INTRODUCTION

India, the world’s largest democracy, is today one of the most favoured destinations of foreign investors and businesses for various reasons including a rapidly growing economy, educated and skilled workforce, huge market size, increasing purchasing power, low costs and political stability. This Synopsis provides a bird’s eye view of the Indian legal framework as applicable to foreign investors and collaborators. The purpose of this Synopsis is to provide a brief idea of the overall Indian legal and regulatory framework, the process of establishment of business in India and the crucial issues involved.

ENTRY STRATEGY

Legal Entity

A foreign entity may establish a business presence in India through a liaison office, branch office, project office, wholly owned subsidiary company or joint venture.

A liaison office can be established to primarily explore and understand the business opportunities and climate in India for the foreign parent entity. A liaison office is not permitted to carry on commercial activities in India.

A branch office can carry on the business activities while a project office can be established to execute a specific project. However, since a branch office or a project office would not be considered a legal entity separate from its parent company, the business income generated by them would be taxable at the rate of tax applicable to the foreign companies (40% plus surcharge and cess) which is higher than the rate of tax applicable to companies incorporated in India (35% plus surcharge and cess; proposed to be reduced to 30% plus surcharge and cess by the Union Budget 2005-06).


In view of restrictions on the activities and tax implications for liaison, branch and project offices, establishment of a wholly owned subsidiary, or strategic alliances through joint ventures or technical collaborations with existing Indian companies by and large remain the preferred options for foreign entities to establish a long term presence in India.

Options for Collaboration

In addition to the option of establishing a wholly owned subsidiary, a foreign entity may enter into following kinds of collaborations with existing Indian companies for its presence in India:

In addition, a foreign entity can import– export goods and services to and from India and appoint distributors for its products in India with or without trademark license. It would, however, be preferable to appoint these distributors on a principal to principal basis to avoid the possibility of taxability of the foreign entity in India.

REGULATORY PERMISSIONS AND COMPLIANCES

The Foreign Investment Promotion Board (“FIPB”) and the Reserve Bank of India (“RBI”) are the nodal government authorities to permit and supervise foreign investments in India. In addition, Ministry of Commerce and Industry and various other ministries and departments of the government prescribe sector specific regulatory compliances and approvals.

Financial Collaboration

Foreign investment upto 100% of the securities of Indian companies is freely permitted in most of the sectors, except a few sectors where FDI beyond prescribed percentages is not permitted without prior government approval, such as insurance, aviation, banking, telecom, real estate, etc., and a few manufacturing sectors requiring industrial license such as alcoholic drinks, tobacco products, defense equipment, hazardous chemicals etc. (“regulated sectors”). Foreign investment is however prohibited in certain sectors including retail trading, atomic energy, lottery, gambling, etc.

A financial collaboration in these regulated sectors consequently requires presence of an Indian equity partner and/or requisite prior government approvals from the FIPB, the RBI and other applicable ministries.

The securities of an existing unlisted Indian company in unregulated sectors can be transferred from its holders to the foreign investor without prior government approval.

To meet additional financial needs, a foreign collaborator can also provide loans to the Indian company as per the detailed government guidelines issued in this regard prescribing interest rate, average maturity period, end use and prior approval in certain cases.

Under these arrangements, foreign entities can provide technical know how and/or license their trademarks to Indian companies against payment of fee and royalty.

For use of foreign technology, Indian companies can remit lump sum fee of upto US$ 2 million and royalty upto 5% of domestic sales and 8% of exports to the technology licensor without any prior government approval. Similarly, for use of trademarks and brand name of the foreign collaborator without technology transfer, payment of royalty upto 2% of exports and 1% of domestic sales is allowed without prior government approval. In case of trademark/brand name license together with technology transfer, the payment for technology transfer subsumes the payment of royalty for use of trademark and brand name of the foreign collaborator.

Post Collaboration Compliances

In regulated as well as free sectors, an Indian company is required to effect certain one time as well as periodic filings with prescribed government regulatory and tax authorities. These filings include intimation of receipt of foreign investment, letters of acceptance, intimation of issue of securities, annual tax, accounts and returns, etc.

