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In rastructure in India A vast land o construction opportunity

pwc

Engineering & Construction



PricewaterhouseCoopers

Contributors Jonathan Hook, Michael Cracknell, Vasant Gujararthi, Ravi Bhamidipati, Amrit Pandurangi, Girish Mistry, Hemal Zobalia, Vishwas Udgirkar, Mukesh Rajani,Graham Dredge, Jimit Devani and Raj Julleekeea.

Principal author Elizabeth Montgomery

Graphic design Hamilton-Brown


http://slidepdf.com/reader/full/infrastructure-in-india-pwc 3/241In rastructure in India: A vast land o construction opportunity

Welcome 3Introduction 5

Foreign Direct Investment (FDI) and the regulatory environment 6

Opportunities 7Roads and highwaysRailPorts and airportsPowerPublic private partnerships

The tax environment or E&C companies investing in India 11Structural considerations or developersInternational tax considerationsHigher depreciation – what lies ahead?Indirect tax issues

Challenges or local players and oreign companies looking to enter the market 14

Building a sustainable uture in India 16

Concluding thoughts 17Further reading 18

PricewaterhouseCoopers expertise in the E&C industry in India 20

Contents


http://slidepdf.com/reader/full/infrastructure-in-india-pwc 4/242 PricewaterhouseCoopers

“Expanding investment in in rastructure can playan important counter cyclical role. Projects andprogrammes [are] to be reviewed in the areao in rastructure development, including purepublic private partnerships, to ensure that theirimplementation is expedited and does not su er

rom [the] und crunch.”

Mr. Manmohan Singh, Indian Prime Minister,(quoted in newspaper reports, October, 2008)



Jonathan Hook

Global Engineering &Construction leader

Ravi Bhamidipati

India Engineering &Construction leader

In this paper, we examine the opportunitiesor the engineering and construction (E&C)industry in India, one o the astest growingeconomies in the world. We also ocus onthe structuring opportunities and some othe challenges overseas participants arelikely to encounter.

India’s economy is big and getting bigger.PricewaterhouseCoopers estimatesthat India will become the world’s thirdlargest economy by 2050. Liberalisation ogovernment regulations and a deliberatestrategy on the part o the Indian

Government to promote in rastructurespells opportunity or E&C companies.

Nearly all o the in rastructure sectorspresent excellent opportunities, with roadsand highways, ports and airports, railwaysand power standing out as particularbright spots, with staggering sums oinvestment planned. Public privatepartnerships (PPPs) are gaining inimportance, and are bene ting romgovernment support – targeted PPPparticipation is US$150 billion. Companiesexperienced in structuring these types odeals should be able to use their expertiseto good e ect in the Indian marketplace.

Operating in India requires a thoroughunderstanding o the local market.Companies need to do their homework inorder to understand a host o tax andregulatory issues be ore bidding onprojects or setting up operations. Whetheror not a permanent establishment is

created, how onshore versus o shoreservices and supplies are managed in aparticular contract, and indirect taximplications can all have a major impacton the bottom line. Further, oreign playersare likely to need to identi y promisinglocal companies, then make a case or apro table partnership, in order to achievea win-win situation in India. Still, there is astrong rationale or many E&C companiesto invest in India sooner, rather than later.Not only are there substantialopportunities now, but establishingrelationships and a presence in the marketcan help to ensure continuing projectpotential over the medium- and long-term.

Looking ahead, we believe that it isimperative that in rastructure developmentoccurs in a sustainable manner, in Indiaand around the globe, i the impact oclimate change is to be slowed to broadlyacceptable levels. The Indian Governmentmust maintain a commitment to ensuringthat rapid growth does not happen at anuntenably high environmental cost, andin rastructure projects will play a key rolein ensuring the success o ‘green growth’.Those E&C companies taking a holisticapproach to building a sustainablein rastructure will have a strongcompetitive advantage.

November 2008

Welcome

Reasons to invest in India:One o the world’s astest growing•

economies – and growth expected tocontinue at 7-7.5% despite the globaldownturnFew restrictions on oreign direct•

investment (FDI) or in rastructureprojectsTax holidays or developers o most•

types o in rastructure projects, someo which are o limited durationOpening up o the in rastructure sector•

through PPPs

Projected spending rom FY07-FY12in selected in rastructure segments:

Electricity: US$167 billion•

Railways: US$65 billion•

Road and highways: US$92 billion•

Ports: US$22 billion•

Airports: US$8 billion•



“The link between in rastructure and economicdevelopment is not a once and or all a air.It is a continuous process; and progress indevelopment has to be preceded, accompanied,and ollowed by progress in in rastructure, i weare to ul ll our declared objectives o generatinga sel -accelerating process o economicdevelopment.”

Dr. V. K. R. V. Rao [noted Indian economist, early 1980s]



The Indian economy is booming, withrates o Gross Domestic Product (GDP)growth exceeding 8% every yearsince 2003/04. This ongoing growthis due to rapidly developing servicesand manu acturing sectors, increasingconsumer demand (largely driven byincreased spending by India’s middleclass) and government commitments torejuvenate the agricultural sector andimprove the economic conditions oIndia’s rural population. Constructionis the second largest economic activityin India a ter agriculture, and has beengrowing rapidly. The production oindustrial machinery has also been on therise – and the increasing fow o goods hasspurred increases in rail, road and porttra c, necessitating urther in rastructureimprovements.

In the scal year ending March 2008,India’s GDP grew by more than 9%. Thisrobust rate o expansion was initially

orecast to continue in the 2008-2009scal year. In summer 2008, however,

the combined impact o slowing Indianconsumption, a higher domestic costo capital and reduced capital access

rom international capital markets raisedconcerns by some analysts that the rate ogrowth might be slowing. In October 2008,India’s Prime Minister, Mr. ManmohanSingh, a rmed the Government’s viewthat a rate o growth o 7-7.5% remains

realistic, even given the global creditcrunch, and assured observers that thecountry’s Government will take actioni necessary to support businesses andthe nancial markets. Mr. Singh has alsosingled out in rastructure investment asparticularly vital.

Indeed, even with a somewhat slowerrate o growth, the Indian economy is stillexpanding signi cantly, and substantialinvestment in in rastructure continuesto be required in order to sustain India’seconomic progress. The country’s

capacity to absorb and bene t rom newtechnology and industries depends on theavailability, quality and e ciency o morebasic orms o in rastructure includingenergy, water and land transportation. Insome areas, roads, rail lines, ports andairports are already operating at capacity,so expansion is a necessary prerequisiteto urther economic growth.

