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India has made many great improvements over the last decade in achieving economic growth and poverty reduction. The most significant advancement came in 1991 when India removed governmental obstacles and allowed its doors to open to foreign investment. Foreign Direct Investment (FDI) has emerged as an eminent source of economic development and employment generation for developing countries (including India) as it contributes in creating a more competitive business environment, enhances enterprise development, human capital formation and international trade integration.
This paper is an attempt to throw light on the policies of the Government of India towards FDI. The paper lists out the options as well as the corresponding procedures prescribed by the Government for the foreign entity to invest in India and also deals with the advantages and drawbacks of those options for FDI.
1. Setting up as an Indian or a Foreign CompanyA foreign company planning to set up business operations in India has the option of either setting up as an Indian company or as a foreign company
1) As An Indian Company
A foreign company can commence operations in India by incorporating a company under the Companies Act, 1956 through Joint Ventures (JV) or Wholly Owned Subsidiaries.
A) Joint Ventures
Foreign Companies can set up their operations in India by incorporating a JV Company with an Indian partner and/or with the general public and operating either as a listed company or as an unlisted company.
Benefits of JV for a foreign investor:
1. Established distribution/ marketing set up of the Indian partner
2. Available financial resource of the Indian partners
3. Established contacts of the Indian partners, which help in smoothening the process of setting up of operations
4. A good strategy for first entering a foreign market, especially when the commercial risks and country risks are high.
5. It creates more flexibility for adapting the operation to meet the requirements under different competitive conditions.
6. It incurs lower cost and lower resource commitment for entering foreign markets.
1. An artificial and uneasy atmosphere is created by trying to combine the resources and the management approaches of two separate companies with different nationalities, backgrounds, experiences, abilities in one enterprise to pursue a common goal, to agree on common means and to work under the same authority, which creates problems in the day-to-day operation and the future planning for the JV.
2. There is fear of the leakage of technical secrets since a strong foreign partner could use this technology for its own competitive advantage and perhaps create a future detriment to the parent company.
3. JVs have to share the profit with local partners as well as reinvest the revenues for future expansion purposes.
B) Wholly Owned SubsidiariesForeign companies can also set up wholly owned subsidiary in sectors where 100% foreign direct investment is permitted under the FDI policy.
For registration and incorporation of the company, an application has to be filed with Registrar of Companies (ROC) as well as RBI. Once a company has been duly registered and incorporated as an Indian company, it is subject to Indian laws and regulations as applicable to other domestic Indian companies.
Foreign equity in such Indian companies can be up to 100% depending on the requirements of the investor, subject to equity caps in respect of the area of activities under the FDI policy.
1. Maintenance of effective control over its subsidiaries
2. Transaction costs including the cost of negotiating and transferring information and capability to another firm, cost of personnel training, cost of losing the opportunity to having direct sales or getting the full amount of profit, and the threat of creating a competitor in markets beyond the purview of the agreement might be avoided.
3. It minimizes the dissemination risk
1. Involves highest level of risk and commitment by the foreign investing companies
2) As A Foreign Company
Foreign Companies can set up their operations in India through
A) Liaison Office/Representative Office: It acts as a channel of communication between the principal place of business or head office and entities in India. It can not undertake any commercial activity directly or indirectly and can not, therefore, earn any income in India. Its role is limited to collect information about possible market opportunities and providing information about the company and its products to prospective Indian customers. It can promote export/import from/to India and also facilitate technical/financial collaboration between parent company and companies in India.
Approval for establishing a liaison office in India is granted by Reserve Bank of India (RBI)B) Project Office: Foreign Companies planning to execute specific projects in India can set up temporary project/site offices in India. RBI has now granted general permission to foreign entities to establish Project Offices subject to specified conditions. Such offices can not undertake or carry on any activity other than the activity relating and incidental to execution of the project. Project Offices may remit outside India the surplus of the project on its completion, general permission for which has been granted by the RBI.
C) Branch Office: Foreign companies engaged in manufacturing and trading activities abroad are allowed to set up Branch Offices in India for the purposes of export/import of goods, rendering 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 company, representing the parent company in India and acting as buying/selling agents in India, rendering services in Information Technology and development of software in India, rendering technical support to the products supplied by the parent/ group companies, foreign airline/shipping company.
A branch office is not allowed to carry out manufacturing activities on its own but is permitted to subcontract these to an Indian manufacturer. Branch Offices established with the approval of RBI, may remit outside India, profit of the branch, net of applicable Indian taxes and subject to RBI guidelines
D) Branch Office on Stand Alone Basis: Such Branch Offices would be isolated and restricted to the Special Economic zone (SEZ) alone and no business activity/transaction will be allowed outside the SEZs in India, which include branches/subsidiaries of its parent office in India.
The above mentioned offices can undertake any permitted activities. Companies have to register themselves with Registrar of Companies (ROC) within 30 days of setting up a place of business in India.
