Law governing Inbound Investment in India

TG Team 16 Feb 2013 3,248 Views 0 comment Print Fema / RBI | Articles

R. Kumar, B.Com. MBA (Finance)

1. Introduction

Over the last several years, there has been considerable liberalization in the inbound investment regime, The Industrial Policy Resolution of 1956 and the statement on Industrial Policy of 1991 provides the basic framework for the overall industrial policy of Indian Government. The process of liberalization started in India with the statement on Industrial Policy of 1991.

The attitude towards foreign investment has been changed significantly, until the 1980s, foreign investment was permitted only in case where a desired technology was not available on any other term. With the introduction of statement on Industrial policy of 1991, the government started taking more liberal attitude. Especially on the Foreign Direct Investment, Foreign Institutional Investor. However there has been a requirement for more changes in the inbound investment regime. The business and legal environment in India differs from the environment overseas. Each country has its own set of issue, regulatory framework in terms of legal and judicial system, tax regime, social and cultural issues and business dynamics. India’s FII regime essentially provides that FII can broadly make investments in shares and permitted securities traded on the Indian stock exchanges, subject to certain parameters. These parameters broadly stipulate that FII registered with the Securities and Exchange Board of India (SEBI), can purchase and sell shares and convertible debentures of an Indian company through a registered broker on a recognized stock Exchange

There are indications that the government may even consider replacing the FII regime with a qualified foreign investor, or QFI, regime, including allowing individual foreign investors to invest in the stock markets in India.

The flight of funds due to the exit by the FIIs (foreign institutional investors) has contributed to reducing liquidity in the domestic market. The liberalization of the ECB regulations and the increase in the cap are likely to help, but with a global liquidity crisis there is only so much to borrow from overseas.

The global liquidity crunch has no doubt affected the fresh FDI in-flows into India. The GOI (Government of India) had set a target of USD40 billion for the fiscal year 2008-09. In the present market conditions this figure looks unrealistic, as big-ticket inflows like those in infrastructure like ports and airports have been put on hold. But, despite the crunch in real terms there has been an increase in the FDI flows, and during April-August 2008 India received FDI of USD14.8 billion which is a 114 per cent increase over the corresponding figure for 2007.

Any analysis of in-bound investment must make the distinction between FDI and investment by the FII. Typically, the former is a long-term outlay and existing FDI is less affected by a liquidity crisis. Whilst fresh inflows of FDI might get adversely affected due to the reduced liquidity and the extent of growth may be lower than expected, India, even with a 7 per cent growth, is still a relatively more attractive destination than the US, the UK and Europe which are experiencing recessionary trends.

2. Why to consider the Inbound Investment

2.1 From the point of view of Foreign Investor

i) India as emerging Economy

India’s economy over the last decade looks in many ways like a success story; after a major economic crisis in 1991, followed by bold reform measures, the economy has experienced a rapid economic growth rate, more foreign investment, and a boom in the information technology sector. India’s rate of economic growth after the 1991 reforms were instituted reached a remarkable 7 percent for three consecutive years, from 1994 to 1997. It creates India’s experience with monetary and fiscal reform, the rapid growth of the information technology sector and India’s grassroots economy.

ii) Trends & incentives of investing in India for foreign businesses

During the last decade there has been a remarkable change in the composition of sources of Foreign Direct Investment (FDI) inflows in India. Due to change in FDI regime, many countries have started investing

The reform process has deregulated the economy and stimulated domestic and foreign investments, taking India firmly into the forefront of investment destinations. The Government, keen to promote investment in the country has radically simplified and rationalized polices, procedures and regulatory aspects, Foreign investment is welcome in almost all sectors, except those of strategic concern (for instance, defence and atomic energy).

A series of incentives has been announced to promote investments. These include import of capital goods at concessional customs duty (subject to fulfillment of certain export obligations), liberalization of external commercial borrowing norms, tax holiday, and concessional tax treatment for certain sector. In addition, several State Government offer incentives, such as subsidy on fixed capital, loans at concessional rates of interest, and attractive power rates, while several incentives are project specific, a number of firms have been successful in negotiating favorable investment terms with the State Government concerned.

Since the initiation of the economic liberalization process in 1991, sectors such as automobiles, chemicals, food processing, oil & natural gas, petrochemicals, power, services, and telecommunications have attracted considerable investments. Today, in the changed investment climate, India offers exciting business opportunities in virtually every sector of the economy.

iii) Economic and business climate in India

The Indian economy rapidly integrates with the world economy. A foreign investor who is interested to undertake business in India will find tremendous opportunities. The Industrial Policy of India offers a great deal of freedom to business houses and entrepreneurs to make their own investment decisions.

Continuity in the economic / global liberalization process and the political consensus that economic change necessitates has placed India on a growth path.

According to Central Statistical Organization (CSO), real Gross Domestic Product (GDP) grew by an impressive 8.7% during the financial year 2007-08. Notably, the agricultural sector grew by 2.6% and the industrial and services sector grew by 8.6% and 10.6% respectively.

2.2 From the point of view of Host country

i) Employment generation

The most important benefit that all host countries desire is to create more work for their people. People in less-developed countries rather are underemployed especially in the agriculture sector. If there are some more factories or farms established by foreign direct investment, those who are unemployed can find jobs and those who are employed can have better job.

ii) Technology Transfer

Technology transfer is another hope of the host countries. The main concern is that when foreign factories will setup in their countries, the foreign experts will teach them some production technology. At least they will have experience in higher technology work.

iii) Economic Prestige

Economic Prestige is a pride of people and their governments of less-developed countries that there are high technology goods produced by modern factories in their countries.

iv) Foreign Currency need

Foreign currency need is another factor to pull foreigners to invest in their countries. Less developed countries actually lack foreign currencies. The easy method to draw foreign currencies is by persuading foreigners to invest in their countries.