The Indian Government recognises thisimperative. As per the Eleventh Five YearPlan, more than US$500 billion worth oinvestment is planned to fow into India’sin rastructure by 2012. Constructionprojects account or a substantial portiono the proposed investments, makingthe E&C sector one o the biggestbene ciaries o the in rastructure boomin India. The regulatory environment isrelaxing to encourage urther oreign directinvestment (FDI).

Private sector participation is integralto these plans. PPPs have beenidenti ed as the most suitable mode orthe implementation o projects – andindeed, are rapidly becoming the undingnorm. Their share o the total plannedin rastructure improvements is projectedto be around 30% (US$150 billion). Powerand road projects top the list, and othertransportation sectors such as railways,ports, and airports are also targeted ormajor investments.

Companies looking to capitalise on the

situation need to plan their strategyor entering the market care ully.Understanding the local market, includingselecting complementary local partners,is vital. Tax optimisation is a key costcomponent – while substantial tax bene tsare provided or in rastructure projects,developers need to be savvy aboutstructuring their contracts. Good taxplanning can have a potentially decisiveimpact, especially in bidding situations, andhelp to avoid unnecessary litigation later.

Introduction



Foreign Direct Investment (FDI) and the regulatoryenvironment

Major in rastructure development requiresa substantial infux o investment capital.The policies o the Indian Governmentseek to encourage investments indomestic in rastructure rom both localand oreign private capital. The countryis already a hot destination or oreigninvestors. As per the World InvestmentReport o the UNCTAD, India was ratedthe second most attractive location (a terChina) or global FDI in 2007.

Currently, India has FDI o about US$21billion per year, well below the targeted

US$30 billion. In order to increaseFDI infows, particularly with a view tocatalysing investment and enhancingin rastructure, the Indian Government hasintroduced signi cant policy re orms. Forexample, it now permits 100% FDI underthe automatic route or a broad range osectors (see Figure 1) – only certain post-investment intimation is required. ForFDI in a ew sectors, a prior approval isrequired, which takes around 6-8 weeks.

As part o policy re orms, the IndianGovernment is constantly simpli yingthe approval route process, includingsetting up several agencies to expediteFDI approval. Further liberalisation isexpected as the Government continues toemphasise in rastructure investment.

In August 2008, a press report stated thatMorgan Stanley was looking to investup to a quarter o its US$4 billion globalin rastructure und in emerging markets,notably India and China – and that in India,Morgan Stanley would ace competition

rom Australia’s Macquarie Group, JPMorgan, Goldman Sachs and DeutscheBank, all looking to channel oreigninvestors’ money into Indian in rastructure.While some o this planned investmentmay be reduced or delayed given thecurrent environment in the credit markets,India is still likely to garner substantialFDI, particularly i its economy is able tomaintain a airly strong rate o growth inthe ace o a global recession.

From an exchange control perspective,India is moving towards ull currentaccount convertibility. Most revenuetransactions are reely permitted,except certain transactions like royalty,consultancy ees, etc., which aresubject to certain limits. Capital accounttransactions need prior approval, exceptwhere speci cally permitted. In order

to promote the construction sector, theIndian Government has relaxed someo the exchange control restrictionsand is now allowing oreign nationals/ citizens to acquire immovable property inIndia, subject to certain conditions andprocedures.

Hurdles to investment remain. AlthoughIndia has a well-developed legalsystem, the current legal and regulatoryenvironment sometimes acts as anobstacle to the necessary injectionso oreign private capital into India’sin rastructure. Major in rastructureprojects are governed by the concessionagreements signed between publicauthorities and private entities. Taridetermination and the setting oper ormance standards vary somewhat bysector. In the roads and highways sector,the ministry generally sets tolls – while inmajor ports projects, and many o thosein electricity generation, an independentregulator will decide relevant tari s. Inthe airport sector, a new independentregulator is planned or 2009 and is likelyto play a major role in determining tari s inconcession agreements or the segment.In some instances, ministry or regulatorcontrol over potential proceeds can act asa disincentive to the private in rastructuredeveloper.

As is the case in many countries, thereis no single regulator which ormulatesthe policy or all in rastructure projects.There is also no standardisation in theconcession agreements across thedi erent in rastructure sectors. As a result,

the development o certain sectors in Indiamay be hampered due to lack o adequateand co-ordinated planning. Projectswhich are approved may ace di cultiesi related projects are substantiallydelayed. One example is Bangalore’s newinternational airport, one o the largest

PPP projects to date. The project is acinggrowing pains related to insu cient roadand rail connections to the new acility,in part due to delays o expected high-speed rail and highway projects under theauspices o other government bodies.

Figure 1: FDI routes

Approval Route– Permission required

Automatic Route– Freely permissible (100%)

Existing Airports – beyond 74%•

Atomic Minerals•

In case o joint venture or technology•

collaboration agreement in the same eld

Green eld airports•

Construction & maintenance o in rastructure•

like ports, harbors, roads and highways

Power generation, transmission and•

distribution and power trading (atomicenergy not permitted)

Mass rapid transport systems•

Townships, housing, built-up in rastructure•

and construction-development projects



Opportunities

What segments present the bestopportunities or E&C companies? ThePlanning Commission o India has plannedextensive expansion in the roads andhighways, ports, civil aviation and airports,and power in rastructure segments – all owhich provide substantial opportunities orE&C companies.

Roads and highwaysIndia’s roads are already congested,and getting more so. Annual growth is

projected at over 12% or passengertra c and over 15% or cargo tra c. TheIndian Government estimates aroundUS$90 billion plus investment is requiredover FY07-FY12 to improve the country’s

road in rastructure. Plans announced bythe Government to increase investmentsin road in rastructure would increase unds

rom around US$15 billion per year to overUS$23 billion in 2011-12 (see Figure 2).The quantum o unds invested as parto these programmes will signi cantlyexceed that invested in recent history.Such programmes would be unded viaa mix o public and private initiatives (seeTable 1).

