The New Corporate Law in India: Difficulties in Organizing Private Equity Investments

Koushal Tanwar,

AURO University

The growth story of India in its various aspects and many colours has been driven and nurtured, through innovation and expansion, by the private equity (PE) form of investments. The much-hailed Companies Act, 2013, and the subsequent amendments were devised for the upholding of corporate governance and empathy in the interests of members and other stakeholders. However, some of its provisions carry unintended repercussions that impact PE investments, causing a disincentive, challenging India’s aspirations of being a preferred destination for foreign direct investment (FDI).

Overview of the New Corporate Regulatory Framework

The Companies Act, 2013, introduced several key provisions that impact PE investments in India:

Section 185: Basically, stops companies from giving loans to directors, which can change how private equity firms structure investments.

Section 42: Every dealer and adviser who offers or sells a security to the public shall meet certain conditions relating to the limitation of investors and ensure compliance with other applicable investment laws and regulations.

Section 62: A company must offer a proportion of new shares to its existing shareholders on any additional capital that it requires. This section basically means that when a company needs to raise capital, it has to offer proportionate new shares to existing retail shareholders, which could potentially dilute the stakes of PE investors.

These changes seek to enhance corporate governance as well as transparency but have nevertheless created complications for PE firms who want to invest in the Indian landscape.

Capital Structure: Challenges and Limitations

The Companies Act, 2013 and subsequent SEBI regulations have imposed various restrictions on the capital of private equity (PE) investments in India:

Article 62: Priority is given to companies existing new shareholdings in the issuance of Shares and This will likely dilute the equity capital of the PE market. This limits the flexibility of private equity firms to invest and negotiate good terms.

SEBI guidelines add requirements and restrictions for preference issues, such as price guidelines, lock-up period and shareholder approval. This reduces the number of changes private equity firms have to make to create a deal. Cost process and other restrictions make it difficult to invest using these instruments.

India's regulatory environment is considered to be less flexible and more restrictive in terms of private sector investment than many investor-friendly policies. Consider creating a special category with more flexible rules for private investment, similar to the Qualified Foreign Investment (QFI) criteria introduced by SEBI. To address these issues and align India's policies with global best practices, collaboration between the government, industry bodies like IVCA and regulators is crucial.

Dividend Distribution: Bottleneck on Returns

Dividend Distribution Tax (DDT) is payable to companies’ distributing dividends under Section 115QA and was introduced to the investor in the Companies Act 2013. Significant growth was affected by the Companies Act 2013, especially in terms of capital structure and dividends.

It reduced dividend payments as the studies show that DDT leads to lower dividend payments from Indian companies. This makes it difficult for private companies to generate capital returns through dividend distribution. This is because companies' income is taxed before it is paid out to shareholders, reducing the total amount paid. Successful exit strategies such as an IPO or stock sales. This impacts their ability to generate positive returns for investors. 

This structure represents the main basis of the private capital market, where a significant part of the return on capital is based on dividends. Lawmakers need to reconsider the DDT regime and explore options to make the corporate tax structure more efficient. Aligning India's dividend policy with international best practices could help unlock more private sector investment and boost economic growth.

The Need for Regulatory Harmonization

The look comes about highlight a few keys focuses with respect to the require for administrative harmonization to address the challenges confronted by private value (PE) speculations in India:

Creating a rare PE venture category is important. To keep up India's engaging quality for outside coordinate speculation (FDI), policymakers might consider making a distinct category for PE ventures, comparable to the Qualifying Remote Financial specialist (QFI) system presented by the Securities and Trade Board of India (SEBI). This might give more adaptability and great directions custom-made to the wants of the PE industry.

Studies have appeared that PE speculations drive financial development and work creation. A World Bank think about found that a 1% increment in PE venture as a rate of GDP leads to a 0.27% increment in GDP per capita[i]. Addressing the administrative challenges confronted by PE speculations in India will require collaborative endeavours between the government, industry bodies like IVCA.

Aligning India's Corporate policies with investor-friendly legislation

According to the survey results, India may consider making the following changes to enable its subsidiaries to participate in more investor-friendly regions such as Singapore and the United Kingdom

India, April 2020 announced that Dividend Distribution Tax (DDT) will be abolished and replaced with a dividend withholding tax effective. Similarly, the new 20% tax deduction[ii] (additional) allows foreign investors to claim reduced tax rates under Indian tax treaties, reducing the risk of paying double tax. This is an important step towards aligning Indian laws with international best practices.

Laws regarding the issuance of shares, transferable instruments and other assets in India are considered more restrictive than Singapore and the United Kingdom. Providing greater flexibility in these areas, similar to the regulatory framework in Singapore and the UK, could make India more attractive for private equity (PE) investment. This will allow private equity firms to develop investments and negotiate better offers. It is a tax resident that qualifies for tax benefits. Providing clearer guidance and security around this need could give foreign investors greater confidence in establishing their investments. This will help alleviate concerns about the uncertainty of the proposal.

Ensuring coordination and harmonization of corporate governance between central and state governments in India (similar to more unified governance in Singapore and the UK) could make it easier for entrepreneurs to follow. This will create better management and efficiency and make India more attractive for foreign investments.

Example: Infosys Limited

Infosys Limited, a major player in the IT services industry in India, has given a clear example of how Dividend Distribution Tax (DDT) affects personal investments and how to get rid of it. Like other companies, Infosys must pay DDT before distributing its reported earnings to shareholders. Tax is an additional 20.56% of total reported income (including additional fees and charges). Using DDT means shareholders, including PE investors, receive lower dividends. This reduces the overall return on their investment and makes Infosys less attractive to private investors who are looking to top earners in the world.

Instead, the tax burden shifts to business owners, who will be taxed at applicable tax rates. The withdrawal of DDT allowed Infosys to distribute more of the total profit, increasing returns to shareholders, including private sector shareholders. With better return potential and improved tax structure, Infosys becomes a better choice for private investors and facilitates greater investment in companies and businesses in India. India creates strong companies by scrapping DDT Companies like Infosys are attractive to private investors who want more money from their investments. This policy reform will bring India's tax structure in line with international standards, create a better investment atmosphere and encourage Indian companies to fortify investment opportunities.

Conclusion

The Companies Act, 2013 had a major impact on private equity (PE) investments in India, especially on capital structure and dividend payments. limitation on the issuance of preferred stock, convertible bonds and dividends make it challenging for private equity firms to make sound investments and provide positive returns to their business organisations. When investing in competition (FDI), policymakers should follow national laws with international best practices. This includes abolishing dividend tax, providing greater flexibility in capital structure, creating special categories for private investment, simplifying the approval process for foreign investment, and coordination between the central and state governments.

Collaboration between government, industry associations such as IVCA and regulators will be important to address these issues. Create a conducive environment for private sector businesses and increase greater flows of foreign direct investment. This will lead to the growth of business, innovation and employment in the country.

REFERENCES

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3. The Rise of India’s Private Equity Market | CAIA, https://caia.org/rise-of-india-private-equity-market (last visited Jul 6, 2024)

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[i] The Rise of India’s Private Equity Market | CAIA, https://caia.org/rise-of-india-private-equity-market (last visited Jul 6, 2024)

[ii] Impact of elimination of dividend distribution tax on Indian corporate firms amid Covid disruptions MDPI, https://www.mdpi.com/1911-8074/14/9/413 (last visited Jul 6, 2024)