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 Luthra & Luthra Law Offices 5 .

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. integrated townships (100%). insurance (26%). defence industry (26%). Many new sectors opened to FDI. Sectoral caps in many other sectors relaxed. was perceived as traditionally opposed to FDI.. print media (26%). tea plantations (100%). but continued with the reforms. BJP coalition government: pursued reforms vigorously and initiated second generation reforms. Luthra & Luthra Law Offices 6 1997 2000 Post 2000 .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 µleft parties¶. but continued with economic reforms. viz. mass rapid transit systems (100%).

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 µChoice¶ and µCompetition¶ (Multiple Player Model) Luthra & Luthra Law Offices 7 .

Present Picture ‡ India: Fourth largest economy in terms of Purchasing Power Parity ‡ Tenth most industrialized economy ‡ GDP growth rate of 8. ‡ Considerable improvement in FDI inflows ‡ FII inflows: ± For the period.Second highest in the world. July 2003 ± Jan 2004 FII inflow has exceeded USD 7 bn. which is more than the cumulative FII inflow in the last five years.1% . ‡ Still a big gap between India and China Luthra & Luthra Law Offices 8 .

Entry Process & Entry Strategies Luthra & Luthra Law Offices 9 .

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 Luthra & Luthra Law Offices 10 .

gun powder.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. nitrocellulose and matches ± Certain hazardous chemicals Luthra & Luthra Law Offices 11 ± ± ± ± . safety fuses.

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 ³Industrial Area´ before the 25th July. Luthra & Luthra Law Offices 12 . 1991. Computer Software and Printing (and any other industry which may be notified in future as µnon polluting industry¶). ‡ Electronics.

‡ Various items reserved exclusively for SSIs. SGD 3. Carry-on-Business (COB) Licence required. 10 million (approx. Luthra & Luthra Law Offices 13 .The Industrial Policy Small Scale Industries ‡ Suitable for Foreign Investment? ± Cap on Investment in fixed assets (plant and machinery) is Rs.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.

Decision generally within 4-6 weeks Luthra & Luthra Law Offices 14 .. 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.

Luthra & Luthra Law Offices 15 . ± All proposals relating to acquisition of existing shares in an existing Indian Company by a foreign investor.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 falling outside notified sectoral policy/ caps or under sectors in which FDI is not permitted.

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 Luthra & Luthra Law Offices 16 .

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. Luthra & Luthra Law Offices 17 . ‡ IT Sector & International Financial Institutions exempted. ‡ New Trend: FIPB examines objections by the earlier partner objectively. ± Same field : Four digit NIC 1987 Code ± Allied field : Three digit NIC 1987 Code.

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 Luthra & Luthra Law Offices 18 .

‡ No ceiling on investment Luthra & Luthra Law Offices 19 .Other modes of Foreign Direct Investment GDR. FCCB ‡ Indian Companies allowed to raise equity capital in the international market through the issue of GDRs/ ADRs/FCCBs. ADR.

ADR. Luthra & Luthra Law Offices 20 . FCCB (Contd.Other modes of Foreign Direct Investment GDR. ‡ Government clearance required when sectoral cap is exceeded. ‡ 25% of the FCCB proceeds can be used for general corporate restructuring.) ‡ No end-use restrictions on GDR/ ADR/ FCCB issue proceeds ± Except ‡ Investment in real estate ‡ Stock markets. or for a project not falling under Automatic Route.

irrespective of the extent of foreign equity in the shareholding. subject to: ± The lump sum payments not exceeding US $ 2 Million.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. Luthra & Luthra Law Offices 21 .

) ± 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.Foreign Technology Collaboration Policy for Automatic approval (contd. Luthra & Luthra Law Offices 22 .

Luthra & Luthra Law Offices 23 .Foreign Technology Collaboration Policy for Automatic approval (contd. ± Registration of FC Agreement with RBI.) ± 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.

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 Luthra & Luthra Law Offices 24 .

The Entry Strategy: Joint Venture Company ‡ Advantages ± Limited liability ± Market Penetration ± Local Partner¶s Expertise and Experience ‡ Vital Considerations ± Choice of Joint Venture Partner ± Due Diligence Luthra & Luthra Law Offices 25 .

± Share Transfer Restriction in a Public Limited Company ± Disproportionate voting Rights: Veto ± Non-compete Luthra & Luthra Law Offices 26 .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.

) ± Agreement for future issue of share capital ± Dispute Resolution ± Non-disclosure of confidential information post termination Luthra & Luthra Law Offices 27 .The Entry Strategy: Joint Venture Company ‡ Vital Considerations (Contd.