The Indian Government, via the NationalHighway Development Program (NHDP), is

planning more than 200 projects in NHDPPhase III and V to be bid out, representingaround 13,000km o roads. The averageproject size is expected to US$150million-US$200 million. Larger projects

are likely to reach the US$700 million-US$800 million range. About 53 projectswith aggregate length o 3000km and anestimated cost o around US$8 billionare already at the pre-quali cation stage.The procurement process avours playerswith good experience and sound nancialstrength.

The opportunities do not stop there. Morethan 10 states are also actively planningthe development o their highways. Whilethe average size o these projects issmaller than the NHDP projects, most willstill be substantial, in the US$100 million-US$125 million range. All told, more than4,500km o state highways are likely to beawarded by the end o 2010.

5,000

10,000

15,000

20,000

25,000

2007-08

15,104 15,97617,273

19,97123,387

2008-09 2009-10 2010-11 2011-12 I n v e s t m e n

t ( U S $ m

i l l i o n

)

National Highways State Roads Rural Roads TotalNorth East Roads

Figure 2: Projected Investment in the Road & Highways Sector in the Eleventh Plan

Table 1: Road In rastructure Detailed Projections (US$ million)

National HighwaysState Roads (Highways, Major District

Roads, Other Roads)Rural

Roads North East Total

YearNHDP1

PublicNHDPPrivate

Non-NHDP(Public) Total Public Private Total

2007-08 3,173 3,702 463 7,338 4,347 1,333 5,680 1,875 212 15,104

2008-09 3,305 3,966 486 7,757 4,528 1,428 5,956 2,025 238 15,976

2009-10 3,464 4,495 510 8,469 4,745 1,618 6,364 2,150 291 17,273

2010-11 3,834 5,685 536 10,055 5,253 2,047 7,299 2,300 317 19,971

2011-12 4,707 6,478 563 11,747 6,488 2,345 8,834 2,463 344 23,387

Total 18,483 24,326 2,557 45,365 25,361 8,771 34,132 10,813 1,401 91,711

1 NHDP – National Highway Development Programme



RailThe Indian Government has alsorecognised existing in rastructure gapsand capacity constraints in the rail system,and as a consequence plans large scaleinvestment over the ve years romFY07-FY12. Projected investments totalUS$65 billion, o which 40% is expectedto be contributed by the private sector.One major PPP programme is already inits initial phases. The Dedicated FreightCorridor project is designed to alleviatecongestion on the rail routes betweenDelhi and Mumbai and Delhi and Kolkotaby building long-distance, cargo-onlyrail lines, at an estimated cost o US$6billion-7 billion.

Other proposed initiatives include thedevelopment o manu acturing plants orrolling stock with long-term committedprocurement or several years, and thesetting up o logistics parks. City metrosystems are also in the pipeline. The rstcorridor o the Mumbai Metro Projecthas already been awarded to RelianceIn rastructure and the Government has

asked the nal shortlisted companiesto submit detailed nancial bids or thesecond phase o the Mumbai Metro.

Indian Railways is also looking orprivate partners to help moderniserailway stations to world-class levels,and or projects ocused on increasingconnectivity with ports.

Ports and airportsIncreasing connectivity with inlandtransport networks is just one o manychallenges currently acing India’s ports,which have seen massive swells in theamount o goods transported. Tra c isestimated to reach 877 million tonnesby 2011-12, and containerised cargo isexpected to grow at 15.5% (CAGR) overthe next 7 years. India’s existing portsin rastructure is not su cient to handlethe increased loads – cargo unloading

at many ports is currently inadequate,even where ports have already beenmodernised. An estimated investment oaround US$22 billion is targeted or portprojects in the ve year period rom FY07-FY12. The National Maritime DevelopmentProgramme includes 276 projects, witha required investment o about US$15billion over the next ten years, with privateinvestment targeted at around US$8billion. In addition to improving road andrail connections, projects related to portdevelopment (construction o jetties,berths, container terminals, deepening ochannels to improve dra t, etc.), will providemajor opportunities or E&C companies.Recent deregulation o the sector nowpermits 100% FDI, and an independenttari regulatory authority has been set upto acilitate projects at major ports.

Air tra c has increased rapidly in recentyears, although this slowed in 2007. Whilea number o Indian airlines have acedchallenging market conditions in 2008, andthe rate o growth is likely to be signi cantlyless than initially projected, Indians are stillfying in much greater numbers. Estimatesmade in 2007 by the Indian Government’sCommittee on In rastructure suggest thatpassenger tra c will grow at a CAGRo over 15% in the next 5 years. Indianmanu acturers are also looking to the skies– the same source anticipates that cargotra c will grow at over 20% p.a. over thenext ve years.

Even i these estimates prove somewhatoptimistic, the growth already achievedhas put tremendous pressure on airportin rastructure. The Indian Government hasprojected that an investment o aroundUS$8 billion in the ve year period romFY07-12 will be needed to help copewith additional demand, and privatesector participation is expected to play akey role. The private sector has alreadystepped up to the challenge o airportin rastructure development in severalcases, with private participation in recentyears at Delhi, Mumbai, Hyderabad,

Cochin and Bangalore supplementing thee orts o the Airports Authority o India.

The Government has proposed theestablishment o an Airport EconomicRegulatory Authority (AERA) to promotee ciency, competitive pricing anda customer- ocused service. Stategovernments are also getting involvedand looking to acilitate the developmento new airports. The total investmenton new airports has been proposed atabout US$10 billion by 2012. Green eldairport projects are planned in resort

destinations and emerging metrossuch as Goa, Pune, Navi Mumbai,Greater Noida and Kannur. Further, 35non-metro airports are proposed ordevelopment. Prequali cation o bidders

or development o Amritsar and Udaipurairport has already been completed,and bids or 10 non-metro airports arescheduled to be invited shortly.

As the density o airports increases invarious regions, increased competition islikely to bring new issues into ocus, suchas corporate per ormance management.

Airports will look to diversi y their revenuesources through the development ocity-side in rastructure. Airlines will alsobe looking or new technology solutionsto maximize revenues and reduce costs.MRO (Maintenance, Repair & Overhaul)

acilities could there ore also present newbusiness opportunities.

The need or improved aviationin rastructure extends beyond theconstruction o new airports – existingmetro airports also require signi cantmodernization and upgrading. EPC

contractors are expected to be soughtor Chennai and Kolkata airports in theimmediate uture.

