Policy framework for FDI in India
India is one of the fastest growing economies since last few years and witnessed a large amount of foreign investment in various sector. The government has formulated it Policy aiming towards attracting more and more funds considering the domestic business concerns simultaneously. This article throws a light upon what has been formulated and the procedure to be followed in the same. This present document is an analysis of the legal requirements, policies and procedures for FDI in India and is helpful for the investors’ lawyers, company secretaries and finance professionals.
POLICY AND REGULATORY FRAMEWORK TOWARD FDI
The Government has put in place a policy framework on Foreign Direct Investment. Which is embodied in the Circular on Consolidated FDI Policy, issued which is updated every six months, to capture and keep pace with the regulatory changes. The Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce & Industry, Government of India makes policy pronouncements on FDI through Press Notes/ Press Releases which are notified by the Reserve Bank of India as amendments to the Foreign Exchange Management (Transfer or Issue of Security by Persons Resident Outside India) Regulations, 2000 (notification No.FEMA 20/2000-RB dated May 3, 2000).
The procedural instructions are issued by the Reserve Bank of India vide A.P. DIR. (series) Circulars. Thus, regulatory framework for FDI consists of Acts, Regulations, Press Notes, Press Releases, Clarifications, etc.
FDI policy is reviewed on an ongoing basis and measures for its further liberalization are taken. Change in sectoral policy/sectoral equity cap is notified from time to time through Press Notes by the Department of Industrial Policy & Promotion. Policy announcement by DIPP are subsequently notified by RBI under FEMA.
FDI Policy permits FDI up to 100 % from foreign/NRI investor without prior approval in most of the sectors including the services sector under automatic route. FDI in sectors/activities under automatic route does not require any prior approval either by the Government or the RBI. The investors are required to notify the concerned Regional office of RBI of receipt of inward remittances within 30 days of such receipt and will have to file the required documents with that office within 30 days after issue of shares to foreign investors.
The present Automatic Route allows Indian companies engaged in all industries except for certain select industries/sectors to issue shares to foreign investors up to 100% of their paid up capital in Indian companies. There are also some areas where though Automatic Route is available, foreign investors cannot invest beyond a certain percentage of the paid up capital of the Indian companies or where investment is subject to some other conditions.
Foreign investors have to, however, keep in mind that they may invest freely under the Automatic Route described above but where such investment does not conform to policies of Government of India, a specific approval from Government must be sought. For example, there are Government guidelines on location of industrial units, or there are certain items like explosives or liquor that need an industrial licence. If the Indian company does not conform to the locational guidelines or needs an Industrial licence then it cannot issue shares under the Automatic Route.
GOVERNMENT APPROVAL ROUTE
All activities which are not covered under the automatic route, prior Government approval for FDI/NRI shall be necessary. Areas/sectors/activities hitherto not open to FDI/NRI investment shall continue to be so unless otherwise decided and notified by Government.
An investor can make an application for prior Government approval even when the proposed activity is under the automatic route.
Proposals requiring Government Approval
FDI up to 100% is allowed under the automatic route in all activities/sectors except the following which will require approval of the Government:
- Activities/items that require an Industrial License.
- All proposals falling outside notified sectoral policy/caps or under sectors in which FDI is not permitted.
- Proposals in which the foreign collaborator has a previous/existing venture/tie up in India in the same.
Prior Government approval for new proposals would be required only in cases where the foreign investor has an existing joint venture, technology transfer, trade mark agreement in the same field. With the amendment of the Press Note 18, joint ventures formed with foreign investment before December 12, 2004 would be considered as “existing JVs” which will fall under the ambit of Press Note 18. The foreign partner in such JV has to obtain a No Objection Certificate (NOC) from the Indian partner for starting new venture in India in the “same” field of activity.
However, Government via Press Note No. 1 (2005 Series) made an exception that even in cases where the foreign investor has a joint venture or technology transfer/ trademark agreement in the ‘same’ field prior approval of the Government will not be required in the following cases:
- Investments to be made by Venture Capital Funds registered with the Security and Exchange Board of India (SEBI); or
- Where in the existing joint-venture investment by either of the parties is less than 3%; or
- Where the existing venture/ collaboration is defunct or sick.
