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- 1. 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
- 2. Evolution of Economic Liberalization Luthra & Luthra Law Offices 2
- 3. 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 Luthra & Luthra Law Offices 3
- 4. 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 Luthra & Luthra Law Offices 4
- 5. 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
- 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 6
- 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 7
- 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 8
- 9. Entry Process & Entry Strategies Luthra & Luthra Law Offices 9
- 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 10
- 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 11
- 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 12
- 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 13
- 14. . The Entry Process Investing in India Automatic Route Prior Permission 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) By exception Approval of Foreign Investment Promotion Board needed. Decision generally within 4-6 weeks Luthra & Luthra Law Offices 14
- 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 15
- 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 16
- 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 17
- 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 18
- 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 19
- 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 20
- 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 21
- 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 22
- 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 23
- 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 24
- 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 25
- 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 26
- 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 27
- 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 28
- 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 29
- 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 30
- 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 31
- 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 32
- 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 33
- 34. Legal Structures facilitating FDI Luthra & Luthra Law Offices 34
- 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 35
- 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 36
- 37. 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. Luthra & Luthra Law Offices 37
- 38. Investment Incentives Luthra & Luthra Law Offices 38
- 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 39
- 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 ecommerce Luthra & Luthra Law Offices 40
- 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 41
- 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 42
- 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 43
- 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 44
- 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 45
- 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 46
- 47. Thank You Luthra & Luthra Law Offices 47
Editor's Notes
- Stability amidst coalition politics and irreversibility of economic reforms Coalitions governments are stable now May 1996 to October 1999 was a phase of unstable central governments, but thereafter the present coalition government, which is also the biggest ever coalition has been very stable. There is growth of coalition culture, and coalition governments in various states in India have also been stable and well functioning. Indian political coalitions have learnt to give stable governments. The reform process is irreversible There is a consensus among various political parties, including both the right wing and the left wing parties, for economic liberalisation. Further, irrespective of the political combination, which formed the government at the Centre, they have almost invariably furthered the liberalisation process. A good indicator of this fact would be the continuous enhancement/ removal of sectoral caps in various industries in last ten years. To conclude:A consensus on economic liberalisation has already emerged among various political parties and the path of economic liberalisation is already divergent from the political ideologies in other fields.
- Industries reserved for Public Sector: (I) Atomic Energy (ii) Railway Transport Compulsory licensing, under Industries (Development & Regulation) Act, 1951is needed in the following industries: (1) Distillation and brewing of alcoholic drinks, (2) Cigars and cigarettes and manufactured tobacco substitutes, (3) Electronic aerospace and defence equipment: all types, (4) Industrial explosives including detonating fuses, safety fuses, gun powder, nitrocellulose and matches, (5) Hazardous chemicals: (a)Hydrocyanic acid and its derivatives, (b) Phosgene and its derivatives, (c) Isocyanates and diisocyanates of hydrocarbon, not elsewhere specified (example: Methly Isocyanate), (6) Drugs and Pharmaceuticals (according to modified Drug Policy issued in September, 1994 and subsequently amended in February, 1999). Note: Manufacture of SSI reserved items by other industrial undertakings and location of industrial undertakings in relaxation of the notified locational policy will attract compulsory licensing. Undertakings that are exempt from obtaining an industrial license are required to file an Industrial Entrepreneur Memorandum and obtain an acknowledgement. No further approval required.
- Relaxation in locational restriction is possible if an industrial license is obtained as per the notified procedure. Location of industrial units is further regulated by the local zoning and land use regulations as also the environmental regulations.
- But SSIs can manufacture any item even outside the reserved list.
- Investment in public sector units as also for EOU/EPZ/EHTP/STP units would also qualify for the Automatic Route. However, Areas/sectors/activities not open to FDI/NRI/OCB investment shall continue to be so unless otherwise decided and notified by Government.
- RBI has granted general permission under Foreign Exchange Management Act (FEMA) in respect of proposals approved by the Government. 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. The FIPB also grants composite approvals involving foreign investment/ foreign technical collaboration.
- FEMA valuation for shares is done differently for listed shares and unlisted or thinly traded shares as follows: Listed shares are valued at market price if the sale is through a merchant banker or stock broker. In other cases, the average price at which the share was quoted at the stock exchange preceding the date of application with a 5% variation may be taken. In case management control is being transferred by a foreign to an Indian promoter, a premium of 25% may be charged. In case of unlisted or thinly traded shares, if the consideration is less than Rupees 20 lakhs, the shares may be sold at a mutually agreed price provided that the auditors of the Indian Company must certify that the valuation has been correctly arrived at. If the consideration payable is more than Rupees twenty lakhs per seller per company, price based on EPS or NAV linked to book value multiple may be taken OR the prevailing market price in small lots as laid down by the RBI Where shares are not listed on stock exchange, the average price of two independent valuations – one by statutory auditor and another by a chartered accountant or a merchant banker. REMITTANCE: remittance of sale proceeds is permitted net of taxes if security is sold on stock exchange or RBI permission has been obtained. CA Certificate that transaction is in compliance with RBI approval is required.
- Electricity is one of the most vital infrastructure inputs for economic development. The demand of electricity in India is enormous and is growing steadily; the supply on the other hand lags far behind. Power sector, therefore, provides a great opportunity for foreign direct investment. 2. It has been decided to allow automatic approval in the RBI route for 100% foreign equity without any upper ceiling. The categories which would qualify for such automatic approval are: a. Hydro-electric power plants; b. Coal/lignite based thermal power plants; c. Oil/gas based thermal power plants. 3. various investment incentives are provided, e.g.: a. New power projects are eligible for a 100 per cent tax holiday in any block of ten years within the first 15 years of operation; b. Indirect tax benefits available such as concessional rates of import duties, a special project import scheme, deemed export benefits, etc., in respect of certain categories of power projects. 4. With the coming into force of the Electricity Act, 2003 generation has been delicensed. 5. Tariff to be fixed by Regulatory Commission based on the Annual Revenue Receipt. 6. The concept of Open Access has been introduced, thus trade in electricity as a business in itself(without the requirement of setting up transmission or distribution network) is a lucrative proposition. 7. There is move from a single buyer model to multiple buyer model – thus there electricity generated can be sold to various customers. 8. Government utilities will be treated as just another player in the market and will not have any preferential treatment. 9. Regulatory commission to administer and regulate the industry and to resolve various disputes.
- FDI upto 100% permitted for development of integrated township, including housing, commercial premises, hotels, resorts etc. Development of land and providing allied infrastructure forms integral part of township development.
- 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. For foreign technology agreements, automatic approval is granted if: Upto 3% of the capital cost of the project is proposed to be paid for technical and consultancy services including fee for architects, design, supervision, etc. Upto 3% of the net turnover is payable for franchising and marketing/publicity support fee, and Upto 10% of gross operating profit is payable for management fee, including incentive fee.