Appearing in CORPORATE COUNSEL™ GUIDE TO DOING BUSINESS IN INDIA
India is hurtling through the twenty-first century at a rate that none but the most prescient could have predicted, albeit while steeped in tradition and a culture that venerates the past. The Green Revolution of the 1950s and 1960s, the brain drain of the 1970s, and the Technology Revolution of the 1980s to the present all have impacted the culture of Shiva, Ganesh, and Krsna. Although the effect of the forces of modernization on this ancient land and people have been, and continue to be, well documented and analyzed, and certainly have been given well-deserved treatment in the early chapters of this book, there is an unmistakably modern outlook that has been given a voice recently. In no other venue is this voice more obvious than in the economic and investment policies emanating from India since the early 1990s.
Indeed, in 1991, India began its economic liberalization process, which culminated in recent efforts by the central and state governments to increase the incentives offered to foreign investors. While the incentives and many advantages offered by India’s large and relatively well-educated middle class are attractive, a company would be well advised to conduct thorough research before entering India. With this caveat, there are many options open to foreign companies looking to enter the Indian market.
II. Business Organization in India
A. Initial Ventures into the Indian Marketplace
Foreign companies may establish subsidiary corporations or joint ventures in India, and these options are discussed in greater detail below. For those companies looking to enter the market more cautiously or those companies unable to make a larger commitment to resources in India, there are a few options available.
1. Branch Office
With permission from the Reserve Bank of India (RBI), a foreign company can open a branch office to represent its interests in India. The branch office serves as an extension of a foreign company doing business in India and is subject to tax in India, but it is not a separately incorporated company. Accordingly, the branch office’s activities in India are limited by the RBI to the following:
- representing the foreign company as a buying or selling agent;
- conducting research for the parent (provided it is shared with Indian companies);
- promoting collaborations between Indian and foreign companies; and
- conducting export and import activities.
2. Project Office
As the name suggests, a project office is essentially a branch office set up by a foreign company to execute specific projects. Project offices are usually set up so that a company may execute public projects awarded to it. In limited circumstances, a project office may be set up to execute private projects. Again, permission from the RBI is required to establish a project office.
3. Liaison Office
An even lesser investment in resources and money is required, and indeed allowed, in India by foreign companies establishing liaison offices. Such offices cannot directly engage in commercial activity or earn any income in India. Therefore, all expenses of the offices are borne by the parent company through remittances from abroad. Additionally, a parent company cannot repatriate money out of India through a liaison office. A company interested in establishing a liaison office in India in order to explore further avenues for investment in the country, oversee its current business interests, or promote its products must obtain permission from the RBI. The RBI required a parent company to submit copies of its memorandum and articles of association, balance sheet, and copies of any contracts entered into in India.
All three above-mentioned entities are regulated by the Companies Act of 1956 (the Act) and must receive permission from the RBI. A parent company must register these entities with the Registrar of Companies (ROC) within thirty days of setting up a place of business in India.
4. Technical Collaborations
A foreign company may also enter into a technical collaboration with an Indian company, whereby it transfers technology only to the Indian company and receives payment for the technology. No separate entity is required to be established for this undertaking, saving many of the costs associated even with the above-mentioned lower cost options. The cost savings, however, come at their own price. While the RBI automatically approves the technology payments by the Indian company to the foreign company, the payments are subject to a 20 percent tax at the source. Additionally, the payments may obligate the Indian company to pay a 5 percent research and development fee.
5. Direct Sales
Finally, of the possible methods of engaging in business in India, the easiest and least costly option may be conducting direct sales in India. Although this option will provide a company less presence in India, it can help a company avoid the payment of income tax in India as long as certain precautions are taken. It is also important to recall that the importer of the goods into India will be subject to duties on the imported goods.
B. Principal Forms of Business Organization for Foreign Companies in India
For those companies willing and able to make a larger investment in resources and monies in India, there are a variety of options available. The principal forms of business organization for foreign companies in India are as follows.
1. Companies: Private/Public/Limited Liability/Unlimited Liability
The Act regulates both public and private companies in India. Either may be formed in India by a foreign parent. In turn, a public or private company may have limited or unlimited liability. In a limited liability company, the personal liability of members can be limited to the amount unpaid on their shares or by a predetermined nominated amount (in other words, by guarantee). In an unlimited liability company, of course, the liability of its members is unlimited. Not surprisingly, the most common form of company in India, apart from government-owned concerns, is the limited liability company. Public and private companies are discussed in more detail below.
2. Joint Ventures
Joint ventures are the most commonly used method of investing in India by foreign companies, as joint ventures are thought to provide maximum visibility and presence in the country. A foreign company interested in establishing a joint venture must do the following:
- (a) obtain in principal approval for the investment, either through the Foreign Investment Promotion Board or the RBI;
- (b) register with the ROC; and
- (c) obtain formal approval from the RBI for bringing in the equity contribution after putting the formal joint venture agreement on the record.
Only after these three steps are accomplished can a company establish a bank account for the foreign equity coming into India which will be converted into share capital after final approval.
