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A Simple guide to Doing Business in India

This is a comprehensive guide on Indian regulatory framework including kinds of entities, foreign direct investment (FDI) and outward remittance.

The favourable policy framework put in place by the Indian Government, including liberalisation of FDI in various sectors and launch of major national development programmes such as ‘Make in India’ and ‘Digital India’, has ensured significant inflow of foreign capital into India.

Improved governance, positive conditions for conducting business, transparency in government procedures and responsive policy-making, with an immediate focus on effective implementation of the Government’s reforms, are expected to make India a preferred destination for foreign investment and set it on a growth trajectory that promises all-round development, economic welfare and strong macroeconomic indicators such as GDP, CPI and revenue collections. The GST, as a radical reform, is an enabler that is revitalising the business environment in India and is greatly enhancing its stature around the world.

The strength of the Indian economy lies in its ability to continue on its path of robust and broad-based growth. Despite global headwinds and economic challenges related to policy development and continuity, the Government’s pro-market efforts such as steps for creating an investor-friendly business environment, rationalisation of FDI limits and measures for resolution of stressed assets will culminate in India becoming a destination of choice for investors.

Residential status of a company is considered a resident of India if it is incorporated in or its Place of Effective Management (PoEM) is in India. PoEM means a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are made in substance. Thus, the global income of a company will be taxed in India if its PoEM is in the country. Residential status of other forms of corporate are permitted in India and operate in the country.

A foreign entity setting up operations in India can either operate as an Indian company (by creating a separate legal entity in the country) or as a foreign entity with an office in India. Operating as an Indian entity Wholly owned subsidiary a foreign company can set up a wholly owned subsidiary in India to engage in business activities permitted under the country’s FDI policy. Such a subsidiary is treated as a separate legal entity and requires at least two shareholders (in the case of a private limited company) and seven shareholders (in the case of a public limited organisation).

In addition, two directors are required, with one of them being an Indian resident. Limited Liability Partnership (LLP) In India, an LLP is structured as a hybrid entity, with the advantages of a company (since it is a separate legal entity with ‘perpetual succession’), and at the same time enjoys the benefits of organisational flexibility associated with a partnership structure. At least two designated partners are required, of which one needs to be an Indian resident. No tax is levied on distribution of profits as dividends to partners, unlike in the case of a company for which Dividend Distribution Tax (DDT) is applicable on repatriation of dividends. Foreign investment in LLPs is permitted in sectors where 100% FDI is permitted under the automatic route without any performance-linked conditions.

Joint Venture (JV) with Indian partners (equity participation) Although a wholly owned subsidiary is generally the preferred option in view of the associated brands and technologies involved, foreign companies also have the option of conducting their operations in India by forming strategic alliances with their Indian partners. Typically, such foreign entities identify partners engaged in the same area of activity or those that can add synergies to their strategic plans in India. Sometimes, formation of JVs is necessitated due to restrictions on foreign ownership in selected sectors under the FDI policy, e.g. the Insurance and Multi-brand Retail Trade segments. Operating as a foreign entity A foreign entity can set up an office in India in the form of a liaison office (LO), a branch office (BO) or a project office (PO), based on the nature of activities it proposes to engage in and its commercial objective. This can be done by submitting an application to an Authorised Dealer (AD) bank.

However, the approval of the RBI is required under the following circumstances:

The applicant is a citizen of or is registered or incorporated in Pakistan. The applicant is a citizen of or is registered or incorporated in Bangladesh, Sri Lanka, Afghanistan, Iran, China, Hong Kong or Macau and the application is for opening a BO, LO or PO in Jammu and Kashmir, the North East region or the Andaman and Nicobar Islands. ‹ The principal business of the applicant is concentrated in four sectors—Defence, Telecom, Private Security, and Information and Broadcasting. However, prior approval of the RBI shall not be required in cases where Government approval or licence/permission by the concerned Ministry/Regulator has already been granted.