3. Modes of Foreign Investment in to India

i. Foreign Direct Investment

ii. Foreign Institutional Investment

iii. Foreign Venture Capital Investment

iv. Non Resident

3.1) Foreign Direct Investment

According to Krugman and Obstfeld, foreign direct investment is international capital flows in which a firm in one country creates or expands a subsidiary in another. It involves not only a transfer of resources but also the acquisition control, i.e. the subsidiary does not simply have a financial obligation to the parent company; it is a part of same organization structure.

3.1.1) Routes Under Foreign Direct Investment

Automatic Route

FDI up to 100% is allowed under the automatic route in all activities/sectors except the following which require prior approval of the Government:

i) where provisions of Press Note 1 (2005 Series) issued by the Government of India are attracted.

ii) where more than 24% foreign equity is proposed to be inducted for manufacture of items reserved for the Small Scale sector.

iii) FDI in sectors/activities to the extent permitted under Automatic Route does not require any prior approval either by the Government or the Reserve Bank of India.

iv) The investors are only required to notify the Regional Office concerned of the Reserve Bank of India within 30 days of receipt of inward remittances and file the required documents along with form FC-GPR with that Office within 30 days of issue of shares to the non-resident investors.

Government Route

FDI in activities not covered under the automatic route requires prior Government approval and are considered by the Foreign Investment Promotion Board (FIPB), Ministry of Finance. Application can be made in Form FC-IL; Plain paper applications carrying all relevant details are also accepted. Decision of the FIPB usually conveyed in 4-6 weeks. Thereafter, filings have to be made by the Indian company with the RBI

General permission of RBI under FEMA

Indian companies having foreign investment approval through FIPB route do not require any further clearance from the Reserve Bank of India for receiving inward remittance and issue of shares to the non-resident investors. The companies are required to notify the concerned Regional Office of the Reserve Bank of India of receipt of inward remittances within 30 days of such receipt and submit form FC-GPR within 30 days of issue of shares to the non-resident investors.

A summary of the FDI policy and regulations applicable in various sectors and activities after incorporating the policy changes up to 31.03.08 is annex hereto.

Policy on Foreign Direct Investment (FDI) Press Note 7 (2008)

31st March 2008

I. Sectors prohibited for FDI

i. Retail Trading (except single brand product retailing)

ii. Atomic Energy

iii. Lottery Business

iv. Gambling and Betting

v. Business of chit fund

vi. Nidhi Company

vii. Trading in Transferable Development Rights (TDRs).

viii. Activity/sector not opened to private sector investment

II. Sector-specific policy for FDI:

In the following sectors/activities, FDI is allowed up-to the limit indicated below subject to other conditions as indicated.

