In recent years, the entry of non-India business to India has been considerably liberalized – this demonstrates a tremendous forward movement from a closed, protective, bureaucratic environment to a freer and more competitive environment with less bureaucratic controls.
Now there are fewer permissions and licences required to do business in India. All Foreign participation is regulated by the Foreign Direct Investment Policy (FDI Policy) as issued by the Ministry of Commerce and Industry, Department of Industrial Policy and Promotion. This policy stipulates the maximum percentages of foreign participation and the general policy matters. Foreign participation is permitted in all areas except in Gambling and betting, Lottery Business, Atomic Energy and Retail Trading (except Single Branded product retailing). The FDI Policy applies caps on certain sectors, in which investment is proposed.
Sectoral caps: Many sectors are open to 100% foreign participation. However, there are certain sectors, such as telecommunication (74%), print media (26%), Single Brand Retailing (51%), Insurance (49%), etc. , which restrict foreign participation to specified percentages.
Sectoral policies: Different sectors (manufacturing, energy, power, mining etc.) which are under the administrative jurisdiction of different ministries, have put in place relevant policy guidelines.
Foreign participation, depending on the sector/industry, may be either through:
- Automatic route (does not require prior approval either by the Government or Reserve Bank of India (RBI) - only post facto reporting to RBI is required)
- Approval route (require prior approval either by the Government or RBI)
CHOOSING A LEGAL STRUCTURE OF YOUR INDIAN ENTITY
The legal structure of the entity/vehicle should be chosen based upon the objectives and purposes for which you are entering into India. Is it for:
- Setting-up of manufacturing / service facility (Incorporated Entity)
- Execution of a project/contract (Project Office)
- Marketing/ servicing of your existing products (Branch Office)
- Liaison work- communication channel between the parent company and Indian companies (Liaison Office)
Entry Options:
If your objective is to set up a manufacturing or service facility – an incorporated entity - the following options are open:
- Incorporating a Wholly Owned Subsidiary (WOS); or
- Entering into a Joint Venture (JV) in an existing entity in India; or
- Acquiring an existing company in India.
If your objective is to execute a project or a contract, market or service existing products or open up a communication channel between the parent and Indian companies, then entry would be achieved by opening a branch office/ Liaison office/ Project Office without incorporating a company in India.
Incorporated Entities (Companies)
Depending on the sectoral caps, as per the FDI Policy, a foreign investor may:
- Establish a Wholly Owned Subsidiary;(WOS)
- Joint Venture company; or
- Acquire an existing company.
Companies can be set up as either public or private.
The Registrars of Companies (ROC) under the Ministry of Corporate Affairs (MCA) operates as a registration authority for the purposes of the Indian Companies Act (ICA).
The Memorandum of Association (MOA) and Articles of Association (AOA) are the charter documents on which a company shall function. The MOA and AOA are subordinate to the ICA.
A company incorporated in India is treated as a domestic company for tax purposes.
All the foreign companies which have set up a place of business in India, whether Liaison Office, Branch Office or Project Office have to comply with certain specific provisions of ICA, including filing of certain returns and documents. In general, there is no restriction on foreign nationals being directors of a company.
No prior approval is required for repatriation of dividends.
A subsidiary can be funded via equity, debt (both foreign borrowing subject to the External Commercial Borrowing Rules and local borrowing) and internal accrual.
Setting up a WOS Company is only permitted if, under the FDI Policy, foreign equity in a target sector is allowed up to 100%.
Joint venture partner can be an Indian or foreigner depending upon sectoral caps in place. One or more foreign parties can jointly invest 100% in a JV, if foreign investment up to 100% is allowed. i.e there are no sectoral caps in place. (the foreign investors may opt for Indian partners as well) One or more Foreign Companies have to invest in a JV jointly with one or more Indian partners in the sectors, which permit less than 100% FDI. (here Indian participation is compulsory)
Wholly or partly - WOS or operating in collaboration with the existing shareholders. Acquiring a listed company can be done only in accordance with the Stock Exchange Board of India (SEBI) Takeover Code. Acquiring/purchasing the assets of an existing company without taking over the liabilities, either under a slump sale or only a particular unit only, depending upon the circumstances in each transaction.
Legal-tax, financial and technical due diligence necessary to avoid any unforeseen liability to either party is of critical importance.
Once the foreign investor has decided whether to set up a WOS, a JV or to acquire an existing company, it then needs to decide upon the type of company:
Types of companies
Private company is restricted from public offering of its shares. Transfer of shares is subject to consent of all shareholders or as stipulated in the AOA. Maximum number of shareholders is limited to fifty (50). No solicitation or acceptance of deposits from persons other than members, directors or relatives of such persons, is allowed. Required to have a minimum paid-up capital of INR 0.1 million (approximately US$ 2,500). Must have at least two directors and two shareholders, where the second shareholder can be a nominee of the first shareholder and can hold as low as one share. Unlike a Public Company, a private company is exempted from many of the requirements of obtaining permissions, approvals from the government and compliances under the ICA.
