India WatchISSUE 18 OCTOBER 2012

In association with

Welcome to the Autumn edition of Grant Thornton’s India Watch, in association with the London Stock Exchange

multi-brand retailers and allow them to sell directly to Indian consumers for the fi rst time. Certainly a step in the right direction, especially for the current Congress-led government which has struggled to implement any signifi cant economic policies in the eight years it has been in power.

Lastly, we give an update on the transfer pricing regulations and explain the major amendments to the rules, including the Advance Pricing Agreements (APA).

If you would like to discuss any of the matters arising in this issue or how Grant Thornton’s South Asia group can help you please contact us.

In this issue we highlight that the Grant Thornton India Watch Index continues to remain strong, although this quarter saw underperformance against its peer indices. Investors’ concern over the slowing down of the Indian economy, depreciation of the Indian Rupee and the political uncertainty surrounding economic reforms was refl ected in the third quarter.

Overall M&A activity continued to remain subdued in Q3 2012, with the quarter clocking up USD 4.42 billion in deal values, vis-à-vis USD 5.91 billion for the same quarter of 2011; domestic M&A however, continued to buck the trend, as with the previous quarters of the year. Private equity also showed an uptick: PE deals notched up a total of USD 2.31 billion in value for Q3 2012, as against a total deal value of USD 1.91 billion for Q3 2011.

On the back of persistent economic unease, Indian policy makers announced new economic reforms in September. The new reforms, if implemented, will pave the way for global businesses to buy up to 51% of the country’s

Anuj Chande Partner, Corporate Finance and Head of South Asia GroupGrant Thornton UK LLPT +44 (0)20 7728 2133 E anuj.j.chande@uk.gt.com

Munesh KhannaSenior PartnerGrant Thornton India LLPT +91 22 6626 2600E munesh.khanna@in.gt.com

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India Watch - Issue 18 October 2012

Grant Thornton India Watch Index saw underperformance against its peer indices this quarter

The Grant Thornton India Watch Smaller Caps Index outperformed FTSE100 and FTSE AIM All Share Index over the nine-month period, closing 8% up compared to FTSE 100’s 3% rise and the 2% increase in FTSE AIM All Share Index, however the Grant Thornton India Watch Smaller Caps Index declined marginally by 2% in the quarter.

80

90

100

110

120

130

Sep 2012Aug 2012Jul 2012Jun 2012May 2012Apr 2012Mar 2012Feb 2012Jan 2012

–– GT India Watch – ALL

–– FTSE 100

–– FTSE AIM ALL-SHARE

–– GT India Watch – smaller caps

–– FTSE ASEAN

–– FTSE AIM 100

–– FTSE AIM UK 50

Source: Thomson Datastream

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The power sector had a mix bag with some companies recovering the ground lost in the previous quarter while Jubilant Energy, Mytrah Energy, KSK Power and Essar were not so resilient. The third quarter saw a good come back by Greenko, up 13%, due to strong operating results. Also, Nandan Cleantec (an India-based biofuel producer), was up by 11% to 67p by the end of the third quarter. OPG Power Ventures was the clear winner in the Index with a 47% rise in Q3 driven by a string of positive news. The company achieved fi nancial closure for its 80MW Chennai IV power project in August, followed with successful commissioning of its 77MW Chennai II plant in September 2012. It appears that investors fi rmly believe in the growth potential of the company which is expecting to increase capacity from 190MW now to 742MW by 2014.

Investors remained cautious over the real estate and infrastructure sector, perhaps refl ecting the sensitivity to high interest rates, rising input cost due to high infl ation and delays in getting regulatory clearances. West Pioneer continued its decline in Q3 and lost 57% in the quarter mainly due to wider macro-economic factors. However, timely development of the Kalyan mall, near Mumbai should provide boost to its share price.

Infrastructure India had a busy quarter. The share price dropped signifi cantly in July when it announced plans to raise new funds to meet short term funding requirement. As a sign of confi dence in the long term growth prospects of the Indian infrastructure sector, the company successfully

raised approximately £41 million by placing new shares at 33p in August 2012. It was a similar case for Oilex. The Company raised approximately £4.75 million via a fully underwritten rights issue to fund the development of is project at Cambay Basin, Gujarat. The share price lost 41% in Q3 due to the cash call and potential dilution, however, the successful development of the Cambay project should provide substantial upside to investors in the medium term.