Sr.No.	Sector/Activity	FDI Cap/Equity	Entry Route	Other Conditions
I	AGRICULTURE
1.	Floriculture, Horticulture, Development of Seeds, Animal Husbandry, Pisciculture, Aqua-culture and Cultivation of Vegetables & Mushrooms under controlled conditions and services related to agro and allied sectors.Note: Besides the above, FDI is not allowed in any other agricultural sector/activity	100%	Automatic
2.	Tea Sector,including tea plantation Note: Besides the above, FDI is not allowed in any other plantation sector/activity	100%	FIPB	Subject to divestment of 26% equity in favour of Indian partner/Indian public within 5 years and prior approval of State Government concerned in case of any change in future land use.
II	INDUSTRY
II A	MINING
3.	Mining coveringexploration and mining of diamonds & precious stones; gold, silver and minerals.	100%	Automatic	Subject to Mines & Minerals (Development & Regulation) Act, 1957Press Note 18 (1998) and Press Note 1 (2005) are not applicable for setting up 100% owned subsidiaries in so far as the mining sector is concerned, subject to a declaration from the applicant that he has no existing joint venture for the same area and /or the particular mineral.
4.	Coal & Lignitemining for captive consumption by power projects, and iron & steel, cement production and other eligible activities permitted under the Coal Mines (Nationalisation) Act, 1973.	100%	Automatic	Subject to provisions of Coal Mines(Nationalization) Act, 1973
5.	Mining and mineral separation of titanium bearing minerals and ores, its value addition and integrated activities.Note: FDI will not be allowed in mining of “prescribed substances” listed in Government of India notification No. S.O. 61(E) dt. 18.1.2006 issued by the Department of Atomic Energy under the Atomic Energy Act, 1962.	100%	FIPB	Subject to sectoral regulations and the Mines and Minerals (Development & Regulation) Act, 1957 and the following conditions-i. value addition facilities are set up within India along with transfer of technology; ii. disposal of tailing during the mineral separation shall be carried out in accordance with regulations framed by the Atomic Energy Regulatory Board such Atomic Energy (Radiation Protection) Rules 2004 and the Atomic Energy (Safe Disposal of Radioactive Wastes) Rules 1987.
II B	MANUFACTURING
6.	Alcohol-Distillation & Brewing	100%	Automatic	Subject to license by appropriate authority
7.	Cigars &Cigarettes- Manufacture	100%	FIPB	Subject to industrial license under the Industries (Development & Regulation) Act, 1951
8.	Coffee& Rubberprocessing & warehousing	100%	Automatic
9.	Defenceproduction	26%	FIPB	Subject to licensing under Industries (Development & Regulation) Act, 1951 and guidelines on FDI in production of arms & ammunition.
10.	Hazardouschemicals, viz., hydrocyanic acid and its derivatives; phosgene and its derivatives; and isocyanates and diisocyantes of hydrocarbon.	100%	Automatic	Subject to industrial license under the Industries (Development & Regulation) Act, 1951 and other sectoral regulations.
11.	Industrialexplosives – Manufacture	100%	Automatic	Subject to industrial license under Industries (Development & Regulation) Act, 1951 and regulations under Explosives Act, 1898
12.	Drugs & Pharmaceuticals including those involving use of recombinant DNA technology	100%	Automatic
II C	POWER
13.	Power includinggeneration (except Atomic energy); transmission, distribution and Power Trading.	100%	Automatic	Subject to provisions of the Electricity Act, 2003
III	SERVICES
14.	CIVIL AVIATION SECTOR
(i)	Airports
a.	Greenfield projects	100%	Automatic	Subject to sectoral regulations notified by Ministry of Civil Aviation
b.	Existing projects	100%	FIPBbeyond 74%	Subject to sectoral regulations notified by Ministry of Civil Aviation
(ii)	Air Transport Services including Domestic Scheduled Passenger Airlines; Non-Schedules Airlines; Chartered Airlines; Cargo Airlines; Helicopter and Seaplane Services
c.	Scheduled Air TransportServices/ Domestic Scheduled Passenger Airline	49%- FDI;100%- for NRI investment	Automatic	Subject to no direct or indirect participation by foreign airlines and sectoral regulations..
d.	Non-Scheduled Air Transport Service/ Non-Scheduled airlines, Chartered airlines, and Cargo airlines	74%- FDI100%- for NRIs investment	Automatic	Subject to no direct or indirect participation by foreign airlines in Non-Scheduled and Chartered airlines. Foreign airlines are allowed to participate in the equity of companies operating Cargo airlines. Also subject to sectoral regulations.
e.	Helicopter Services/Seaplane services requiring DGCA approval	100%	Automatic	Foreign airlines are allowed to participate in the equity of companies operating Helicopter and seaplane airlines. Also subject to sectoral regulations.
(iii)	Other services under civil aviation sector
f.	Ground Handling Services	74%- FDI100%- for NRIs investment	Automatic	Subject to sectoral regulations and security clearance.
g.	Maintenance and Repair organizations; flying training institutes; and technical training institutions	100%	Automatic
16.	Banking -Private sector	74%(FDI+FII)	Automatic	Subject to guidelines for setting up branches / subsidiaries of foreign banks issued by RBI.
17.	BROADCASTING
a.	FM Radio	FDI +FIIinvestment up to 20%	FIPB	Subject to Guidelines notified by Ministry of Information & Broadcasting.
b.	Cable Network	49%(FDI+FII)	FIPB	Subject to Cable Television Network Rules (1994) Notified by Ministry of Information & Broadcasting.
c.	Direct-To-Home	49%(FDI+FII). Within this limit, FDI component not to exceed 20%	FIPB	Subject to guidelines issued by Ministry of Information & Broadcasting.
d.	Setting uphardware facilities such as up-linking, HUB, etc	49%(FDI+FII)	FIPB	Subject to Up-linking Policy notified by Ministry of Information & Broadcasting.
e.	Up-linking a News& Current Affairs TV Channel	26%FDI+FII	FIPB	Subject to guidelines issued by Ministry of Information & Broadcasting.
f.	Up-linking a Non-news & Current Affairs TV Channel	100%	FIPB	Subject to guidelines issued by Ministry of Information & Broadcasting.
18.	Commodity Exchanges	49% (FDI+FII)Investment by Registered FII under PIS will be limited to 23% and Investment under FDI Scheme limited to 26%.	FIPB	FII purchases shall be restricted to secondary market only.No foreign investor/entity, including persons acting in concert, will hold more than 5% of the equity in these companies.
19.	ConstructionDevelopment projects, including housing, commercial premises, resorts, educational institutions, recreational facilities, city and regional level infrastructure, townships. Note: FDI is not allowed in Real Estate Business	100%	Automatic	Subject to conditions notified vide Press Note 2(2005 Series) including: a. minimum capitalization of US$ 10 million for wholly owned subsidiaries and US$ 5 million for joint venture. The funds would have to be brought within six months of commencement of business of the Company. b. Minimum area to be developed under each project- 10 hectares in case of development of serviced housing plots; and built-up area of 50,000 sq. mts. in case of construction development project; and any of the above in case of a combination project. [Note 1: For investment by NRIs, the conditions mentioned in Press Note 2 / 2005 are not applicable. Note 2: For investment in SEZs, Hotels & Hospitals, conditions mentioned in Press Note 2(2005) are not applicable]