Application for proposals requiring prior Govt’s approval should be submitted to FIPB in fresh Application . The application shall be filed online through FIPB portal. Plain paper applications carrying all relevant details are also accepted. No fee is payable. The following information should form part of the proposals submitted to FIPB: –
a) Whether the applicant has had or has any previous/existing financial/technical collaboration or trade mark agreement in India in the same or allied field for which approval has been sought; and
b) If so, details thereof and the justification for proposing the new venture/technical collaboration (including trade marks).
c) Applications can also be submitted with Indian Missions abroad who will forward them to the Department of Economic Affairs for further processing.
d) Generally foreign investment proposals received in the DEA (Department of Economic Affairs) are placed before the Foreign Investment Promotion Board (FIPB) within 15 days of receipt. The decision of the Government in all cases is usually conveyed by the DEA within 30 days.
PROHIBITED SECTORS FOR FDI IN INDIA
FDI is not permissible in the following cases
- Gambling and Betting, or
- Lottery Business, or
- Business of chit fund
- Nidhi Company
- Housing and Real Estate business (to a certain extent has been opened. For details please see note on Construction)
- Trading in Transferable Development Rights (TDRs)
- Retail Trading (discussions are being held to open this area-B2B and Cash & Carry are permitted)
- Atomic Energy
- Agricultural or plantation activities or Agriculture (excluding Floriculture, Horticulture, Development of Seeds, Animal Husbandry, Pisiculture and Cultivation of Vegetables, Mushrooms etc. under controlled conditions and services related to agro and allied sectors) and Plantations(other than Tea plantations)
GENERAL PERMISSION OF RBI UNDER FEMA
RBI has granted general permission under Foreign Exchange Management Act (FEMA) in respect of proposals approved by the Government. Indian companies getting foreign investment approval through FIPB route do not require any further clearance from RBI for the purpose of receiving inward remittance and issue of shares to the foreign investors.
The companies are however required to notify the concerned Regional office of the RBI about receipt of inward remittances within 30 days of such receipt and to file the required documents with the concerned Regional offices of the RBI within 30 days after issue of shares to the foreign investors or NRIs.
FDI IN LIMITED LIABILITY PARTNERSHIPS (LLP’S)
Government of India recently allowed FDI in LLP’s however LLPs with FDI will not be allowed to operate in agricultural/plantation activity, print media or real estate business. FDI in LLP is allowed with the previous approval of the Government. Further it is allowed with the Government’s approval only in those sectors in which 100% FDI is allowed under automatic route under the FDI policy. Thus those sectors which are not available under automatic route is not available for FDI in LLP. The followings are some conditions with respect to FDI in LLP’s.
- LLPs with FDI will not be eligible to make any downstream investments.
- Foreign Capital participation in LLPs will be allowed only by way of cash consideration.
- Investment in LLPs by Foreign Institutional Investors (FIls) and Foreign Venture Capital Investors (FVCIs) will not be permitted.
- LLP’s are not allowed to raise ECB (external commercial borrowings)
FDI IN EOUS/ SEZS/ INDUSTRIAL PARK/ EHTP/ STP
Special Economic Zones (SEZs)
100% FDI is permitted under automatic route for setting up of special Economic Zone. Units in SEZ qualify for approval through automatic route subject to sectoral norms. Details about the type of activities permitted are available in the Foreign Trade Policy issued by Department of Commerce. Proposals not covered under the automatic route require approval by FIPB.
100% Export Oriented Units (EOUs)
100% FDI is permitted under automatic route for setting up 100% EOU, subject to sectoral norms. roposals not covered under the automatic route would be considered and approved by FIPB.
Capitalization of Import Payables
FDI inflows are required to be under the following modes;
- By inward remittances through normal banking channels or
- By debit to the specified account of person concerned maintained in an authorized dealer/authorized bank.
