| DESTINATION INDIA | | | | route their investments into India through any of the tax |
| A LEGAL SYNOPSIS | | | | heavens having beneficial DTAA with India. |
| By: | | | | Most of the DTAA's provide that, if a foreign company |
| Alishan Naqvee | | | | has a permanent establishment ("PE") in India, its |
| LexCounsel, Law Offices, New Delhi | | | | income accruing in India would be taxable in India at the |
| E-mail: CONTENTS | | | | rate applicable to foreign companies (i.e. 40% plus |
| 1. Introduction | | | | surcharge and cess). |
| 2. Entry Strategy | | | | 4.3 Transfer Pricing Regulations |
| 2.1 Legal Entity | | | | India has implemented transfer pricing regulations. |
| 2.2 Options for Collaboration | | | | Generally speaking, these rules govern the minimum |
| 3. Regulatory Permissions and Compliances | | | | profit margin to be maintained by the Indian companies |
| 3.1 Financial Collaboration | | | | in transactions with associated enterprises. Arguably, |
| 3.2 Technology Collaboration & Trademark License | | | | the transfer pricing regulations legitimize provision of |
| 3.3 Post Collaboration Compliances | | | | services by Indian companies to foreign parent and |
| 3.4 Registrations and Licenses | | | | other entities on a cost plus basis, as per the industry |
| 4. Taxes and Tax Benefits | | | | norm and avoid PE implications for the foreign entity in |
| 4.1 Tax Structure | | | | India. |
| 4.2 International Taxation | | | | 4.4 Tax Benefits |
| 4.3 Transfer Pricing Regulations | | | | In India, substantial direct and indirect tax benefits |
| 4.4 Tax Benefits | | | | exemptions for the initial few years are provided to |
| 5. Return On Investment | | | | units engaged in specific business activities, such as |
| 5.1 Repatriation of Profits | | | | export oriented software and hardware units; specified |
| 5.2 Repatriation of Fees and Royalties | | | | infrastructure projects; units in backward areas, special |
| 6. IP Protection | | | | economic and free trade zones. |
| 7. Human Resources and Labour Issues | | | | The export oriented software and services units are |
| 7.1 Costs | | | | offered exemption of customs duty on imports, |
| 7.2 Key Issues | | | | exemption of excise duty and sales tax on domestic |
| 8. Dispute Resolution | | | | purchase of capital goods in addition to exemption of |
| 9. Due Diligence | | | | octroi. Due to availability of tax benefits/exemptions |
| 10. Disclaimer | | | | and availability of educated workforce, India is fast |
| 1. INTRODUCTION | | | | becoming the global hub for software development |
| India, the world's largest democracy, is today one of | | | | and business process outsourcing. |
| the most favoured destinations of foreign investors | | | | The DTAA, transfer pricing regulations and tax |
| and businesses for various reasons including a rapidly | | | | benefits provide an opportunity to the foreign investors |
| growing economy, educated and skilled workforce, | | | | to arrive at an efficient tax structuring of investments |
| huge market size, increasing purchasing power, low | | | | and business in India. Foreign investors can, considering |
| costs and political stability. | | | | the tax rates in both jurisdictions, ability of the Indian |
| This Synopsis provides a bird's eye view of the Indian | | | | companies to provide services at a cost plus basis |
| legal framework as applicable to foreign investors and | | | | and tax exemption available for specific activities, |
| collaborators. The purpose of this Synopsis is to | | | | decide the quantum of their investments in India. |
| provide a brief idea of the overall Indian legal and | | | | 5. RETURN ON INVESTMENTS |
| regulatory framework, the process of establishment of | | | | Foreign investors can repatriate funds out of India |
| business in India and the crucial issues involved. | | | | though a number of options including dividends, fees for |
| 2. ENTRY STRATEGY | | | | technical and administrative services, royalties, etc. |
| 2.1 Legal Entity | | | | 5.1 Repatriation of Profits |
| A foreign entity may establish a business presence in | | | | Indian companies can remit their profits to a foreign |
| India through a liaison office, branch office, project | | | | collaborator by way of dividend subject to dividend |
| office, wholly owned subsidiary company or joint | | | | distribution tax @ 12.5% plus surcharge and cess. |
| venture. | | | | There is no limit on the rate of dividend that can be |
| A liaison office can be established to primarily explore | | | | distributed or repatriated out of India. However, there |
| and understand the business opportunities and climate | | | | are certain conditions with regard to computation of |
| in India for the foreign parent entity. A liaison office is | | | | profits and transfer of upto 10% of profits of the |
| not permitted to carry on commercial activities in India. | | | | company to its reserves before declaring dividend. |
| A branch office can carry on the business activities | | | | Branch offices of foreign companies can also remit |