In spite of tough fund raising conditions in the UK, the dragging of the Eurozone crisis and the slowdown of the Indian economy, the secondary fund raising witnessed in the third quarter, emphasises the long term growth prospects of Indian small caps.

Anuj Chande Partner, Corporate Finance and Head of South Asia GroupGrant Thornton UK LLPT +44 (0)20 7728 2133 E anuj.j.chande@uk.gt.com

* The India Watch Index consists of 31 Indian companies listed on AIM or the Main Market (excluding GDRs). We only consider companies to be Indian if they are domiciled in India and/or foreign companies holding Indian assets or Investment companies with Indian promoters. The index has been created via Datastream, a Thomson Reuters product and is weighted by Market Value. To avoid distortion of index trends, the two largest market cap entities, Essar Energy and Vedanta Resource, are excluded.** Data sourced from Thomson Reuters.

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India Watch - Issue 18 October 2012

July - September 2012 M&A dealscapeOverall M&A activity for Q3 2012 continued to decline by about 34% and 24% in value and volume terms respectively, as compared to the corresponding quarter of 2011. However, there

Home run: Domestic M&A and PE shore up deal activity in the face of cross border caution

Overall M&A activity continued to remain subdued in Q3 2012, with the quarter clocking up USD 4.42 billion in deal values, vis-à-vis USD 5.91 billion for the same quarter of 2011; domestic M&A however, continued to buck the trend, as with the previous quarters of the year. Private equity also showed an uptick: PE deals notched up a total of USD 2.31 billion in value for Q3 2012, as against a total deal value of USD 1.91 billion for Q3 2011.

is a distinct trend – both inbound and outbound activity has fallen in 2012, whereas domestic M&A activity, including internal restructuring exercises, has continued to largely buck the trend through the year.

Q3 Deal Summary Volume Value (USD billion)

Year 2010 2011 2012 2010 2011 2012

Inbound 19 35 24 1.19 2.63 0.77

Outbound 36 27 31 0.63 3.16 2.75

Cross Border 55 62 55 1.82 5.79 3.52

Domestic 41 59 46 0.69 1.11 1.29

Mergers & Internal Restructuring 30 27 11 11.00 0.53 0.08

Total M&A 126 148 112 13.51 7.43 4.88

PE 58 90 91 1.71 1.87 2.24

QIP 16 3 1 2.18 0.27 0.08

Grand Total 200 241 204 17.40 9.57 7.2

Deal summary: July - September 2012

Quarterly Trends Domestic

M&A Trend*Cross Border: Inbound Trend

Cross Border: Outbound Trend

USD Bn 2011 2012 2011 2012 2011 2012

Q1 2.4 16.32 13.75 1.26 1.73 0.69

Q2 1.00 1.24 6.74 3.61 4.26 1.45

Q3 1.64 1.36 2.63 0.77 3.16 2.75

*Includes Internal Restructing

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Top M&A sectors: July - September 2012

Acquirer Target SectorDomestic/Crossborder USD million

ONGC Videsh Hess Corp-Azeri, Chirag and Guneshli Oil & Gas Outbound 1,000.00

GMR Group United Fiber System Ltd Engineering Outbound 598.00

Lodha Developers Jwala Real Estate Real Estate Domestic 490.91

Grasim Industries Terrace Bay Pulp Textile & Apparels Outbound 360.00

Infosys Ltd Lodestone Holding AG IT & ITeS Outbound 349.00

Hospira Inc Orchid Chemicals & Pharmaceuticals Pharma, Healthcare & Biotech Inbound 200.00

Dalmia Cement (Bharat) Ltd Adhunik Cement Cement Domestic 197.27

Crompton Greaves Ltd ZIV Group Electricals & Electronics Outbound 192.00

Chemtura CorporationSolaris Chemtech (bromine manufacturing & distribution business)

Manufacturing Inbound 142.00

Adcock Ingram Holdings Ltd COSME Farma Laboratories Ltd Pharma, Healthcare & Biotech Inbound 96.00

This tepid performance on the cross border M&A front is explicable considering many of the factors that reined in inbound and outbound M&A activity in the fi rst three quarters of 2012: decreasing GDP growth forecasts, stubborn infl ation and interest rates on the home front, and the slow pace of European economies in coming away decidedly from the brink.