PowerIncreased manu acturing activitiesand a growing population are alsocausing a surge in power usage. India



has the th largest electricity grid inthe world with 135 GW capacity, andthe world’s third largest transmissionand distribution (T&D) network. Largeinvestments are needed to meet growingdemand and provide universal access.The policy and regulatory rameworkis pro-investment – shi ting away rom‘negotiated and guaranteed’ to ‘open andmarket competition’. Given the increasedcompetition, diversity, and number oopportunities, project and collaborationrisk must be more care ully assessed andmanaged.

An investment o US$167 billion isprojected or electricity projects in the veyear period rom FY07-FY12. The massivenumber and scope o potential projectshas attracted a number o new investors,lenders and operators. All new awardsare through open, competitive bidding.

A rush is on to develop new assets,harness natural resources, and attractglobal nance – but an industry ocus andstrategy is necessary to properly tap intothis opportunity.

E&C companies may want to considerinvolvement in the construction o powerstations, and T&D networks, particularlyi sustainable building and generationtechnologies can be leveraged. The IndianGovernment is also looking to encouragethe generation o wind and solar powerby providing generation-based incentivesto those companies who do not claimaccelerated depreciation, so E&Ccompanies with experience in buildingthese types o alternative energy projectsmay nd excellent opportunities.

Public private partnershipsFunding India’s wide-ranging, US$500billion programme o in rastructureexpansion over a ve-year period islikely to be beyond the means o totalgovernment unding, so policies havebeen designed to acilitate privateinvestment to the maximum level possible.



I the Indian Government’s targetedlevel o private sector involvement andinvestment are met (approximately 30%),the quantum o unding required wouldbe around US$150 billion – dwar ngthe investment achieved over the pastdecade by comparison. Achieving thislevel o investment is ambitious. Several

rameworks and plans are already inplace, however, that may acilitatereaching these goals.

The PPP/PFI market in India is still at arelatively early stage. However, over thepast decade or so, there has been anincreasing trend at the central as well asstate government level to use PPPs ormeeting critical in rastructure gaps. Theresults have been quite encouraging.Establishing a PPP is now consideredto be the de ault option or majorin rastructure projects in sectors such asroads, railways, airports, ports and othertransport segments. First pre erence willbe given to the PPP model, and only incases where projects are expected to ailto attract private sector interest will moretraditional models be considered.

Most in rastructure sectors have an overalllong-term plan and programme thatprovides guidance on the projects thatare likely to come up or development.Key policy rameworks or procuremento projects through PPPs have alsobeen dra ted. For example, the NHDPdiscussed earlier in this paper details along-term plan or the roads and highwayssegment, with seven de ned phasesand largely clearly identi ed projects(along with project costs) and an agreedtime rame. The roads and highwayssegment also has a generally success ul

PPP model concession ramework. TheNHDP is mandated to a dedicated agencythat also has clearly earmarked sourceo unding coming in to support theprogramme. Almost all the other sectorshave similar plans.

Over the last 3-4 years, there has beena push towards expanding the scopeo PPPs or the provision o urbanin rastructure through establishment oanother government programme or urbanrenewal across the country. This is likelyto urther increase the scope, scale andnumber o PPPs in the country.

Not surprisingly, international interest inIndian PPPs has soared in 2008, with over50 international players showing interestin a variety o types o projects in the rstthree quarters o the year. Local players

are also increasing their interest. Untilrecently, only a very limited number o largedomestic players were ully conversantwith PPP models and had the capability todeliver on them. However, local developersand contractors are catching up astand domestic capacity has increasedsubstantially in recent months.

E&C companies looking to participatein this burgeoning segment do acecertain hurdles. The typical PPP projectdesign and preparation process is stilllargely technically-oriented, with limitedappreciation o the overall nancial andcommercial risk issues involved. O tenin ormation distortions in the markethave led to large variations in the bids/ o ers received during the procurementprocess. Further, the procurementprocess is o ten highly prescriptive, ratherthan participative. The emphasis is oncon orming to public sector requirements,which may not o er value or moneyand does not encourage innovativesolutions, rather than evolving the projectcon guration to be delivered over thelong-term in a partnership approach.

And while the public sector is dictatingthe terms, it is quite o ten not willing toshoulder concomitant risk. The currentconcession structure is highly assetoriented, rather than ocusing on servicedelivery. Private sector participants areo ten required to assume considerablerisk, including demand risk, and theapportionment o risk is in some casesquite ine cient.

Financing or PPP/PFI projects can also bea key constraint, as long-term nancing andinstruments have been in scarce supply.PPP projects have so ar been largely

nanced domestically using plain vanilladebt with relatively low gearing. Commercialbanks are the major source o debt withgenerally short tenor (being about 50% oconcession period). At the current time,it is di cult to predict how the nancingsituation will evolve over the short-term.Certainly, access to credit has become armore restrictive on a global basis, howeveri India’s growth continues to outper ormmost other economies, it could emerge as apre erred destination or investment.

India has become an attractive PPP

market and its attractiveness is likelyincrease in the uture. Contractorsable to negotiate and partner with therelevant ministries should nd excellentopportunities, particularly companies witha longer-term view.



E&C companies looking to invest in Indianeed to consider a variety o tax issues.Overall tax rates can be relatively high,so care ul tax planning is vital. Someo the relevant taxes applicable to E&Ccompanies are listed in Table 2.

Trans er pricing regulations wereintroduced in India in 2001. Althoughtrans er pricing regulations are a relativelyrecent phenomenon, the authorities havetaken an aggressive stance. There is noadvance pricing arrangement (APA) yetin India, so the implications o trans erpricing remain somewhat uncertain.

The Government’s strong ocus onpromoting in rastructure developmentalso extends to tax policy, with a numbero policy measures and incentives now inplace or the construction o in rastructure

acilities, including a numbers o taxholidays, although Minimum AlternateTax (MAT) o 11.33% may be payable onbook pro ts during this period. Relevanttax holidays, their applicability, and theeligibility o each in rastructure sector aredetailed in Table 3.

Structural considerations ordevelopersDividends paid by an Indian companyare subject to a Dividend Distribution Tax(‘DDT’) o around 17%.

In February 2008, the Finance Ministerannounced some relie whereby a dividendpaid to a parent company by its subsidiarywould not be liable to DDT, subject toprescribed conditions. Earlier, corporateshad a lean structure with one companyhaving many divisions catering to di erentbusinesses.

