Introduction to Investment Structures in India
Until 1991, the Indian economy was a closed market. India’s economic liberalization dramatically changed the situation for foreign investment – today FDI up to 100 percent is allowed under the automatic route in most sectors/activities.
Under the automatic route, FDI does not require any prior agreement and only involves intimation to the Reserve Bank of India within 30 days of inward remittances and/or of the issuing of shares to non-residents.
Structures for foreign investment into India include liaison offices, project offices, branch offices and wholly owned subsidiaries. Here, we overview each structure in terms of the situations in which it is appropriate, permissible activities and limitations. We then examine the concept of permanent establishment, and FDI under the automatic and government approval route.
A liaison office (LO) is often chosen by overseas companies as the first step towards setting up a company in India. The major advantage of establishing a liaison office is that, if it is obeying regulations and only adhering to the business activities stated below, it is not subject to taxation in India.
A liaison office can engage in the following activities:
- Representing the parent company/group companies;
- Promoting export/import from/to India;
- Promoting technical/financial collaborations between parent/group companies and companies in India; and
- Assisting communication between parent company and Indian companies.
A liaison office is not allowed to commence any commercial, trading or industrial activities, directly or indirectly, and is required to sustain itself out of private remittances received from its foreign parent company through usual banking channels.
To establish a liaison office, a foreign parent company should have a net worth of no less than US$50,000 and have a three-year profit making track record in its home country. Companies without a significant profit record and/or capital amount may find it difficult to get permission for a liaison office by the Reserve Bank of India (RBI).
Applications to establish a liaison office are sent to the Reserve Bank of India (RBI) and a license to operate is generally given for three years (after which it needs to be renewed).
Any foreign company engaged in manufacturing or trading activities overseas is allowed to set up a branch office (BO) in India to:
- Export/import goods;
- Render professional or consulting services; or
- Promote technical or financial collaborations between Indian companies and parent or overseas group companies.
A BO’s business activities must be in compliance with a parent company’s activities. A branch office is considered to be a foreign company in India by the RBI, which means that BOs are treated as an addition of the foreign company for income tax purposes.
A BOs allowable scope of activities is broader than for a liaison office, however BOs are still generally forbidden from engaging in retail trading, manufacturing or processing activities within India.
The major exception to this rule is in special economic zones, where branch offices can be established to undertake manufacturing and service activities without RBI approval if conditions are met.
To qualify to open a branch office, the foreign parent company should have a net worth not less than US$100,000 and a profit-making track record for the preceding five years.
Similar to a liaison office, applications to establish a branch office are sent to the RBI and a license to operate is generally given for three years (after which it needs to be renewed).
The project office (PO), essentially a branch office set up with the limited purpose of executing a specific project, allows companies to establish a business presence for a limited period of time.
A business must secure a contract from an Indian company in order to execute a project in India and thus establish a project office.
This project must be:
- Funded with remittances from abroad;
- Funded by a joint or multilateral financing agency;
- Cleared by an appropriate authority; or
- Based on a contract awarded by a company or entity in India which in turn is funded by a public financial institution or bank in India.
Otherwise, RBI permission is required.
Wholly Owned Subsidiary
Wholly owned subsidiaries (WOS) are the most suitable and widely used form of business enterprise for foreign investors in India because they allow total control over business operations, provide limited liability, and have fewer restrictions on business activities than liaison offices and project offices. They have independent legal status as Indian companies distinct from the foreign parent company.
Foreign investment in India is regulated under the Foreign Exchange Management Act, 1999, and is allowed under two routes i.e. the automatic route and government approval route (described below).
A WOS requires a minimum of two directors, and has from two to fifty shareholders with limited liability. No track record is required for the shareholders and the shareholders can be other legal entities. The minimum paid-up capital requirement is INR100,000 (approx US$2,000). No approvals of other regulatory authorities are needed.
A wholly owned subsidiary is subject to Indian laws and regulations as applicable to other domestic Indian companies and treated as an Indian company for taxation.
Whether an enterprise is a permanent establishment (PE) determines the right of the state to charge taxes on the income of an enterprise that accrues or arises in India.
A PE is a fixed place of business through which the business of an enterprise is carried on. Whether a foreign-invested enterprise is a PE depends on their business model and any tax treaty between India and the foreign company’s country.
Important concepts in determining a permanent establishment include:
If there is no business connection between a non-resident entity and a resident-entity, the resident entity may not be a PE of the non-resident entity, and the resident-entity would have to be assessed for income tax as a separate entity. In such a case, a non-resident entity will not be liable to tax in India.
Attribution of Profits
The PE criterion is commonly used in international double taxation conventions to determine the taxability of an income in the country from which it originates. As per double taxation conventions, the profits of an enterprise of a contracting state shall be taxable only in that state unless the enterprise carries on business in the other contracting state through a PE.
The tax treaties that are entered by India with other states recognize mainly three types of PE:
Fixed Place PE
A fixed place of business, with a degree of permanence, at which business is wholly or partially carried out.
An agency that secures orders wholly or almost wholly on behalf of foreign enterprises, regularly delivers goods from a maintained stock of goods and has the authority to conclude contracts on behalf of foreign enterprises.
The foreign enterprise furnishes or performs services in India through employees or other personnel for a specified period, which varies by country.
Automatic vs. government approval route
FDI in India can be done through two routes – the automatic route and the government route – with most done through the former.
FDI in sectors/activities to the extent permitted under the automatic route does not require any prior approval either by the Government or RBI. Investors are only required to notify the regional office associated with the RBI within 30 days of receipt of inward remittances and to file the required documents with that office within 30 days of the issuing of shares to foreign investors.
The FDI policy allows investment up to 100 percent under the automatic route in all the sectors/activities except:
1. Sectors prohibited for FDI:
- Lottery business including government/private lottery, online lotteries, etc.
- Gambling and betting including casinos etc.
- Chit funds
- Nidhi company
- Trading in Transferable Development Rights
- Real estate business or construction of farm houses
- Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes.
- Activities/sectors not open to private sector investment e.g. atomic energy and railway transport (other than mass rapid transport systems).
2. Activities requiring an industrial license
3. All the proposals falling outside notified sectoral policy/caps under the sectors in which FDI is not permitted.
4. Proposals in which the foreign collaborator has an existing collaboration in India in the existing field.
5. Proposals for acquisitions of shares in an existing Indian company in financial services sector where stock exchange regulations are attracted.
Under the government route, the foreign investor or the Indian company are required to obtain prior approval of the Government of India, Ministry of Finance and the FIPB or Department of Industrial Policy & Promotion (in the case of 100 percent export-oriented units).
The activities/sectors for which the automatic route is not available, and thus the government route for foreign investment must be used, include the following:
- Public sector banks and credit information companies
- Commodities and stock exchanges
- Asset reconstruction companies
- Power exchanges
- Atomic energy and related projects
- Petroleum, including exploration/refinery/marketing
- Defense and strategic industries
- Print media
- Satellite establishment and private security agency services
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