However, September 2012 saw some good news on the policy front, with measures such as the opening up of the multi-brand retail sector being announced by the Indian government. Whilst investors are treating the reforms with cautious optimism, these reforms are expectedto lead to heightened deal activity in the coming months.

The domestic and global uncertainties notwithstanding, India Inc. put in a robust performance on the domestic deal activity front with acquisitions, both 100% and majority1, featuring prominently.

Oil and Gas earned top spot due to the September outbound deal announcement by ONGC Videsh Ltd. The company signed defi nitive agreements for the acquisition of Hess

Oil & Gas [21%]

Engineering [12%]

Real Estate [11%]

IT & ITeS [11%]

Textiles & Apparels [9%]

Others [36%]

Top M&A sectors: July - September 20121 These two categories together contributed to more than 80% of domestic deal activity for Q3 2012.

Source: Grant Thornton Dealtracker database, July, August and September 2012 editions

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India Watch - Issue 18 October 2012

Corporation’s 2.72% participating interest in the Azeri, Chirag and the Deep Water Portion of Guneshli Fields in the Azerbaijan sector of the Caspian Sea and 2.36% interest in the Baku-Tbilisi-Ceyhan pipeline, for a reported USD 1 billion. This has put the spotlight back on a sector that saw signifi cant deal values in 2011, but had remained muted since due to policy issues, especially with respect to obtaining requisite clearances from various Indian regulatory authorities.

The real estate sector entered the top performers’ chart due to domestic M&A activity, led by Lodha Developers’ 100% stake acquisition of DLF’s subsidiary Jwala Real Estate for a reported USD 490 million. Siel Infrastructure and Estate Developers Pvt Ltd also undertook an internal restructuring exercise, while Providence Educational Academy and CHD Developers completed domestic acquisitions in the sector. We also expect to witness increased deal activity in the country going forward, propelled by many factors – PE investments into this sector from 2003 – 2007 vintage funds are now potentially at the end of their cycle and likely to be looking for exits through secondary and strategic sales in the face of depressed IPO markets; basic sustained demand in the affordable housing sector; increasing debt, in the wake of high interest rates and slow demand for corporate spaces.

The IT&ITES sector, which also featured as a top performer in Q1 and Q2 2012, contributed to 11% of deal value in Q3 2012. A prominent deal in this space on the cross border front was Infosys Ltd’s outbound acquisition of Lodestone Holdings AG for a reported USD 349 million,

Investor Investee Sector USD million Bain Capital Genpact Ltd IT & ITeS 1000.0

Macquarie SBI Infrastructure Fund, SBI Macquarie Infrastructure Trust

Ashoka Concessions Ltd Infrastructure Management 150.0

Naspers, Tiger Global Flipkart Online Services IT & ITeS 150.0

Citigroup Venture Capital International Cox & Kings's Unit Prometheon Holdings Travel & Tourism 137.8

Standard Chartered PE Inox India Ltd (INOXCVA) Manufacturing 45.0

Blackstone SH Kelkar & Company Pvt Ltd FMCG, Food & Beverages 44.4

Brick Eagle Capital Xrbia Developers Ltd Real Estate 40.0

Actis AGS Transact Technologies IT & ITeS 40.0

Goldman Sachs Nova Medical Centers Pvt Ltd Pharma, Healthcare & Biotech 40.0

Red Fort Capital Prestige Estates Real Estate 36.4

Top PE deals: July - September 2012

while domestic deal activity saw Tata Consultancy Services acquiring Computational Research Laboratories, among other deals. We expect the IT&ITES sector to continue to contribute to deal activity in the coming months.

Other sectors expected to witness substantial M&A activity are retail and aviation. The recent policy announcements widening the scope of foreign investment in these sectors are expected to see large foreign players entering the vast Indian retail sector and the troubled Indian aviation sector, by partnering with existing Indian players, while also leading to some consolidation in the space.