Following the recent change in DDT, manycorporates may be considering restructuringtheir corporate structure so that di erentbusiness streams have separate Indianoperating companies with one commonIndian parent. While such types ostructuring may help the parent companyto unlock shareholder value and should notimpose any additional levy o DDT, it shouldbe noted that introducing a new corporatelayer at the Indian level will bring the sharesin the Indian operating company within theIndian capital gains tax net.

Additionally, even i DDT is not due ondividend payments, there would be an upto 10% cash trap in the Indian operating

The tax environment or E&C companies investingin India

Table 2: Types o taxes which may be applicable or E&C companies operating in India

Table 3: Overview o tax holiday terms or various in rastructure segments

Nature o tax Governing Authority Rate o Tax (in %)

Income Tax Central Government 33.99

Fringe Bene t Tax Central Government 33.99

Custom Duty Central Government Up to 31.70

Excise Duty Central Government Up to 14.42

Service Tax 1 Central Government 12.36

Sales Tax/Value Added Tax (‘VAT’) 1 State Government 4.00 to 12.50

1

India is planning to implement a uni ed goods and service tax (GST) in 2010 at a rate still to be determined.

Sector Applicability Time- rame Eligibility

Power ‘Undertaking’ which•

generates power‘Undertaking’ which•

transmits or distributespower‘Undertaking’ which•

carries out substantialrenovation andmodernisation +

10 consecutive years•

out o 15 years All the above•

should commence(+complete) be oreMarch 31, 2010

Ports & Airports

Indian companies•

developing and/oroperating & maintainingports and airports

Applicable also to•

Inland waterway, Inlandport, Navigationalchannel in the sea


out o 15 years‘New’ in rastructure•

acility Agreement with•

government/ statutorybody

Railways Indian companies•

developing and/oroperating & maintainingrail system





Roads &Highways

Indian companies•

developing and/oroperating & maintainingroads and highways‘Roads’ – includes toll•

roads, bridges‘Highways’ – includes•

housing or otherintegral activities





Water Includes water•

supply project, watertreatment system,irrigation project,sanitation and seweragesystem or solid wastemanagement system




government/statutorybody



companies, as in accordance with Indianregulatory provisions, only 90% o acompany’s distributable reserves may bepaid as dividends.

There ore, a construction companyworking on multiple projects in Indiashould consider all relevant actorsbespoke to their requirements be orestructuring their operations.

International tax considerationsE ective tax structuring into India is vital

as this impacts on how attractive a projectis to target investors and has a directinfuence on the net internal rate o return.It is there ore particularly important thatinternational investment opportunitiesare structured appropriately to take intoconsideration tax, accounting, regulatoryand legal aspects. We have outlined belowsome o the key areas to consider.

Entry and exit strategy

Holding company location – Appropriateplanning in respect o a holding company

jurisdiction is necessary to minimise Indianwithholding tax and Indian capital gains onthe sale o shares in Indian companies.

Financing – In order to introduce debt intoIndia, there are various issues that need tobe considered such as the Indian ExternalCommercial Borrowings rules, withholdingtax issues on distributions out o India andthe availability o a tax deduction or thedistribution at the Indian level.

Holding the investment

Permanent Establishments – One othe risks with managing investments inIndia is managing the Indian permanent

establishment position, where i theIndian tax authorities success ullyargue that there is an Indian permanentestablishment o the oreign operationsin India, then there maybe signi cantadverse tax implications. It is there oreimportant to care ully manage theoperations carried out at the Indian level.In practical terms in the E&C industry,activities generally take a long durationto complete, and hence PE clauses(especially xed base and service PE)come into play in this industry more o ten.Table 4 details common types o PEs andtheir considerations.

Cash and profts repatriation

Pro t repatriation – There are variousoptions on repatriating pro ts rom thestructure, such as dividend distributions,share sale, capital reductions, etc, all withdi ering tax impacts.

Engineering, procurement andconstruction (EPC) contracts –onshore versus o shore

In the E&C industry, the execution oprojects is undertaken substantially byway o an engineering, procurement andconstruction (EPC) contract. A typical EPCcontract will have the ollowing scope owork in a single project:

Supply o equipment (o shore and•

onshore)Installation/commissioning•

Services (o shore and onshore)•

So tware/technology trans er (o shore•

and onshore)

Under a typical EPC contract, a non-resident contractor per orms a multitude oactivities. The scope o work under an EPC

contract would include both onshore ando shore activities (see Figure 3). Taxabilityo payments received by oreign companiesunder EPC contracts has become a mattero great debate and litigation. Onshoresupplies and services are normally taxable inIndia. O shore supply o goods and servicesunder a composite contract are somethingo a grey area. The Indian revenue authoritieso ten attempt to bring the entire EPCcontract, including the o shore supplies andservices, within the range o taxes in India.The tax authorities may cite a businessconnection in India, and also note thepresumed indivisibility o EPC contracts .

Nonetheless, some recent landmark judicial rulings with regard to EPCcontracts in India suggest that taxoutcomes or each o the componentso the contract must be determinedindependently. These rulings have broughtabout a general principle that pro t romo shore supplies would not be taxable inIndia, subject to the ollowing conditions:

Principal to principal transaction•

Title (i.e. risk and ownership) in the•

o shore supplies passed to the buyeron high seas (outside India)Sale consideration is received outside•

IndiaSale is at arm’s length•

Although the above rulings suggest thato shore supply and services may not tobe taxed in India, the taxability dependson the speci cs o each case. Further, therevenue authorities have not accepted theabove rulings and the matter is pendingbe ore the higher judicial authority. E&C

companies should take care to structurecontracts in a tax e cient manner, takinginto account the particulars o each project.



Higher depreciation – whatlies ahead?

In order to make in rastructure projectsmore attractive or companies andinvestors, the Indian Government isre-examining the existing depreciationpolicy or such entities. The in rastructuresector may be eligible or a higher rateo depreciation in book value or BOOT(build, own, operate, trans er) projects. TheGovernment is still examining this proposaland also evaluating whether depreciation

should be allowed or, alternatively, therecould be a policy or amortisation o theentire expenditure or such companies.Private players are needed to investin in rastructure projects on the BOOTbasis, and in the uture, in rastructurecompanies may bene t rom the creationo a sinking und by such companies orthe concession period. Such a und woulddepend on the li e o the project and theconcession period could vary widely,depending on the contractual conditions othe speci c project.