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. Luthra & Luthra Law Offices 28 .

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 Luthra & Luthra Law Offices 29 .

The Entry Strategy: Branch Office ‡ Permissible activities (Contd. ± Foreign Airlines/ Shipping Companies ‡ Issue: Project/ Branch Office ± Permanent Establishment Luthra & Luthra Law Offices 30 .) ± Representing the parent company in India and acting as Buying and Selling Agent ± Rendering Technical Support to the products supplied by parent/group companies.

work as channel of communication etc.The Entry Strategy: Liaison Office ‡ Liaison office for ± Promotion of business interest. spreading awareness of company¶s products. Luthra & Luthra Law Offices 31 . ± 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. explore opportunities.

after payment of all applicable taxes in India Luthra & Luthra Law Offices 32 .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.

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 Luthra & Luthra Law Offices 33 .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.

Legal Structures facilitating FDI Luthra & Luthra Law Offices 34 .

Telecom. Capital Market and Competition Law ‡ Ensuring level playing field vis-à-vis Government Corporations and inter se private players ‡ Expertise in the subject matter involved ‡ Expeditious resolution of dispute Luthra & Luthra Law Offices 35 . Insurance.Facilitating FDI in India Emergence of Independent Regulators: Electricity.

Information and Broadcasting ‡ Regulator to curb Anti-Competitive Practices ‡ Government Directives Luthra & Luthra Law Offices 36 .Facilitating FDI in India Emergence of Independent Regulators (Contd.) ‡ Regulators under consideration: Petroleum. Railways.

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.Facilitating FDI in India Labour laws ± a more contractual approach. Luthra & Luthra Law Offices 37 . 1970 under consideration. ‡ 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.

Investment Incentives Luthra & Luthra Law Offices 38 .

Incentives for investment in Telecom Sector ‡ Movement towards technology neutral nified Licensing Regime ‡ Permission for Inter-Circle & Intra-Circle Mergers ‡ Exemplary growth in teledensity. 2004. ‡ Companies commencing operations before 31st March. 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 Luthra & Luthra Law Offices 39 . subscriber base etc.

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 Luthra & Luthra Law Offices 40 .

± Oil/gas based thermal power plants. 2003 ‡ The Act provides for: Multiple Buyer Model. Open Access. ± Coal/lignite based thermal power plants. delicensing of generation ‡ 100% FDI Automatic Route in: ± Hydro-electric power plants. Luthra & Luthra Law Offices 41 . Power Trading as an independent business.Incentives for Investment in Power Sector ‡ New Legal Regime: Electricity Act. Independent Regulatory Body.

Luthra & Luthra Law Offices 42 .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. ± Various indirect tax incentives: ‡ Concessional rate of import duties ‡ Special project import scheme ‡ Deemed export benefit for certain categories of power projects. ± The Deadline for income tax exemption for new power projects extended from 2006 to 2012.

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.Reforms in Financial Sector ‡ FIIs allowed in Capital Market. ‡ Equity issue pricing is market determined Luthra & Luthra Law Offices 43 .

subject to following conditions: ‡ Foreign company to be registered as Indian company under Companies Act.FDI in Real Estate: Policy & Issues ‡ Press Note 4 (2002 Series) ± 100% FDI under Automatic Route PERMITTED FOR Integrated Townships. ‡ Conditions post acceptance of FDI proposal ‡ ‡ ‡ ‡ Minimum capitalization norms Upfront payment Minimum lock-in period Time bound completion of project Luthra & Luthra Law Offices 44 .000 population to be developed by the investor. ‡ Minimum area of development: 100 acres as per local bylaws/rules.Integrated Township Development with a successful track record. minimum of 2000 dwelling houses for about 10. In absence of such by laws/rules. 1956 ‡ Core Business .

sports and health units for tourists and Convention/ Seminar units and organizations. tour operating agencies. Publicity.FDI in Hotel and Tourism:Policy and Issues ‡ 100% FDI under Automatic Route ‡ ³Hotel´ includes Restaurant. amusement. ‡ Automatic approval for Technical. Luthra & Luthra Law Offices 45 . air and water transport facilities to tourists. leisure. Managerial services subject to specified limits. adventure and wild life experience to tourists. surface. Marketing. entertainment. beach resorts and other tourist complexes providing accommodation and/or Catering ‡ ³Tourism related industries´ includes travel agencies. units providing facilities for cultural. Consultancy.

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 Luthra & Luthra Law Offices 46 .

Thank You Luthra & Luthra Law Offices 47 .

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