20.	Courier servicesfor carrying packages, parcels and other items which do not come within the ambit of the Indian Post Office Act, 1898.	100%	FIPB	Subject to existing laws and exclusion of activity relating to distribution of letters, which is exclusively reserved for the State.
21.	Credit Information Companies	49 % (FDI+FII)Investment by Registered FII under PIS will be limited to 24% only in the CICs listed at the Stock Exchanges within the overall limit of 49% foreign investment.	FIPB	Foreign Investment in CIC will be subject to Credit Information Companies (Regulation) Act, 2005.FII investment will be subject to the conditions that: (a) No single entity should directly or indirectly hold more than 10% equity (b) Any acquisition in excess of 1% will have to be reported to RBI as a reporting requirement; and (c) FIIs investing in CICs shall not seek a representation on the Board of Directors based upon their shareholding.
22.	Industrial Parks both setting up and in established Industrial Parks	100%	Automatic	Conditions in Press Note 2(2005) applicable for construction development projects would not apply provided the Industrial Parks meet with the under-mentioned conditions-i. it would comprise of a minimum of 10 units and no single unit shall occupy more than 50% of the allocable area; ii. the minimum percentage of the area to be allocated for industrial activity shall not be less than 66% of the total allocable area.
23.	Insurance	26%	Automatic	Subject to licensing by the Insurance Regulatory & Development Authority
24.	Investingcompanies in infrastructure / services sector (except telecom sector)	100%	FIPB	Where there is a prescribed cap for foreign investment, only the direct investment will be considered for the prescribed cap and foreign investment in an investing company will not be set off against this cap provided the foreign direct investment in such investing company does not exceed 49% and the management of the investing company is with the Indian owners.
25.	Non Banking Finance Companies
i) ii) iii) iv) v) vi) vii) viii) ix) x) xi) xii) xiii) xiv) xv) xvi) xvii) xviii)	Merchant Banking UnderwritingPortfolio Management Services Investment Advisory Services Financial Consultancy Stock Broking Asset Management Venture Capital Custodial Services Factoring Credit Rating Agencies Leasing & Finance Finance Housing Finance Forex Broking Credit card Business Money changing business Micro credit Rural credit	100%	Automatic	Subject to:a. minimum capitalization norms for fund based NBFCs – US$ 0.5 million to be brought upfront for FDI up to 51%; US$ 5 million to be brought upfront for FDI above 51% and up to 75%; and US$ 50 million out of which US$ 7.5 million to be brought upfront and the balance in 24 months for FDI beyond 75% and up to 100%. b. minimum capitalization norms for non-fund based NBFC activities- US$ 0.5 million. c. foreign investors can set up 100% operating subsidiaries without the condition to disinvest a minimum of 25% of its equity to Indian entities subject to bringing in US$ 50 million without any restriction on number of operating subsidiaries without bringing additional capital. d. joint venture operating NBFCs that have 75% or less than 75% foreign investment will also be allowed to set up subsidiaries for undertaking other NBFC activities subject to the subsidiaries also complying with the applicable minimum capital inflow. e. compliance with the guidelines of the RBI. f. The minimum capitalization norms would apply would be applicable where the foreign holding in a NBFC(both direct and foreign holding in a NBFC(both direct and indirect) exceeds the limits indicated at (a) above g. The capital for the purpose of minimum capitalization norms shall consist of ordinary shares only.
26.	PETROLEUM & NATURAL GAS SECTOR
a.	Refining	49% in case of PSUs100% in case of Private companies	FIPB(in case of PSUs) Automatic (in case of private companies)	Subject to Sectoral policy and no divestment or dilution of domestic equity in the existing PSUs.
b.	Other thanRefining and including market study and formulation; investment/ financing; setting up infrastructure for marketing in Petroleum & Natural Gas sector.	100%	Automatic	Subject to sectoral regulations issued by Ministry of Petroleum & Natural Gas
27.	PRINT MEDIA
a.	Publishing ofnewspaper and periodicals dealing with news and current affairs	26%	FIPB	Subject to Guidelines notified by Ministry of Information & Broadcasting.
b.	Publishing ofscientific magazines/ specialty journals/ periodicals	100%	FIPB	Subject to guidelines issued by Ministry of Information & Broadcasting.
28.	TELECOMUNICATIONS
a.	Basic and cellular, Unified Access Services, National/International Long Distance, V-Sat, Public Mobile Radio Trunked Services (PMRTS), Global Mobile Personal Communications Services (GMPCS) and other value added telecom services	74%(Including FDI, FII, NRI, FCCBs, ADRs, GDRs, convertible preference shares, and proportio- nate foreign equity in Indian promoters/ Investing Company)	Automaticup to 49%. FIPB beyond 49%.	Subject to guidelines notified in the PN 3(2007)
b.	ISP with gateways, radio paging, end-to-end bandwidth.	74%	Automaticup to 49%. FIPB beyond 49%.	Subject to licensing and security requirements notified by the Dept. of Telecommunications.
c.	(a) ISP without gateway,(b) infrastructure provider, providing dark fibre, right of way, duct space, tower (Category I); (c) electronic mail and voice mail	100%	Automaticup to 49%. FIPB beyond 49%.	Subject to the condition that such companies shall divest 26% of their equity in favour of Indian public in 5 years, if these companies are listed in other parts of the world. Also subject to licensing and security requirements, where required.
d.	Manufacture of telecom equipments	100%	Automatic	Subject to sectoral requirements.
29.	TRADING
a.	Wholesale/cash & carry trading	100%	Automatic
b.	Trading for exports	100%	Automatic
c.	Trading of items sourced from small scale sector	100%	FIPB	Subject to the condition that the test marketing approval will be for a period of two years and Investment in setting up manufacturing facilities commences simultaneously with test marketing.
d.	Test marketing of such items for which a company has approval for manufacture	100%	FIPB
e.	Single Brand product retailing	51%	FIPB	Subject to guidelines for FDI in trading issued by Department of Industrial Policy & Promotion videPress Note 3 (2006 Series).
30.	Satellites Establishmentand operation	74%	FIPB	Subject to Sectoral guidelines issued by Department of Space/ISRO
31.	Special Economic Zones and Free Trade WarehousingZones covering setting up of these Zones and setting up units in the Zones	100%	Automatic	Subject to Special Economic Zones Act, 2005 and the Foreign Trade Policy.