Indirect tax issues

The majority o the E&C services renderedby a company in India are subject toeither service tax, VAT, or both, dependingon whether the services rendered byE&C companies are in the nature o aconstruction contract or service contract.

Apart rom the above, there are certainother indirect tax issues which need to beaddressed appropriately, especially relatingto contract structuring. Companies need

to ensure that indirect taxes are taken intoaccount as they make decisions aroundhow to structure a particular project.

Table 4: Types o Permanent Establishments, when they occur, and issues to consider

Type o PE Occurs when a oreigncompany:

Issues to consider

Fixed base PE Has a virtual presence in India, eitherby way o a branch o ce or anyother manner which depicts a virtualpresence in India.

Implications should be known prior toestablishing a project o ce in India.

Agency PE Has a dependent agent in India Ensuring that an Indian companydoes not act as a dependent agent

or the oreign company.

Service PE Renders services in India through itsemployees or personnel or a periodaggregating more than a speci ed

period in any twelve month period,although this depends on the speci cterms o each tax treaty.

Planning o international assignmentsto ensure that employees do not stayin India or a period exceeding the

speci ed period.

Figure 3: Elements o a Typical EPC Contract

EPC Contract

Engineering& Design

Supply ofEquipment

Erection, Installation &Commissioning

Offshoreservices

Onshoreservices

OffshoreSupply

OnshoreSupply

Onshore



Challenges or local players and oreign companieslooking to enter the market

Without doubt then, there is hugeopportunity in the Indian in rastructurespace in the short- and medium-termsat least. The policies o the IndianGovernment, which have been evolvingvery rapidly in recent years, continue toencourage the private sector in takingon a larger and more diverse role – rombeing an in rastructure builder (undera publicly nanced arrangement) to anin rastructure developer (under PPPstructures which include private nance).These developments have led to a largenumber o in rastructure projects open up

as opportunities or the private sector.Considering the liberal FDI guidelines,these lucrative projects present both anopportunity and a threat to local players. Inmany cases, oreign players are believedto have greater technological expertise,deeper pockets and more extensiveexperience compared to domesticcompanies. These advantages could meanoverseas companies winning work at theexpense o local players, or partneringwith them. Domestic E&C companiesmay there ore look at oreign entrants in

the market as tough competitors – or asstrong potential partners.

I most o the orecasted projects goahead as planned, there should be morethan enough work or everyone. WhartonBusiness School’s 2007 analysis o India’sconstruction boom pointed out that theproposed US$50 billion in rastructurespend per year in India is nearly two andhal times the current turnover o the entireexisting domestic construction industry(US$15 billion and growing ast), and thatmany o the major E&C companies have

massive order backlogs. Wharton alsofagged talent shortages as an issue inkey skilled trades such as tting, welding,masonry and plumbing – so drawing onthe talent pool o oreign partners mayhelp in supplementing and training localtradesmen. India is also acing shortageso construction equipment and machinery.

Domestic production o equipment andmachinery is ramping up ast, but in theshort term, a oreign partner may beable to help ll in any gaps. There aremany actors that infuence the role o thelocal players vis-à-vis oreign players – orexample, the criteria used or the selectiono developers is an important infuenceron what role the oreign players will take.Risk-sharing on a PPP project also needsto be care ully considered. The revenues omost in rastructure projects in India will bedenominated in the local currency. Foreignplayers will need to consider the currency

and tax issues already mentioned in somedetail, particularly on a PPP project wheresigni cant private investment is also sought.

International EPC contractors, includingToyo Engineering, Jacobs H&G, Uhde,Tecnimont and Aker Kvaerner, are alreadyleading players in India. At the same time,many Indian companies e.g. Larsen &Toubro (L&T), Gammon, Bharat HeavyElectrical Limited (‘BHEL’), Engineers IndiaLtd and Thermax have either scaled uptheir skill sets or extended their operationsto overseas projects.

India has a very well establishedin rastructure developer market. Local

rms have evolved in recent times intoully-fedged national players (and in some

cases international players). In certainsectors, such as highways, power andwater, the local rms also have signi cantlyprogressed on the technological ront.Some o the India-based companiessuch as L&T, Punj Lloyd, Reliance, GMR,Suzlon, Tata Power, etc. are very active inthe international markets and thus, can nomore be deemed ‘local’ E&C companies.

Indeed, they are global organisationsbased out o India. These and other largerms clearly look at oreign players as

both partners and competitors. However,smaller and medium-sized in rastructureconstruction companies and developers(such as KMC, Nagarjuna, IVRCL,Gammon, etc.) are o ten happy to partner

“Foreign rms donot get their ownin rastructure toexecute projects, suchas skilled manpower,plants & equipmentsand constructionmaterials etc. Theyusually try to employlocally availableresources in order tocut costs.”Quote rom a Government representative



“Let us tie up with oreign companies romcountries where we intend to do business in.While we can help them enter India, they couldhelp us in expanding our business outside Indiain countries where they operate.”Quote rom an Indian E&C company

“Foreign companies o er an excellentopportunity or a comprehensive tie-up to winprojects and share the spoils. An attendantbene t is the trans er o technology to us at theend o it all.”Quote rom an Indian E&C company

“Entry o oreign players needs to be viewed asa positive development to add value and state-o -the-art technology to our highway projects.These rms will bring with them greater expertisein areas o highway construction technology,project management, project implementationand monitoring expertise as well as technology

trans er. The resultant bene ts include savings incost, time and improved quality o works, to thebene t o all.”Quote rom a Government representative

with oreign players without necessarilyconsidering them as competitors.

The recent guidelines issued by theIndian Government or the selectiono PPP developers have also led to aslightly distorted behaviour in the localmarketplace. The guidelines avourlarger players, even when the projectinvestments and execution can be easilycarried out by mid-sized companies.This has led to situations where manyo the small/medium-sized local playersare looking at partnering with the oreign

players primarily or the purpose ogetting quali ed and winning the job,rather than to actually bring in investmentor expertise. It is expected that suchbehaviour will soon change as theguidelines become more refective omarket dynamics and mid-sized Indiancompanies mature.

