Doing Business in India – Investment & Trade – Part 2

Here is the 2nd 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.

INVESTMENT AND TRADE

The India story changed dramatically from 1991 when Government announced its new industrial policy, basically de-licensing industry and introducing fiscal and regulatory reforms. This vastly encouraged foreign investment. The cumulative Foreign Direct Investment (FDI) from 1991 to 2007 has exceeded US$ 54,628 million (in 2006 – 2007, alone it was US$ 15,726 million – a 184% increase from the previous year).

The top investing countries are Mauritius, USA, Japan, Netherlands, U.K., Germany, Singapore, France, Republic of Korea and Switzerland. The top sectors attracting highest FDI are telecommunications, services (financial and non-financial), transportation industry, fuels, chemicals, food processing, electrical equipments, drugs and pharmaceuticals, cement and gypsum products and metallurgical industries.

Government Policy:

Government policy as to FDI can be classified under three categories. First; sectors where it is prohibited (for instance, it is not permitted in retail trading; atomic energy and agricultural). Second; sectors where it is subject to a cap e.g. in telecommunication FDI upto 49 percent is permitted – with Government permission it can go up to 74 percent – (but not beyond). The third is the residuary category where no Government permission is required. In other words, unless a sector is prohibited or investment is sought beyond the sectoral cap specified, FDI does not require prior Government approval. It only requires a post facto intimation to the Reserve Bank of India (RBI).

For sectors where FDI is prohibited or for specific sectoral caps and the guidelines pertaining thereto please see the Government websites: www.dipp.nic.in or www.rbi.org.in

Government approval is further required in the following cases:

1. Proposals in which the foreign investor has an existing financial/technical collaboration in India in the same field.
2. Proposals for acquisitions of shares in an existing Indian company in financial service sector and where Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 is attracted.
3. Activities/items that require an industrial license. An industrial license is required inter alia for industries of social or environmental importance such as alcoholic drinks, cigars and cigarettes, electronic aerospace and defence equipment.

Foreign Investment Promotion Board (FIPB)

Foreign Investment Promotion Board (FIPB) is the competent body to consider and recommend foreign direct investment (FDI), which do not come under the automatic route. The FIPB consists of:

– Secretary, Department of Economic Affairs	Chairman
– Secretary, Department of Industrial Policy & Promotion	Member
– Secretary, Department of Commerce	Member
– Secretary, (Economic Relation), Ministry of External Affairs	Member

The FIPB normally takes up to 30 days to grant approval.

Foreign Portfolio Investments:

Only Foreign Institutional Investors (FIIs) registered with the Securities & Exchange Board of India (SEBI) or Non-resident Indians may invest in shares through the stock exchange.

Foreign pension funds, mutual funds, investment trusts, asset management companies, nominee companies are allowed in this category. Each investor can invest up to 10% of the total paid up capital issued by the Indian company. Total investment by foreign investors in an Indian company should not exceed 24% of the paid up capital or paid up value of each series of convertible debentures issued by the Indian company. However, this limit of 24% can be increased to the sectoral limit with the shareholder’s approval.

Repatriation Of Funds:

The Government has allowed repatriation of funds arising out of sale proceeds or dividends without any restriction. For repatriation, the following is necessary:

1. The investor has not chosen to invest on a non – repatriable basis nor is the security subject to non – repatriation.
2. The sale of security has been made in accordance with the prescribed guidelines.
3. Tax clearance certificate has been obtained from the tax authorities.

OFF SHORE BORROWINGS:

As a matter of fiscal policy, Government regulates External Commercial Borrowings (ECBs). The guiding principle of the ECB policy is to keep borrowing maturities long, costs low, and encourage infrastructure and export sector financing which are crucial for overall growth of the economy. Government has been streamlining and liberalising ECB procedures in order to enable Indian corporates, to have greater access to international finances.

ECB can be accessed under two routes, namely, the “automatic route” and “approval route”.