III. In Sectors/Activities not listed above, FDI is permitted up to 100% on the automatic route subject to sectoral rules/ regulations applicable.

IV. Prior Government approval for FDI required in the following circumstances:

i) Where provisions of Press Note 1 (2005 Series) issued by the Government of India are attracted;

ii) Where more than 24% foreign equity is proposed to be inducted for manufacture of items reserved for the Small Scale sector.

Current News

On 2 January’2009, the Government has cleared the way for $50-million foreign direct investment from Pepsico, by exempting the beverages major from fulfilling a requirement to divest 49% stake in bottling firms to Indian companies.

3.2) Foreign Institutional Investment

Foreign Institutional investors (FIIs) are entities established or incorporated outside India and make proposals for investments in India. The FII, given its short-term nature, might have bi-directional causation with the returns of other domestic financial markets like money market, stock market, foreign exchange market, etc. These investment proposals by the FIIs are made on behalf of sub accounts, which may include foreign corporates, individuals and funds etc. The biggest source through which FIIs invest is the issuance of Participatory Notes (P-Notes), which are also known as Offshore Derivatives.

FIIs can invest in the stocks and debentures of the Indian companies. In order to invest in the primary and secondary capital markets in India, they have to venture through the portfolio investment scheme (PIS). According to RBI regulations, the ceiling for overall investment for FIIs is 24% of the paid up capital of the Indian company. The limit is 20% of the paid up capital in the case of public sector banks. However, if the board and the general body approve and pass a special resolution, then the ceiling of 24% for FII investment can be raised up to sectoral cap for that particular segment.

There is a long list of entities that are eligible to get registered as FIIs such as pension funds, mutual funds, insurance companies, investment trusts, banks, university funds, endowments, foundations, sovereign wealth funds, hedge funds and charitable trusts. In fact, asset management companies, investment managers, advisors or institutional portfolio managers set up and/or owned by NRIs are also eligible to be registered as FIIs. The nodal point for FII registrations is SEBI and hence all FIIs must register themselves with SEBI and should also comply with the exchange control regulations of the central bank. Apart from being allowed to invest in securities in primary and secondary markets, FIIs can also invest in mutual funds, dated government securities, derivatives traded on a recognised stock exchange and commercial papers.

FIIs are among the major sources of liquidity for the Indian markets. If FIIs are investing huge amounts in the Indian stock exchanges then it reflects their high confidence and a healthy investor sentiment for our markets. But with the current global financial turmoil and a liquidity and credit freeze in the international markets, FIIs have become net sellers

FIIs showed huge interest in 2007, pumping in the highest ever net investment of US$ 17.23 billion in the equity markets and were instrumental in the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) clocking record index levels of over 20,000 and 6,000, respectively. In fact, during the year, FIIs were net buyers in 10 out of 12 months, turning net sellers in the rest, primarily to make up the losses on account of the sub-prime crisis in the US.

This surge in FII investment has led to the cumulative net investments by FIIs into Indian equities to total US$ 52.76 billion by the end of November 2008, since December 1993, when FIIs were allowed to enter India. As of November 28, 2008, 1581 FIIs and 4824 sub-accounts were registered with the Securities and Exchange Board of India (SEBI).

SEBI announces new regulations for FII’S

Market regulator Security Exchange Board of India recently announced new rules for foreign investments through financial instruments such as participatory notes, asking FIIs to wind up P-Notes* for investing in derivatives within 18 months.

SEBI also imposing curbs on P-Notes for investing in spot market.

In derivatives, foreign institutional investors (FIIs) and their sub-accounts cannot issue fresh P-Notes and will have to wind up their current position in 18 months.

In spot market, FIIs will not be allowed to issue P-Notes more than 40 per cent of their assets under custody. The reference date for calculating such assets will be September 30.

Those FIIs who have issued P-Notes of more than 40 per cent of their assets could issue such instruments only if they cancel, redeem, or close their existing PNs. Those FIIs who have issued P-Notes less than 40 per cent of their assets under custody can issue additional instruments at the rate of 5 per cent of their assets.

Note

* P-Notes are instruments like contract notes issued by FIIs to overseas investors who cannot directly invest in equity market as they are not registered.

3.3) Foreign Venture Capital Investment

In the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (hereinafter referred to as “the Principal Regulations”),

“As per clause (iiia) of regulation 2 ‘Foreign Venture Capital Investor’ means an investor incorporated and established outside India which proposes to make investment in #Venture Capital Fund(s) or Venture Capital Undertaking(s) in India and is registered with SEBI under SEBI (Foreign Venture Capital Investors) Regulations, 2000;”

# “As per clause (xia) of regulation 2 ‘Venture Capital Fund’ means a fund established in the form of a trust, a company including a body corporate and registered under the Securities and Exchange Board of India (Venture Capital Fund) Regulations, 1996 which has a dedicated pool of capital raised in a manner specified under the said Regulations and which invests in Venture Capital Undertakings in accordance with the said Regulations.”