| while a project office can be established to execute a | | | | business profits to their principal subject to withholding |
| specific project. However, since a branch office or a | | | | tax @ 40% plus surcharge and cess (unless lower tax |
| project office would not be considered a legal entity | | | | rate is prescribed by the DTAA). |
| separate from its parent company, the business | | | | 5.2 Repatriation of Fees and Royalties |
| income generated by them would be taxable at the | | | | The royalty for transfer and use of technology, |
| rate of tax applicable to the foreign companies (40% | | | | trademark and brand name, can be remitted to foreign |
| plus surcharge and cess) which is higher than the rate | | | | collaborators subject to withholding tax @20% plus |
| of tax applicable to companies incorporated in India | | | | surcharge and cess (unless lower tax rate is |
| (35% plus surcharge and cess; proposed to be | | | | prescribed by the DTAA). If the foreign collaborator |
| reduced to 30% plus surcharge and cess by the Union | | | | belongs to a country having DTAA with India, it can |
| Budget 2005-06). | | | | avail credit of withholding taxes paid in India. Research |
| In view of restrictions on the activities and tax | | | | and Development Cess @5% is also payable by the |
| implications for liaison, branch and project offices, | | | | Indian importer of technology on payments towards |
| establishment of a wholly owned subsidiary, or | | | | imported technology. |
| strategic alliances through joint ventures or technical | | | | 6. IP PROTECTION |
| collaborations with existing Indian companies by and | | | | India recognizes the value of intellectual property rights |
| large remain the preferred options for foreign entities | | | | and has well established procedures for protection of |
| to establish a long term presence in India. | | | | patents, trademarks, designs and copyrights. |
| 2.2 Options for Collaboration | | | | The true and first inventor of a product or process |
| In addition to the option of establishing a wholly owned | | | | can register it as a patent in India. Trademarks, for |
| subsidiary, a foreign entity may enter into following | | | | services and goods, and designs (industrial designs, |
| kinds of collaborations with existing Indian companies | | | | excluding functional designs) can also be registered in |
| for its presence in India:a. Financial Collaboration: Joint | | | | India by its owner. As far as copyrights are concerned, |
| Ventures, by investment in the shares or convertible | | | | registration is not compulsory. Copyrights in original |
| debentures ("securities") of the Indian company | | | | literary, dramatic, musical and artistic works, |
| together with Indian partner;b. Technical Collaboration: | | | | cinematography films and sound recordings can also |
| By licensing technology or patents to the Indian partner; | | | | be registered. The registration of copyright is however |
| andc. Trademark/Brand Name License: To the Indian | | | | not compulsory to initiate a legal action against |
| partner with/without technical collaboration. | | | | infringement. |
| In addition, a foreign entity can import- export goods | | | | Violation of IP rights is a punishable offence in India. |
| and services to and from India and appoint distributors | | | | The owners of patents, trademarks, designs and |
| for its products in India with or without trademark | | | | copyrights can institute appropriate legal actions |
| license. It would, however, be preferable to appoint | | | | against the infringer and restrain the infringer from |
| these distributors on a principal to principal basis to | | | | using the IP pending conclusion of the legal action. |
| avoid the possibility of taxability of the foreign entity in | | | | 7. HUMAN RESOURCES AND LABOUR ISSUES |
| India. | | | | 7.1 Costs |
| 3. REGULATORY PERMISSIONS AND | | | | India arguably has the world's largest educated |
| COMPLIANCES | | | | workforce available at salaries substantially below the |
| The Foreign Investment Promotion Board ("FIPB") and | | | | international standards. A statute prescribing minimum |
| the Reserve Bank of India ("RBI") are the nodal | | | | wages to be paid to different classes of employees is |
| government authorities to permit and supervise foreign | | | | in force in India. However, the minimum wages |
| investments in India. In addition, Ministry of Commerce | | | | prescribed under this statute are not only far below |
| and Industry and various other ministries and | | | | the minimum wages payable to similarly qualified and |
| departments of the government prescribe sector | | | | skilled workers in developed economies across the |
| specific regulatory compliances and approvals. | | | | world, they are also much below the salaries ordinarily |
| 3.1 Financial Collaboration | | | | paid in India to such workers by reputed employers. |
| Foreign investment upto 100% of the securities of | | | | In addition to salary, certain other employee benefits |