No approval shall be necessary from RBI for a company to establish a branch /unit in SEZs to undertake manufacturing and service activities subject to the following conditions:
a. Such units are functioning in those sectors where 100% FDI is permitted.
b. Such units comply with part XI of the Companies Act(section 592 to 602)
c. Such units function on a stand alone basis,
d. In the event of winding up of business and for remittance of winding-up proceeds, the branch shall approach an authorized dealer in foreign exchange with the document required as per FEMA.
Such offices can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch or Office or other place of business) Regulations, 2000.
2. Procedures prescribed for FDIFDI in relation to control or ownership of a company in India takes one of two routes:
1) Procedure Under "Automatic Route"
FDI in sector/ activities to the extent permitted under automatic route does not require any prior approval either by Government of India or RBI. The investor are only required to notify the Regional office concerned of RBI and file the required documents with that office within 30 days of receipt of inward remittances. The investment should be in accordance with the prescribed guidelines. This procedure is applicable only for fresh investments directly in Indian companies and not for purchase of shares from the existing shareholders.
This route is available to all sectors or activities that do not have a sector cap i.e. where 100% foreign ownership is permitted, or for investments that are within a sector cap and where the Automatic route is allowed.
A) For New ventures
All items/activities for FDI up to 100% by Non-Resident Indians (NRI)/Overseas Corporate Bodies (OCB) fall under the Automatic Route except those that expressly require a prior Government approval. Investment in Public Sector Units as also for units located in Export Oriented Units (EOU)/Export Processing Zones (EPZ)/Special Economic Zones (SEZ)/Electronic Hardware Technology Parks (EHTP)/ Software Technology Parks (STP) would also qualify for the Automatic Route.
Investment under the Automatic Route is governed by the notified sectoral policy and equity caps and RBI ensures compliance of the same. Any change in sectoral policy/sectoral equity cap is notified by the SIA in the Department of Industrial Policy & Promotion.
B) For Existing Companies
Automatic route for FDI/NRI/OCB investment is available to the existing companies with an expansion programme, subject to following additional requirements that:
# the increase in equity level must result from the expansion of the equity base of the existing company without acquisition of existing shares by NRI/OCB/foreign investors;
# the money to be remitted should be in the sector(s) under the automatic route.
Otherwise, the proposal would need Government approval through the FIPB supported by a Board Resolution of the existing Indian company.
For existing companies without an expansion programme, the additional requirements are that:
# they are engaged in the industries under automatic route (including additional activities covered under the automatic route regardless of whether the original activities were undertaken with Government approval or by accessing the automatic route);
# the increase in equity level must be from expansion of the equity base; and
# the foreign equity must be in foreign currency.
2) Procedure Under Government ApprovalFDI in activities not covered under the automatic route requires prior Government Approval and are considered by the Foreign Investment Promotion Board (FIPB). Approvals of composite proposals involving foreign investment/ foreign technical collaboration are also granted on the recommendation of the FIPB.
Application of all FDI cases, except Non-Resident Indian (NRI) investments and 100% Export Oriented Units (EOUs), should be submitted to the FIPB Units, Department of Economic Affairs (DEA), Ministry of Finance. Applications for NRI and 100% EOU cases should be presented to SIA in Department of Industrial Policy and Promotion. Application can also be submitted with Indian Missions abroad who forward them to the Department of Economic Affairs for further processing.
A) Regulation and procedures
Approval procedures have been laid out for undertakings that are
# exempt from industrial licensing requirements (including existing units undertaking substantial expansion);
# subject to compulsory industrial licensing; and
# small scale units exceeding the prescribed limit of investment in plant and machinery and continuing to manufacture small scale reserved item(s) or, in cases where exemption from industrial licensing granted for any item, is withdrawn.
B) Government approval (FIPB route)
For the following categories, Government approval for FDI/NRI/OCB through the FIPB shall be necessary:
# proposals requiring an Industrial License.
# proposals in which the foreign collaborator has a previous venture/tie-up in India in the same or allied field. However, this condition is not applicable for proposals in the Information Technology industry.
# proposals relating to acquisition of shares in an existing Indian company.
# proposals falling outside notified sectoral policy/caps or under sectors for which FDI is not permitted and/or whenever any investor chooses to make an application to the FIPB and not to avail of the automatic route.
Indian companies getting foreign investment approval through FIPB route do not require any further clearance from RBI for the purpose of receiving inward remittance and issue of shares to the foreign investors. These Companies are required to notify the RBI of receipt of inward remittances within 30 days of such receipt and file required documentation within 30 days of issue of shares to Foreign Investors.
3. FDI in the Small Scale Sector
Small Scale Undertakings (SSUs) are defined as units having investments in fixed assets in plant and machinery of not more than INR 10 million. Under the small scale industrial policy, equity holding by other units including foreign equity in a small scale undertaking is permissible up to 24 per cent. However there is no bar on higher equity holding for foreign investment if the unit is willing to give up its small scale status. In case of foreign investment beyond 24 per cent in a small scale unit which manufactures small scale reserved item(s), an industrial license carrying a mandatory export obligation of 50 per cent must be obtained.
