India at the centrestage of global investments

GPS Education | 1 Article

Current Environment

The most significant development in the education sector in the past year was the announcement of the National Education Policy (NEP) 2020, which has the potential to transform the education system in the country.

Some of the key highlights of NEP 2020 include:

• Increasing government spending on education to 6% of GDP across the centre and states from the current levels of just over 4.43 %
• Formal integration of vocational education/skill building with schools and higher education through various mechanisms like inclusion of vocational courses as part of curriculum, using credit-based system covering both traditional and vocational courses for award of certificates/degrees/diplomas, offering of vocational courses by schools and higher education institutions (HEIs), etc.
• Segregating the regulatory and service delivery roles of the government through structural changes
• Focus on early childhood care and education, foundational literacy and numeracy, and vocational education
• Setting up of several education sector bodies, including National Education Technology Forum (NETF), National Higher Education Commission and National Research Foundation for leveraging new technologies in learning
• Increasing focus on research and development
•  Introducing four-year degree programmes in science, commerce, and arts, with multiple entry and exit points
• Transforming HEIs into large multidisciplinary universities, higher education clusters, and autonomous degree awarding colleges
• Internationalisation of education

From the perspective of Budget 2022-23, the key imperative is to augment public and private financing for undertaking the systemic infrastructure upgrade and transformation envisaged in NEP 2020. This would require:

• Enhancing the level of government funding both in terms of capex and opex, especially in technology upgradation, research facilities, physical infrastructure, and asset maintenance
• Addressing constraints faced by private universities to attract investments/funding, given that education is not a for profit sector/industry
• Further, foreign educational institutions have not set up centres/institutes in the country and it is estimated that annually, over 450,000 students pursue higher education abroad, leading to a foreign exchange outflow of over US$13 billion or INR 98,000 crore . An effective strategy for attracting renowned foreign educational institutes to set up in-country campuses could help reduce this outflow and further augment education infrastructure.
• Enabling economically disadvantaged students to pursue higher education through financial support
• Providing additional impetus for public private partnerships to augment educational infrastructure and reach and provide additional financing to the sector

Expectations

Expectation #1: Facilitate increased allocation to the education sector to assist implementation of NEP

A) As far as government spending is concerned, there is a need for increased budgetary spending (as % of GDP) by the central government, which can be linked to:

• Matching allocations by the states as well as

• States implementing a minimum set of reforms as envisaged by the NEP 2020 within a defined timeline

B) For private education institutions, additional lending by banks and financial intermediaries can be encouraged by modifying the guidelines under priority sector Lending to:

• Increase the cap of INR 5 crore currently allowed under priority sector lending for construction of schools

• Bringing “higher education institutions” under priority sector lending

C) Endowments, both from domestic and foreign alumni, represent the other major source of financing which is yet to be tapped fully unlike in other countries such as the US and the UK. While the Ministry of Education has already made a beginning by notifying the Centrally Funded Technical Institution Endowment Fund initiative in 2020, the guidelines for endowment funds can be further strengthened in areas such as the following:

• Appointment of professional fund managers to enable higher returns on corpus through diversification of investment portfolio beyond fixed deposits and government securities

• Streamlining regulations for channelising foreign endowments into the country, including in the form of stocks/shares, etc.

D) At the level of students, while the cap for student Loans has already been increased from INR 10 lakh to INR 20 lakh, the problem of non-performing assets needs to be addressed through expanded coverage and linkage to credit registries as well as credit enhancement through tie-ups with employing corporates, etc.

Expectation #2: Guidelines for setting-up of International Branch Campuses (IBCs) by foreign universities

At present, there is no operating model in place for opening IBCs in India. Fundamentally, there are two alternate models which have been used globally, namely:

⁻ Direct investment by the foreign HEI with a combination of funding options, in terms of (a) self-funded where the foreign institution sets up a branch campus in the country independent of external support; (b) with partial financing support from host country banks and financial institutions for facilities/infrastructure development and (c) partial financing support by private companies and philanthropic institutions in the host country under CSR and other applicable guidelines

⁻ Collaboration with a domestic HEI where the investments are shared between the two partners, with additional support from banks and financial institutions

Leveraging the experience of countries like Malaysia, UAE, etc., which have been able to attract reputed global HEIs in setting up local branches/campuses, the Government of India may consider having International Education Zones (IEZs) where IBCs can be set up with flexible regulations around investment structures, repatriation of surplus, international mobility, etc. IEZs can have a separate regulatory and oversight mechanism with a provision for light touch regulation for foreign HEIs which set up a direct presence with identical operational and management practices as in their parent campuses, offer an identical academic curriculum, and share a large pool of common faculty with their parent campuses. In case of the Dubai International Academic City, which is one of the more successful global education hubs, there is no difference in the qualification/degree/certificate offered by the IBC and parent campus. For other foreign HEIs which collaborate with domestic institutions, suitable regulatory mechanisms factoring in the uniqueness and strengths of individual institutions can be instituted.