| Indian companies is freely permitted in most of the | | | | and contributions, such as provident fund and |
| sectors, except a few sectors where FDI beyond | | | | employee state insurance are also payable by the |
| prescribed percentages is not permitted without prior | | | | employer (together with the employees). |
| government approval, such as insurance, aviation, | | | | The availability of economical educated workforce |
| banking, telecom, real estate, etc., and a few | | | | facilitates the foreign investors to source international |
| manufacturing sectors requiring industrial license such | | | | quality services and products at comparatively lower |
| as alcoholic drinks, tobacco products, defense | | | | costs. |
| equipment, hazardous chemicals etc. ("regulated | | | | 7.2 Key Issues |
| sectors"). Foreign investment is however prohibited in | | | | Due to rapid industrial development and growth of |
| certain sectors including retail trading, atomic energy, | | | | employment opportunities in big cities, the employers in |
| lottery, gambling, etc. | | | | these cities often face problems of attrition. Foreign |
| A financial collaboration in these regulated sectors | | | | investors may therefore review the industry salary |
| consequently requires presence of an Indian equity | | | | standards before employing workforce, check the |
| partner and/or requisite prior government approvals | | | | employment history of prospective employees for |
| from the FIPB, the RBI and other applicable ministries. | | | | consistency and sincerity and include adequate |
| The securities of an existing unlisted Indian company in | | | | protection in the employment documentation to avoid |
| unregulated sectors can be transferred from its | | | | breach of confidentiality and attrition. |
| holders to the foreign investor without prior | | | | Indian labour statutes are employee friendly and |
| government approval. | | | | discourage hire and fire practices. While the |
| To meet additional financial needs, a foreign | | | | employment of manager and administration level |
| collaborator can also provide loans to the Indian | | | | employees is governed by and can be terminated as |
| company as per the detailed government guidelines | | | | per their employment contracts, employees at lower |
| issued in this regard prescribing interest rate, average | | | | levels, called "workman", can be terminated only in |
| maturity period, end use and prior approval in certain | | | | accordance with the procedure laid down under law |
| cases. | | | | (unless the termination as per the employment |
| 3.2 Technology Collaboration & Trademark License | | | | contract is more beneficial to the employees). |
| Under these arrangements, foreign entities can provide | | | | Export oriented units situated at most of the prominent |
| technical know how and/or license their trademarks to | | | | locations in India are permitted to employ workers in |
| Indian companies against payment of fee and royalty. | | | | shifts, beyond the regular office hours. |
| For use of foreign technology, Indian companies can | | | | 8. DISPUTE RESOLUTION |
| remit lump sum fee of upto US$ 2 million and royalty | | | | The judicial structure in India consists of courts and |
| upto 5% of domestic sales and 8% of exports to the | | | | tribunals in defined hierarchy. The apex court in India is |
| technology licensor without any prior government | | | | the Supreme Court, at New Delhi. Below the Supreme |
| approval. Similarly, for use of trademarks and brand | | | | Court, every state has its own High Court and |
| name of the foreign collaborator without technology | | | | subordinate courts. The courts exercise jurisdiction |
| transfer, payment of royalty upto 2% of exports and | | | | based on their territorial, pecuniary and statutory limits. |
| 1% of domestic sales is allowed without prior | | | | In addition, specific disputes, such as consumer and tax |
| government approval. In case of trademark/brand | | | | disputes are adjudicated by specially constituted |
| name license together with technology transfer, the | | | | tribunals. |
| payment for technology transfer subsumes the | | | | Litigation in India is usually long drawn. Further, |
| payment of royalty for use of trademark and brand | | | | judgments of only a few foreign courts can be directly |
| name of the foreign collaborator. | | | | executed in India. Consequently, arbitration and |
| 3.3 Post Collaboration Compliances | | | | conciliation are prevalent methods of dispute resolution. |
| In regulated as well as free sectors, an Indian company | | | | A foreign investor and its Indian partner can agree to |
| is required to effect certain one time as well as | | | | resolve the disputes arising between them through |
| periodic filings with prescribed government regulatory | | | | arbitration conducted in or outside India. India is |
| and tax authorities. These filings include intimation of | | | | signatory to the Geneva Convention of 1927 and the |