An overall analysis would seem to indicate that outbound and domestic deals have driven M&A activity for the quarter, indicating that India Inc. in itself remains confi dent of internal and external prospects.

Private Equity: Supporting deal activityPE deals in Q3 2012 clocked up USD 2.24 billion in deal value, as against a total deal value of USD 1.87 billion for Q3 2011, representing a circa 20% increase. Deal volumes also increased for the quarter at 91, vis-à-vis 90 for the corresponding 2011 quarter. This quarter has also seen the highest PE deal value for the year so far.

The IT&ITES sector topped the PE charts, contributing to 59% of the deal activity for the quarter. The largest deal in this space was Bain Capital’s purchase of a 30% stake in Genpact Ltd from existing PE investors General Atlantic and Oak Hill Capital Partners, for a reported USD 1 billion, indicating an increasing trend of secondary and strategic sales being used as exit options by PEs. Many other deals in this space

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India Watch - Issue 18 October 2012

Karthik Balisagar Associate Director and Assistant Head of Valuations South Asia GroupGrant Thornton UK LLPT +44 (0)20 7865 2475 E karthik.balisagar@uk.gt.com

With special thanks for their contribution to Ankita Arora and Swetha Sunder of Grant Thornton India Dealtracker team.

IT & ITeS [59%]

Infrastructure Management [7%]

Travel & Tourism [6%]

Real Estate [4%]

Pharma, Healthcare & Biotech [6%]

Others [18%]

Top PE sectors: July - September 2012were in the e-commerce subsector, including Nasper’s and Tiger Global’s investment in Flipkart Online Services Pvt Ltd, Accel Partners’ investment in Big Tree Entertainment Pvt Ltd, and an investment into Bigshoebazaar by Fidelity Growth Partners India, Qualcomm Ventures, Nexus Venture and Catamaran Ventures.

The overall PE performance in the third quarter also points to a trend of PE becoming an increasingly accepted source of fi nancing in India against the backdrop of dormant capital markets, high cost debt and a gradually evolving Indian entrepreneurial class willing to sell out or work with professionals.

OutlookWhile M&A activity in the quarter has thus far provided little to cheer about, the fl urry of activity on the policy front in September may well pin down Q3 2012 as the turning point in the fortunes of India Inc. The Indian government in September announced its decision to allow 51% FDI in multi-brand retail and 100% FDI in single-brand retail, while also opening up the aviation sector.

The freeing up of the retail sector is expected to directly improve domestic and inbound activity, with players such as the Tata Group, Aditya Birla Group and Arvind Ltd already announcing domestic consolidation plans2, and foreign players such as Walmart and Carrefour expressing keen interest in the country, as per media reports. Knock-on effects are also expected to be seen in related sectors such as logistics, storage and real estate. Aviation is also expected to see some inbound activity.

Although policy measures could boost economic activity, it remains to be seen if these can be executed without friction. There appears to be a political vacuum on such policy changes and without adequate consensus there is also a looming threat that implementation of such policies could be painfully slow or in the worst case could be jettisoned with a change in government.

Further, an overall increase in foreign investor confi dence in India Inc. and lacklustre IPO markets may also lead to an increase in PE exits through strategic or trade sales, which could lead to a further increase in M&A activity.

2 Source: Livemint, 27 September 2012

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India Watch - Issue 18 October 2012

888888888

Munesh KhannaSenior PartnerGrant Thornton India LLPT + 91 22 6626 2600E munesh.khanna@in.gt.com

In addition, India’s export market continued to feel the strain of the world’s on-going austerity with factory output falling, for the third time in four months, by around 1.8% against the previous year. Lower export earnings and disappointing direct foreign investments resulted in an almost 15% pressure on the Indian rupee.