Foreign players looking to enter into theIndian marketplace and team with localplayers need to evaluate care ully thecost competitiveness o their prospectiveparticipation. India has witnessed

huge interest rom a number o oreignin rastructure companies in the past,but not many have really been able too er a cost-competitive proposal. SinceIndia has evolved its own model o costcompetitive delivery in many sectors( or example, in telecoms), local playershave an incentive to work with oreigncompanies only i the partnering o ersa competitive edge over other bidders.There have been ew such success storiesso ar where the oreign player has o ereda particularly cost-competitive productor service. In instances where we haveseen the success ul entry o oreignplayers (such as in the port sector), oreigncompanies have o ten been able to bringtechnology or management advantages,or expanded reach into internationalmarkets, to supplement the capabilities olocal partners.



Building a sustainable uturein India

Whilst the need or greater in rastructureinvestment is clear, equally important isthe need to sustainably manage suchinvestments. The Indian Government’ssuccess in in rastructure provision will bemeasured not by the quantum o undsinvested, but on how in rastructurecontributes to the achievement o India’seconomic, social and environmentalobjectives. Importantly, in rastructureinvestment should be considered as ameans to an end, not an end in itsel .

Challenges in in rastructure provision arenot unique to India. Uncertainty, scarcityo available unds or investment, andcompeting priorities present challenges toall governments in in rastructure planningand delivery. Sustainability requires that

uture generations are not compromisedby the investment decisions o currentgenerations. Sustainably managingin rastructure through the appropriatepricing, unding and prioritisation

rameworks is important to ensure thebene ts that accrue rom the signi cantinvestment that India is currently making

in key social and economic in rastructureare maximised.

Global climate change creates urtherchallenges. New in rastructure must notonly support social and economic goals, itmust also do so within acceptableenvironmental parameters. In our analysis The World in 2050: Implications of global

growth for carbon emissions and climatechange policy 2, we set out a number opossible scenarios or climate changebased on projected growth rates. In onlyone o the scenarios, ‘Green growth +Carbon capture and storage (CCS)’, wereemissions held to levels that are broadlyconsidered to be ‘acceptable’ byclimatologists.

Given that India’s growth rate is likely tocontinue at high levels, it is important thatconsiderations o issues such as uel mix,encouraging more uel e cient modes otransport such as rail, and the possibleuse o CCS technology, come ully intodiscussion and are implemented wheneverpossible.

In our view, it is imperative that debate onthe issue o sustainability in in rastructureprovision is heightened and that thechallenge that it presents is e ectivelymet. Government and in rastructureagencies will also need to retain su cient

ocus on issues o easibility andprioritisation when the primary ocus shi tsto delivery.

E&C companies looking to bid on majorprojects need to ensure that they aretaking a holistic approach whichincorporates sustainability issues into thedesign o the project, both in the planningand the delivery stages. Those that do sohave a unique opportunity to make amajor di erence in a growing economywhile enhancing their own bottom line.

2 Available to download at www.pwc.com



Concluding thoughts

Although it may not always be easy tonavigate the plethora o views, opinionsand perceptions expressed by various localstakeholders, a vast opportunity exists

or oreign contracting companies lookingto invest in Indian in rastructure. Already,a number o contractors rom Europe,

Australia, China, Malaysia and Korea havemade their presence elt in India. Further,many E&C companies, particularly romJapan, Spain, France and the UK arealso now aggressively looking out oropportunities to enter India or business.

Overall, the opportunities to develop asigni cant business in India are extremelypromising or E&C companies, i theyhave care ully selected strong localpartners, structured contracts sensibly tomaximise tax bene ts where appropriate,and taken a long-term, sustainableperspective. Foreign companies who donot acknowledge the opportunity in goodtime may miss out on a critical opportunityto establish a long-term presence in oneo the world’s largest growth markets.



Further reading:

International Mobility in the Engineering & Construction Industry

In this paper, we take a close look at trends and best practice across the E&C industrywith regard to moving people to work abroad. We draw on interviews with 24 companiesin the sector rom around the globe, covering areas such as international assignmentpolicy, compliance, reward, cost e ectiveness and talent management.

PwC Annual Global CEO Survey – E&C summary

A summary document containing the highlights rom our interviews with over 50 CEOsand executives within the sample who were rom E&C companies. We compare theresults o their responses with the global average across all industries – with someinteresting ndings.

Global Economic Crime Survey – E&C industry supplement

Examines the views o over 300 E&C industry executives and compares and contraststheir thoughts with those o their peers across all industries, as well as with E&Cexecutives’ views rom our 2005 survey. The results suggest that E&C executives needto take economic crime more seriously.

Building New Europe’s In rastructure – Public Private Partnerships in Centraland Eastern Europe

Explores the current developments and uture opportunities within the in rastructuresector o the CEE region. In the paper, we outline the opportunities in in rastructureprojects in CEE, EU unding, challenges and key success actors on bidding anddelivering on projects in CEE – a region requiring signi cant in rastructure investment.

Building Knowledge

A quarterly series o short papers on highly topical issues or E&C companies, hittingdirectly to the heart o the business issue addressed.

Other publications rom PricewaterhouseCoopers relating to the E&Cindustry are available to download ree o charge at www.pwc.com/e&c



Destination India

Gives potential oreign investors a bird’s eye view o the tax and regulatory ramework inIndia. A oreign investor looking at investment opportunities in India, needs to decide itsentry strategy and business model while bearing in mind the gamut o Indian laws andregulations impacting such oreign investment. The publication attempts to provide anintroductory summary o the policies, laws and regulations in India and a guide to themore important aspects o doing business in India

Buying into India

Highlights a number o opportunities and challenges or investment in India with aparticular ocus on Industrial Products, setting out the signi cant variations rom state tostate in terms o the labour market, quality o in rastructure, and governmental attitudesto investment amongst other things.

India Spectrum

This quarterly newsletter encompasses a summary o recent important judicial andlegislative developments in the eld o direct tax, indirect tax, trans er pricing, exchangecontrol regulations, and mergers & acquisitions.

Additionally, urther reading on investing and operating in India, includingthe ollowing, is available to download at www.pwc.com/in



Key contacts or E&C in India:In India, PricewaterhouseCoopers hasextensive experience o working with E&Ccompanies and has a dedicated group oover 350 pro essionals advising clientsin the industry. The in rastructure teamworks closely with our Real Estate, PPP& Government practices. Our knowledgemanagement programme ocuses onthe building o close networks and thesharing o in ormation and expertise. Ourassignments in all regions o the sub-continent have included both private andpublic sector clients.