Investment by Foreign Venture Capital Investor

A registered Foreign Venture Capital Investor (FVCI) may, through the Securities and Exchange Board of India; apply to the Reserve Bank for permission to invest in Indian Venture Capital Undertaking (IVCU) or in a VCF or in a scheme floated by such VCFs. Permission may be granted by Reserve Bank subject to such terms and conditions as may be considered necessary.

The registered FVCI permitted by Reserve Bank under sub-paragraph (1), may purchase equity / equity linked instruments / debt / debt instruments, debentures of a IVCU or of a VCF through Initial Public Offer or Private Placement or in units of schemes/funds set up by a VCF.

The amount of consideration for investment in VCFs/IVCUs shall be paid out of inward remittance from abroad through normal banking channels or out of funds held in an account maintained with the designated branch of an authorised dealer in India

3.4) Non-Resident Investment

For all sectors excluding those falling under Government approval, NRIs (which also includes Persons of Indian Origin – PIOs) are eligible to bring investment through the automatic route of RBI. The Government through the FIPB considers all other proposals, which do not fulfill any or all of the criteria for automatic approval. Further, under the non-repatriation scheme (i.e. capital is not repatriable outside India), NRIs are permitted to invest even in those sectors where sectoral caps are prescribed under the FDI policy. NRIs are also permitted to purchase and sell shares/convertible debentures under the portfolio investment scheme through a branch designated by an authorised dealer for the purpose and duly approved by the RBI, subject to fulfillment of certain conditions.

The total holding by each NRI cannot exceed 5% of the total paid up equity capital or 5% of the paid up value of each series of convertible debentures issued by an Indian company. Further, the total holdings of all NRIs put together cannot exceed 10% of paid up equity capital or paid up value of each series of convertible debentures. This limit of 10% may be increased to 24% by the concerned Indian company by sanction of the shareholders through a special resolution.

4. Strategy for entry in India

A foreign company planning for setting up operations in India has the following alternative options for formulating its entry strategy:

• Wholly owned subsidiaries

• Joint Ventures

• Liaison Office

• Project Office

• Branch Office

A foreign company can set up a wholly owned subsidiary company in India for carrying out its activities. Such subsidiary is treated as an Indian resident and an Indian Company for all Indian regulations (including Income Tax, FEMA and Companies Act), despite being 100per cent foreign owned. At least two shareholders are mandatory. Joint Venture with an Indian Partner preferably with majority equity participation Though a wholly owned subsidiary has been the most preferred option, foreign companies have also been setting up shop in India by forging strategic alliances with Indian partners. The trend in this respect is to choose a partner who is in the same field/area of activity and has sufficient experience and expertise in his line of activity.

Liaison/Representative Office

Setting up a liaison or representative office is a common practice for foreign companies seeking to enter the Indian markets. Prior approval from RBI is required for setting up a Liaison Office followed by registration with the RoC. The role of such offices is limited to collecting information about the possible market and providing information about the company and its products to prospective Indian customers. Such offices act as “Listening and transmission posts” and provide a two-way information flow between the foreign company and the Indian customers. A liaison office is not allowed to undertake any business activity other than liaison activities in India and cannot, therefore, earn any income in India, in terms of the approval granted by RBI.

Project Office

Foreign companies planning to execute specific projects in India can set up temporary project /site offices in India for this purpose. RBI has granted general permission to a foreign entity for setting up a project office in India, subject to fulfillment of certain conditions. The foreign entity only has to furnish a report to the jurisdictional Regional Office of RBI giving the particulars of the project / contract and register the Project Office with the RoC.

Branch Office

Foreign companies engaged in manufacturing and trading activities abroad can set up Branch Offices in India for the following purposes, with the prior approval of RBI and subsequent registration with RoC:

• Representing the parent company in India and acting as buying/selling agent in India

• Rendering professional or consultancy services

• Rendering services in Information Technology and development of software in India

• Rendering technical support to the products supplied by parent/group companies

• Foreign airline/shipping company

• Promoting technical or financial collaborations between Indian companies and parent or

overseas group company

• Carrying out research work, in which the parent company is engaged

• Export/Import of goods

In general, manufacturing activity cannot be undertaken through a branch office. Foreign companies can, however, establish branch office / unit for manufacturing in a SEZ subject to fulfillment of certain conditions.

5. Tax Consideration with regards to Foreign Investment in India

5.1 Effective tax rate for the Assessment Year 2008-09; 2009-10

i. In case of a Foreign company, 40% of the total income. The income tax so calculated or in section 111A or section 112 shall in case of every foreign company be increased by a surcharge of 2.5% of such income tax, if the total income exceeds Rs. 1 crore.

ii. Rate of tax for foreign companies on dividend received from Indian company shall be 20% as increased by surcharge, education cess and secondary higher education cess as applicable, and section 115O shall not be applicable.

Marginal Relief

In case of foreign company, where the total income exceeds Rs. 1 crore, then the aggregate of income tax and surcharge shall be restricted to:

(Tax on Rs.1 crore) + (Total Income – Rs. 1crore)

Education Cess and Secondary Higher Education Cess

The income tax so computed shall be increased by surcharge shall further be increased by Education cess and Secondary Higher Education cess by 2% & 1% respectively.

5.2 Provisions of Capital Gain arises on transfer of Capital assets

5.2.1. a. Capital Gain on transfer of capital assets being Shares or Debentures in an Indian Company shall be computed by applying the first proviso to section 48.

