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