Joint ventures may take the form of green field projects or takeovers and strategic alliances.
a. Green Field Projects
A green field project is one that is set up with new manufacturing facilities and new machinery by a joint venture company that is formed by 51 percent foreign equity. The remaining 49 percent in equity may be held by an Indian company, financial institution, or made available to the public through the Indian stock exchanges. In some high-priority industries, the government is encouraging even more foreign investment. For example, in the power industry, foreign equity of up to 100 percent is allowed. The list of high-priority industries allowing not only greater amounts of foreign investment but also repatriation of capital invested and income accruing in India can be found in Annexure III to the Industrial Policy Act of 1991.
b. Takeovers and Strategic Alliances
These forms of joint ventures occur with existing Indian companies in a niche market. For example, in the technology sector, many joint ventures have been formed in order to take advantage of India’s well-educated and expanding labor base and abundant raw materials.
C. Encouragement of Investment in India
The Indian government has established the Foreign Investment Promotion Board to oversee, encourage, and effectuate foreign investment in joint ventures in India. Additionally, the government has authorized automatic approval for up to 74 percent foreign equity (and up to 100 percent equity held by nonresident Indians) in joint ventures in certain activities. Moreover, automatic approval for 51 percent foreign equity is available for companies engaged primarily in exports. For a list of high-priority industries allowing greater amounts of foreign investment and repatriation of capital invested and income accruing in India, please refer to Annexure III to the Industrial Policy Act of 1991.
D. Private and Public Companies
As indicated above, the Act regulates both private and public companies in India. The Department of Company Affairs, with the assistance of both the ROC and the Company Law Board (CLB) which operate under it, ensures compliance with the Act.
1. Private Companies
Private companies are defined under the Act as those companies for whom
- the right to transfer shares is restricted;
- the number of shareholders or members is limited to between two and fifty;
- the taxation rates are higher; and
- the shares and debentures cannot be offered to the public.
While private companies seem to have some restrictions, they enjoy many more benefits and privileges under the Act. Among the myriad rights that private companies enjoy are the following:
- they do not have to hold statutory meetings and send statutory reports to shareholders and the ROC;
- they may appoint directors for life;
- they are not limited in the compensation they can offer to management personnel;
- approval of the central government is not necessary for loans to directors;
- they can make loans to other companies without restriction;
- they can purchase shares in other companies; and
- they may issue shares without issuing a prospectus or delivering a statement in lieu of prospectus’? to the ROC.
In some circumstances, however, a private company may be deemed to be a public company, such as
- when 25 percent or more of the company’s paid-up capital is held by one or more public companies;
- when the company owns 25 percent or more of the paid-up share capital of a public company;
- when the company accepts or renews deposits from the public; or
- when the company’s average annual turnover exceeds Rs. 100 million during a period of three consecutive financial years.
2. Public Companies
Simply put, public companies are those that are not private and to which the above restrictions and definitions do not apply. Public companies must have a minimum of seven members or shareholders. Certain provisions of the Act apply only to public companies; these include the following provisions:
- those restricting the company from giving financial assistance to subscribe its own shares;
- those restricting the amount of compensation given to management (limited to 11 percent of the net profit of the company during the financial year);
- those restricting the authority of the board of directors;
- those restricting loans to directors; and
- those regarding the future issue of share capital.
E. The Logistics of Forming a Company in India
In order to incorporate in India, a company must register with the ROC. This registration usually involved a two-part process: (1) name approval; and (2) submission of necessary documentation and fees to the ROC.
1. Name Approval
Initially, the ROC in the state or union territory in which the company will maintain its registered office must approve the proposed name of the company. There are some restrictions on the proposed name. For example, obviously a new company cannot have the same name as an existing company. In addition, a private limited company’s name must end with “Private Ltd.”? and a public limited company’s name must end with “Limited”?
2. Documents and Fees to Be Submitted to the ROC
In order to incorporate in India, a company must submit various documents to the ROC, including the following:
- Memorandum of association, which sets forth the objects and parameters of the company’s mission and activity. In India, it is relatively difficult to amend the objects clause of the memorandum; any proposed amendments have to be approved by the Company Law Board. Therefore, one will find that the memorandum usually has myriad objects, many of which are never pursued or implemented, in order that the company will never be found to be acting ultra vires.
- Articles of association, which contain the rules and regulations for managing the company and achieving its goals and objectives. These include any restrictions on transferring a company’s share capital. A private company must file its articles, although this is optional for a public company. If a public company does not file its own articles, a model set incorporated in the Act is applied to the company.
- Registration fee, which is scaled according to the share capital of the company, as stated in the memorandum of association.
Once the ROC receives the required documentation and fees, it will issue a certificate of incorporation. A private company can begin conducting business once it receives its certification of incorporation.
A public company, on the other hand, must also file its prospectus with the ROC if it wishes to invite the public to subscribe to its share capital. If the public company decides to obtain its capital privately, the company may file a “statement in lieu of prospectus”? with the ROC. Thereafter, the ROC will issue the “certificate of commencement of business”? After receiving this certificate, the public company can begin conducting its business.
