Entry Strategies for Foreign Companies in India

'Entry Strategies for Foreign Companies’

There are several strategies by which a foreign enterprise can set up Indian operations. This Memo aims to set out the various entry options available to a foreign investor for foreign direct investment. Broadly, entry strategies may be classified into two major types:-

1. A foreign investor may directly set up its operations in India through a branch office or liaison office or project office of the foreign Company ; or

2. It may do so through an Indian arm i.e. through a subsidiary company set - up in India under Indian laws;

A Foreign company is one that has been incorporated outside India and conducts business in India. These companies are required to comply with the provisions of the Indian Companies Act, 1956 as far as their Indian operations are concerned. Foreign companies can set up their operations in India through opening of liaison, project and branch offices. This is possible only after taking written permission for this from the Reserve Bank of India. Further, such companies have also to register themselves with the Registrar of Companies (ROC) within thirty days of setting up a place of business in India. This is qualitatively different from a case where the foreign company sets up another distinct le gal incorporated entity in India as a subsidiary which would itself be a domestic company duly registered under the Companies Act, 1956.

There is thus a choice involved in deciding whether the foreign company is itself to operate in India by setting up a local representative office such as a Project/Site or Liasion or Branch office or whether the foreign company is in turn to set up a new different company as a subsidiary incorporated under India’s domestic company law provisions.

In case of the former, the further choice between setting up a Project/Site Office, Liasion Office and Branch Office of the Foreign company itself can be evaluated as under.

I. Liaison Office:

A Liaison Office is in the nature of a representative office set up primarily to explore and understand the business and investment climate. A Liaison Office is not permitted to undertake any commercial / trading / industrial activity, directly or indirectly, and is required to maintain itself out of inward remittances received from abroad through normal banking channels. The role of such offices is, therefore, limited to collecting information about possible market opportunities and providing information about the company and its products to prospective Indian customers.

The opening and operation of such offices is regulated by the Foreign Exchange Management (Establishment of India of Branch or office or other place of business) Regulations, 2000. Approval from the Reserve Bank of India (RBI) , the apex foreign exchange management authority in India, is required for opening such offices.

Permissible Activities:

The Liaison Office is permitted to undertake only the following activities:

§ Representing in India the parent Company / group Companies

§ Promoting export/ import from/ to India

§ Promoting technical / financial collaborations between the parent / group companies and companies in India

§ Acting as a communication channel between the parent company and Indian

companies

Restriction on Activities:

However, there are strict restrictio ns on the activities of the liaison office:

§ No commercial operation can be done by the liaison office (No invoicing)

§ The liaison office must maintain a QA22C account with the bank. This is a special account that only allows inflows from abroad.

§ The liais on office can neither borrow, nor lend money

§ All expenses of the office must be met through inward remittances to the office from abroad (parent company) through the bank. The liaison office is not subject totaxation in India

§ However, the office must file regular returns to the RBI. Such returns must include Audited Annual accounts and an activity report for the year.

Suitability of a Liaison Office

The Liaison Office generally acts as a communication channel between the parent company overseas and its present or prospective customers in India. The Liasion Office can also be set up to establish business contacts or gather market intelligence to promote the products or services of the overseas parent company. The Liasion office is not legally an entity distinct from the foreign parent company.

The Liaison Office cannot undertake any business activity in India nor earn any income in India.

The Liaison Office has to meet its entire expenses from funds received from the parent company through normal banking channels. At the time of closure of the Liasion Office, the RBI grants permission to repatriate the balance in the Indian bank account to the parent company.

Since the Liaison Office is not permitted to earn any income, it should not constitute a taxable entity in India. However, the Liaison Office would be required to withhold tax from certain payments and hence to comply with the requisite tax withholding requirements under the domestic tax law.

To open a Liaison of fice, the foreign company has to apply to the Reserve Bank of India and is normally granted permission within 2 to 4 weeks. Usually the permission is for a period of 3 years, but this can be extended.

1. II. Branch Office:

A branch would mean an establishment carrying on substantially the same activity as its Head Office. The opening and operation of such offices is regulated by the same Foreign Exchange Management (Establishment of India of Branch or office or other place of business) Regulations, 2000. Foreign companies intending to open a Branch Office in India need to obtain prior permission of RBI which would encompass approval to the particular scope of activities that are inte nded to be carried out in India.

Permitted Activities:

As per the guidelines laid down by the RBI, the Branch Office in India is allowed to carry on only the following activities:

§ Export / Import of goods

§ Rendering professional or consultancy services

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

§ Promoting technical or financial collaboration between Indian companies and parent or overseas group companies

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

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

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

A Branch office is considered a part of the foreign company and is not treated as a separate legal entity. The office can undertake import and export, but not manufacturing. Whether or not a Branch Office can carry out trading, even wholesale cash and carry trading, is a controversial matter. An examination of this issue is beyond the scope of this Memo. A Branch office is subject to taxation in India at 48% on income accrued in India. This rate is a little higher than the rate applicable to domestic companies including subsidiaries. Thus a Branch office enjoys a simpler regulatory regime but is subject to a higher tax rate. If there is a double taxation agreement with the country in which the foreign company is incorporated, the tax paid in India can be set off against the total tax payable by the parent company abroad.