| receipt of foreign investment, letters of acceptance, | | | | New York Convention of 1958 and consequently the |
| intimation of issue of securities, annual tax, accounts | | | | awards under these conventions are enforceable in |
| and returns, etc. | | | | India through specified statutory procedure. |
| In addition, specific industries need to file periodic | | | | 9. DUE DILIGENCE |
| reports with the administrative ministry and | | | | We provide below a non-exhaustive list of viability |
| departments, such as quarterly and annual returns by | | | | verifications that may be conducted and caution that |
| the software technology parks with the Director, STPI. | | | | may be exercised by the foreign investors while |
| 3.4 Incorporation, Registrations and Licenses | | | | establishing business in India through wholly owned |
| Incorporation of a company in India is an administrative | | | | subsidiaries or collaborations: |
| process which takes approximately 15 to 20 working | | | | 1. Verify the financial position of and possession of |
| days from filing of incorporation related documents. A | | | | assets by the prospective partner; |
| company incorporated anywhere in India is entitled to | | | | 2. Verify that the sector permits the proposed |
| carry on business activities throughout India. | | | | investment and obtain requisite approvals; |
| In addition, an Indian company would require to obtain | | | | 3. Ensure that the business understanding is well |
| various sector and location specific licenses and | | | | documented and is tax efficient; |
| registrations, including registrations and licenses under | | | | 4. Consider PE implications in India while finalizing the |
| the direct and indirect taxes, import-export regulations, | | | | collaboration structuring; |
| labour laws and trade and municipal regulations. These | | | | 5. Discuss in detail and decide the control and |
| license and registrations can ordinarily be obtain within | | | | management issues of the Indian venture, including |
| three weeks of filing the requisite documents. | | | | shareholding structure, constitution of its board of |
| 4. TAXES AND TAX BENEFITS | | | | directors and committees; |
| 4.1 Tax Structure | | | | 6. Ensure inclusion of provisions concerning control and |
| India has a multi tier tax system comprised of direct | | | | management of the company in its articles of |
| and indirect taxes. The main taxes are income tax, | | | | associate and timeline for issue of securities after |
| sales tax, excise (levied on manufacturing/value | | | | receipt of investment and procedure for dissolution of |
| addition), service tax (levied on provision of specified | | | | the venture; |
| services), customs duty, octroi (on entry of goods in | | | | 7. Timelines in India may, sometime, due to unavoidable |
| certain areas), stamp duty (on execution of specified | | | | circumstances extend beyond the time originally |
| documents) and property taxes. | | | | expected. The business plans should take this factor |
| The income tax applicable to Indian companies is 35% | | | | into account; |
| plus surcharge and cess (proposed to be reduced to | | | | 8. Take steps towards IP registration and protection; |
| 30% plus surcharge and cess by the Union Budget | | | | 9. Verify employment history of the employees; and |
| 2005-06). No minimum corporate income tax is | | | | 10. Adopt alternative dispute resolution mechanisms. |
| payable by Indian companies in absence of profits. | | | | 10. DISCLAIMER |
| Generally all business expenses are deductible from | | | | This Synopsis is not intended to be and should not be |
| taxable income. Indian companies are also required to | | | | construed as legal advise. While adequate care and |
| withhold income tax from various payments and | | | | caution has been exercised by the author in preparing |
| deposit it with the government. | | | | and providing this Synopsis, the business requirements |
| India proposes to introduce a uniform value added tax | | | | of different foreign investors may differ and require in |
| systems with effect from April 1, 2005, in an attempt | | | | depth consideration and resolution of crucial legal |
| to unify certain indirect taxes. | | | | issues. Before taking any concrete business decisions, |
| 4.2 International Taxation | | | | readers are advised to obtain specific legal advise |
| India has entered into double taxation avoidance | | | | from competent counsel in their own judgment. The |
| agreements ("DTAA") with several countries around | | | | author and the firm disclaim all liability to any person or |
| the world. Generally, the provisions of DTAA prevail | | | | entity concerning consequences of anything done or |
| over the domestic tax provisions and offer bilateral | | | | omitted to be done wholly or partly in reliance upon this |
| relief to residents in both jurisdictions in respect of | | | | Synopsis. |
| foreign taxes paid. Foreign investors can consider to | | | | |