Further, in the case of proposal for opening a PO relating to defence sector, no separate reference or approval of Government of India is required if the said non-resident applicant has been awarded a contract by/ entered into an agreement with the Ministry of Defence or Service Headquarters or Defence Public Sector Undertakings. The applicant is a Non-Government Organisation (NGO), Non-Profit Organisation, or an entity, agency or department of a foreign government.

Once an office has been set up, it needs to be registered with the Registrar of Companies. Each type of office can be established for the specific objectives mentioned below. LOs Setting up an LO or representative office is a common practice among foreign companies or entities seeking to enter the Indian market. The role of LOs is limited to collecting information about the market and providing data pertaining to the company and its products to prospective Indian customers. An LO is only allowed to undertake liaison activities in India, and therefore, cannot earn any income in the country.

BOs Compared to an LO, a BO can be set up and engage in a wide range of activities, including revenue generation, in India. Foreign entities can set up branch offices in the country to conduct the following activities:

  • Export and import goods
  • Provide professional or consultancy services
  • Participate in research in which their parent companies are engaged
  • Promote technical or financial collaboration between Indian companies and their parent organisations
  • Represent their parent companies in India and act as their buying or selling agents in the country
  • Offer IT and software development services in India
  • Provide technical support for products supplied by their parent or group companies
  • Represent foreign airlines or shipping companies.

FDI reforms Foreign Direct Investment (FDI) is a major driver of economic growth and a source of non-debt finance for economic development in India. The Government has put in place an investor-friendly policy, under which FDI up to 100% is permitted through the automatic route in most sectors and activities. In the recent past, the Government has implemented reforms in its FDI policy in a number of segments.

The measures it has undertaken have resulted in increased FDI inflows into the country. During FY 2014-15, total FDI inflows into India amounted to USD 45.15 billion as against USD 36.05 billion in FY 2013-14. In FY 2015-16 and FY 2016-17, India received total FDI of USD 55.56 billion and USD 60.22 billion respectively. During FY 2017-18 and FY 2018-19, India’s FDI inflows remained strong at USD 60.97 billion and USD 64.37 billion respectively.

Foreign Direct Investment in India increased by 1824 USD Million in August of 2019. Foreign Direct Investment in India averaged 1385.66 USD Million from 1995 until 2019, reaching an all time high of 8569 USD Million in August of 2017 and a record low of -1336 USD Million in November of 2017.

The following are some of the key initiatives taken by the Government in the recent past:

  • The Government released the Draft National e-Commerce Policy in relation to FDI in the marketplace model of e-commerce.
  • The Government has proposed 100% FDI for insurance intermediaries.
  • The Government released the National Digital Communications Policy, 2018, which aims to attract FDI inflows of USD 100 billion by 2022 in the Telecommunications sector.
  • The Government clarified that Real Estate Broking Services would be eligible for 100% FDI under the automatic route.
  • The Government allowed 100% FDI under the automatic route for single brand retail trading and is planning to ease local sourcing norms.
  • The Government has proposed to further open up FDI in the Aviation, Media and Insurance sectors.
  • The Government has proposed to increase the statutory limit for Foreign Portfolio Investor (FPI) investment in a company from 24% to the sectoral foreign investment limit with an option for concerned corporates to limit it to a lower threshold.
  • The Government has proposed to permit FPIs to subscribe to listed debt securities issued by Real Estate Investment Trusts (ReITs) and Infrastructure Investment Trusts (InvITs).
  • Ease of doing business India has recorded a jump of 23 positions on its rank of 100 in 2017 and now ranks 77th among 190 countries assessed by the World Bank. India’s leap of 23 ranks on the Ease of Doing Business ranking is significant considering that it had improved its rank by 30 places last year, a rare feat for any large and diverse country of India’s size.

As a result of continued efforts by the Government, India has improved its rank by 53 positions in the last two years and 65 positions in the last four years.

  • The highlights of India’s performance in 2018 are:
  • The World Bank has recognised India as one of the top improvers for the year.
  • This is the second consecutive year in which India has been recognised as one of the top improvers.
  • India is the first BRICS and South Asian country to be recognised as a top improver for two consecutive years.
  • Since 2011, India has recorded the highest improvement in two years by any large country in the doing business assessment, having climbed 53 positions.
  • As a result of its continued positive performance, India now holds the top spot among South Asian countries as against the 6th position in 2014.

India’s FDI policy covers 27 sectors and activities with sectoral caps or conditions for receiving foreign investment. Insurance, Construction and Development, Retail, Telecom and Media are some of these sectors. Foreign investment is allowed in India via the following routes:

Automatic route: Prior approval is not required from the Government to receive foreign investment.

Approval route: This requires the Government’s approval for receiving foreign investment. Foreign investment-related proposals under the government approval route (involving a total inflow of foreign equity of more than INR 50 billion) need to be placed before the Cabinet Committee on Economic Affairs (CCEA) of the Government for further consideration. Computation of foreign investment From the perspective of the FDI policy, investments made directly by a non-resident entity in an Indian company are considered for foreign investment limits or sectoral caps, along with any investment made by a resident Indian entity (the majority of such entities being owned or controlled by non-residents).

Any downstream investments made by an Indian company (owned or controlled by non-residents either under the FDI route or the portfolio investment route) also need to comply with sectoral caps and conditions. Details of downstream investments made by foreign-owned and controlled companies have to be intimated to the Department for Promotion of Industry and Internal Trade (DPIIT) and RBI. Any portfolio investment made by a Securities and Exchange Board of India (SEBI)-registered FPI, known as a Registered Foreign Portfolio Investor (RFPI), is also regarded as a ‘foreign’ investment. Such investments are subject to individual and aggregate investment limits of 10% and 24%, respectively (and the aggregate limit can be increased up to the sectoral cap with a board and special resolution).

The individual and aggregate limit for NRIs investing under the Portfolio Investment Scheme is capped at 5% and 10%, respectively (and the aggregate limit for them can be increased to 24% with a board and special resolution). In addition, RFPIs are eligible to invest in government securities and corporate debt from time to time, subject to limits specified by the RBI and SEBI. Valuation-related norms Issue of shares to non-residents or transfer of shares by residents to non-residents, and vice versa, is subject to valuation-related guidelines, based on which there needs to be a fair valuation of shares. This valuation is done in accordance with internationally accepted pricing methodologies on an arm’s length basis—duly certified by a chartered accountant (CA) or SEBI-registered merchant banker in the case of unlisted companies.

However, if shares are listed, the consideration price cannot be less than that arrived at in accordance with SEBI’s guidelines. When non-residents (including NRIs) make investments in Indian companies by subscribing to the Memorandum of Association, such investments may be made without the need for a valuation. Funding options in India A foreign company setting up an Indian entity (subsidiary or JV) can fund it through the following options: Equity capital Equity shares constitute the common stock of a company. Equity capital comprises securities representing equity ownership in an enterprise. It provides voting rights to and entitles the holder to a share in its success via dividends or capital appreciation, or both. Issue of equity shares by an Indian company to a foreign resident needs to comply with the sectoral caps detailed in the Government’s FDI policy.

Fully and compulsorily convertible preference shares and debentures Indian companies can also receive foreign investments through issue of fully and compulsorily convertible preference shares and debentures. The conversion formula or price for issue of equity shares, based on their conversion needs, needs to be determined in advance at the time they are issued. Optionality clauses are allowed in fully and compulsorily convertible preference shares, debentures and equity shares under the FDI scheme in the following circumstances:

There is a minimum lock-in period of one year.

This period is effective from the date the capital instruments are allotted. After the lock-in period, and subject to the provisions of the FDI policy, non-resident investors exercising their option or right are allowed to exit without any assured returns, in accordance with pricing- and valuation related guidelines issued by the RBI from time to time. External Commercial Borrowings (ECBs) ECBs are commercial loans and include bank loans, buyers’ credit, suppliers’ credit, securitised instruments (e.g. floating rate notes and fixed rate bonds), Foreign Currency Convertible Bonds (FCCBs), Foreign Currency Exchangeable Bonds (FCEBs), INR denominated bonds or a financial lease from non-resident lenders in any freely convertible foreign currency or Indian rupees. However, the ECB framework is not applicable for investments in Non-convertible Debentures (NCDs) made by RFPIs in India. An ECB can be raised by an Indian ‘Eligible Borrower’ from an ‘Eligible Lender’ as follows:

  • Foreign Currency (‘FCY’) denominated ECB
  • Indian Rupee (‘INR’) denominated ECB

ECBs can either be availed of under the automatic route or the approval route. Under the approval route, prior permission of the RBI is required to raise ECBs. Under either route, it is mandatory to periodically provide post-facto intimation to the RBI, as prescribed under the Foreign Exchange Management Act (FEMA), 1999. Borrowers eligible for ECBs include all entities eligible to receive FDI (except LLPs). Eligible lenders should be residents of FATF or IOSCO compliant countries and include foreign equity holders of Indian borrowing entities holding the prescribed percentage of capital. The RBI has prescribed the limits up to which ECBs can be availed and its approval is required to raise funds beyond these limits. ECB guidelines also prescribe an ‘all-in-cost’ ceiling for raising funds through ECBs. This includes the rate of interest, other fees, expenses, charges and guarantee fees (whether paid in foreign currency or INR), but not commitment fees, pre-payment fees or charges and Withholding Tax payable in Indian rupees. In the case of fixed rate loans, the swap cost and the spread should be equal to the floating rate in addition to the applicable spread. The all-in-cost ceiling depends on the track under which ECBs have been raised, and is prescribed through a spread over the benchmark, i.e. 450 basis points per annum over the Benchmark rate for the particular currency.

The negative list for end use of ECB is as follows:

a) Real estate activities

b) Investment in the capital market

c) Equity investment

d) Repayment of rupee loans (except for specific cases)

e) On-lending to entities for the above activities.

Non-convertible, optionally convertible or partially convertible preference shares and debentures issued on or after 1 May 2007 are considered as debt, and all the norms applicable to ECBs in relation to eligible borrowers, recognised lenders, amounts, maturity, end-use stipulations, etc., are applicable in such cases. Investment by FPIs in corporate debt securities FPIs can make investment under the corporate bond route, including in unlisted corporate debt securities in the form of NCDs or bonds issued by public or private companies. The RBI relaxed the existing concentration norms for investment by an FPI in Corporate Debt by limiting the exposure to a single corporate (including exposure related entities) to 20% of the FPI’s corporate bond portfolio.

Significant exchange control-related regulations Foreign exchange transactions are regulated by FEMA, under which foreign exchange transactions are divided into two broad categories:

  • current account transactions and
  • capital account transactions.

Transactions that alter the foreign assets or liabilities, including contingent liabilities, of a person resident in India or the assets or liabilities of a person in India who is resident outside the country, including transactions referred to under Section 6(2) and 6(3) of FEMA, are classified as capital account transactions. Transactions other than these are classified as current account transactions. The Indian rupee is fully convertible for current account transactions, subject to a negative list of transactions, which are either prohibited or which require the prior approval of the Central Government or the RBI. Current account transactions The RBI has delegated its powers to AD banks (entities authorised by the RBI) in relation to monitoring of or granting permission for remittances under the current account window. All current account transactions are usually permitted unless they are specifically prohibited or restricted.

According to the Current Account Transaction (CAT) Rules, withdrawal of foreign exchange is prohibited for the following purposes:

