Foreign Direct Investment in India: Evolution & The Legal Regime
Rajiv K. Luthra
Managing Partner
Luthra and Luthra
Law OfficesTelephone: 91-11-2335 0633
Fax: 91 11 2372 3909
E-mail: [email protected]
Luthra & Luthra Law Offices 2
Evolution of Economic Liberalization
Luthra & Luthra Law Offices 3
Phases of Indian Economy1947-1980
• 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
Luthra & Luthra Law Offices 4
Phases of Indian Economy1991-2000
• Liberalization and Globalization of Indian Economy– Increased emphasis on private sector
participation– Limited extent of FDI participation– Gradual improvement in the enabling
environment
Luthra & Luthra Law Offices 5
Phases of Indian Economypost 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 6
Progressive Liberalisation Pre-1991 FDI was allowed selectively up to 40% under FERA
This period was dominated by the Congress party
1991 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
1997 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.
2000 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.
Post 2000 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.
Luthra & Luthra Law Offices 7
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)
Luthra & Luthra Law Offices 8
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
Luthra & Luthra Law Offices 9
Entry Process & Entry Strategies
Luthra & Luthra Law Offices 10
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 11
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
Luthra & Luthra Law Offices 12
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’).
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. 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.
Luthra & Luthra Law Offices 14
The Entry Process.
Automatic Route Prior Permission
Investing in India
General rule•Inform RBI within 30 days ofinflow/issue of shares• Pricing: FEMA Regulations
•Unlisted – CCI•Listed – SEBI
• Cap of Rs. 600 Crore(approx SGD 222 million)
By exceptionApproval of ForeignInvestment Promotion Board needed.Decision generally within 4-6 weeks
Luthra & Luthra Law Offices 15
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.
Luthra & Luthra Law Offices 16
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 17
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.
Luthra & Luthra Law Offices 18
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 19
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
Luthra & Luthra Law Offices 20
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.
Luthra & Luthra Law Offices 21
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;
Luthra & Luthra Law Offices 22
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.
Luthra & Luthra Law Offices 23
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.
Luthra & Luthra Law Offices 24
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 25
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 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.– Share Transfer Restriction in a Public Limited
Company– Disproportionate voting Rights: Veto– Non-compete
Luthra & Luthra Law Offices 27
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
Luthra & Luthra Law Offices 28
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 29
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 30
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
Luthra & Luthra Law Offices 31
The Entry Strategy: Liaison Office
• Liaison office for– Promotion of business interest; spreading
awareness of company’s 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.
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, after payment of all applicable taxes in India
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, 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 34
Legal Structures facilitating FDI
Luthra & Luthra Law Offices 35
Facilitating FDI in India Emergence of Independent Regulators:
Electricity, Telecom, Insurance, 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 36
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
Luthra & Luthra Law Offices 37
Facilitating FDI in IndiaLabour 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.
Luthra & Luthra Law Offices 38
Investment Incentives
Luthra & Luthra Law Offices 39
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
Luthra & Luthra Law Offices 40
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 e-commerce
Luthra & Luthra Law Offices 41
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.
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.– 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.
Luthra & Luthra Law Offices 43
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
Luthra & Luthra Law Offices 44
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
Luthra & Luthra Law Offices 45
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.
Luthra & Luthra Law Offices 46
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 47
Thank You