3. Share Capital
Two kinds of share capital or stock originally were permitted under the Act: preference share capital (preferred stock) or equity share capital (common stock). A third type of stock was recognized by the Companies (Amendment) Act of 1999 sweat equity shares. These shares are the shares issued by a company at a discount, or issued without any monetary payment required, in recognition of consideration given by a person or entity in the form of labor, know-how, intellectual property, etc.
The percentages of shares held by a person or entity have a legal significance. For example, only those persons holding greater than 50 percent of the shares of the company may pass an ordinary resolution concerning the adoption of annual accounts, capital structure of the company, the appointment of auditors, and the appointment of directors. Only those persons holding greater than 75 percent of the shares of the company can pass a special resolution, such as a resolution changing the memorandum and articles of association of the company. Therefore, a foreign company must thoroughly investigate its potential share holdings in relation to its ability to achieve its objectives.
4. The Securities and Exchange Board of India
Established in 1989, the Securities and Exchange Board of India (SEBI) is comprised of representatives from the Ministries of Finance and Law, the RBI, and appointees from the central government.
Importantly for the foreign investor, SEBI has created an Overseas Investors Cell (Cell) in order to address questions on registration procedures and other investment-related queries and concerns. The Cell is designed to facilitate investments by foreign investors and to enhance their confidence in SEBI’s regulatory and enforcement mechanisms. The Cell can be contacted via e-mail at email@example.com
Under SEBI’s guidelines, a company may issue debentures to raise funds for its various capital needs. The most common types of debentures are fully convertible debentures (FCD), nonconvertible debentures (NCD), and partly convertible debentures (PCD).
6. Accounting Practices
The Act sets forth the book of accounts that a company must maintain and preserve for at least eight years. Additionally, the Act requires every company to appoint an auditor. Certain companies, like public limited companies, must also appoint a full-time company secretary. The Income Tax Act requires every company to follow a uniform accounting year from April 1 to March 31.
Within sixty days of its annual general meeting, each company is required to file an annual return with the ROC. The return should list the members or shareholders of the company, the debenture holders, management personnel, and the company’s debts.
The Act requires that every company have a board of directors. Each private company must have at least two directors, and each public company must have at least three directors. The board of directors for a public company must meet once every three months and at least four times a year.
F. Other Approvals Necessary before Commencing Business in India
The Indian government, through the Ministry of External Affairs, lists the following table of special approvals required before a company may commence business in India.
Approvals/Clearances Required for New Projects
Approvals/Clearances Required Departments to Be
Approached and Consulted
Registration/IEM/Industrial license DIC for SSI/SIA for large and medium industries
Allotment of land State DI/SIDC/Infrastructure
Permission for land use (in case industry is located outside an industrial area)
a. State DI
b. Dept. of Town and Country Planning
c. Local authority/Dist. Collector
Site approval from environmental angle State Pollution Control Board and Ministry of Environment and Forests for specified industries
NOC and consent under Water and Air Pollution Control Acts State Pollution Control Board
Approval of construction activity and building plan a. Town and country planning
b. Municipal and local authorities
c. Chief Inspector of Factories
d. Pollution Control Board
e. Electricity Board
Sanction of power State Electricity Board
Use and storage of explosives Chief Controller of Explosives
Boiler Inspection Certificate Chief Inspector of Boilers
a. SFC/SIDC for term loans
b. For loans higher than RS 15 million, all India financial institutions like IDBI, ICICI, IFCI, etc.
Registration under States and Central Sales Tax Acts a. Sales Tax Dept.
b. Central and State Excise Act Depots
Clearance for extraction of minerals State Director of Mines and Geology
ISI Certificate Regional Office of the Bureau of Indian Standards (BIS)
Quality Marking Certificate Quality Marking Centre of the state government
Weights and measures Inspector of Weights and Measures
Code number for export and import Regional Office of Director General of Foreign Trade
SIDC: State Industrial Development Corporation
SSI: Small Scale Industries
SIA: Secretariat of Industrial Assistance
SSIDC: Small Scale Industrial Development Corporation
SFC: State Financial Corporation
DIC: District Industry Centre
GOI: Government of India
IDBI: Industrial Development Bank of India
ICICI: Industrial Credit and Investment Corporation of India
IFCI: Industrial Finance Corporation of India
The reader would be well advised to take into consideration the many approvals and permits that must be obtained when calculating the time line, budget, and available resources for commencing business in India.
G. Winding Up and Dissolution
The Act sets forth the procedures for winding up a company’s operations and dissolving the company. This process may be accomplished either through the court system or by the members of the company. Before this process can begin, however, a company must obtain approval from the government under the Industrial Disputes Act (concerning the displacement of labor). If a sick or weak company has been referred to the Board of Financial and Industrial Reconstruction (Board), it may be wound up and dissolved pursuant to an order of the Board. Finally, once permission is obtained from the RBI, a final settlement to members may be paid out.
This chapter endeavors to give a brief but thorough introduction to many of the issues to be considered when investing in India, but it clearly cannot raise or discuss the myriad details involved. The reader would be well advised to consult the appropriate counsel both in his or her home country and in India before embarking on a journey that is sure to be at times frustrating, confusing, and challenging, yet ultimately rewarding.