China is going broke

China is going broke.

This statement comes as a shock to those who have heard over and over that China is a rising economic superstar and will soon be the greatest economy on Earth, surpassing the U.S. in the No. 1 role.

How can China be going broke? 

China started 2015 with about $4 trillion in hard currency reserves. About $1 trillion fled the country in 2015 and 2016 based on fears of yuan devaluation. That’s classic capital flight.

Another $1 trillion is relatively illiquid, including direct investments in mines and natural resources through sovereign wealth funds such as China Investment Corp. That’s wealth, but it’s not money that can be used in a liquidity crisis.

Finally, $1 trillion has to be held as a precautionary reserve to bail out China’s insolvent banks and Ponzi-style “wealth management products.” Failure to bail out the banks… could lead to social unrest that would topple Communist rule, so that won’t be allowed.

That leaves only $1 trillion of the original $4 trillion in liquid form. And if it keeps jettisoning dollars at this rate,China will be devoid of usable liquid assets by late 2017.-from DR

Rakesh Jhunjhunwala: Buy Now

If you ask me, it is a time to buy.

I would not say what.

But I feel bullish because there are all indicators.

I think the primary reason for FII selling will reverse.

I think lot of local money will come.

The markets are very bearish about the demonetisation. The revival in demand will be far, far faster and fourth thing I feel is that market has shown technically, having rebounded from 7900 levels,

if you have the money, buy now 

said Rakesh Jhunjhunwala

Tax Trauma for India Funds

I must state upfront that I am an interested party in the tax debate highlighted in this article.

The Central Board of Direct Taxes (CBDT) issued a clarification on December 23, 2016, laying out under what circumstances foreign portfolio investors (FPIs) are impacted by the indirect transfer provisions (effectively the Vodafone case).

The clarification says that if an FPI has more than 50 per cent of its assets in India, with a value greater than ₹ 10 crore, then any investor with a greater than five per cent interest in or contribution to the assets under management (AUM) of the FPI will be covered by the indirect transfer rules and will be subject to Indian tax whenever this investor sells or redeems its shares in the FPI/fund.

If these clarifications were to be implemented, it will sound the death knell for the home-grown India-dedicated fund industry. Most boutique India funds (mine included) would find it incredibly difficult to operationalise these rules.

These rules will only impact India-dedicated funds, mostly niche investment boutiques focussed on institutional capital and setup by Indian professionals.

The big foreign firms such as Capital, Fidelity, KKR, Blackstone etc. will be unaffected as they do not invest in India through India-dedicated vehicles and hence have less than 50 per cent of assets in India, or focus on retail investors, with no investor greater than five per cent.

There will be at least 50 funds ($30-35 billion in AUM) affected, across both public and private equity. Funds such as Kedaara, Multiples, Nalanda, Westbridge etc. — all are India-dedicated, setup by Indians and have a very sophisticated and concentrated investor base, which in most cases have each contributed more than five per cent of the fund’s AUM.

Most funds of this type only have 15-20 core investors, who provide the bulk of their capital. These concentrated core investors are endowments, family offices and foundations. This is the most sophisticated capital in the world and they like being the majority of a fund’s AUM. Exactly the type of money that is long-term and which India should want. These funds also, by and large, tend to focus on mid-sized companies. That is their USP, and why investors give them capital.

Why Are The Rules Unworkable?

Firstly, it amounts to double taxation of the investor. All funds, irrespective of jurisdiction, will pay a minimum of 50 per cent of local taxes (capital gains) from the financial year 2018 (FY18) onwards and full Indian taxes within two years. The gains the investor makes in net asset value (NAV) are after the fund has paid local taxes.

As an example, under these rules, an investor has invested at a NAV of 100 in 2016, in 2020 she redeems at a NAV of 125, she will have to pay capital gains on this appreciation of 25, despite the fund’s NAV being calculated post local taxes. Even though the subscription to the fund and redemption will both be done offshore, wherever the fund is incorporated (Cayman or Singapore etc.), the investor will still have to pay tax, assuming the investor has contributed more than five per cent of the fund’s corpus. The US-based investors may even face triple tax as they may not get a set-off on the Indian taxes paid on redemption. Investors tell me they have not seen this type of indirect transfer provisions being applicable on funds in any other jurisdiction that they operate in.

Secondly, the rate of tax will be between 30-40 per cent for short-term capital gains (less than three years) and 10-20 per cent for holdings greater than three years, depending on the structure of the investor. These investors will not get the concessional rates on capital gains available to local investors. Tax rates of this magnitude will significantly reduce the attractiveness of Indian equity assets.

Thirdly, the onus of withholding taxes on redemption falls on the FPI. Non-compliance can lead to penal interest and other penalties according to the Indian domestic tax law. Most FPIs will not be willing to take on any potential tax liability linked to investor redemptions.

Investors into these India funds, whose gains may be taxable under these indirect transfer provisions, would need to obtain a tax ID in India, file tax returns in India and comply with all Indian procedural requirements (facing scrutiny?).

I cannot imagine any global investor willing to do this. Most endowments and foundations do not pay any tax in their home country. They have little internal capability to handle paying taxes in India!

It is true that while these indirect transfer provisions have been a part of the law since 2012, the tax authorities have not applied these provisions against FPIs till date. These recent clarifications have got investors and funds worried. Will we see a slew of tax notices now?

There is also a growing sense of fatigue among investors. Given the complexity of dealing with tax issues in India, I get a sense that some investors are questioning the wisdom of allocating money to India-dedicated funds. Are the returns worth the administrative overhead?

I hope that a clarification is issued exempting FPIs from these indirect transfer provisions. If the government were to go ahead and implement these provisions, I am afraid that most India-dedicated funds will face existential questions. India will lose access to a very large pool of sophisticated long-term capital, and for how much incremental tax revenue? Has anyone done a cost-benefit analysis? Whatever incremental tax we may receive as a country through these indirect transfer provisions on FPIs will pale in comparison to losing access to these long-term pools of capital.

I hope better sense prevails, it cannot be the intention of the government to kill all India-dedicated funds. We seem to be collateral damage.
wrote Akash Prakash of Amansa Capital