In certain cases, where income is deemed to have originated in India and such income includes royalties, fees for technical services, interest and capital gains including capital gains from share of capital in India, Branch offices may repatriate profits to their Head Office

without obtaining prior approval. The procedure for opening a Branch office is that a formal application needs to be made to the Reserve Bank Of India (RBI) for representing the interests of the foreign company. The permission from RBI generally takes about 2 to 4 weeks and is considered on a case-to-case basis. Newly incorporated foreign companies or foreign compa nies with weak track records or inactive backgrounds or non transparent pedigree or special status unknown to Indian law such as an LLC or an S Corporation or an LLP (Limited Liability Partnerships) or a PC (Professional Corporation), can have difficulty getting the necessary approval. The application should cover the following points:

§ Operating history of the company worldwide

§ Proposed activities in India

§ Reasons for wanting to open a branch office

§ Figures of imports and exports of last three years

§ Any foreign exchange implications

Restrictions on operations

The RBI usually imposes the following conditions while granting permission to establish a Branch Office:

§ The Branch Office would not expand its activities or undertake any new trading, commercial or industrial activity other than that is expressly approved by the RBI

§ The entire expenses of the Branch Office in India will be met either out of the funds received from abroad through normal banking channels or through income generated by it in India

§ The Branch Office will not accept any deposits in India;

§ The commission earned by the Branch Office from parties abroad for any agency business will be repatriated to India through normal banking channels.

Repatriation of profits

A Branch Office can remit the profits (net of any withholding tax) generated out of its operations in India on production of the prescribed documents, and on establishing that it has earned a net profit by undertaking the permitted activities. The Branch Office need not retain any profits as reserves in India

1. III. Project office

Foreign companies can establish Project Offices in India specifically for the purpose of execution of specific projects. A Project Office means a place of Business to represent the interests of Foreign Company executing a project in India but excludes a Liaison Office. A Project Office is similar to a branch office but opened for the limited purpose of executing a particular contract. As Project Offices are opened for undertaking a specific activity they cannot perform any other function or undertake any other activity. Generally, companies engaged in turnkey projects or installation projects, set up Project Offices. All expenses of Project Offices must be met through inward foreign currency remittances if the rupee component of the contract, if any, is not sufficient to meet the said expenses. The opening and operation of such offices is regulated by the Foreign Exchange Management (Establishment of India of Branch or office or other place of business) Regulations, 2000. RBI approval is required to open a Project office. Site Offices are opened as part of a Project Office network.

Pre-condition of setting –up a project office:

I. A foreign Company may open a Project office in India provided it has secured from an Indian company, a contract to execute a project in India, and

(a) the project is funded directly by inward remittance from abroad; or

(b) the project is funded by a bilateral or multilateral International Financing Agency; or

(c) the project has been cleared by an appropriate authority; or

(d) a company or entity in India warding the contract has been granted Term Loan by a public Financial Institution or a Bank in India for the project

II. The Foreign Company is required to furnish a report to the concerned Regional Office of Reserve Bank of India under whose jurisdiction the Project Office is set up, giving details as under:

(a) Name and address of the foreign company;

(b) Reference no. and date of letter awarding the contract referred;

(c) Total amount of contract

(d) Address and tenure of project office;

(e) Nature of project undertaken.

Remittance of Surplus:

A Project office in India may remit outside India the surplus of the Project on its completion, net of applicable Indian taxes on production of the following documents and establishing the net surplus:

(a) Certified copy of the final audited project accounts;

(b) A Chartered Accountant’s certificate showing the manner of arriving at the remittable surplus

(c) Income-tax assessment order or either documentary evidence showing payment of income –tax and other applicable taxes, or a chartered Accountant’s certificate stating that sufficient funds have been set aside for meeting all Indian tax liabilities; and

(d) Auditor’s certificate stating that no statutory liabilities in respect of the project are

outstanding. A company executing (or planning to execute) a specific and identifiable contract can open a Project office. An example would be the laying of a gas pipeline or performance of an engineering contract. Typically, these are granted in respect of Government approved projects but this is not a necessary condition. Private sector projects can also be given permission for setting up of Project office and Site offices.

The procedure for opening such an office is to apply to the RBI with details of the project to be executed and the details of the project office to be set up. RBI will accord approvals specific to the project. The project office cannot operate after the completion of the specified project.

2. Wholly owned subsidiary

In case of latter, viz. the establishment of a legally distinct and juristically separate company incorporated under Indian law, in which the foreign company would own shares, all or some, the foreign company and/or its agents act as a promoter of the Indian subsidiary company. The Government has now made it easier than ever before for foreign entities to start wholly owned subsidiaries. In most cases, a company can be incorporated by a foreign company acting itself or through other promoters. This procedure is under the Companies Act, 1956.

Subsequently or as part of the incorporation process itself, shares can be acquired by the foreign company. For this also, in most cases, no other approval is required though there are certain reporting requirements with the RBI. In some cases, prior permission from the FIPB (Foreign Investment Promotion Board) acting for the Government, or the RBI or from an RBI authorized dealer can be required. The circumstances in which this is necessary is, however, beyond the scope of this Memo.

Such subsidiaries whether wholly or only partially owned, are registered with the Registrar of Companies (ROC). These are Indian companies and become subject fully to Indian laws. They have to file all returns to the ROC and to the Income Tax authorities as other Indian companies do. They have to maintain their books of accounts. Except in special permission cases and except in the matter of restrictions if any on repatriation overseas of dividend, Indian law does not treat such companies differently from other companies without any FDI (foreign direct investment). For most purposes but not always, downstream subsidiaries are treated as direct subsidiaries. In case of joint venture subsidiaries, that is to say where the foreign company does not own the entire shareholding, issues of control and management arise. This Memo does not deal with issues arising in such contexts but it should be noted that Indian law contains various deeming provisions that override contractual terms between such JV partners and also that Indian company law contains various provisions that cannot be overridden either by contract or even by special articles of incorporation.