For enabling adequate domestic financing to such IEZs, thereby making it more attractive to foreign HEIs, lending by banks and financial institutions to units in such zones should be construed a part of priority sector lending.

From the tax perspective, the following may be considered:

⁻ Steps may be taken to reduce the tax burden of IBCs, especially during the initial phase, through mechanisms like tax holiday, capex deduction, reduction in tax rates, etc., on the basis of fulfilment of various criteria in terms of extent of progress, enrolment of domestic students, percentage of students offered scholarships, etc.

⁻ Going beyond IEZs, to enable the overall school and HEI eco-system meet increased investment requirements under the NEP 2020. The provisions under section 10(23C) may be reassessed to allow for a higher retention of surplus beyond the current 15% of gross income/revenues, with suitable underlying conditions that the surplus be reinvested in infrastructure augmentation and collaborations with reputed global HEIs in setting up IBCs in India.

GPS Infrastucture Financing | 1 Article

Current Enviornment

• With a likely GDP multiplier effect of 2-2.5, the National Infrastructure Pipeline (NIP) of INR 111 lakh crore is expected to be one of the key pillars for sustained growth of the Indian economy over the next decade. Over 20% of the NIP is expected to require private financing with a preference for long term investors, given the long gestation period of infrastructure projects.
• The government has identified asset recycling as a key mechanism for resource mobilisation for infrastructure development. Accordingly, the National Monetisation Pipeline (NMP) of operating infrastructure assets aggregating to around INR 6 lakh crore was announced in October 2020.
• From the perspective of the Union Budget 2022-23 and the overall policy/regulatory framework, the following issues need to be addressed:

o While there has been increasing interest from overseas long-term infrastructure investors like sovereign wealth funds, pension funds, private equity funds, etc., a large part of infrastructure financing is still provided by banks and NBFCs which have a shorter liability profile. This leads to an asset liability mismatch and creates stress on the system.

o Despite having a domestic pension fund corpus of around INR 7 lakh crore as of September 2021, the extent of investment in infrastructure assets is quite limited partly due to existing investment guidelines and partly due to limited capacity of pension fund managers to invest in core infrastructure assets. The situation is similar in case of other long-term investors like life insurance companies. Indian pension fund investments are predominantly in government securities (50%), followed by corporate debt (30%), with investments in equity being only around 20%. This is quite unlike the largest pension markets like the US, UK, Canada, Australia, Netherlands, Switzerland and Japan, etc., where investments in equity or equity linked instruments were around 43%, 29% in bonds and around 26% in alternate assets .

o Additionally, pension penetration in India is extremely low with the pension corpus being only around 14% of GDP compared with over 50% in the US and over 100% in countries like Canada and Australia. This also has an added implication of inadequate resources for public social security coverage – given the impending change in India’s demographic profile by 2027 with the higher than working age population exceeding the working age population, this is likely to have adverse implications. The primary reasons include (a) exclusion of micro, small & medium enterprises (MSMEs) from Pillar II (as per the widely accepted World Bank 5 Pillar framework) i.e., occupational pension and (b) limited coverage of Pillar III i.e., personal pension, primarily due to inadequate awareness/financial literacy as well as limited penetration of most financial intermediaries beyond Tier 1 urban centres.

Expectations
Top three asks:

1. Policy and regulatory initiatives

The following measures may be considered to make available increased long-term financing of infrastructure projects by pension funds:

• Expand the coverage of Pillar II, i.e., occupational pension to contractual workers, micro enterprises, ASHA & Anganwadi workers, construction sector workers, enterprises with less than 20 employees, through an auto-enrolment facility, backed by (a) flexible contribution mechanisms; (b) provision for premature withdrawal for major life events like construction of dwelling units, marriage, etc., and (c) matching contribution by the government.
• For specific NPS schemes which are targeted at the relatively financially literate section of the population including Tier II schemes, remove the existing limit of up to 5% investment in alternate assets with the discretion of deciding on the portfolio being left to the trustees, with corresponding strengthening of governance, disclosure and risk-based supervision mechanisms, with the end objective of providing investors comprehensive information to take informed decisions.
• Additional incentives as below may be considered for expanding coverage and attracting additional contribution to pension funds with specific focus on infrastructure financing and higher investment limits in alternate assets:

o Weighted tax deduction of 150% to 200% of personal contribution
o Increased exemption on final withdrawal / maturity of funds