Issue of equity to non-residents against other modes of FDI inflows or in kind is not permissible under automatic route. Issue of shares for consideration other than cash requires prior Government Approval.
However, Issue of equity shares against lump sum fee, royalty payable and external commercial borrowings (ECBs) in convertible foreign currency are permitted, subject to meeting all applicable tax liabilities and sector specific guidelines.
Industrial Licensing Policy
Industrial Licenses are regulated under the Industries (Development & Regulation) Act, 1951. The requirements of Industrial licence has been progressively reduced. At present industrial licence for manufacturing is required only for the following:
- Industries retained under compulsory licensing,
- Items reserved for small scale sector; and
- When the proposed location attracts locational restriction industries requiring Compulsory Licensing
The following industries require compulsory industrial license:
- Distillation and brewing of alcoholic drinks;
- Cigars and cigarettes of tobacco and manufactured tobacco substitutes;
- Electronic Aerospace and defence equipment: all types;
- Industrial explosives including detonating fuses, safety fuses, gun powder, nitrocellulose and matches;
- Hazardous chemicals;
- a) Hydrocyanic acid and its derivatives
- b) Phosgene and its derivatives
- c) Isocyanates and di-isocyanates of hydrocarbon, not elsewhere specified example: Methyl Isocyanate); and
- Drugs and Pharmaceuticals (according to modified Drug Policy issued in September, 1994 and subsequently amended from time to time)
Prior Government approval required in all cases where Industrial Licence is required to start the business. i.e. all sectors requiring industrial license comes under approval route and requires Government approval.
INDUSTRIES UNDER SMALL-SCALE SECTOR
An industrial undertaking is defined as a small-scale unit if the capital investment in plant and machinery does not exceed Rs 10 million. Small-scale units can get registered with the Directorate of Industries/District Industries Centre of the State Government. Such units can manufacture any item, and are also free from locational restrictions.
Manufacture of items reserved for small-scale sector
Non-small scale units can manufacture items reserved for the small scale sector only after obtaining an industrial license. In such cases, the non-small scale unit is required to undertake an obligation to export 50 per cent of the production of SSI reserved items.
FDI IN SSI UNITS
A small scale unit cannot have more than 24 per cent equity in its paid up capital from any industrial undertaking, either foreign or domestic. If the equity from another company (including foreign equity) exceeds 24 per cent, even if the investment in plant and machinery in the unit does not exceed Rs 10 million, the unit loses its small-scale status.
Industrial undertakings are free to select the location of a project. Industrial Licence is required if the proposed location is within 25 KM of the Standard Urban Area limits of 23 city having population of 1 million as per 1991 census.
Locational restriction does not apply:
- i) If the unit were to be located in an area designated as an ‘’industrial area’’ before the25th July, 1991.
- ii) Electronics, Computer software and Printing and any other industry, which may be notified in future as “nonpolluting industry”, are exempt from such locational restriction.
The location of industrial units is subject to applicable local zoning and land use regulations and environmental regulations.
FOREIGN TECHNOLOGY AGREEMENTS
For promoting technological capability in Indian industry, acquisition of foreign technology is encouraged through foreign technology collaboration agreements. Inductions of know-how through such agreements are permitted either through automatic route or with prior approval from the Government.
Scope of Technology Collaboration
The terms of payment under foreign technology collaboration, which are eligible for approval through the automatic route and by the Government approval route are technical know-how fees, payment for design and drawing, payment for engineering service and royalty. Payments for hiring of foreign technicians, deputation of Indian technicians abroad, and testing of indigenous raw material, products, and indigenously developed technology in foreign countries are governed by separate RBI procedures and rules and are not covered by the foreign technology collaboration approval. Similarly, payments for imports of plant and machinery and raw material are also not covered by the foreign technology collaboration approval.