We have played an integral part inthe evolution o the highways sector,serving as a thought leader or theNHAI & Department o Road Transportand Highways. We have assisted NHAIin the award and nancial close o 35projects (total length o about 1700km)and cost o around US$3.5 billion. Wealso assisted the NHAI in the preparationand nalization o the Model Concession

Agreement being used or NHAI Projects.Other projects include: Review o ModelConcession Agreement (MCA), BOT Tollagreement & BOT Annuity agreements,

OMT (Operation Maintenance Trans er)agreements. Further, we assisted the NHAIin evaluating various development models

or National Highways and are assistingState Governments in various aspects opolicy ormulation or the road sector.

Our team has also advised both publicand private entities on aviation issues,spanning rom work on the concessionagreement or Bangalore International

Airport and advising the Airport Authorityo India on a easibility study o venon-metro airports, to bid support or

a development project in Mumbai, toadvising the AAI/Ministry o Civil Aviationon ormulating cargo policy.

Our experience in the area o ports

development includes advising on someo the rst port projects on a PPP basis,providing bid advisory and nancial closeassistance and strategic advice to largeIndian/international port developers, aswell as advice to key logistics player instrategic investments and valuations

or ports. We are currently advising agovernment ministry on the development oan international container trans-shipmentterminal.

PricewaterhouseCoopers experts werealso involved in the rst rail BOT project

in India. We have experience advisingrailways on PPP structuring options orrailway projects and have also advisedon assignments or PPP structuring/ bankability studies. We are also advisingthe Ministry o Railways on strategy

ormulation or the development omanu acturing acilities or rolling stock.

As PPP projects are still relatively newto India, there are many taxation issueswhich are either evolving or still to bedetermined. There ore, adopting thecorrect tax position is important. Althoughthere are various tax incentives providedto in rastructure companies, greater ocusis required to optimise the utilisation otax incentives. Further, there are variousother important issues such as permanentestablishments and the taxability o EPCcontracts, which need to be considered atthe time o entering into a contract.

Tax is also a key cost component. It isimperative that companies structuretheir contracts in order to achieve taxoptimisation. Good tax planning canhave a potentially decisive impact,especially in the bid process, and canprovide a clear competitive advantage.PricewaterhouseCoopers was named2007 India Tax Firm o the Year byInternational Tax Review (ITR) magazine.

India E&C leader

Ravi [email protected]+91 (22) 6669 1308

Advisory

Amrit [email protected]+91 (124) 4620 517

Vishwas [email protected]+91 (124) 4620 557

Tax

Girish [email protected]

+91 (22) 6689 1433

Hemal [email protected]+91 (22) 6689 1466

International tax

Raj [email protected]+44 (0)1895 522 398

PricewaterhouseCoopers expertise in the E&Cindustry in India



This publication is printed on paper manu actured rom 75% recycled bre and made using elemental chlorine- ree pulp under a management system certi ed to ISO 14001.It was printed using vegetable based inks

Global & key regions E&C territory leaders around the worldGlobal LeaderJonathan Hook+44 (20) 7804 4753

AsiaSimon Neill+85 (2) 2289 2334

EuropeGuillermo Masso Lopez+34 (91) 568 4353

Middle EastKeshav Choudhary+973 (39) 911 458

USKent Goetjen+1 (860) 241 7000

AustraliaPeter Le Huray+61 (3) 8603 6192

Belgium

Jan Van raechem+32 (2) 710 7239

BrazilFelipe Ayoub+55 (71) 3243 1913

CanadaMichael Cli ord+1 (416) 869 2399

ChileGuido Licci+ 56 (2) 940 0019

ChinaThomas Leung+86 (10) 6533 2838

Czech RepublicJiri Koval+420 (251) 152 044

DenmarkJacob Fromm Christiansen+45 (0) 3925 3295

FinlandEero Kivi+358 (0) 9 2280 1934FranceLouis–Pierre Schneider+33 (0) 1 5657 8023

GermanyMartin Nicklis+49 (721) 8400 2351

Hong KongSimon Neill+85 (2) 2289 2334

HungaryBaki Erdal+36 (1) 461 9195

India

Ravi Bhamidipati+91 (22) 6669 1308

IrelandParaic Burke+353 (0) 1792 8655

ItalyGiorgio Greco+39 (02) 7785 319

JapanKen Moriwaki+81(03) 6266 5735

LuxembourgSerge Saussoy+352 (49) 4848 3056

MexicoJavier Garcia+52 (0) 55 52636129

NetherlandsGerard Bergers+31 (10) 407 5846

New ZealandCraig Rice+64 (9) 355 8641

NorwayKnut Grotli+47 (0) 95 26 01 26

PortugalCésar Gonçalves+351 (0) 213 599 436

RussiaJulia Tabakova+7 (49) 5232 5468

South AfricaDiederik Fouche+27 (11) 797 4291

Spain

Javier Lapastora+34 (91) 5684 631

SwedenPeter Lindstrand+46 (8) 5553 3197

SwitzerlandWilly Wenger+41 (0) 58 792 6160

ThailandChanchai Chaiprasit+66 (0) 2 344 1373

TurkeyHusnu Dincsoy+90 (212) 326 6054

UKJonathan Hook+44 (0) 20 7804 4753

UkraineVladimir Didenko+380 (44) 490 6777

USKent Goetjen+1 (860) 241 7000

Our Engineering & Construction industry practice is comprised o a network o morethan 4,000 industry pro essionals located in over 50 countries around the world.

Our Global E&C network – recognisedor its industry credentials and extensive

expertise – is ocused on providingservices to contractors, housebuilders,building products companies, pro essionaland support services companies,

governments as well as to private andpublic sector clients o the industry.

PricewaterhouseCoopers providesindustry- ocused assurance, tax, andadvisory services to build public trust

and enhance value or its clients and theirstakeholders. More than 155,000 peoplein 153 countries across our network sharetheir thinking, experience and solutions todevelop resh perspectives and practicaladvice. Our specialised services to the

E&C sector include contract disputeresolution, acquisitions, PPPs, costreduction and structuring.

An in–depth understanding o key industryissues and practical experience o working

with our clients are central to the deliveryo our services to E&C companies. Manyo these issues drive our programme opublications and thought leadership orthe sector.

“PricewaterhouseCoopers” re ersto the network o member rms oPricewaterhouseCoopers InternationalLimited, each o which is a separate andindependent legal entity.

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