LEGAL ISSUES ON FOREIGN INVESTMENTS IN INDIA

As a result of various policy initiatives taken, the Indian economy has been rapidly changing from a restrictive regime to a liberal one. The present legal framework allows an easy entry to a foreign investor in India.

The liberalization of the foreign investment regime in India commenced in 1991 and thereafter has been gradually liberalized by successive governments. Deregulation, privatization and easing of restrictions on foreign investments and acquisition are some of the main factors that have acted as significant catalysts in attracting foreign investments. India is now ushering in the second generation reforms aimed at further and faster integration of the Indian economy with the global economy.

The outcome is evident- India has been ranked third for global foreign direct investments (FDI) in 2009, following the economic meltdown, and will continue to remain among the top five attractive destinations for international investors during the next two years, according to the United Nations Conference on Trade and Development (UNCTAD) in a new report on world investment prospects titled, ‘World Investment Prospects Survey 2009-2011”.

Regulatory Framework

The key Indian regulatory authorities in the context of Foreign Direct Investment (“FDI”) are the Foreign Investment and Promotion Board (“FIPB”), which formulates foreign investment policy, and the Reserve Bank of India (“RBI”), India’s central bank, with the primary responsibility of implementing and enforcing foreign exchange regulations and government policy.

Issues Regarding FDI in India

FDI is permitted through following forms of investments:

• Financial collaborations.
• Joint ventures and technical collaborations.
• Capital markets via Euro issues (Foreign Currency Convertible Bonds (FCCBs)/Equity Shares under the Global Depository Mechanism).
• Private placements or preferential allotments.

FDI is freely allowed in all sectors including the service sector in India, with certain restrictions in a few sectors where the existing and notified sectoral policy does not permit FDI beyond a ceiling. FDI for most cases can be brought through Automatic Route under the powers delegated to the RBI and for the remaining case as elaborated below through the Government approval.

Under current rules, foreign investment up to 100% is permitted in almost all industry sectors. There remain only a handful of industry sectors in which no FDI or limited FDI is permitted – these tend to be “sensitive” sectors, either for security reasons, such as defence or telecommunications, or for political reasons, such as agriculture, retail, real estate, banking and insurance. In addition, the government has been simplifying procedural aspects such as the approval process in respect of FDI.

Process for Foreign Direct Investment

Automatic Route

Investment under the Automatic Route is available to new ventures and also to  existing companies proposing to inject foreign equity. However the Automatic Route would not be available to those who have any previous joint venture in the same or allied field in India. Investors investing under the Automatic Route do not require any approval from any of the authorities. FDI in the public sector would also qualify under the Automatic Route. The investors are only required to notify the relevant Regional Office of RBI within 30 days of receipt of inward remittances and file the required documents with that office within 30 days of the issuance of shares to foreign investors.

Government Approval

The Government Approval through FIPB for FDI are essential for the following cases:

1.      Proposals which require industrial licence;

2.      FDI being more than 24 % in the equity capital of the units manufacturing items reserved for the small scale industries;

3.      Proposals in which a foreign collaborator has a previous venture in India;

4.      Proposals relating to acquisition of shares in an existing Indian company in favour of a foreigner investor; and

5.      Proposals falling outside the notified sectoral policy in which FDI is not permitted.

Government Approvals are accorded on the recommendation of the FIPB. Application for all FDI cases should be submitted to the FIPB Unit, Department of Economic Affairs, Ministry of Finance. No fee is payable. The application is generally processed in 4-6 weeks. There is no requirement of notification to RBI after getting FIPB’s approval.

Entry Options

Foreign investors planning to set up business in India have two options, either to set up a separate corporate entity in India, i.e. incorporating an Indian company or through an unincorporated entity, for instance a branch office of the foreign entity. Incorporation of an Indian company can be possible under the provisions of the Indian Companies Act, 1956. The foreign investors can invest in such Indian company up to 100% of capital depending upon sectoral guidelines prescribed by the Government of India. Under the second option, a foreign company are allowed to operate in India, subject to conditions and activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office of Other Place of Business) Regulations, 2000, through setting up either of the following: liaison office/representative office, project office, or branch office.

Points to note

Decide structure of your India entry: It could be a JV with an Indian partner or a 100% Indian subsidiary. Except for certain sectors a foreigner can set up a 100% subsidiary in India with full repatriation of capital and dividend facility.

Identify a good strategic partner in India: This will help in a long way in the success of a venture in India. Do a background check on the local partner by due diligence with their customers, trade partners, employees, bankers, suppliers etc.

Identify a good market and sector of FDI: India offers a great opportunity for FDI on account of its strong democracy system, strong financial system, wide and potential market, good command of the English language, strong work-force and education system, growing urban class, strong information technology infrastructure and investment favorable policy of the government. There are certain issues with the taxation policy. However they are expected to be eradicated after the introduction of the proposed new taxation policy discussed below.

Price: The purchase or sale price of any transaction in Indian securities between a resident Indian and a foreign investor is regulated by prescribed pricing guidelines which limit flexibility. For example, the price of any shares sold in a listed company has to be above the minimum price calculated in accordance with a formula linked to the market value of the shares over a prescribed period preceding the sale. A different methodology applies for the sale of shares in an unlisted company.

Tax: India has entered into a Double Tax Avoidance Agreement with many countries including Malaysia. The agreement allocateS the taxing jurisdiction between the source country and residence country. Wherever such jurisdiction is given to both the countries, the agreement prescribes a maximum rate of tax in the source country which is generally lower than the rate of tax under the domestic laws of that country. The double taxation in such cases is avoided by the residence country agreeing to give credit for tax paid in the source country thereby reducing tax payable in the residence country by the amount of tax paid in the source country.

Presently, due to various central and state taxes on goods and services, the Indian taxation framework is fragmented. There is a little cascading of taxes in the present taxation system. From both the domestic and foreign investment perspective a suitable reform in indirect tax is required to do away with the multiplicity of taxes thereby reducing cumbersome requirements, high cost of transaction and nagging uncertainty in tax liability for a business.

The Government of India is supposed to introduce a new tax policy from April 2010 that will sweep away part of the current VAT system, a variety of state level direct and indirect taxes, excise duties, service tax and luxury tax and replace them with a single Goods and Services Tax (GST). The GST is expected to be India’s magnet to draw foreign investment. In its final shape, it offers a seamless, transparent tax structure that leaves no room for discretion with the state or central government to change rates. It is expected that subsuming all indirect taxes and levies under a single tax regime will create a grand common market with little distortions due to local factors.

Dispute Resolution

Broadly speaking, Indian law recognises the freedom of parties in an international contract to choose both the governing law, the forum (arbitration/courts) and the jurisdiction for settling disputes. However, the FIPB often requires as a condition of its approval that agreements involving FDI be governed by Indian law. Litigation in India is an onerous and time-consuming process. Arbitration is therefore a popular dispute resolution option.

FDI regime in India has been liberalized to a great extent and a very large number of foreign investors has benefited thorough these policies. Though there are certain important sectors like retail trade and telecommunications in which 100% FDI is not permitted but the steps are being taken by the Indian government to attract investors in these segments also. Even under the present policies, India is being viewed as an investment heaven, and it is very difficult for wise investors to ignore India.