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Saturday, July 28, 2012

Will the draft Indian GAAR guidelines discourage creative structuring?

Earlier this year, the Indian Revenue Department released its position paper on implementing the much awaited anti tax avoidance rules, expectedly on pro revenue lines. What was of interest in the paper (http://finmin.nic.in/the_ministry/dept_revenue/Draft_GAAR_GuidelineITAct1961.pdf) besides the illustrations, was the criteria for defining  impermissible avoidance arrangement  as one whose
(a) its main purpose is to obtain a „tax benefit‟, and,
(b) it also has one of the following characteristics:
(i) it creates rights and obligations, which are  not normally created between parties dealing at arm‟s length; (ii) it results in misuse or abuse of the provisions of the tax law; (iii) it lacks commercial substance; (iv) it is carried out by means or in a manner which is normally not employed for an authentic (bona fide) purpose.
It is point b(iv) that bears interest here. Structuring of transactions(for my earlier posts on structuring read these posts    ), needs ample creativity, customization and is often only constrained by the regulations/tax laws which it aims to circumvent. Such an explicit provision will give the Revenue leverage to attack innovative structures, and therefore defeat the first mover advantage of the early adopters. Of course, this may only ensure legal wars over the meaning of ‘normally not employed’ and so on, but this puts innovative structures at risk. Hence, till more clarity on this point, those structuring transactions for Indian clients would be well advised to exercise caution. 

ICAI Award for excellence in financial reporting-an analysis

Now is the time of the year when the Institute of Chartered Accountants of India opens its annual competition for the best presented annual report. The different categories are as per activity(service, infrastructure, manufacturing, non profit, public sector), ownership(public, private) and turnover(>500 crores and others). You can read about it at this link Like many other awards, its reputation was somewhat tarnished post the Satyam scam(as Satyam was an award winner too), but it has bounced back. The object of this post is to educate the reader about the award criteria, and to comment on it. I had also ranked companies’s financial reporting as an academic exercise during my stay in IIM Ahmedabad, so I can claim some expertise in ranking!
  1. ·         Compliance with statutory/regulatory norms
  2. ·         Quality of financial reporting(‘clean’ audit report without qualifications/adverse comments)
  3. ·         Adequacy and presentation of financial information by using schedules, cross references, subtotals, rounding off, charts/graphs/comparative highlights, financial ratios. Interestingly, ‘lucidity, clarity and comprehensively’ from the angle of individual/small shareholders is also rewarded here maybe for inclusiveness!
  4. ·         Extent, nature and quality of non financial information including HR accounting, CSR activities, MD&A of company and subsidiaries, risk management, governance/ethics etc.

The award criteria in my view, miss out on the following important elements of the annual report
  • ·         Segment Reporting-this should explicitly get weight(most companies escape by stating just one reportable segment!)
  • ·         Intangible Assets-Few companies disclose their patents and other IPR. Hence, this should be incentivized, to allow shareholders to spot the next Apple :P
  • ·         Too much importance to CSR/ethics-this is activity which the company spins, not necessarily which it does well. Rewarding mere reporting of this seems inappropriate, as it is unaudited information and often spinned too well
  • ·         In this digital age, using the web version effectively and uploading high resolution coloured pictured form of annual report is not rewarded. In an era where electronic version is sent by default to those shareholders having email IDs on record, this aspect assumes importance.
  • ·         Other information like investor presentation, conference call transcripts, videos etc are not evaluated at all. This being useful non financial information helping to interpret the financial reports, should certainly get some weightage. 

Sunday, July 15, 2012

Understanding telecom retail in India-some pointers

At the outset, let me clarify that I do not consider myself an expert on telecom(or on anything else for that matter :P). This blog post is only based on certain observations/analyses and inferences during personal visits to telecom stores in Mumbai and Bangalore. For modern trade(malls etc), this may not apply due to space issues and also as they often do not carry the entire product range.

  1. Commoditized SIMs/data cards: Thanks to the relatively low margins that retailers make on SIM activations, the poor SIM salespersons are given a stall outside the main store(!) with a packet of forms etc. So it is abundantly clear about their pecking order in the hierarchy of things!
  2. Single brand versus multi brand stores:- All the operators be it Airtel, Idea, Vodafone, Reliance, Aircel all have exclusive outlets, which seem to focus on the consumer experience and awareness. That is why in the outlets I've seen, the focus is more on 1-1 selling and wider display of products/schemes, rather than the claustrophobic multi product strores I've seen(like The Mobile Store), that focus on max yield per square foot
  3. Recharges not always sold in telecom outlets:-As that involves manual effort and all, many don't find it profitable to sell these recharges..indeed its mostly the kirana stores and other non exclusive outlets that sell these. 
  4. Handset demos often not given:- Shops are aware that customers often check out the devices in the shops and then shop for it online. This problem is for books also, but there one cannot avoid showing the book itself unless its plastic shrinkwrapped(which may bring down sales though..). So often only the expensive/fancy phones are displayed but not the entry level handsets below Rs 10,000. And demos are given only for displayed products, few retailers will open the box and show you. 
  5. Multi brand recharges/devices/data market:- Most retailers give a wide bouquet of all the popular operators, so there is no brand loyalty at the retailer level. So often the same retailer will have nameboards showing his name from all the main operators! 
Anyways, given that around 90%+ of Indian voice market is prepaid(and from early indications the data market seems going the same way), the front end is resembling a FMCG set-up. For fixed line, a DSA setup seems to work due to the unique economics of that business. 

Sunday, July 8, 2012

Telecom industry economics 101-a primer

Telecom pricing has always seemed opaque, random and complex. But there is logic behind the seeming madness, which I try to explain below

  1. Fair usage policy which restricts the user speed for 'unlimited speed' beyond certain limits, attempts to invert the Pareto principle on its head. After all, the specious logic used for fair usage policy is that a few users by their huge usage lower the overall experience for everyone else. Agreed, but that is what the Pareto principle is all about. By trying to avoid that, this is a novel experiment to avoid that here(i.e socialize the usage in a way). However, it does seem a success-logically and financially
  2. Call termination charges are levied by the destination network, and impose a lower ceiling on calls tariffs between operators. But for intra-operator calls, this is not applicable(except within circles where due to separate license norms, they are subject to separate P&L and transfer pricing), and so operators can offer it at near zero prices(like say 2paise for a minute!). There, the pricing would probably factor in opportunity cost of using the spectrum(since that is a finite resource) and other network effects, but not out of pocket costs.
  3. Like Dominos, Subway and Starbucks which sell a base and try to earn superprofits on the top-ups/upsize options, those economics/rationales apply more so to telecom, with its low incremental costs per minute. So lessons from the F&B industry can be profitably applied here
  4. The cost structure from the operational side is largely fixed(spectrum, network) except for companies like Airtel which have a per-time slot cost structure thanks to innovative deals with their service providers. From the marketing side, channel partners get a fixed fee for customer acquisition, and therefore churn is very expensive for telcos which cannot recoup that fee(that is why an upfront fee/activation charge/registration fee is usually charged, that generally goes to recoup these upfront costs).
  5. Telecom is intimately linked to customer behaviour(how they talk, listen to music, surf data) and so like food, it is VERY local. That is why tariff plans are also localized, and increasingly with the special offers/'best plan suggestion'; telcos are trying to refine their price discrimination by targeting offers to the n=1 target segment.
Will try to explain more later, but this is all for now.