Here is the 3rd part of a 4 part article written by Sumeet Kachwaha of Kachwaha & Partners giving legal perspective of things if you plan on doing business in India. This aims to be an easy to read, yet comprehensive overview of legal issues involved in doing business in India.
The law of corporations in India is governed by the Companies Act, 1956. Broadly, there are two types of companies – Public Limited Companies and Private Limited Companies. While Public Limited Companies describe themselves merely as “Limited Companies”, Private Limited Companies are obliged to indicate clearly the fact that they are a Private Company by adding after their name “Pvt. Ltd.”
Private Limited Companies:
A Private Limited Company can be formed with a minimum of two persons as shareholders and a minimum of two directors. The minimum paid up capital for a Private Company is about US$ 2500 (approximately). A private company has the following features:
- The right to transfer shares is restricted as per its Articles of Association.
- The maximum number of its shareholders is limited to 50.
- No offer can be made to the public to subscribe to its shares and debentures.
- No invitation or acceptance of deposits from persons other than members, directors or their relatives is allowed.
- Lesser number of compliance requirements.
Thus generally, where there is no requirement for raising finances through the public and the ownership is intended to be closely held, a Private Limited model is followed.
A company which does not contain restrictive provisions in its Articles is a Public company. Unlike Private companies, Public companies can be formed with a minimum of seven members. There is no maximum limit on shareholders for Public companies. The minimum paid-up capital required for a Public company is about US$ 12500 (approximately) and the minimum number of directors is three.
There is no need to appoint an Indian director or Indian shareholder to incorporate a company.
Incorporation is through registration with the Registrar of Companies (ROC). The ROC is a statutory authority formed under Companies Act and has numerous offices all over India.
For incorporation, the following steps are involved:
- Selection of name of the company and getting it approved from the ROC. Upon scrutiny and satisfaction, the ROC issues a name availability letter.
- After the name is approved, Memorandum and Articles of Association (MoA) are drafted.
- MoA along with other necessary documents are filed with the ROC. The filing fees is dependent on the authorised share capital of the Company.
- After scrutinising the documents, the ROC issues a Certificate of Incorporation.
Whereas Private companies can commence their business from the date of Certificate of Incorporation, Public companies are required to file certain additional documents and obtain a Certificate of Commencement of Business.
A company can normally be incorporated within a period of 15 to 20 days. The Government has recently introduced e-filing through which Company incorporation (including subsequent statutory documents) can be filed in electronic form. Details of e-filing procedure are available at the website of Ministry of Company Affairs at www.mca.gov.in.
There are three ways to wind up a company:
- Voluntary winding up,
- Winding up under orders of the court,
- Declaration of the company as defunct
(i) Voluntary Winding Up:
This is permitted when the company has no debt or is in a position to meet its liability in full within a maximum period of three years. The consent of all the creditors have to be taken. Upon approval of the Registrar of Companies, a private liquidator is appointed to dispose off the assets and prepare a preliminary report. This is subject to scrutiny by the Official Liquidator and upon his satisfaction of legal compliances. The final order of winding up is subject to orders of the High Court.
(ii) Winding Up Under Orders Of The Court:
This can happen under a variety of circumstances. Mostly it happens where the company is unable to pay its debts and the Court is satisfied that it would be just and equitable to wind up the company. This route involves an elaborate and time consuming exercise whereunder the High Court appoints a liquidator and the directors of the company are required to file a statement of assets and liabilities of the company with the liquidator upon which the liquidator takes up the task of disposing off assets and satisfying the debts of the company from the proceeds. Once the debts are satisfied (to the extent they can be) and all monies which can be recovered are recovered, the court passes a final order for winding up. The debts of the company are paid out as per a schedule of priority. The top most priority goes to the workmen and the secured creditors. Next in terms of priority are Government taxes. Only thereafter the debts of unsecured creditors are payable.
(iii) Declaration As A Defunct Company:
This option can be resorted to without any recourse to a court. This route is available through a simple letter to the Registrar of Companies stating that the company is not carrying on any business for a year or more. Upon being so satisfied, the Registrar can strike off the name of the company from the Register of Companies on the ground that it is a defunct company. However notwithstanding that the name of the company is struck off, the company and its directors shall continue to be responsible for any undischarged obligation of the company as if it had not been dissolved. Further the directors of the company are required to furnish an affidavit to the Registrar to the effect that the company has no assets or liabilities and has not been carrying on any business during the last year or more. Further any one director is required to furnish an indemnity bond to the effect that he would satisfy the liabilities of the company if any after the name of the company has been struck off from the Register.
Usually these proceedings conclude within three months or so.
TAKEOVER OF LISTED COMPANIES:
In order to protect the interest of small investors and to promote fairness in the capital market, the Securities & Exchange Board of India (SEBI) has framed Regulations providing for acquisition and takeover of shares (commonly called the Takeover Code). The Code has the following significant features:
No person can acquire shares in a listed company which would take his holding upto 15% or beyond without first making a public announcement to the shareholders of the company and an open offer to them, to acquire their shares to the extent of 20% of voting rights at the “offer price” (as finally approved by SEBI). In other words, a person wishing to acquire upto 15% or more shares of the company must make a public offer for upto a minimum of 20 percent of the voting rights in the Target Company.
