Foreign Direct Investment in India: Evolution & The Legal Regime

Rajiv K. Luthra
Managing Partner Luthra and Luthra Law Offices
Telephone: 91-11-2335 0633 Fax: 91 11 2372 3909 E-mail: rajiv@luthra.com

Evolution of Economic Liberalization

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Phases of Indian Economy 1947-1980

Command and Control Economy
Allocation of resources by the Government (budgetary grants) Government took active part in setting priorities for the economy Self-Reliance was the buzz word Nationalisation of Banks Limited scope for private participation
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Phases of Indian Economy 1991-2000

Liberalization and Globalization of Indian Economy
Increased emphasis on private sector participation Limited extent of FDI participation Gradual improvement in the enabling environment

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Phases of Indian Economy post 2000

Political Coalitions have started providing stable governments Government to get out of owning and managing businesses: Disinvestment Policy Gradual relaxation in the FDI Policy

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Progressive Liberalisation
Pre-1991 1991 FDI was allowed selectively up to 40% under FERA This period was dominated by the Congress party 35 high priority industry groups were placed on the Automatic Route for FDI up to 51% Minority Congress government: Initiated economic reforms in a big way Automatic Route expanded to 111 high priority industry groups up to 100%/ 74%/ 51%/50% United Front Government: Inclusive of left parties, was perceived as traditionally opposed to FDI, but continued with the reforms. All sectors placed on the Automatic Route for FDI except for a small negative list BJP coalition government:(coalition of Left and Right wing parties) was traditionally seen as opposed to FDI, but continued with economic reforms. Many new sectors opened to FDI; viz., insurance (26%), integrated townships (100%), mass rapid transit systems (100%), defence industry (26%), tea plantations (100%), print media (26%). Sectoral caps in many other sectors relaxed; BJP coalition government: pursued reforms vigorously and initiated second generation reforms.
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1997

2000

Post 2000

Consensus on Economic Liberalisation

Change in perception
Indian Business Houses Government Legal Framework: shift from a Positive List to a Negative List (FERA FEMA)

Gradually all sectors moving to Choice and Competition (Multiple Player Model)
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Present Picture
India: Fourth largest economy in terms of Purchasing Power Parity Tenth most industrialized economy GDP growth rate of 8.1% - Second highest in the world. Considerable improvement in FDI inflows FII inflows:
For the period, July 2003 Jan 2004 FII inflow has exceeded USD 7 bn, which is more than the cumulative FII inflow in the last five years.

Still a big gap between India and China

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Entry Process & Entry Strategies

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The Industrial Policy

Industrial Licensing
All Industrial undertakings exempt from obtaining an industrial license to manufacture, except for:
Industries reserved for the Public Sector Industries retained under compulsory licensing Items of manufacture reserved for the Small Scale Sector If the proposal attracts locational restriction

Industrial Entrepreneur Memorandum

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The Industrial Policy

Industries reserved for the Public Sector: (1) Atomic Energy and (2) Railway Transport Compulsory licensing needed in the following industries:
Distillation and brewing of alcoholic drinks Cigars and cigarettes and manufactured tobacco substitutes Electronic aerospace and defence equipment of all types Industrial explosives including detonating fuses, safety fuses, gun powder, nitrocellulose and matches Certain hazardous chemicals
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The Industrial Policy

Locational Policy
Industrial undertakings are free to select the location Location to be 25 km away from any city with a million strong population Exceptions:
When located in an area designated as an Industrial Area before the 25th July, 1991. Electronics, Computer Software and Printing (and any other industry which may be notified in future as non polluting industry).
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The Industrial Policy

Small Scale Industries
Suitable for Foreign Investment?
Cap on Investment in fixed assets (plant and machinery) is Rs. 10 million (approx. SGD 3,70,000)

Not more than 24 per cent of total equity can be held by any industrial undertaking either foreign or domestic Upon such equity exceeding 24% the SSI status is lost. Carry-on-Business (COB) Licence required.

Various items reserved exclusively for SSIs.

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The Entry Process

Investing in India

Automatic Route
General rule Inform RBI within 30 days of inflow/issue of shares Pricing: FEMA Regulations Unlisted CCI Listed SEBI Cap of Rs. 600 Crore (approx SGD 222 million)

Prior Permission
By exception Approval of Foreign Investment Promotion Board needed. Decision generally within 4-6 weeks

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The Entry Process: Automatic Route

All items/activities for FDI investment up to 100% fall under the Automatic Route except the following:
All proposals that require an Industrial Licence. All proposals in which the foreign collaborator has a previous venture/ tie up in India. All proposals relating to acquisition of existing shares in an existing Indian Company by a foreign investor. All proposals falling outside notified sectoral policy/ caps or under sectors in which FDI is not permitted.

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The Entry Process: Government Approval

FIPB Approval
For all activities, which are not covered under the Automatic Route Composite approvals involving foreign investment/ foreign technical collaboration Published Transparent Guidelines vs. Earlier Case by Case Approach Downstream Investment
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Subsequent Investment in the same or allied field

Press Note 18
No Automatic Route for FDI and/or technology collaboration for those who have or had any previous joint venture/technology transfer/ trade mark agreement in the same or allied field.
Same field : Four digit NIC 1987 Code Allied field : Three digit NIC 1987 Code.

IT Sector & International Financial Institutions exempted. New Trend: FIPB examines objections by the earlier partner objectively.

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Acquisition of shares in a Listed Company

Takeover Code
Acquisition of more than specified equity stakes would entail public offer Pricing: Average of 26 weeks or 2 weeks, whichever is higher No takeover of management before completion of Takeover Code formalities

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Other modes of Foreign Direct Investment

GDR, ADR, FCCB

Indian Companies allowed to raise equity capital in the international market through the issue of GDRs/ ADRs/FCCBs. No ceiling on investment

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Other modes of Foreign Direct Investment

GDR, ADR, FCCB (Contd.) No end-use restrictions on GDR/ ADR/ FCCB issue proceeds Except
Investment in real estate Stock markets.

Government clearance required when sectoral cap is exceeded, or for a project not falling under Automatic Route. 25% of the FCCB proceeds can be used for general corporate restructuring.
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Foreign Technology Collaboration

Foreign technology collaborations are permitted either through the automatic route or by the Government.
Policy for Automatic Approval
To all industries for foreign technology collaboration agreements, irrespective of the extent of foreign equity in the shareholding, subject to:
The lump sum payments not exceeding US $ 2 Million;

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Foreign Technology Collaboration

Policy for Automatic approval (contd.)
Royalty payable being limited to 5 per cent for domestic sales and 8 per cent for exports, subject to a total payment of 8 per cent on sales No restriction on the duration of the royalty payments The aforesaid royalty limits are net of taxes and are calculated according to standard conditions.

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Foreign Technology Collaboration

Policy for Automatic approval (contd.)
Payment of royalty up to 2% for exports and 1% for domestic sales is allowed under automatic route on use of trademarks and brand name of the foreign collaborator without technology transfer. Registration of FC Agreement with RBI.

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The Entry Strategy

Forms in which Business can be conducted in India
Wholly owned subsidiary Joint Venture Company Branch Office Project Office

India Presence: Liaison Office

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The Entry Strategy: Joint Venture Company

Advantages
Limited liability Market Penetration Local Partners Expertise and Experience

Vital Considerations
Choice of Joint Venture Partner Due Diligence

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The Entry Strategy: Joint Venture Company

Vital Considerations (Contd.) Clearly defined agreement Terms of the Shareholders Agreement should be reflected in the Articles of the Company. Share Transfer Restriction in a Public Limited Company Disproportionate voting Rights: Veto Non-compete

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The Entry Strategy: Joint Venture Company

Vital Considerations (Contd.)
Agreement for future issue of share capital Dispute Resolution Non-disclosure of confidential information post termination

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The Entry Strategy: Branch Office

Purpose/Viability of a Branch Office
Represent the business interest of foreign company For the purpose of execution of the Project

Project Office is in the nature of a Branch Office set up for a particular project.

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The Entry Strategy: Branch Office

Permissible activities for a Branch Office
Export/Import of goods Professional or Consultancy Services Carrying out research work in which the parent company is engaged Promoting technical or financial collaborations between Indian Companies and parent or overseas group companies
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The Entry Strategy: Branch Office

Permissible activities (Contd.)
Representing the parent company in India and acting as Buying and Selling Agent Rendering Technical Support to the products supplied by parent/group companies. Foreign Airlines/ Shipping Companies

Issue: Project/ Branch Office Permanent Establishment

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The Entry Strategy: Liaison Office

Liaison office for
Promotion of business interest; spreading awareness of companys products; explore opportunities; work as channel of communication etc. Cannot carry on any commercial, trading or industrial activity or earn any income in India Is required to maintain itself out of inward remittances received from abroad through normal banking channels.
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The Entry Strategy

Branch Office/Liaison Office can be set up only with prior RBI approval Profit of the Branch or Surplus of the project after completion can be remitted, after payment of all applicable taxes in India

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Exit Issues
Transfer of shares from non-resident to non-resident does not require RBI approval for pricing Transfer of shares from non-resident to resident does not require any FIPB Approval, though RBI approval is required for pricing
Pricing as per FEMA listed and unlisted securities RBI permission not required if sale through Stock Exchange

Mauritius Route: Capital Gain Advantage

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Legal Structures facilitating FDI

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Facilitating FDI in India

Emergence of Independent Regulators: Electricity, Telecom, Insurance, Capital Market and Competition Law
Ensuring level playing field vis--vis Government Corporations and inter se private players Expertise in the subject matter involved Expeditious resolution of dispute
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Facilitating FDI in India

Emergence of Independent Regulators (Contd.) Regulators under consideration: Petroleum, Railways, Information and Broadcasting Regulator to curb Anti-Competitive Practices Government Directives

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Facilitating FDI in India

Labour laws a more contractual approach.
Move towards: hire and fire
Progressive use of discretionary executive powers
Permissions granted for closure of unviable units Inspections only upon workers grievances Voluntary Retirement Schemes EPZs, SEZs etc may be exempted from application of certain labour laws Amendment to Industrial Disputes Act under consideration Amendment to Contract Labour (Regulation & Abolition) Act, 1970 under consideration.

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Investment Incentives

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Incentives for investment in Telecom Sector

Movement towards technology neutral Unified Licensing Regime Permission for Inter-Circle & Intra-Circle Mergers Exemplary growth in teledensity, subscriber base etc. Companies commencing operations before 31st March, 2004, would enjoy tax benefits:
100% deduction for first five years 30% deduction for next five years

Exemption from tax on interest income and long term capital gains in certain cases Import duty rates have been reduced for various telecom equipment
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Investment Incentive for IT Industry

Software companies have a ten year tax holiday on their export income In 1998 the Government set up a new Ministry of Information Technology The Information Technology Act, 2000 was passed to tackle cyber crimes and facilitate ecommerce

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Incentives for Investment in Power Sector

New Legal Regime: Electricity Act, 2003 The Act provides for: Multiple Buyer Model, Independent Regulatory Body, Open Access, Power Trading as an independent business, delicensing of generation 100% FDI Automatic Route in:
Hydro-electric power plants; Coal/lignite based thermal power plants; Oil/gas based thermal power plants.
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Incentives for Investment in Power Sector

Other investment incentives:
New Power Projects eligible for 100% tax holiday in any block of ten years, within first fifteen years of operation. The Deadline for income tax exemption for new power projects extended from 2006 to 2012. Various indirect tax incentives:
Concessional rate of import duties Special project import scheme Deemed export benefit for certain categories of power projects.
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Reforms in Financial Sector

FIIs allowed in Capital Market, can invest both in Debt and Equity FDI cap in private sector banks raised to 74%
10% cap on voting rights

The Mutual Fund market is also open now to foreign players. Equity issue pricing is market determined
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FDI in Real Estate: Policy & Issues

Press Note 4 (2002 Series)
100% FDI under Automatic Route PERMITTED FOR Integrated Townships, subject to following conditions:
Foreign company to be registered as Indian company under Companies Act, 1956 Core Business - Integrated Township Development with a successful track record. Minimum area of development: 100 acres as per local bylaws/rules. In absence of such by laws/rules, minimum of 2000 dwelling houses for about 10,000 population to be developed by the investor.
Conditions post acceptance of FDI proposal

Minimum capitalization norms Upfront payment Minimum lock-in period Time bound completion of project

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FDI in Hotel and Tourism:Policy and Issues

100% FDI under Automatic Route Hotel includes Restaurant, beach resorts and other tourist complexes providing accommodation and/or Catering Tourism related industries includes travel agencies, tour operating agencies, units providing facilities for cultural, adventure and wild life experience to tourists; surface, air and water transport facilities to tourists; leisure, entertainment, amusement, sports and health units for tourists and Convention/ Seminar units and organizations. Automatic approval for Technical, Consultancy, Marketing, Publicity, Managerial services subject to specified limits.
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Conclusion
Economics occupies centre stage in 2004 elections Rising expectations; rising prosperity Legal regime: more stable and predictable Bureaucracy: changing with the times The Future beckons

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Thank You

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