER LOOK

The draft GAAR guidelines, first unveiled in June, were heavily criticised by both Indian businesses and international investors resulting in Singh forming an expert committee to provide further recommendations.

Haque says that the overarching principle that runs through the recommendations is that the GAAR provisions should be applied only in case of arrangements which are very clearly abusive, contrived and artificial. Additionally, to the relief of many, the recommendations state that the implementation of GAAR should be deferred by three years until April 2016 in order to ensure the relevant mechanisms are in place; existing investments as of the date of commencement of GAAR should not, upon exit, attract GAAR provisions; and income tax on gains arising from transfer of listed securities should be free from income tax.

According to Haque, the introduction of GAAR in the Income Tax Act was a knee jerk reaction to the recent Indian Supreme Court judgment which held that the Indian tax authorities had no basis to tax the sale by a non Indian subsidiary of indirect assets in an Indian telecom company, Hutchinson Essar. “Seeking to retrospectively tax such headline M&A deals can only have an outcome of hurting foreign investor confidence and an outflow of foreign funds, given the uncertainty that has been created,” he says, adding that deferring of GAAR implementation and the recommendations on existing grandfathering of existing investments “are both good recommendations” made by the expert committee to ensure existing investors are not prejudiced by the GAAR rules upon exit. “However, there is much criticism of the broad discretion proposed to be given to Indian tax authorities to override arrangements under Indian’s double tax treaties,” says Haque. “Mauritius’ status as India’s largest investor on paper may be impacted – possibly to Singapore’s advantage.”

Gorthi of Trilegal calls the recommendations “very positive.” He notes that when GAAR was first unveiled, there was a huge uproar because “it was a recipe for disaster”, as it reversed the burden of proof by requiring that the assessees prove that they were not avoiding tax. “That was watered down in the initial draft, and the Shome committee put it beyond question,” he says. “Pushing implementation back for three years gives people enough time to restructure if they have to, or apply their minds to see how they can become GAAR compliant.” He adds that the recommendations also clarify that the availing of a treaty benefit cannot be struck down using GAAR. “That’s really crucial, because we were worried that inbound investment using Mauritius SPVs for tax benefits would be called into question a few years later,” he says. “This was leading to immense amounts of delays in M&A transactions, and a lot of unnecessary negotiations around whether Mauritius benefits would be available or not. The recommendations should go some way to put those discussions to rest, and let people get on with business.

ARBITRATION: A LANDMARK JUDGMENT

In Bharat Aluminium Co v Kaiser Aluminium Technical Services Inc, the Supreme Court overruled an earlier controversial judgment that allowed Indian courts to set aside foreign arbitral awards on grounds that they were contrary to Indian law. With the Bharat Aluminium judgment, however, Indian courts can only set aside or annul an award that is made in India, making it consistent with international arbitration law and practice which state that as an arbitral award can only be set aside by the courts of the seat of the arbitration. Additionally, the Supreme Court has held that the provisions relating to interim relief do not apply to a foreign seated arbitration, and so, it will no longer be possible for parties to apply to Indian courts for interim relief such as freezing assets or bank accounts, or obtain an anti-suit injunction in support of arbitration outside India.

Gorthi says that the judgment answers a lot of questions that were in the air, and which always led to delays and a lack of clarity; not just when parties were in a dispute and invoking an arbitration clause, but also when they were working on a deal and negotiating an arbitration agreement. “There was very little clarity about things like the sanctity of an international arbitration process, and the ability of Indian courts to interfere in that process,” he says."This judgment really does address that quite satisfactorily. It will provide a measure of comfort to international companies that are entering into arbitration agreements with Indian counterparties.”

Haque agrees that it is a positive development for foreign investors, “who can now be assured that international arbitration involving Indian counterparts outside India provides a stable and predictable dispute resolution mechanism when doing business in India with their Indian counterparts."

However, the Supreme Court has declared that the judgment will only apply prospectively to arbitration agreements executed after the date of the decision. This means that current and future arbitration proceedings initiated under an arbitration agreement prior to this date could still be subject to judicial intervention by the Indian courts. Understandably, this has lawyers concerned. “I can understand that you don’t want to move the goalposts for existing arbitration matters that are before various courts. But in cases where the arbitration agreement has not been invoked, I would have thought that the judgment should have applied to them,” Gorthi says.

RISING INTEREST

What these developments have combined to do, though, is increase the level of interest among foreign investors for India. “It’s still early days, but as a result of this, enquiries have gone up,” says Gorthi. “As I mentioned, we’re talking to clients in insurance, we’re talking to clients who are already here as wholesale cash and carry operations, and looking now to expand into multibrand retail trading. Obviously as a result of all of this, there has been an uptick in work enquiries. He adds that aviation is another sector that’s clearly “another area of interest” for his firm.

Haque says the introduction of these measures has seen an uptick in India inbound activity generally. "If you are an international MNC or private equity investor, India is a jurisdiction that you can't ignore," he says. "The expert committee recommendations around GAAR implementation have assuaged some fears thought it may have prompted more exits than investments in recent weeks.” Additionally, he says that the clarity brought in by the Bharat Aluminium judgment has been a welcome development for foreign investors who want to avoid intervention of the Indian court system.

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