Government has delegated powers to Reserve Bank of India to allow payments for foreign technology collaboration by Indian companies under automatic route subject to the following limits:
(i) The lump sum payments not exceeding US $ 2 Million;
(ii) Royalty payable being limited to 5 per cent for domestic sales and 8 per cent for exports. The aforesaid royalty limits are net of taxes and are calculated according to standard conditions.
Terms of payment qualifying for automatic route is irrespective of the extent of foreign equity in the Indian company.
Use of trademarks and brand name
Payment of royalty up to 2% for exports and 1% for domestic sales is allowed under automatic route for use of trademarks and brand name of the foreign collaborator without technology transfer. Royalty on brand name/trade mark shall be paid as a percentage of net sales, viz., gross sales less agents’/dealers’ commission, transport cost, including ocean freight, insurance, duties, taxes and other charges, and cost of raw materials, parts and components imported from the foreign licensor or its subsidiary/affiliated company.
In case of technology transfer, payment of royalty subsumes the payment of royalty for use of trademark and brand name of the foreign collaborator.
ENTRY OPTIONS FOR FOREIGN INVESTORS IN INDIA
A foreign company planning to set up business operations in India has the following options:
- By incorporating a company under the Companies Act,1956 through
- Joint Ventures; or
- Wholly Owned Subsidiaries
Foreign equity in such Indian companies can be up to 100% depending on the requirements of the investor, subject to equity caps in respect of the area of activities under the Foreign Direct Investment (FDI) policy.
As an Unincorporated Entity
As a foreign Company through
- Liaison Office/Representative Office
- Project Office
- Branch Office
Such offices can undertake activities permitted under the Foreign Exchange Management (Establishment in India of branch or office of other place of business) Regulations,2000.
Incorporation of Company
For registration and incorporation, an application has to be filed with Registrar of Companies (ROC). Once a company has been duly registered and incorporated as an Indian company, it is subject to Indian laws and regulations as applicable to other domestic Indian companies.
Liaison Office/Representative Office
The role of the liaison office is limited to collecting information about possible market opportunities and providing information about the company and its products to prospective Indian customers. It can promote export/import from/to India and also facilitate technical/financial collaboration between parent company and companies in India. Liaison office can not undertake any commercial activity directly or indirectly and can not, therefore, earn any income in India. Approval for establishing a liaison office in India is granted by Reserve Bank of India (RBI).
Foreign Companies planning to execute specific projects in India can set up temporary project/site offices in India. RBI has now granted general permission to foreign entities to establish Project Offices subject to specified conditions. Such offices can not undertake or carry on any activity other than the activity relating and incidental to execution of the project. Project Offices may remit outside India the surplus of the project on its completion, general permission for which has been granted by the RBI.
Foreign companies engaged in manufacturing and trading activities abroad are allowed to set up Branch Offices in India for the following purposes:
- Export/Import of goods
- Rendering professional or consultancy services
- Carrying out research work, in which the parent company is engaged.
- Promoting technical or financial collaborations between Indian companies and parent or overseas group company.
- Representing the parent company in India and acting as buying/selling agents in India.
- Rendering services in Information Technology and development of software in India.
- Rendering technical support to the products supplied by the parent/ group companies
- Foreign airline/shipping company.
A branch office is not allowed to carry out manufacturing activities on its own but is permitted to subcontract these to an Indian manufacturer. Branch Offices established with the approval of RBI, may remit outside India profit of the branch, net of applicable Indian taxes and subject to RBI guidelines Permission for setting up branch offices is granted by the Reserve Bank of India (RBI).
Branch Office on “Stand Alone Basis” in SEZ
Such Branch Offices would be isolated and restricted to the Special Economic zone (SEZ) alone and no business activity/transaction will be allowed outside the SEZs in India, which include branches/subsidiaries of its parent office in India.
No approval shall be necessary from RBI for a company to establish a branch/unit in SEZs to undertake manufacturing and service activities provided that:
(i) Such units are functioning in those sectors where 100% FDI is permitted,
(ii) Such units comply with part XI of the Companies Act (Section 592 to 602),
(iii) Such units function on a stand-alone basis