A SSU manufacturing small scale reserved item(s), on exceeding the small-scale investment ceiling in plant and machinery by virtue of natural growth, needs to apply for and obtain a Carry-on-Business (COB) License. No export obligation is fixed on the capacity for which the COB license is granted. However, if the unit expands its capacity for the small scale reserved item(s) further, it needs to apply for and obtain a separate industrial license.
4. Other Modes of Foreign Direct Investments
1. Global Depository Receipts (GDR)/American Deposit Receipts (ADR)/Foreign Currency Convertible Bonds (FCCB).Indian companies are allowed to raise equity capital in the international market through the issue of GDRs/ADRs/FCCBs. These are not subject to any ceilings on investment. An applicant company seeking Government’s approval in this regard should have a consistent track record for good performance (financial or otherwise) for a minimum period of 3 years. There is no restriction on the number of GDRs/ADRs/FCCBs to be floated by a company or a group of companies in a financial year. A company engaged in the manufacture of items covered under Automatic Route whose direct foreign investment after a proposed GDRs/ADRs/FCCBs issue is likely to exceed the prescribed percentage for automatic approval, or which is implementing a project not contained in project falling under Government Approval route, would need to obtain prior Government approval.
2. Minority stakes in host-country firms,for example, through the direct purchase of shares on the local stock exchange. These investments are often referred to as passive or portfolio investments, because the investors do not assume control of the firm's operations and may have very little input into how the firm is managed. Minority stakes in foreign firms are often obtained through privatizations of state-owned enterprises and debt-equity swaps of both private and state-owned firms.
3. Licensing agreements with host-country firms.The MNC may transfer the rights to use a specific technology to a local firm, which would be responsible for production and marketing in the local market. The local firm would pay the MNC for the right to use its technology. This type of arrangement offers the MNC a low-risk way of entering a foreign market. MNCs sometimes acquire shares of local firms with which they enter into licensing agreements.
5. Investment in a Firm or a Proprietary Concern By NRIsA Non-Resident Indian or a Person of Indian Origin resident outside India may invest by way of contribution to the capital of a firm or a proprietary concern in India on a non-repatriation basis provided,
i) Amount is invested by inward remittance or out of NRE/FCNR/NRO account maintained with AD
ii) The firm or proprietary concern is not engaged in any agricultural/plantation or real estate business i.e. dealing in land and immovable property with a view to earning profit or earning income there from.
iii) Amount invested shall not be eligible for repatriation outside India.
NRIs/PIOs may invest in sole proprietorship concerns/ partnership firms with repatriation benefits with the approval of Department of Economic Affairs, Government of India/ RBI.
6. List of Sectors where FDI is restrictedSectors where FDI is not permitted are restricted to Railways, Atomic Energy and Atomic Minerals, Postal Service, Gambling and Betting, Lottery and basic Agriculture or plantations activities or Agriculture (excluding Floriculture, Horticulture, Development of Seeds, Animal Husbandry, Pisiculture and Cultivation of Vegetables, Mushrooms etc. under controlled conditions and services related to agro and allied sectors) and Plantations (other than Tea plantations).
7. Sectors which attract Ceiling on Foreign Ownership SectorTelecom, Coal and lignite, Mining, Private sector banking, Insurance, Domestic airlines, Petroleum (other than refining), Refining, Investing companies/ Services sector, Atomic minerals, Defence industry sector, Broadcasting, Setting up hardware, facilities such as uplinking, HUB, etc., Cable network, Direct-to-Home, Terrestrial Broadcasting FM, Small scale industries (SSI) sector, Satellites, Tea sector, Print Media.
8. Taxation in IndiaForeign nationals working in India are generally taxed only on their Indian income. Income received from sources outside India is not taxable unless it is received in India. The Indian tax laws provide for exemption of tax on certain kinds of income earned for services rendered in India. Further, foreign nationals have the option of being taxed under the tax treaties that India may have signed with their country of residence.
Remuneration for work done in India is taxable irrespective of the place of receipt. Remuneration includes salaries and wages, pensions, fees, commissions, profits in lieu of or in addition to salary, advance salary and perquisites. Taxable payments include all allowances and tax equalisation payments unless specifically excluded. The stock options granted by the employer are taxable as capital gains at the time of sale of shares acquired due to exercise of options.
Prior to 1991, the Indian government policies on FDI were stricter as compared to most industrialized economies and the government exercised a high degree of control over industrial activity by regulating and promoting much of the economic activity.
The Industrial Policy of 1991 greatly enhanced the business climate in India, led to various trade reforms in Indian economy and provided clarity to foreign businesses looking to invest in India.
The Government of India has introduced a liberal, transparent and investor-friendly FDI policy and it regularly reviews the policies and guidelines and makes necessary changes towards FDI in order to make foreign investment beneficial both for the Indian economy as well as for foreign investors.
The above mentioned options and the procedures prescribed by the Government of India have enhanced the FDI in India which has ultimately facilitated the growth of economy of India.
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