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