2. Rationalising tax benefits for Sovereign Wealth Funds (SWF) and Foreign Pension Funds (FPF)

To encourage more investment in Indian infrastructure from SWF and FPF, ensuring clarity in tax incentives is essential. Section 10(23FE) of the Act provides an exemption in respect of dividend, interest income and long-term capital gains, arising from various infrastructure investments made by a prescribed SWF, FPF and wholly owned subsidiary of the Abu Dhabi Investment Authority (ADIA) in the form of debt or share capital or units. The government may consider issuing the following clarifications to ensure tax clarity, avoid litigations and encourage infrastructure investments via the said route:

o In case of ADIA, exemption is granted specifically to a wholly owned subsidiary of ADIA. However, there is no such specific mention in respect of a special purpose vehicle (SPV), held directly or indirectly, by an eligible SWF or FPF, to be eligible for notification and exemption under section 10(23FE) of the Act. It is recommended that a clarification be issued to confirm that SPV held directly or indirectly, by an eligible SWF or FPF are also eligible to be notified for the income-tax exemption under section 10(23FE) of the Act.

o It is recommended that suitable amendments be made to include interest in non-corporate entities such as LLPs, partnerships, etc., as an eligible mode for investment under section 10(23FE) of the Act.

o It is recommended that, for avoidance of doubt and in line with the stated intent and objective, the benefit of exemption under section 10(23FE) of the Act is extended to LTCG arising from indirect transfers [as envisaged in section 9(1)(i) of the Act] of assets located in India.

o In order to encourage capital flows to affordable housing projects and smart city initiatives and in line with the stated intent and objective of the exemption, it is recommended to expand the scope of the exemption contained in section 10(23FE) of the Act to other categories of non-resident investors such as real estate funds especially those that invest in affordable housing projects and smart city initiatives of the Indian government.

3. Easing tax burden in relation to debt financing for infrastructure projects

The infrastructure sector is debt intensive, with higher interest cost compared with other sectors. Generally, low-cost foreign borrowings are raised from outside India. Due to Public Private Partnership (PPP) requirements, individual projects are typically set-up as separate Special Purpose Vehicles (SPVs) by the promoter. However, lenders insist on joint guarantee by parent and SPV for the project. In this regard, current reading of section 94B of the Act provides that debt issued by non-resident lender [non associated enterprise (AE)] to a resident subsidiary under guarantee of resident parent (being an AE) would be covered under the provision. Hence, limit on interest deduction leads to additional tax cost in the hands of subsidiary even when the transaction is entered with non-AE, thereby discouraging funding to such sector from outside India and does not appear to be in line with government’s policy of attracting foreign funds for key debt intensive sectors. Hence, it is recommended that such restriction be applicable only in case of borrowing from AEs.

Further, as per section 94B of the Act, interest in excess of 30% of EBDITA of the borrowing entity cannot be claimed as a tax deduction. In other words, interest deduction of the Indian borrowing entity is restricted to 30% of its EBDITA. In this regard, there usually exists a particularly high capital requirement in the infrastructure sector, especially in the initial years. Hence, it is recommended that considering the practical/sector requirement, a higher limit, i.e., a higher percentage of EBDITA ought to apply in case of infrastructure companies, at least in the initial 8-10 years.

4. Introducing consolidated or group taxation

As indicated above, infrastructure projects are usually domiciled in separate SPVs due to various reasons such as regulatory compulsion, banker’s comfort, need to segregate cashflows, etc. Having multiple SPVs for a single line of business results into inefficiencies and increased compliance burden. Further, the losses of one SPV cannot be set-off against profits of another SPV. Hence, the following measures may be considered to streamline tax provisions and make more proceeds available in the hand of investors.

o Consolidated group tax filing approach – A group of wholly owned or majority-owned companies be treated as a single entity for tax purposes and intra-group transactions are ignored for return filing purposes.

o Group taxation approach - Allowing the offsetting of losses incurred by one or more group company against the profits of other companies in the group.

Similar approaches have been adopted by a number of countries such as the US, France, Australia, etc. These relaxations would also be beneficial in case of asset monetisation where the infrastructure investment trust (InvIT) or real estate investment trust (ReIT) invests in a holding company with multiple subsidiaries in the form of SPVs.