Once the acquirer has obtained upto 15% or more shares in the company, the acquirer may resort to “creeping acquisition” of upto 5 percent of the voting rights in the Company per financial year, without making any public offer. This way the acquirer can consolidate his shareholding in the Company upto a total of 55%. Beyond 55%, the requirement of making an open offer again comes into play.
However any inter se transfer of shares amongst the promoters / joint venture partners in the company would not attract the provisions of the Code.
Failure to comply with the Code entails negation of the transaction and also penal liability.
Corporate governance assumed greater significance in India post liberalization. Following a few instances of malpractices, it was felt necessary to lay greater emphasis on corporate governance to ensure transparency and encourage corporate growth. Earlier Corporate Governance was ensured through some fairly standard provisions under the Companies Act providing for inter alia minimum number of board meetings, shareholders meetings, rotation of directors etc. In 2005 the Securities Exchange Board of India (the market regulator) introduced Clause 49 in the Listing Agreement of all Public companies, wishing to list their shares in any stock exchange. Clause 49 essentially provides for the following measures:
Constitution Of Board Of Directors:
- The Board should have a combination of executive and non-executive directors. Not less than fifty percent of the Board should comprise of non-executive directors.
- One-third of the Board should comprise of independent directors where the Chairman of the Board is a non-executive director and half of the Board should comprise of independent directors where the Chairman is an executive director. Independent director shall mean a non-executive director who apart from receiving director’s remuneration does not have any material pecuniary relationships or transactions with the company, its promoters or directors
- It is necessary for all listed companies to have an Audit Committee. This committee shall review the financial statements in consultation with the management.
Summary Of Related Party Transactions:
- Where the transactions are entered with parties related to promoters, directors etc. a summary of the same is to be placed periodically before the audit committee.
- Every company is required to give a Corporate Governance report along with its annual accounts stating inter alia its strengths, opportunities, risks and concerns.
STRUCTURING OF CROSS-BORDER BUSINESS
Foreign investors have the following structuring options for entry into India:
- Liaison Office/Representative Office
- Branch Office
- Project office
- Incorporation of Company
a. Liaison Office:
Liaison office basically acts as a representative and cannot carry out any commercial or industrial activity on its own. Setting up a liaison office needs prior permission of the Reserve Bank of India (RBI). A liaison office typically undertakes the following:
- Representing the parent / group company and acting as a communication channel.
- Marketing for the parent Company – without actually entering into any contract itself.
All expenses for establishing and running the liaison office have to be met through inward remittances. No income can be generated locally. As the liaison office is not permitted to be engaged in any commercial activity, it earns no income and is therefore not liable to pay any income tax.
b. Branch Office:
Prior approval from the RBI is required for setting up a branch office. However, Government has granted general permission to foreign companies for setting up branch offices in designated Special Economic Zones for undertaking manufacturing and service activities. Branch office can perform almost all the activities that a parent company can perform in India without the hassle of going for incorporation. Typically, the branch office carries out the following activities:
- Entering into contracts for export / import of goods.
- Rendering professional or consultancy services.
- R & D
- Promoting technical or financial collaboration.
- Acting as buying / selling agents.
- Rendering services or technical support.
The major advantage of a branch office is the ease of setting up and exiting. However, profits from the branch office is taxable in India and the tax is higher than that for an Indian Company. A branch office is taxed at the rate of 41.86%, whereas an Indian Company (incorporated in India) is taxed at the rate of 33%. Profits (post tax) are fully repatriable out of India.
c. Project Office:
Foreign companies can set up a Project Office for carrying out a specific project in India. Prior approval from the RBI is not required. Project offices however cannot carry out any activity other than the activity relating to the project. Like branch office, a project office is also subject to income tax at the rate of 41.86%. A foreign company may open a Project Office in India provided it has secured a contract from an Indian company to set up a project in India and the following conditions are fulfilled:
- the project is funded by inward remittances from abroad, or
- the project is funded by a bilateral or multilateral International Financing Agency, or
- the project has been cleared by an appropriate authority, or
- Indian company awarding the contract has been granted term loan through a Public Financial Institution or bank in India.
d. Incorporation Of Indian Company:
A foreigner can incorporate a wholly or partly owned company in India.
While this option affords greater freedom in operation and lesser tax liability, it entails expense in complying with the administrative procedures under the Companies Act. Also winding up (if necessary) becomes a long and cumbersome exercise. This option is advisable if the operations planned in India are large enough to justify the additional administrative burden.
A company incorporated in India (by foreigners) is liable to pay tax at the rate applicable to any other domestic company (currently 33.66%).
A foreign company can open a franchise in India. Many companies such as Mc Donald’s, Pizza Hut, Subway, Kentucky Fried Chicken have entered India through the franchising route. Franchising is contract driven i.e. through an agreement with the Indian counterpart. Prior approval of the RBI is required by the Indian partner for remitting money for acquisition of franchise in India.
Reserve Bank of India has allowed royalty payment up to 2% for exports and 1% for domestic sales on the use of foreign trade mark and brand name without any transfer of technology. Further, for use of trade mark, a company is required to obtain licence from the trade mark authorities. There is no fixed term for the grant of license and the same is dependent on the terms of license agreement entered into between the would be licensor and the licensee.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Doing Business in India Series: