Framework for setting up of Wholly Owned Subsidiaries by Foreign Banks in India – Taxation matters
The Reserve Bank has been receiving queries from foreign banks regarding capital gains tax and incidence of Stamp Duty on conversion of existing foreign bank branches into wholly owned subsidiaries.
In this context it may be indicated that Government of India has inserted, by the Finance Act, 2012, a new Chapter XII-BB titled- ‘Special Provisions relating to Conversion of Indian Branch of a Foreign Bank into a Subsidiary Company’ in Income Tax Act, 1961, inter alia, exempting capital gains arising from such conversion from capital gains tax, with effect from April 1, 2013.
As regards applicability of stamp duty in the case of conversion of existing branch of a foreign bank into a wholly owned subsidiary, a new section ‘8E’ has been inserted in Indian Stamp Act, 1899 vide Banking Laws (Amendment) Act, 2012 notified in Gazette of India Notification dated January 18, 2013, exempting from stamp duty any conversion of a branch of a foreign bank into wholly owned subsidiary or transfer of shareholding of a bank to a holding company in terms of the scheme or guidelines of RBI.
Foreign bank desirous of converting their branches into wholly owned subsidiaries may take into account the above developments.
It may be recalled that Reserve Bank issued the ‘Framework for setting up of Wholly Owned Subsidiaries by Foreign Banks in India’ on November 6, 2013.
Assistant General Manager
Press Release : 2013-2014/1064
RBI releases Framework for setting up of Wholly Owned Subsidiaries by Foreign Banks in India
Date : 06 Nov 2013
The Reserve Bank of India (RBI) today released on its website, the framework for setting up of Wholly Owned Subsidiaries (WOS) by foreign banks in India. The policy is released in pursuance of the announcement made in the Second Quarter Review of Monetary Policy 2013-14 (para 26).
The policy is guided by the two cardinal principles of (i) reciprocity and (ii) single mode of presence. As a locally incorporated bank, the WOSs will be given near national treatment which will enable them to open branches anywhere in the country at par with Indian banks (except in certain sensitive areas where the Reserve Bank’s prior approval would be required). They would also be able to participate fully in the development of the Indian financial sector. The policy incentivises the existing foreign bank branches which operate within the framework of India’s commitment to the World Trade organisation (WTO) to convert into WOS due to the attractiveness of near national treatment. Such conversion is also desirable from the financial stability perspective. To provide safeguards against the possibility of the Indian banking system being dominated by foreign banks, the framework has certain measures to contain their expansion if the share of foreign banks exceeds a critical size. Certain measures from corporate governance perspective have also been built in so as to ensure that the public interest is safeguarded.
In 2004, Government of India with a view to liberalising foreign direct investments (FDI) in private sector banks raised the FDI limit to 74 per cent in the private sector banks under the automatic route and also permitted foreign banks, regulated by a banking supervisory authority in the home country and meeting the Reserve Bank’s licensing criteria to hold 100 per cent paid up capital, to set up a WOS in India.
To operationalise the FDI guidelines, the Reserve Bank released the roadmap for presence of foreign banks in India in consultation with the Government of India on February 28, 2005. The roadmap was divided into two phases – the first phase spanning the period March 2005 to March 2009 and the second phase beginning after a review of experience gained in the first phase.
In the first phase, foreign banks already operating in India were allowed to convert their existing branches to WOS while following the ‘one-mode presence’ criterion and the WOS was to be treated at par with the existing branches of foreign banks for branch expansion in India. The second phase of the roadmap which was to commence in April 2009 envisaged removal of limitations on the operations of WOS and treating them on par with the domestic banks to the extent appropriate. During the first phase no foreign bank came forward to set up or convert their branches into WOS in the absence of adequate incentives.
As a sequel to the roadmap of 2005 and pursuant to the announcements made in the Annual Policy Statement for 2010-11, the Reserve Bank issued a Discussion Paper in January 2011 on the mode of presence of foreign banks in India. The framework for setting up of WOS by foreign banks in India has now been finalised taking into account the feedback received on the Discussion Paper and factoring in the lessons from the crisis which favours a subsidiary mode of presence from financial stability perspective.
Key features of the Framework
The issue of permitting WOS to enter into M&A transactions with any private sector bank in India subject to the overall investment limit of 74 per cent would be considered after a review is made with regard to the extent of penetration of foreign investment in Indian banks and functioning of foreign banks (branch mode and WOS).
Principal Chief General Manager
Press Release : 2013-2014/936
a) At present, foreign banks have presence in India only through branches.
b) The global financial crisis of 2008 has shown that the growing complexity and interconnectedness of financial institutions, coupled with the lack of effective cross-border resolution regimes, have compromised the ability of home and host authorities to cope with the failure of too big to fail (TBTF) and too connected to fail (TCTF) institutions. Globally a number of policy options have been proposed to address this problem, including measures to contain the negative externalities arising out of size and interconnectedness, improving the capital and liquidity buffers held by such institutions, and enhancing their resolvability. The lessons learnt during the crisis lean in favour of domestic incorporation of foreign banks.
c) In general, following are the main advantages of local incorporation:
d) A number of jurisdictions, therefore, impose requirement of local incorporation for foreign banks mainly for (i) protecting local retail depositors, (ii) easing the resolution process, and (iii) affording greater regulatory comfort.
e) At present, foreign banks, if eligible, are allowed by the Reserve Bank of India (RBI) to set up business in India through a single mode of presence i.e. either branch mode or a wholly owned subsidiary (WOS) mode1. In the aftermath of the crisis and building on the lessons from the crisis, the RBI issued a Discussion Paper in January 2011 on the mode of presence of foreign banks in India. Taking into account the feedback received on the Discussion Paper, the Scheme for setting up of WOS by foreign banks in India has now been finalised. It has been decided, as hitherto to, allow foreign banks to operate in India either through branch presence or they can set up a wholly owned subsidiary (WOS) with near national treatment. The foreign banks have to choose one of the above two modes of presence and shall be governed by the principle of single mode of presence.
f) Having regard to the foregoing, Reserve Bank, in terms of the powers conferred on it under Section 35A read with Section 44A of the Banking Regulation Act, 1949, in the public interest and in the interest of banking policy hereby issues a ‘Scheme for Setting up of Wholly Owned Subsidiaries (WOS) by foreign banks in India’.
2. Branch mode or wholly owned subsidiary
a) All foreign banks which are not carrying on banking business in India and which wish to do so in the future and to whom the matters referred to in paragraph 4 apply shall carry on banking business in India only through a wholly owned subsidiary.
b) Foreign banks which are not carrying on banking business in India and which wish to do so in the future and to whom the matters referred to in paragraph 4 do not apply have the option to carry on banking business in India either through a wholly owned subsidiary or through the branch mode. If they choose to carry on banking business through the branch mode, and in case at a later date they come within the purview of paragraph 4, they shall convert their branches into WOS.
c) Foreign banks which commenced banking business in India from August 2010 onwards were required to furnish an undertaking that they would convert their branches into wholly owned subsidiaries if so required by RBI. Accordingly, such banks shall convert their branches into a wholly owned subsidiary if the matters specified in paragraph 4 apply to them.
d) Foreign banks which commenced banking business in India before August 2010 shall have the option either to continue their banking business through the branch mode or to convert those branches into a wholly owned subsidiary.
e) The branch expansion of both the existing foreign banks and the new entrants present in the branch mode would be subject to India’s WTO commitments.
f) In respect of foreign banks which are presently carrying on banking business in India and which are required to convert their branches into a wholly owned subsidiary or opt to do so, the conversion shall only be in accordance with a scheme mandated in the public interest to be approved by RBI under Section 44A of the Banking Regulation Act 1949 and which is in accordance with the conditions specified in paragraph 20.
3. Eligibility for setting up a wholly owned subsidiary
a) Setting up of WOS by a foreign bank in India should have the approval of the home country regulator/supervisor.
b) A foreign bank applying for setting up a WOS in India must satisfy RBI that it is subject to adequate prudential supervision as per internationally accepted standards, which includes consolidated supervision in its home country.
c) The factors taken into account while considering applications for setting up WOS in India would include the following:
These criteria represent the minimum that an applicant will need to meet for applying to RBI for granting a licence under Section 22 of the Banking Regulation Act, 1949 (to set up a bank as a WOS of the parent bank) and is not an exhaustive list. The final decision to grant licence will be that of RBI.
4. Conditions requiring presence as WOS only
Foreign banks which have commenced banking business in India after August 2010 or foreign banks which are not at present carrying on banking business in India but wish to do so in the future shall carry on banking business in India only through a wholly owned subsidiary, if any of the matters as described hereunder are applicable:
b) If a foreign bank, which has set up its presence in India through branch mode after August 2010, is considered by RBI as being systemically important by virtue of the size of its business2.
5. National treatment
a) Under the FDI policy as set out in the Government of India’s Department of Industrial Policy and Promotion (DIPP) Circular F.No. 5(2)/2013-FC-I dated April 5, 2013 (Circular 1 of 2013) read with A.P. (DIR Series) Circular No.1 dated July 4, 2013 issued by RBI under FEMA, 1999 and Notification No. FEMA. 285/2013 – RB dated August 30, 2013, WOSs of the foreign banks, even though locally incorporated, being foreign owned and controlled companies, will be treated as “foreign banks” in line with DIPP press notes 2, 3 and 4 (2009 Series) read with A.P. (DIR Series) Circular No. 01 dated July 4, 2013 and A.P.(DIR Series) Circular No. 44 dated September 13, 2013 in terms of which a company owned by non-residents ‘means an Indian company where more than 50% of the capital in it is beneficially owned by non-residents and/or “controlled“ by non-residents. The term ‘control’ has been defined in A.P.(DIR Series) Circular No. 44 dated September 13, 2013 as under:
‘Control’ shall include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements.
Providing the extent of national treatment to WOS of foreign banks needs to be considered from the financial stability perspective. From financial stability perspective down side risk may arise if the foreign banks, i.e. WOSs of the foreign banks and foreign bank branches together come to dominate the domestic financial system. To address this risk, restrictions would be placed on further entry of new WOSs of foreign banks, when the capital and reserves of the foreign banks (i.e. WOSs and foreign bank branches) in India exceed 20% of the capital and reserves of the banking system. In such eventuality prior approval of RBI will be required for capital infusion into the existing WOSs of foreign banks. As regards foreign banks in branch mode of presence, as per the WTO commitments licences for new foreign banks may be denied when the maximum share of assets in India both on and off balance sheet of foreign banks’ branches to total assets both on and off balance sheet of the banking system exceeds 15 per cent.
6. Minimum capital requirement
a) The initial minimum paid-up voting equity capital for a WOS shall be Rs. 5 billion.
b) The newly set up WOS of the foreign bank would be required to bring in the entire amount of initial capital upfront, which should be funded by free foreign exchange remittance from its parent.
c) In the case of an existing foreign bank having branch presence in India, which desires or is required to convert into a WOS:
d) The WOS shall meet the Basel III requirements on a continuous basis from the time of its entry / conversion5. WOS shall, however, maintain a minimum capital adequacy ratio, on a continuous basis for an initial period of 3 years from the commencement of its operations, at 10 per cent i.e. 1 per cent higher than that required under the phased implementation of Basel III6. In addition, WOS shall also maintain capital conservation buffer and other buffers as applicable under extant capital adequacy framework.
7. Use of group resources
The WOS would be responsible for the core management functions which cannot be outsourced including to Group entities whether in India or abroad as laid down in RBI’s Outsourcing Guidelines contained in Circular DBOD.No.BP. 40 /21.04.158/2006/07 dated November 3, 2006 and circular DBOD.No.BP. 97/21.04.158/2008/09 dated December 11, 2008 as applicable to scheduled commercial banks in India, including branches of foreign banks operating in India. As regards IT services including its outsourcing, the guidelines contained in circular DBS.CO.ITC.BC.No. 6/31.02.008/2010/11 dated April 29, 2011 titled ‘Working group on Information Security, Electronic Banking, Technology Risk Management and cyber Frauds – Implementation of recommendations’ as applicable to all scheduled commercial banks (excluding RRBs) will also be applicable to WOSs of foreign banks
8. Corporate governance
The composition of the board of directors of WOS should meet the following requirements:
a) not less than 51 percent of the total number of members of the board of directors shall consist of persons as defined under Section 10A of the Banking Regulation Act, 1949;
b) not less than two-third of the directors should be non-executive directors;
c) not less than one-third of the directors should be independent of the management of the subsidiary in India, its parent and any subsidiary or other associate of the foreign bank parent;
d) not less than 50 per cent directors should be Indian nationals/NRIs/PIOs subject to the condition that one-third of the directors are Indian nationals resident in India;
e) WOSs of foreign banks will have Part-time Chairman and full time Chief Executive Officer (CEO);
f) RBI’s approval for appointment/re-appointment, etc of the Part-time Chairman (non-executive director) should be obtained in terms of Section 10B(1A) of the Banking Regulation Act, 1949;
g) RBI’s approval for appointment/re-appointment, etc. of the CEO/ Whole Time Directors including remuneration and other terms of appointment should be obtained in terms of Section 35B of the Banking Regulation Act, 1949;
h) The Guidelines on Compensation of Whole Time Directors /Chief Executive Officers, etc. issued in terms of circular DBOD No.BC. 72/29.67.001/11-12 dated January 13, 2012 as applicable to private sector banks in India, would also be applicable to WOSs;
i) The CEO would be appointed on full time basis and should be resident in India;
j) The directors should conform to the ‘Fit and Proper’ criteria as laid down in RBI circular DBOD.No.BC.105 /08.139.001 /2003-04 dated June 25, 2004, as amended from time to time; and
k) All other provisions of the Banking Regulation Act, 1949 in respect of composition of board of directors, as applicable to private sector banks in India would also be applicable to WOSs.
9. Statutory, regulatory, prudential and other requirements
a) The WOS will be governed by the provisions of the Companies Act, 1956, Banking Regulation Act, 1949, Reserve Bank of India Act, 1934, Foreign Exchange Management Act, 1999, Payment and Settlement Systems Act, 2007 and other relevant statutes, directives, prudential regulations and other guidelines/instructions issued by RBI and other regulators from time to time.
b) In all the cases where foreign bank parent/group of the WOS in India has NBFCs, the regulatory framework for consolidated prudential reporting and supervision, currently applicable to branches of foreign banks as laid down in circular DBOD No.FSD.BC. 46/24.01.028/2006-07 dated December 12, 2006 will also be applicable to WOS.
c) In case Know Your Customer (KYC)/Anti Money Laundering (AML)/Combating the Financing of Terrorism (CFT) deficiencies are found in respect of any jurisdiction / bank, banks from such jurisdictions would be subjected to enhanced prudential requirements.
10. Raising of Non-equity capital in India
WOS of foreign banks may raise rupee resources through issue of non-equity capital instruments, as allowed to domestic banks.
11. Branch Expansion/Authorisation
a) The guidelines on branch authorisation presently applicable to domestic scheduled commercial banks and as amended from time to time would generally be applicable to WOS of foreign banks.
b) In accordance with extant guidelines, WOS would be permitted to open branches in Tier 1 to 6 centres (except at certain sensitive locations) without having the need to take prior permission from Reserve Bank of India in each case, subject to reporting, as under:
i) At least 25 percent of the total number of branches opened during the financial year must be opened in unbanked rural (Tier 5 and Tier 6) centres, i.e. centres which do not have a brick and mortar structure of any scheduled commercial bank for customer based banking transactions.
ii) The total number of branches opened in Tier 1 centres during the financial year cannot exceed the total number of branches opened in Tier 2 to 6 centres and all centres in the North Eastern States and Sikkim.
iii) An incentive in the form of a branch in a Tier 1 centre would be given for opening of a branch in Tier 2 to Tier 6 centres of underbanked districts of underbanked States.
iv) In case the WOS is unable to open all the branches it is eligible for in Tier 1 centres, it may carry-over (open) these branches during subsequent two years.
v) If for some reason a WOS is unable to meet obligations of opening branches in Tier 2 to 6 centres in aggregate, or in unbanked rural centres (Tiers 5 to 6 centres) during the financial year, it must necessarily rectify the shortfall in the next financial year.
vi) This general permission would be subject to compliance with the parameters stated above as well as regulatory/supervisory comfort in respect of the individual WOS. RBI would have the option to withhold the general permission to banks which fail to meet the above mentioned criteria along with imposing penal measures on banks which fail to meet the inclusion obligations above.
c) WOS would require prior approval of RBI for opening branches at certain locations that are sensitive from the perspective of national security and the general permission referred to at (b) above would not be applicable to opening of branches in such centres. A list of such centres would be made available to WOSs by RBI.
12. Priority sector lending requirements for WOS
a) The WOSs will comply with the priority sector lending requirements as laid down in RBI’s Master Circular RPCD.CO.Plan.BC.9/04.09.01/2013-14 dated July 1, 2013. The targets and sub-targets would be as under:
WOS of Foreign Banks
Total Priority Sector
40 percent of Adjusted Net Bank Credit (ANBC) or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher.
18 percent of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher.
Of this, indirect lending in excess of 4.5% of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher, will not be reckoned for computing achievement under 18 percent target. However, all agricultural loans under the categories ‘direct’ and ‘indirect’ will be reckoned in computing achievement under the overall priority sector target of 40 percent of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher.
Micro & Small Enterprises (MSE)
Advances to micro and small enterprises sector will be reckoned in computing achievement under the overall priority sector target of 40 percent of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher.
40 percent of total advances to micro and small enterprises sector should go to Micro (manufacturing) enterprises having investment in plant and machinery up to Rupees 1 million and micro (service) enterprises having investment in equipment up to Rupees 0.4 million.
20 percent of total advances to micro and small enterprises sector should go to Micro (manufacturing) enterprises with investment in plant and machinery above Rupees 1 million and up to Rupees 2.5 million, and micro (service) enterprises with investment in equipment above Rupees 0.4 million and up to Rupees 1 million.
Export credit is not a separate category. Export credit to eligible activities under agriculture and MSE will be reckoned for priority sector lending under respective categories.
Advances to Weaker Sections
10 percent of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher.
The priority sector lending / achievements for a year ending March 31st, will be based on the adjusted net bank credit (ANBC) outstanding as on March 31st of the previous year.
b) As per the instructions contained in paragraph I(ii) of circular RPCD.CO.Plan.BC. 13/04.09.01/2012-13 dated July 20, 2012 foreign banks with branch mode of presence in India having 20 or more branches have been given a maximum period of 5 years starting from April 1, 2013 to achieve priority sector targets and sub-targets. These instructions would be applicable to those foreign banks having 20 or more branches, which choose to convert into WOSs.
The above relaxation, upto a maximum period of five years based on the action plan submitted to RBI by an existing foreign bank with less than 20 branches, opting to convert into a WOS, would be available from the date of conversion into a WOS.
13. Use of credit rating and parent / head office support
a) The parent of the WOS would be required to issue a letter of comfort (LOC) to the Reserve Bank for meeting the liabilities of the WOS. Reserve Bank would take into account this commitment of the parent to support the subsidiary before a foreign bank is allowed to set up a WOS in India.
b) On arm’s length basis, WOSs would be permitted to use parental guarantees/credit rating only for the purpose of providing custodial services and for international operations. However, WOS should not provide counter guarantee to its parent for such support.
14. Declaration of dividends
The WOS of a foreign bank, being a company incorporated in India, may declare dividend like domestic banks subject to criteria laid down in RBI circular DBOD.No. BP.BC. 88/ 21.02.067/2004/05 dated May 04, 2005 which may be repatriated as per the provisions of FEMA 1999.