It was on the back of this persistent economic unease, among other things, that Indian policy makers announced new economic reforms and policy initiatives in September. The new reforms, when implemented, will pave the way for global businesses such as Wal-Mart and Tesco to buy up to 51% of the country’s multi-brand retailers and allow them to sell directly to Indian consumer for the fi rst time. The new reforms include a cut in the country’s diesel subsidies as well as a loosening of the rules on foreign investment in airlines and TV, and an agreement to sell off stakes in four state owned companies. The policy initiatives address the need to have a more transparent tax and regulatory regime and more openness to attract foreign direct investment.

While India’s Prime Minister and Finance Minister, have publicly stated that the reforms and policy initiatives were needed to revive investor confi dence, they have been aggressively opposed by India’s trade unions and have resulted, not only in the resignation of a number of coalition party government ministers, but also a nationwide strike.

Ironically, the strikes caused by the reforms, have cost the Indian economy an estimated loss of USD2.25 billion, according to the Confederation of Indian Industry.

Nevertheless, the reforms and policy initiatives are likely to have a much more benefi cial impact on India’s economy over the long-term. Some analysts believe they will help jump-start an economy which over the last few years has seen a signifi cant reduction in its growth rate. On the

An update on the Indian economy

other hand though, while many are pleased that the Government is beginning to react to the country’s declining growth rate, they are concerned that the new policies do not go far enough. They also question whether the reforms will actually be implemented effectively in the face of increasing opposition from political allies and opponents as well as taking into consideration the country’s long history of ineffective policy reform.

What can certainly be said, however, is that while it will be some time before the effi cacy of these new reforms can be measured, it is certainly a step in the right direction – especially for the current Congress-led coalition government which has struggled to implement any signifi cant economic policies in the eight years it has been in power.

In summary, while India’s economy came out of the ‘credit crunch’ in a much better position than most due to, among other things, a well regulated fi nancial sector and high domestic consumption, it now seems widely accepted that if India is to get back to growth rates of over 9%, it will need the help of carefully managed external capital and, it might just be these reforms that relieve the downward pressure on India’s economy.

As reported in the last India Watch economic update, India saw real GDP fall to around 6.5%, for the fi nancial year ended 31 March 2012, down from the 8.4% recorded in the previous fi nancial year. Furthermore, the fi nal quarter of the fi scal year saw Indian GDP grow at its slowest rate since 2003.

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India Watch - Issue 18 October 2012

Facelift to the decade long Indian Transfer Pricing Regulations

One of the key amendments introduced by the government is the applicability of transfer pricing regulations for specifi ed domestic transactions (SDT) with effect from 1 April 2012 if the value of transactions exceeds approximately USD 1 million. This change in law was a fallout of the thought-provoking Supreme Court case of Commissioner of Income Tax IV, Delhi v GlaxoSmithKline Asia Ltd, wherein the court stated that the ambit of TP should be widened to include domestic transactions where tax arbitrage opportunities are available, eg profi t shifting between a loss-making and a profi t-making entity or between a company enjoying a tax holiday and a company operating at the marginal tax rate.

The other amendments include widening the scope of international transactions to include business restructuring transactions, the introduction of penalties for non-reporting of transactions (2% of transaction value), increasing the scope and powers of revenue and tinkering with the arm’s length range from 5% to 3%.

Some of these amendments are introduced retrospectively thus changing the status quo of the open litigation issues. These amendments will have far reaching effects on the taxpayers.

Advance Pricing Agreements (APA)One of the most positive outcomes of the recent amendments is introduction of the APA regime. The APA rules have heralded the beginning of the much awaited dispute resolution mechanism in the Indian transfer pricing environment. Though the government announced the introduction of the APA in the Finance Act 2012, the detailed rules were out on 30 August 2012.

The APA rules defi ne an APA as an agreement between the Central Board of Direct Taxes (CBDT) and any person, which determines, in advance, the arm’s length price or specifi es the manner of the determination of arm’s length price (or both), in relation to an international transaction. The salient features of the APA rules are:

• applicable to all persons undertaking or proposing to undertake international transactions• provide for unilateral, bilateral as well as multilateral APAs• applicable for a time period not exceeding 5 years• depending on the value of the international transaction, the fee range from INR 1 million to INR 2 million the taxpayer is given an option to amend, withdraw or renew the application• APAs to be entered by the Central Board of Direct Taxes (CBDT) with the approval of Central Government.

