Doing business with India - through the legal and regulatory lens
With a headline growth rate of almost 6% in 2012 and a population of 1.3 billion, India as a market to seriously engage with is difficult to ignore.
The economic rationale for doing business in or with India may be sound; however entering into a new emerging market is fraught with challenges. There are many legal and regulatory issues that should be taken into account at an early stage. This article will explore the top-level issues that a foreign investor must consider before taking the business decision to do business with India.
Foreign Investment Framework
India’s Foreign Direct Investment Policy (FDI Policy) provides two routes for foreign investment:
1, The automatic route (no prior Government approval is needed); or
2, The approval route (prior Government approval is needed), which inter-alia depends on the sector in which foreign investment is sought to be brought in.
The FDI Policy also outlines the sectorial limits, which cap the amount of foreign investment in certain sectors such as telecommunications and insurance. Entry into such sectors follows the approval route. Several sectors in India however are free for 100% foreign investment. This removes the need to have a local partner for purely regulatory reasons, but economic and logistical reasons may still remain for such an alliance. In addition, there are exchange control regulations, which regulate the price at which shares in an Indian company can be acquired by a foreign investor.
Business Entity Formation
A number of structures can be adopted for carrying out business in India. These include setting up a:
1, Liaison / representative office;
2, Branch office;
3, Limited Liability Partnership; or a
4, Subsidiary company, being either a public limited company or a private limited company.
The type of office that is appropriate will depend on the nature of the activities being carried out. In most circumstances, prior approval for the office is required from the Reserve Bank of India (RBI). An office has the advantage of being easier to close down, however branch offices are subject to strict exchange control guidelines and have unlimited liability.
Companies provide greater flexibility of operations and also benefit from limited liability. The decision as to the type of company to choose will be based on the on-going compliance requirements (which are slightly more onerous for a public limited company) and the end objectives of the entity. By way of illustration, a private limited company is not permitted to raise additional monetary resources from members of the public. In the event that a foreign investor establishes an entity in India only for the purpose of making downstream investments in the country, any foreign investment in such holding company would require prior approval of the Government.
Often, strong local domain expertise will be needed for a foreign investor to penetrate several market segments, and accordingly a joint venture is often a recommended route for market entry. Although several joint ventures have ended in tears, others have stood the test of time and have become case studies for cultural integration. By way of an example, the Maruti-Suzuki joint venture brought the first rush of Japanese technology for the Indian automobile segment and continues to spearhead the automotive segment in India.
Due Diligence and Entity Selection
Before embarking on a joint venture arrangement, a thorough due diligence exercise on legal, tax and accounting fronts is essential. This allows the parties to identify and understand the issues and risks associated with a joint venture and to be better prepared to exploit the opportunities. Existing Indian companies can bring their own baggage of liabilities and most investors prefer to incorporate a new limited liability company to serve as the joint venture vehicle. The business vehicle used for the joint venture will depend on the benefits and drawbacks of each type of entity, the local laws, and the tax and commercial environment in which they operate.
The taxation environment in India is complex and should be assessed at an early stage, particularly in view of the proposed Direct Taxes Code, due to come into force in April of 2013. Local advice must be sought, and the complexity of the regime and the myriad of taxes are well illustrated by the fact that India ranked 164 out of 183 economies in the paying taxes section of the 2011 World Bank Doing Business Guide.
When entering a new market, it is important to have in mind a suitable exit strategy. This may be particularly relevant with joint venture arrangements in case things were not to go as per expectations. Certain exit options commonly used in the Western world such as put options are of dubious enforceability in India, though most joint venture agreements in India still retain them.
Many more international companies are looking eastward when seeking out new markets for their business. India offers a rich diversity and huge potential that are highly regarded in this part of the world. There are undoubtedly traps for the unwary, but India certainly has a compelling attraction from which a well-advised company can reap its reward.