15. Investment by the WOS in subsidiaries and other companies
The investment in subsidiaries and other companies by WOS would be guided by the extant instructions on para-banking activities by banks, contained Master Circular dated July 1, 2013, which, inter alia, include the following:
16. Dilution of WOS to 74 per cent
WOS of foreign banks may, at their option dilute their stake to 74 per cent or less in accordance with the extant FDI policy on foreign investment in banking sector and list on stock exchanges in India
17. Mergers / Acquisitions
After a review is made with regard to the extent of penetration of foreign investment in Indian banks and functioning of foreign banks (branch mode and WOSs), WOSs may be permitted, subject to regulatory approvals and such conditions as may be prescribed, to enter into mergers and acquisition transactions with any private sector bank in India subject to the overall foreign investment limit of 74 per cent.
18. Business model
19. Other conditions
20. Procedure for conversion of existing branches of foreign banks into WOS
21. Application procedure
Application, in Form III prescribed vide Rule 11(a) of the Banking Regulation (Companies) Rules, 1949 together with the additional information as may be required for setting up of WOS by foreign banks should be made to the Principal Chief General Manager, Reserve Bank of India, Department of Banking Operations and Development, International Banking Division, 13th floor, Central Office Building, Shahid Bhagat Singh Marg, Mumbai – 400 001.
1 Though as per the road map for presence of foreign banks in India, announced in 2005, foreign banks wishing to establish presence in India for the first time can either (i) choose to operate through branch presence or (ii) set up 100% wholly owned subsidiary (WOS), following the one-mode presence criterion, no foreign bank chose to set up 100 per cent owned subsidiary.
2 A foreign bank operating under branch mode of presence in India would be considered to be systematically important once its assets in Indian books (on balance sheet and credit equivalent of off-balance sheet items) become 0.25% of the total assets (inclusive of credit equivalent of off-balance sheet items) of all scheduled commercial banks in India as on March 31 of the preceding year. RBI would furnish consolidated data on credit equivalent of off-balance sheet items for the banking industry for this purpose.
3 The elements and eligibility criteria of regulatory capital instruments for existing foreign bank branches are different from those applicable to domestic banks. Accordingly, conversion of branches of an existing foreign bank into WOS would require re-organisation of the capital structure. The WOS would be allowed to repatriate the ineligible regulatory capital to its parent with prior approval of RBI.
4 Net worth would comprise Paid-up capital plus Free Reserves including Share Premium but excluding Revaluation Reserves, plus Investment Fluctuation Reserve and credit balance in Profit & Loss account, less debit balance in Profit and Loss account, Accumulated Losses and Intangible Assets. No general or specific provisions should be included in computation of net worth.
5 Basel III Capital Regulations have been implemented in India as on April 1, 2013 in phases. The Basel III capital ratios would be fully implemented as on March 31, 2018.
6Please refer to Master Circular DBOD.No.BP.BC.2 /21.06.201/2013-14 dated July 1, 2013 on Basel III Capital Regulations. Banks operating in India are required to maintain a minimum capital to risk-weighted assets ratio (CRAR) of 9% (other than capital conservation buffer and countercyclical capital buffer etc.) on an on-going basis
7Group entities for this purpose would be as under: –
(a) enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise (this includes holding companies, subsidiaries and fellow subsidiaries); (b) associates and joint ventures of the reporting enterprise and the investing party or venturer in respect of which the reporting enterprise is an associate or a joint venture; (c) individuals owning, directly or indirectly, an interest in the voting power of the reporting enterprise that gives them control or significant influence over the enterprise, and relatives of any such individual; (d) associates / joint ventures of the holding company and/or its fellow subsidiaries; (e) entities sharing common brand name with entities in (a), (b), (c), (d) above; (f) key management personnel and relatives of such personnel; (g) enterprises over which any person described in (c) or (f) is able to exercise significant influence. This includes enterprises owned by directors or major shareholders of the reporting enterprise and enterprises that have a member of key management in common with the reporting enterprise; For this purpose, control, significant influence, associate, joint venture,key management personnel, subsidiary and holding company shall have the same meaning as defined in the Accounting Standard AS 18 (Related Party Disclosures) issued by the Institute of Chartered Accountants of India