The Indian Transfer Pricing (TP) regulations have undergone a sea change in the past few months. Since the inception of the regulations, transfer pricing has emerged as the biggest area of tax dispute.To address such disputes, the government introduced various amendments in the TP regulation in the Finance Bill 2012.

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India Watch - Issue 18 October 2012

The APA process

The negotiation process

Board Approval

APA Team (APA director and APA officers)

Taxpayer

Discussion

India United Kingdom

Tax authorities including experts from econmics, statistics, law etc.

Bilateral /MultilateralUnilateral

Competent Authority

Associated Enterprise (AE)

DG International Taxation

Competent Authority

• Pre filing conference

Deficiency letter within 1 month

Pre-analysis Application Post compliance

Renewals

Roll backs not enabled

• Application• PRELIMINARY SCREENING• Negotiation• Execution

• Annual Compliance Report• Annual Compliance Report

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From a tax payer perspective, some of the concerning aspects that are not covered under the rules are: no roll backs, no defi nitive time frame to conclude an APA and a lack of fi rewall provisions. While rollbacks are not enabled, the authorities believe that they would defi nitely have a precedence value in case of pending litigation. However, while entering into an APA, the taxpayer in India would not only need to conduct feasibility study of Indian APA rules but also undertake the cost-benefi t analysis of APA rules of the other countries in case of bilateral or multilateral APAs.

For example, when entering a APA in the UK pre –fi ling meetings are optional, there are no fi ling fees and the UK rules provide for a timeframe of 18 to 21 months from the date of the formal submission to conclude an APA. Thus for an India-UK APA, even though Indian rules do not mention a time frame to conclude the APA, since the UK has a timeframe, the same could act as a guideline.

The benefi ts of an APA are several, ie provide tax and fi nancial certainty to the taxpayer, avoid penalties, avoid double taxation, plan for future TP strategies and reduce time-cost and effort in the transaction.

Case StudyThe below example highlights how an APA can provide certainty to the taxpayer:

Company M is headquartered in the UK. It is engaged in the manufacturing of Fast Moving Consumer Durable Goods (FMCG). Company M is the legal owner of the brand, technology and know-how of the products.

Company M has a subsidiary in India, ie Company D. Company D acts as an exclusive full-fl edged distributor in India of Company M’s products. It does not own any intangible property. To be able to sell in a competitive

market, Company D incurs more than normal marketing and advertising expenditure (like any full-fl edged distributor).

The tax authorities in India are challenging this non-routine marketing and advertising expense. Interestingly, the Indian tax authorities have two different views on such expenses.

One view of the tax authorities is that such non-routine expenses should be recovered from the legal owner of the brand by way of cost plus mark up. Another view is that Company D has created marketing intangible in India and should earn a share of global profi ts, ie profi t split method.

Given the above background, the APA route may provide certainty to the taxpayer, the transfer price would be decided in a cohesive manner and both companies would avoid the risk of double taxation.

The introduction of Indian APA Rules is a silver lining to the tough transfer pricing audit regime in India. It aims to reduce a lot of litigation time and cost of the taxpayer and tax authorities if adopted in the right spirit. Given the pragmatic approach of the government, the APA mechanism should stand the test of time.

Karishma R PhatarphekarPartner and Practice Leader Transfer PricingGrant Thornton India LLP T +91 22 6626 2625E karishma.rp@in.gt.com

About usGrant Thornton UK LLP established a dedicated South Asia Group in 1991 to serve Asian owned businesses in the UK as well as those investing into and from the Indian subcontinent. We are proud to be one of the fi rst UK accountancy fi rms to focus on this region.

We are widely recognised as one of the leading international fi rms advising on India-related matters and have been in involved in every IPO involving an Indian company on AIM, with the exception of the real estate sector.

For those clients requiring advice in both the UK and India we offer a seamless service building on the already strong and close relationship between Grant Thornton UK LLP and Grant Thornton India.

International and emerging markets blogAs part of our commitment to remaining at the forefront of changes and developments in regards to UK-India relationship we will be using this space to post original thought leadership and research relevant to the industry. The idea is to encourage discussion around these issues and to open up new areas and debate.

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