As per the first proviso to Section 48, the capital gains arising from the transfer of shares or debentures in an Indian company shall be computed by converting

i) the cost of acquisition of the asset

ii) the expenditure incurred wholly and exclusively in connection with such transfer and

iii) sale consideration received or accruing as a result of capital asset

into the same foreign currency as was initially utilised in the purchase of such shares or debentures. The capital gain so computed in the foreign currency shall be reconverted into Indian currency.

The method of conversion is stated as per rule 115A which is as follows

a) The cost of acquisition shall be converted at the average of the telegraphic transfer buying rate (TTBR) and the telegraphic transfer selling rate (TTSR) (of the foreign currency initially utilised for the purchase of shares/debentures) as on the date of acquisition of shares/debentures.

b) The expenditure in connection with the transfer shall be converted at the average of TTBR and TTSR (of the foreign currency initially utilised for the purchase of shares/debentures) as on the date of transfer of shares/debentures.

c) The sale consideration shall be converted at the average of TTBR and TTSR (of the foreign currency initially utilised for the purchase of shares/debentures) as on the date of transfer of shares/debentures.

d) The capital gains computed in the foreign currency shall be converted into Indian currency by applying TTBR as on the date of transfer of shares/debentures.

5.2.1. b. Computation of tax on Capital Gain arises on transfer of capital assets being Shares

-Short term capital gain under section 111A

Short term capital gain arises on transfer of capital asset being equity shares in a company or a unit of an equity oriented fund on or after 1.10.2004 and such transaction is chargeable to securities transaction tax shall be charge at the rate of 10% for Assessment Year 2008-09 & at 15% for Assessment Year 2009-10

-Long term capital gain on transfer of Shares

After introduction of section 10(38) by the Finance Act, 2004, any long term capital gain arises on transfer of capital assets being Equity shares, Units of equity oriented fund shall be exempt from tax.

Explanation

a. Section 10(38) shall not apply in the following cases

i) where listed equity shares are sold on or after 1.10.2004 other than through recognized stock exchange.

ii) where units of equity oriented fund are sold on or after 1.10.2004 other than through recognized stock exchange.

iii) where Listed Debentures/Bonds are sold since exemption under section 10(38) is not available for Listed debenture/bonds.

iv) where units of a Mutual Fund other than Equity oriented Fund are sold since exemption under section 10(38) is not available to units of a Mutual Fund other than equity oriented fund.

b. Equity oriented fund means a fund-

i) Where the invisible funds are invested by way of equity shares in domestic companies to the extent of more than 65% of the proceeds of such fund; and

ii) which has been set up under a scheme of Mutual Fund specified under section 10(23D)

Further incentives to attract foreign investments

As per section 47(viii) the transaction shall not be regarded as transfer if Bonds or Global Depository Receipts referred to in section 115AC, made outside India by a Non-Resident to another Non-Resident

5.2.2. Capital Gain on transfer of capital assets other than Shares

5.2.2.1 Short term capital gain

Short term capital gain arises on transfer of capital assets shall be charged at normal corporate/individual tax rates p

5.2.2.2 Long term Capital Gain under section 112

Any long term capital gain arises on transfer of capital asset shall be chargeable at rate of 20%

5.2.2.3 Proviso to Section 112

Where the tax payable in respect of any income arising from the transfer of a long term capital asset, being listed securities or units or zero coupon bond, exceeds 10% of the amount of capital gains computed before giving effect to the provisions of the second proviso to section 48 (i.e. without indexation), then such excess shall be ignored for the purposes of computing the tax payable by the assessee. In other words the tax on capital gains from listed securities or units or zero coupon bonds being long term shall be the lower of the following:

(i) Tax on capital gains computed normally @ 20% as per the provisions of section 112 or

(ii) Tax on capital gains computed normally but without giving the benefit of indexation (i.e. the second proviso to section 48), if applicable, @ 10% as per the provisions of section 112.

6. General Incentive Provisions

6.1 Special Economic Zones (SEZs)

6.1.1 Units set up in SEZs (Section 10AA)

With effect from the assessment year 2006-07 undertakings set up in SEZs are eligible for income tax holiday for 10 years (100 percent exemption for first 5 years and 50 percent exemption for the next 5 years), on the profits derived from exports from the year in which such undertaking begins manufacturing or commences its business activities. Further, a deduction of 50 percent of profits is available for another 5 consecutive years i.e. from Eleventh assessment year to Fifteenth assessment year provided an equivalent amount is debited to the profit & loss account of the previous year and credited to Special Economic Zone Re-investment Allowance Reserve Account and further fulfillment of certain conditions.

6.1.2 Offshore Banking Units (OBUs) set up in SEZs (Section 80LA)

Banking Units in SEZ entitled to tax holiday of 100% for first 5 years and 50% for next 5 years. Similar deduction available to units of International Financial Services Centre

“Offshore Banking Unit” means a branch of a bank located in a SEZ and which has obtained the permission under section 23(1)(a) of the Banking Regulation Act, 1949.

6.1.3 Minimum Alternate Tax (MAT) provisions not to apply to units in or developers of SEZs [Section 115JB(6)] –

Sub-section (6) has been inserted to provide that the provisions of MAT contained in section 115JB would not apply to the following income accruing or arising on or after 1st April 2005 –

(i) income from any business carried on by an entrepreneur in a SEZ;

(ii) income from services rendered by an entrepreneur from a unit in a SEZ;

(iii) income of a Developer from the development of a SEZ.

6.1.4 No tax on dividends distributed, declared or paid on or after 1.4.2005 by the Developer of a SEZ or the enterprise developing a SEZ [Section 115-O(6)]-

(i) Sub-section (6) has been inserted to provide that no tax on dividends would be chargeable in respect of the total income of an undertaking or enterprise engaged in –

(a) developing a SEZ; or

(b) developing and operating a SEZ; or

if such dividend, whether interim or final, is declared, distributed or paid by such Developer or Enterprise –

on or after 1.4.2005 out of its current income.

(ii) It is to be noted that such dividend does not attract tax neither in the hands of the Developer or the Enterprise nor in the hands of the person receiving such dividend [not falling under section 10(23G)].

(iii) Consequential amendment has been made in section 10(34) by inserting an Explanation to provide that the dividend referred to in section 115-O shall not be included in the total income of the assessee, being a Developer or Entrepreneur.

6.2 Export Oriented Units (Section 10B)

As per Circular No.01/2005F.No.149/194/2004-TPL Deduction under Section 10-B of the Income Tax Act which provides for 100% deduction of profits derived by a hundred per cent Export Oriented Undertaking, from export of articles or things or computer software manufactured or produced by it. The deduction is available for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce articles or things or computer software. However, no deduction under section 10-B is available after assessment year 2009-10.

7. Other Relevant Provision related to Foreign Investment

7.1 Taxation of Royalty or Fees for Technical services received by a Foreign Company or non-resident non corporate assessee u/s 115A

Under domestic law, the royalties/technical fees payable to non residents having a permanent establishment in India are taxed on net basis. On the other hand, the royalties/technical fees payable to non residents not having a permanent establishment in India are taxed on gross basis. Concessional tax rates, as given below, apply if the agreement relates to a matter included in industrial policy or the agreement has been approved by the Government of India:

• For Contracts entered on or after 1 June 2005 10%

• For contracts entered into after 31 May 1997 but before 1 June 2005 20%

• For contracts entered into on or before 31 May 1997 30%

Applicability of Section 44DA: Section 44DA provides that income by way of royalty or fees for technical services received by non-residents and foreign companies from the Government or an Indian concern under an agreement made after 31.03.2003, will be computed on a net basis i.e. after allowing all expenses under the chapter of P/G/B/P and taxed at the regular tax rate i.e. 40%, if the following conditions are satisfied:

-such non-resident carries on business in India through Permanent Establishment or performs professional services from fixed place of profession in India, and

-the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such ^permanent establishment or fixed place of profession, as the case may be.

Section 44DA also provides that, with respect to the above mentioned income no deduction shall be allowed in respect of

-any expenditure or allowance which is not wholly or exclusively incurred for the business of such permanent establishment or fixed place of profession in India; and

-amounts paid by the permanent establishment to the head office or to any of its other office except reimbursement of actual expenses.

Further, the foreign company/ non-resident will have to comply with the following requirements:

-maintain prescribed books of account in accordance with section 44AA of the Income Tax Act, 1961.

-get the books of accounts audited; and

-furnish audit report in the prescribed form.

7.2 Taxation of Interest in the Hands of Foreign Companies u/s 115A

Where the foreign company or a non resident earn any income by way of interest received from Government or an Indian concern on moneys borrowed by the Government/ Indian concern in foreign currency, then, the income tax payable by the foreign company/Non-resident shall be 20% of the amount of interest.

7.3 Tax on Long Term Capital Gains arising from transfer of units purchased in foreign currency u/s 115AB

Where overseas financial organisations earn any income by way of long term capital gains arising from the transfer of Units purchased in foreign currency, then the income tax payable shall be at the rate of 10% of the Long Term Capital Gains.

Explanation

a) Units means unit of a mutual fund or of the Unit Trust of India

b) Overseas financial organisation means any fund, institution, association or body, whether incorporated or not, established under the laws of a company outside India and which has entered into an arrangement for investment in India with any public sector bank or public financial institution or mutual fund. Such arrangement should be approved by the Securities and Exchange Board of India.

7.4 Tax on income from bonds or Global Depository Receipts purchased in foreign currency or capital gain arising from their transfer u/s 115AC

i) Where non-resident including foreign company earn any income by way of interest on bonds of an Indian company issued in accordance with such scheme as the Central Government may by notification in the official gazette, specify in this behalf, or on bonds of a public sector company sold by Government, and purchased by him in foreign currency; or

ii) Where non-resident including foreign company earn any income by way of long term capital gains arising from the transfer of bonds or as the case may be, Global Depository Receipts purchased by him in foreign currency,

then the income tax payable shall be as follows

i) 10% of income earned by way of interest as referred in (i) above

ii) 10% of the long term capital gain referred in (ii) above

7.5 Tax on income of Foreign Institutional Investors from securities or capital gains arising from their transfer u/s 115AD

Where the Foreign Institutional Investors earn income by way of Interest on securities other than units as referred in section 115AB or income by way of short term or long term capital gains arising from the transfer of the above securities then the amount of tax payable shall be as follows

i) 20% of income earned by way of interest on securities

ii) 10% of income by way of Long Term Capital Gain

iii) 30% of income by way of Short Term Capital Gain

iv) Short term capital gain covered by Section 111A

10% for Assessment Year 2008-09

15% for Assessment Year 2009-10

The rates mentioned above shall be increased by the Surcharge (where applicable) Education cess & Secondary Higher Education Cess

8. Conclusion

From the above discussion it has been clear that Indian Government has made very liberal Industrial policies in almost all sectors and provides tax incentives to attract the foreign investor so that the our economy grow faster and achieve its objectives.

(Author can be reached at sunraj.18@rediffmail.com)