Welcome to the June edition of Freehills’ India Update.
India Update is our regular newsletter covering recent Indian legal and business developments and highlights.
In this edition of India Update we cover the following issues:
Entry options for foreign investors
Sovereign wealth funds investing in India
Liberalisation – overseas investments in energy and natural resources sectors
Bids in foreign currency for projects to be executed in India
Salary relating to services rendered outside India not taxable in India
Deal watch
Entry options for foreign investors
In this update we will examine the different options foreign companies have to set up business operations in India. As with the formation of entities in any jurisdiction, selection of an entity form for India and its ultimate formation requires careful consideration. The purpose of this update is to provide a high level overview of the key issues related to such entity formation.
Foreign companies have the option to set up their business operations in India either in the form of incorporated entities (by incorporating a company) or unincorporated entities (by setting up a branch, liaison or project office).
Setting up incorporated entities
Foreign companies who intend to commence any sort of business activity within India usually establish some form of business entity that is a subsidiary to a foreign parent. In most cases, a foreign company can own up to 100 per cent of the equity of an Indian company. This however is subject to India’s exchange control regulations and foreign investment policy.
Companies in India are regulated under the Companies Act 1956 (Companies Act). A company in India may be set up as:
- a private company which:
- has a minimum paid-up capital of Rs100,000 ($2,500)
- by its constitution restricts the right of the shareholders’ to transfer the shares
- has the number of shareholders limited to 50, and
- prohibits invitation to the public to subscribe for any shares in or debentures of the company.
- a public company (listed or unlisted) which has a minimum paid-up capital of Rs500,000 ($12,500).
The Companies Act prescribes specific requirements for incorporation depending on the type of entity established. The formation of a company in India is fairly consistent with the formation of business entities in other jurisdictions. The incorporation process is similar for both, private and public companies. The incorporation process is simple and generally takes approximately two to three weeks.
Setting up offices
Separately, Indian law also provides for a series of business forms which can be used to carry out a narrow range of business activities. For foreign companies whose operations in India are either nascent, or limited in terms of purpose, scope and geography, use of these business entities may be feasible. In the past, many of the foreign companies would first set up liaison or branch offices in India as an intermediate step before setting up an incorporated entity or entering into a joint venture with a local partner. This helped the foreign companies to understand the Indian market and sometimes find a joint venture partners (if that was of interest).
The different forms of unincorporated entities under Indian law are a:
- liaison office
- branch office, or
- project office.
Such offices can undertake activities permitted under the regulations issued under the Foreign Exchange Management Act. Setting up a branch or a liaison office in India requires the prior approval of the Reserve Bank of India. The approval process is straight forward and typically takes six to eight weeks. Setting up a project office does not require prior approval of the Reserve Bank of India.
Liaison office
A liaison office (or representative office) acts as a channel of communication between the company’s head office and its Indian operations. It is not permitted to undertake any commercial or trading or industrial activity, directly or indirectly, and therefore must be fully funded from outside of India.
The activities of the liaison office are typically restricted to the following:
- representing the parent company or group companies in India
- promoting exports from and imports to India
- promoting technical and financial collaborations between parent or group companies and companies in India, and
- acting as a channel of communication between the parent company and Indian companies.
The role of the liaison office is limited to collecting information about possible market opportunities and providing information about the parent or other group companies to prospective customers in India. Since it has no income, it is not taxed in India.
Branch office
Foreign companies engaged in manufacturing and trading activities outside India are allowed to set up a branch office in India. A branch office is permitted to carry on a wider scope of activities than a liaison office. These activities include:
- exporting and importing goods
- providing professional or consultancy services
- carrying out research assignments for the parent company
- promoting technical or financial collaborations between Indian companies and the parent or overseas group company
- representing the parent company in India and acting as the buying and selling agent in India
- providing information technology services and development of software in India, and
- providing technical support to the products supplied by parent and group companies.
A branch office is not permitted to engage in any manufacturing activities in India on its own but may sub-contract such activities to an Indian manufacturer. The profits of a branch office are permitted to be remitted outside India subject to the payment of the applicable Indian laws.
Project office
Foreign companies planning to execute specific projects in India can set up temporary project/site offices in India for this purpose. A project office represents the interest of a foreign company executing a specific project in India. Such offices are prohibited from undertaking any activity other than the activity relating, and incidental to, the execution of the project for which the office is established. In order to set up a project office, a foreign company must have a contract to execute a project in India.
Setting up offices or incorporated entities in India?
The benefits of the traditional approach of setting up a branch office or a representative office as an intermediate step before setting up a company in India is now debatable.
Until recently, foreign direct investment in most sectors in India required prior government approval. The incorporation of a company (especially by a foreign company) was a time consuming exercise and took more than six to ten weeks. This has changed considerably. Today, foreign direct investment in most sectors in India do not require prior government approval. Further, the process of incorporation of a company has become relatively simple. This means that it is comparatively easier today to set up a company in India than setting up a branch or a representative office.
Apart from logistical ease, the income of a branch office of a foreign company in India is taxed at the higher rate of 40 per cent (as it is taxed as a foreign company) compared to that of a company incorporated in India (30 per cent).