  • Remittance from lottery winnings
  • Remittance of income from racing, riding, etc., or any other hobby
  • Remittance for purchase of lottery tickets, banned or prescribed magazines, football pools, sweepstakes, etc.
  • Payment of commission on exports for equity investments in the JVs or wholly owned overseas subsidiaries of Indian companies ‹ Remittance of dividend by a company for which the requirement of ‘dividend balancing’ is applicable
  • Payment of commissions on exports under the ‘rupee state credit’ route, except for commissions of up to 10% of the invoice value of export of tea and tobacco
  • Payment for the ‘call back services’ of telephones
  • Remittance of the interest income of funds held in a non-¬resident special rupee (account) scheme CAT Rules also specify transactions27 for which withdrawal of foreign exchange is only permitted with the prior approval of the Central Government. However, the Government’s approval is not required if payment is made from funds held in the Resident Foreign Currency Account of the remitter. Resident individuals can avail of the foreign exchange facility for the purposes mentioned in Para 1 of Schedule III of the FEM (CAT) Amendment Rules, 2015, dated 26 May 2015 (within a limit of USD 250,000), as prescribed under the Liberalised Remittance Scheme (LRS).

Current account transactions entered by residents other than individuals, undertaken in the normal course of business, are freely permitted, except in the following cases of remittances being made by corporate organisations:

  • Remittances towards consultancy services procured from outside India for infrastructure projects of up to USD 1,00,00,000 per project and of up to USD 10,00,000 per project for other projects
  • Pre-incorporation expenses of up to 5% of investment brought in or USD 1,00,000, whichever is higher
  • Donations of a maximum of USD 50,00,000 for a specified purpose or up to 1% of forex earning in the preceding three financial years
  • Commission per transaction to agents abroad for sale of residential flats or commercial plots of up to USD 25,000 or 5% of inward remittance, whichever is higher Any remittance in excess of USD 250,000 and the limits given above for the specified purposes mentioned will require the prior approval of the RBI.

Capital account transactions

The general principle for capital account transactions is that these are restricted unless specifically or generally permitted by the RBI, which has prescribed a number of permitted capital account transactions for individuals resident in or outside India. These include the following:

  • Investment made in foreign securities by a person resident in India
  • Investment made in India by a person resident outside the country
  • Borrowing or lending in foreign exchange
  • Deposits between persons resident in India and persons resident outside the country
  • Export or import of currency
  • Transfer or acquisition of immovable property in or outside India Under the LRS, resident individuals can remit up to USD 2,50,000 per financial year for any permitted capital account transactions.

The permissible capital account transactions of an individual under the LRS include:

  • Opening of a foreign currency account outside India
  • Purchase of property outside the country
  • Making investments in foreign countries
  • Setting up wholly owned subsidiaries and JVs outside India
  • Giving loans, including in Indian rupees, to NRI relatives With respect to overseas investments in a JV or wholly owned subsidiary, the limit for a financial commitment is up to 400% of the net worth of an Indian entity as on its last audited balance sheet date.

However, any financial commitment exceeding USD 1 billion (or its equivalent) in a financial year requires the prior approval of the RBI, even when the total financial commitment of the Indian entity is within the eligible limit under the automatic route (i.e. within 400% of its net worth according to its last audited balance sheet). In order to set up offices abroad, AD banks are permitted to allow remittances by Indian entities towards initial expenses of such offices. The limit set is 15% of their average annual sales, income or turnover during the previous two financial years or up to 25% of their net worth, whichever is higher. Remittances of up to 10% of an entity’s average annual sales, income or turnover are allowed for the recurring expenses it has incurred on its normal business operations during the previous two financial years. Repatriation of capital Foreign capital invested in India is usually repatriable, along with capital appreciation, after payment of taxes due, provided the investment was originally made on a repatriation basis.

Acquisition of immovable property in India by Foreign nationals of non-Indian origin, who are resident outside India, are not permitted to acquire any immovable property in the country unless this is by way of inheritance. However, they can acquire or transfer immovable property in India on a lease, which does not exceed five years, without the prior permission of the RBI. Foreign companies that have been permitted to open branches or POs in India are only allowed to acquire immovable property in the country that is necessary for or incidental to their carrying out such activities. Foreign enterprises that have been permitted to open LOs in India can only acquire property by way of a lease (that does not exceed five years) to conduct their business in the country. Royalties and fees for technical know-how Indian companies can make payments against lump sum technology fees and royalties without being subject to any restrictions under the automatic route.

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