In addition, specific industries need to file periodic reports with the administrative ministry and departments, such as quarterly and annual returns by the software technology parks with the Director, STPI.

Incorporation, Registrations and Licenses

Incorporation of a company in India is an administrative process which takes approximately 15 to 20 working days from filing of incorporation related documents. A company incorporated anywhere in India is entitled to carry on business activities throughout India.

In addition, an Indian company would require to obtain various sector and location specific licenses and registrations, including registrations and licenses under the direct and indirect taxes, import-export regulations, labour laws and trade and municipal regulations. These license and registrations can ordinarily be obtain within three weeks of filing the requisite documents.

TAXES AND TAX BENEFITS

4.1

India has a multi tier tax system comprised of direct and indirect taxes. The main taxes are income tax, sales tax, excise (levied on manufacturing/value addition), service tax (levied on provision of specified services), customs duty, octroi (on entry of goods in certain areas), stamp duty (on execution of specified documents) and property taxes.

The income tax applicable to Indian companies is 35% plus surcharge and cess (proposed to be reduced to 30% plus surcharge and cess by the Union Budget 2005-06). No minimum corporate income tax is payable by Indian companies in absence of profits. Generally all business expenses are deductible from taxable income. Indian companies are also required to withhold income tax from various payments and deposit it with the government.

India proposes to introduce a uniform value added tax systems with effect from April 1, 2005, in an attempt to unify certain indirect taxes.

International Taxation

India has entered into double taxation avoidance agreements (“DTAA”) with several countries around the world. Generally, the provisions of DTAA prevail over the domestic tax provisions and offer bilateral relief to residents in both jurisdictions in respect of foreign taxes paid. Foreign investors can consider to route their investments into India through any of the tax heavens having beneficial DTAA with India.

Most of the DTAA’s provide that, if a foreign company has a permanent establishment (“PE”) in India, its income accruing in India would be taxable in India at the rate applicable to foreign companies (i.e. 40% plus surcharge and cess).

Transfer Pricing Regulations

India has implemented transfer pricing regulations. Generally speaking, these rules govern the minimum profit margin to be maintained by the Indian companies in transactions with associated enterprises. Arguably, the transfer pricing regulations legitimize provision of services by Indian companies to foreign parent and other entities on a cost plus basis, as per the industry norm and avoid PE implications for the foreign entity in India.

Tax Benefits

In India, substantial direct and indirect tax benefits/exemptions for the initial few years are provided to units engaged in specific business activities, such as export oriented software and hardware units; specified infrastructure projects; units in backward areas, special economic and free trade zones.

The export oriented software and services units are offered exemption of customs duty on imports, exemption of excise duty and sales tax on domestic purchase of capital goods in addition to exemption of octroi. Due to availability of tax benefits/exemptions and availability of educated workforce, India is fast becoming the global hub for software development and business process outsourcing.

The DTAA, transfer pricing regulations and tax benefits provide an opportunity to the foreign investors to arrive at an efficient tax structuring of investments and business in India. Foreign investors can, considering the tax rates in both jurisdictions, ability of the Indian companies to provide services at a cost plus basis and tax exemption available for specific activities, decide the quantum of their investments in India.

RETURN ON INVESTMENTS

Foreign investors can repatriate funds out of India though a number of options including dividends, fees for technical and administrative services, royalties, etc.


5.1 Repatriation of Profits

Indian companies can remit their profits to a foreign collaborator by way of dividend subject to dividend distribution tax @ 12.5% plus surcharge and cess. There is no limit on the rate of dividend that can be distributed or repatriated out of India. However, there are certain conditions with regard to computation of profits and transfer of upto 10% of profits of the company to its reserves before declaring dividend.

Branch offices of foreign companies can also remit business profits to their principal subject to withholding tax @ 40% plus surcharge and cess (unless lower tax rate is prescribed by the DTAA).

Repatriation of Fees and Royalties

IP PROTECTION

India recognizes the value of intellectual property rights and has well established procedures for protection of patents, trademarks, designs and copyrights.

The true and first inventor of a product or process can register it as a patent in India. Trademarks, for services and goods, and designs (industrial designs, excluding functional designs) can also be registered in India by its owner. As far as copyrights are concerned, registration is not compulsory. Copyrights in original literary, dramatic, musical and artistic works, cinematography films and sound recordings can also be registered. The registration of copyright is however not compulsory to initiate a legal action against infringement.