Automatic route: ECB for investment in the real sector, industrial sector, especially infrastructure sector in India, falls under the automatic route, i.e. will not require RBI / Government approval. The maximum amount of ECB which can be raised by an eligible borrower under the automatic route is US$ 500 million during a financial year. However, NGOs engaged in micro-finance activities can raise ECB only upto US$ 5 million in a financial year for permitted end use.

Approval route: All cases which fall outside the purview of the automatic route, will be decided by an Empowered Committee set up by Reserve Bank of India.

For further information on ECB policies please see www.finmin.nic.in

SPECIAL ECONOMIC ZONES:

Special Economic Zones (SEZ) are getting recognized as fast growth engines which can boost manufacturing and create new job opportunities at an unprecedented scale. India has taken a major policy initiate to encourage SEZs. With a view to simplify the procedures it has enacted a Special Economic Zone Act, 2005 and notified the Rules thereunder in the year 2006. There is a great rush to set up SEZs all over India and almost every major Indian business house has got into the act.

Incentives offered to develop SEZs include:

• Exemption from customs/excise duties for development of SEZs.
• Income Tax exemption on export income for a block of 10 years in a 15 year period.
• Exemption from minimum alternate tax under the Income Tax Act.
• Exemption from dividend distribution tax under the Income Tax Act.
• Exemption from Central Sales Tax and Service Tax.

Incentives and facilities available to persons setting up units in SEZ include:

• Duty free import/domestic procurement of goods for development, operation and maintenance of SEZ units.
• 100% Income Tax exemption on export income for SEZ units for first 5 years; 50% for the next 5 years and 50% of the ploughed back export profits for next 5 years.
• Exemption from minimum alternate tax under the Income Tax Act.
• External commercial borrowing by SEZ units upto US $ 500 million in a year without any maturity restriction through recognized banking channels.
• Exemption from Central Sales Tax and Service Tax.
• Single window clearance for Central and State level approvals.
• Exemption from State sales tax and other levies as extended by the respective State Governments.

FDI up to 100% is allowed through the automatic route for all manufacturing activities in SEZs, except for the following: (i) arms and ammunition, explosives and allied items of defence equipment, defence aircraft and warships (ii) atomic substances (iii) narcotics and psychotropic substances and hazardous chemicals (iv) distillation or brewing of alcoholic drinks (v) cigarettes/cigars and manufactured tobacco substitutes (vi) Sectoral norm as notified by Government shall apply to foreign investment in services.

TRANSFER OF TECHNOLOGY

Transfer of technology (or technical support) is a common feature of joint venture agreements or turn – key projects. It is also usual in the franchising and hotel industry.

Payment Incidents:

Transfer of technology usually entails payment under the following heads:

1. Royalty
2. Payment for designs and drawings
3. Payment for engineering services
4. Technical know how fees

Government Permissions:

Government permission for remittance of funds for transfer of technology is required where it does not fall under the “automatic route”. The following payments fall under the automatic route (and hence do not require Government approval):

1. Lump sum payment, up to US$ 2 million.
2. Royalty payment can be made up to 5% of domestic sales and 8% of exports without any restriction on duration of such payments. These payments are net of taxes. Royalty is calculated on the basis of net ex-factory sale price exclusive of excise duties, less the cost of the standard bought out components and the landed cost of imported materials including ocean freight insurance, custom duties etc.
3. Royalty payment up to 2% for exports and 1% for domestic sales on the use of trade mark and brand name of a collaborator without any transfer of technology is also allowed under the automatic route.
4. In relation to the hotel industry, automatic permission is available, subject to the following conditions:
   1. Technical and Consultancy services: Lump sum fee does not exceed US$ 2,00,000
   2. Franchising and Marketing support: Up to 3% of gross room sales.
   3. Management Fees: Up to 10% of the gross operating profits.

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:

The Legal Environment
Investment and Trade
Company Incorporation
Intellectual Property Rights