Public company should not restrict public offering and its shareholders should be free to transfer of shares.
Unincorporated Entities
- Foreign Companies can open a BO subject to prior approval by the RBI.
Scope of activities of BO is limited to:
- Export/import of goods.
- Rendering professional or consultancy services.
- Carrying out research work, in which the parent company is engaged.
- Promoting technical or financial cooperation between Indian companies and the parent company/group.
- Representing the parent company in India and acting as a buying/selling agent.
- Providing technical support to the products/services supplied by parent/group companies.
A BO is not allowed to undertake manufacturing activities on its own but is permitted to subcontract these to an Indian manufacturer. BOs established with the approval of RBI may remit the profits outside India, subject to applicable Indian taxes and RBI guidelines. For Income Tax (IT) purposes, a BO is treated as an extension of the foreign corporation in India and taxed at the rate applicable to Foreign Companies. Upon winding up, transfer of assets of BO to subsidiaries or other LO/BO is allowed with specific approval of the RBI. Remittance of Profits net of taxes is permitted.
BO on “Stand Alone Basis” in Special Economic Zone (SEZ)
SEZ-BOs may be set up in SEZs on the condition that no business activity is conducted outside of SEZ. SEZ-BO is allowed to undertake manufacturing activities within SEZ. No approval is necessary from RBI for a company to establish a branch in SEZs to undertake manufacturing and service activities provided that such BO is engaged in activities which permit 100% FDI under the FDI Policy. Other conditions are:
- Such units comply with part XI of the ICA (registration as a Foreign Company),
- Such units function on a stand-alone-basis,
- In the event of winding up of business and for remittance of winding-up proceeds, the SEZ-BO shall approach an authorized dealer in foreign exchange with the prescribed documents.
- Remittance of Profit net of taxes is permitted.
Liaison Office (LO)
Foreign Companies can open a LO subject to prior approval of RBI. LO acts as a representative of the parent company for promotional and communication purposes. LO is not allowed to do business with third parties in its own name therefore, cannot earn any income in India. Any violation can lead to serious complications with the RBI, other statutory authorities and the federal tax authorities.
Permitted activities for a Liaison office in India of a person resident outside India:
- Representing in India the parent company/ group companies.
- Promoting export import from / to India.
- Promoting technical/ financial collaborations between parent/ group companies and companies in India.
- Acting as a communication channel between the parent company and Indian companies.
- Partnership/ Proprietary concerns set up outside India are not allowed to establish BO/ LO.
- Upon winding up, transfer of assets of LO to subsidiaries or other LO/BO is allowed with specific approval of the RBI.
- No Remittance of profit is permitted since the permitted activities cannot generate profit.
A Foreign Company which has secured a contract from an Indian company to execute a project in India may establish a PO.
Other conditions:
- the project is funded directly by inward remittance from abroad; or
- the project is funded by a bilateral or multilateral International Financing Agency; (World Bank or the International Monetary Fund, etc.) or
- the project has been cleared by an appropriate authority; or
- a company or entity in India awarding the contract has been granted Term Loan by a Public Financial Institution or a bank in India for the project.
- The Foreign Company shall furnish a report to the RBI giving details of itself and the project.
- Establishing a PO is not subject to any prior approval by the RBI, though, certain post facto filings are necessary.
- PO cannot undertake or carry on any activity other than the activity relating and incidental to execution of the project.
- PO may remit outside India the surplus profits of the project on its completion.
Ordinary partnerships under the Indian Partnership Act, 1932 are not a suitable form for FDI due to unlimited liability. Tax Rates for both the partnership and the company incorporated in India under ICA are same i.e.30%. There is a proposal pending for enacting legislation for limited liability partnerships which, if passed, may prove useful for FDI in services sectors.
CONCLUSION
The choice of an appropriate vehicle by a foreign entrant needs to be taken on the basis of the short term, medium term and long term perspectives and business plan.
A foreign entrant can start with a LO, which may help to ‘test the waters’. Of course, this has its own limitation because it cannot do business in India. However, any business generated through a LO can be contracted between the parent company/head office and the client and accordingly executed by the parent company/head office. If the foreign entrant is satisfied with the initial results, it can then proceed to set up a BO or an incorporated entity.
On the other hand, if the foreign entrant has an initial understanding of the Indian market, it can straightaway choose to have a BO at one or more places, subject to RBI approval. The main drawback of a BO is that it is not permitted to manufacture, although it can render after sales service. Further, retail trading is not permitted. However B-2-B trading is not considered as retail trading and is permitted.
If manufacturing (full or in part) in India is contemplated, a foreign entrant needs to have an incorporated entity in India. Among the incorporated entities, the ideal and most favoured incorporated vehicle for FDI is a private limited company. It can have a joint venture with an Indian partner or set up a wholly owned subsidiary, depending on the sectoral cap restrictions under the FDI policy. It can be a closely held company with appropriate restrictions on the right to transfer shares (unlike a listed/unlisted public company, where no such restriction is legally permitted) and less statutory restrictions and compliance requirements.
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