Violation of IP rights is a punishable offence in India. The owners of patents, trademarks, designs and copyrights can institute appropriate legal actions against the infringer and restrain the infringer from using the IP pending conclusion of the legal action.

HUMAN RESOURCES AND LABOUR ISSUES

Costs

India arguably has the world’s largest educated workforce available at salaries substantially below the international standards. A statute prescribing minimum wages to be paid to different classes of employees is in force in India. However, the minimum wages prescribed under this statute are not only far below the minimum wages payable to similarly qualified and skilled workers in developed economies across the world, they are also much below the salaries ordinarily paid in India to such workers by reputed employers.

In addition to salary, certain other employee benefits and contributions, such as provident fund and employee state insurance are also payable by the employer (together with the employees).


The availability of economical educated workforce facilitates the foreign investors to source international quality services and products at comparatively lower costs.

Key Issues

Due to rapid industrial development and growth of employment opportunities in big cities, the employers in these cities often face problems of attrition. Foreign investors may therefore review the industry salary standards before employing workforce, check the employment history of prospective employees for consistency and sincerity and include adequate protection in the employment documentation to avoid breach of confidentiality and attrition.

Indian labour statutes are employee friendly and discourage hire and fire practices. While the employment of manager and administration level employees is governed by and can be terminated as per their employment contracts, employees at lower levels, called “workman”, can be terminated only in accordance with the procedure laid down under law (unless the termination as per the employment contract is more beneficial to the employees).

Export oriented units situated at most of the prominent locations in India are permitted to employ workers in shifts, beyond the regular office hours.

DISPUTE RESOLUTION

The judicial structure in India consists of courts and tribunals in defined hierarchy. The apex court in India is the Supreme Court, at New Delhi. Below the Supreme Court, every state has its own High Court and subordinate courts. The courts exercise jurisdiction based on their territorial, pecuniary and statutory limits. In addition, specific disputes, such as consumer and tax disputes are adjudicated by specially constituted tribunals.

Litigation in India is usually long drawn. Further, judgments of only a few foreign courts can be directly executed in India. Consequently, arbitration and conciliation are prevalent methods of dispute resolution. A foreign investor and its Indian partner can agree to resolve the disputes arising between them through arbitration conducted in or outside India. India is signatory to the Geneva Convention of 1927 and the New York Convention of 1958 and consequently the awards under these conventions are enforceable in India through specified statutory procedure.

DUE DILIGENCE

We provide below a non-exhaustive list of viability verifications that may be conducted and caution that may be exercised by the foreign investors while establishing business in India through wholly owned subsidiaries or collaborations:

1.Verify the financial position of and possession of assets by the prospective partner; 2. Verify that the sector permits the proposed investment and obtain requisite approvals; 3. Ensure that the business understanding is well documented and is tax efficient; 4. Consider PE implications in India while finalizing the collaboration structuring; 5. Discuss in detail and decide the control and management issues of the Indian venture, including shareholding structure, constitution of its board of directors and committees; 6. Ensure inclusion of provisions concerning control and management of the company in its articles of associate and timeline for issue of securities after receipt of investment and procedure for dissolution of the venture; 7. Timelines in India may, sometime, due to unavoidable circumstances extend beyond the time originally expected. The business plans should take this factor into account; 8. Take steps towards IP registration and protection; 9. Verify employment history of the employees; and 10. Adopt alternative dispute resolution mechanisms.

DISCLAIMER

This Synopsis is not intended to be and should not be construed as legal advise. While adequate care and caution has been exercised by the author in preparing and providing this Synopsis, the business requirements of different foreign investors may differ and require in depth consideration and resolution of crucial legal issues. Before taking any concrete business decisions, readers are advised to obtain specific legal advise from competent counsel in their own judgment. The author and the firm disclaim all liability to any person or entity concerning consequences of anything done or omitted to be done wholly or partly in reliance upon this Synopsis.

Alishan Naqvee has experience in areas of transactional law and dispute resolution and regularly authors on Indian legal issues.