It seems then that incorporation of an Indian subsidiary will often be the better way forward for many foreign companies.
It is good news for the foreign institutional investors, hedge funds and sovereign wealth funds looking for exposure in India. Securities Exchange Board of India (SEBI), India’s capital market regulator, has liberalised the rules applicable to foreign institutional investors. SEBI has allowed sovereign wealth funds to trade in Indian shares and government securities through sub-accounts of foreign institutional investors registered in India. However, the new regulation limits the investments to sovereign funds that have an asset base of at least $2 billion and are listed.
In addition, international or multilateral organisations, foreign governmental agencies and overseas central banks can also trade in Indian securities once they are registered as foreign institutional investors.
As per the existing regulations, an Indian entity is allowed to make direct investments in joint ventures or wholly owned subsidiaries outside India up to 400 per cent of its net worth. Such investments do not require approval of the Government of India. With a view to provide greater flexibility to Indian parties for investments abroad, Indian companies are now allowed to invest in excess of 400 per cent of their net worth in the energy and natural resources sectors such as oil, gas, coal and minerals. However, such investments would require prior approval of the Reserve Bank of India.
Until recently, a person residing in India was permitted to incur liability in foreign exchange and make or receive payments in foreign exchange in respect of global bids. This was only in cases where the central government had authorised such projects to be executed in India and the approval of the concerned administrative ministry was obtained. The Reserve Bank of India has now simplified the process. Persons residing in India who have been awarded contracts are now permitted to incur liability in foreign exchange. They can make or receive payments in foreign exchange in respect of global bids for projects to be executed in India without obtaining prior approval of the Government of India.
A tax tribunal in India has dealt with the issue of whether the salary income of a foreign national accruing and arising from services rendered outside India is taxable in India. In this particular case the foreign national rendered services partly in India and partly in other countries as per the terms clearly specified in his employment contract. The foreign national was resident in India but not ordinarily a resident in India. The tribunal held that there was no inference that the employee while working outside India rendered services in respect of operations in India. Therefore, it could not be said that the period of employment in other countries should also be considered as services rendered in India. Accordingly, the proportionate salary for the days on official duty outside India was not taxable in India. This should however be distinguished from a situation where the services rendered outside India is inextricably linked with the employee’s employment in India. If that is the case, the employee’s entire income would be taxed in India.
The international M&A activity has been adversely affected by the credit crunch and the looming recession in the United States. Lately, it has also been affected by the spiralling cost of oil. However, the growth in Asia particularly China and India is robust and to some extent has compensated for the slowdown in developed countries. The size of the cross border deals in China and India are getting bigger. According to one report, emerging-markets M&A activity so far in 2008 is up 17 per cent over last year at this time, while for the rest of the world it is down 43 per cent.
There have been many large cross border mergers and acquisitions in India in recent times.
Japan’s Daiichi Sankyo acquires promoter stake in Ranbaxy Laboratories
Ranbaxy Laboratories, one of the largest pharmaceutical companies in India, which has a good foothold in the lucrative global generic drug market, announced that the Indian promoters have sold their stake in the company to Japan’s Daiichi Sankyo for somewhere between $3.4 billion and $4.6 billion. Daiichi Sankyo bought the promoter’s 34.8 per cent stake for US$2.4 billion, and another 9.3 per cent through a preferential allotment of equity shares. Daiichi will now have to make an open offer to the public shareholders for at least 20 per cent of Ranbaxy’s shares.
The all cash deal is the largest exit by a promoter family in India.
South African telecommunications major in merger talks
After Bharti Airtel, India’s biggest telecommunications company, ended its talks with South Africa’s MTN after being unable to reach an understanding on the structure and control issues of the post-merger entity, another Indian telecommunications company, Reliance Communications (RCOM), is believed to have been courted by MTN for a potential merger. If successful, this deal will eclipse Tata Steel's $13 billion takeover of Corus Steel last year, as India's biggest foreign investment so far.
Link Group India venture
Australian registry major Link Group, a company owned by global private equity major Pacific Equity Partners, has acquired majority stake in Intime Spectrum Registry, an Indian company, for an undisclosed sum. Post-acquisition, the company will function under the name Link Intime. The acquisition will help Link Group's foray into India and will result in the creation of one of the largest registry and financial services firms in India.
This article was written by Rohit Kumar, Legal Associate admitted in India, Melbourne.
Freehills India team
Freehills is the Australian law firm of choice for many leading Indian companies investing in Australia and South-East Asia. We won the India Deal of the Year award for Tata Power’s acquisition of PT Kaltim Prima Coal and PT Arutmin Indonesia.
In addition, we have been one of the most active, if not the most active, Australian law firm in India.
We have excellent relationships with leading Indian law firms, investment banks and the Big Four accounting firms in India.
Freehills is committed to strengthening its India practice group and has recently employed several Indian-qualified lawyers. The mix of Indian lawyers based in our Sydney and Melbourne offices and Australian lawyers with Indian experience enhances the understanding of the Australian-Indian investment and capital flows.
The core India team at Freehills has been involved in advising several major Australian companies on their investments into, and operations in, India.
More information
For information regarding possible implications for your business, contact a member of the India team.