An Overview of business structures for foreign investments under Indian regulations
Darkness is frightening in childhood, however, as we grow up, the fear of darkness is left far behind, because we are able to embrace it better. Knowledge empowers us, while uncertainty invokes fearfulness. If you are travelling to a foreign land, it’s an adventurous trip. However, if your money is travelling to a foreign land, it’s called a risky detour. Adventure in life translates to risk in business. New markets bring uncertainty to your business future, especially if the market is dynamically diverse from your homeland. One such economy which can give Goosebumps to any business around the world is India. Many successful businesses have succumbed here and one of the common learning from all those business failures is the strategic choice of business structure.
A discordant business structure can complicate your already complicating business entry into India, while a wise choice can save you from snags and efforts, both often translating to savings in monetary terms, and at times, help you even salvage your business investment, if the business goes wrong. So, if you are planning to step your foot into Indian markets, with your foreign investment, here’s a guide to various business structures available as per regulations in India.[a]
Howdy, Foreign Investments!
When your foreign money first tries to enter India, it is greeted by the Reserve Bank of India (RBI) and regulated by the Foreign Exchange Management Act, 1999 (FEMA). So, be prepared to work in sync with the two. A foreign entity can set up its primary business operations in India adopting the following different strategies, based on the business structure, arrangement and type of activities to be performed. As per the regulations in India, the regulatory structures include Liaison Offices (LO), Branch Offices (BO), Project Offices (PO) and Wholly Owned Subsidiaries (WOS).
Liaison Offices (LO)
If you are planning to conduct activities which merely represent or promote your foreign counterpart, or establish a communication channel with the same, a liaison office would be your best strategy. A liaison office is the most favoured way of stepping first foot in the Indian economy. The reason being the advantage of not being taxed in India, if it complies with the regulations established around a liaison office.
Application for establishing a liaison office has to be submitted to RBI for approval. License is granted to a liaison office typically for a period of 3 years, and thereafter, the same can be renewed for a subsequent period of 3 years.
A liaison office cannot commence any commercial, trading or industrial activities, directly or indirectly. It has to coordinate its activities only out of the funds received from the foreign counterpart, through usual banking channels.
As per FEMA Act, a liaison office can engage in the following activities:
- Representing in India the parent company/group companies.
- Promoting export / import from / to India.
- Promoting technical/financial collaborations between parent/group companies and companies in India.
- Acting as a communication channel between the parent company and Indian companies.
Amongst the other conditions to establish a liaison office, the foreign company should have a net worth of USD 50,000 and a three-year track record of making profits in the home country where it belongs.
Insurance and banking companies can establish a liaison office only after obtaining permission from regulatory authorities Insurance Regulatory and Development Authority of India (IRDAI) and Department of Banking Regulation (DBR, RBI) respectively.
Supreme court of India in an interim order passed in the case Bar Council of India vs A K Balaji and others directed RBI to prohibit any new foreign law firm from establishing a Liaison Office in India. Thereby, until further directives are issued, apart from existing foreign law firms in India who already have a liaison office in India, the firms cannot establish a liaison office in India.
Branch Offices (BO)
If you are planning to sell your products manufactured by your company or render services in India, a branch office is a suitable option. Companies incorporated outside India, if engaged in manufacturing or trading activities, can establish a branch office in India to promote or sell products, represent parent company, render services or carry research work.
Similar to Liaison Office, application for establishing a branch office has to be submitted to RBI for approval. License is granted for a period of 3 years, and thereafter, the same can be renewed for a subsequent period of 3 years. To establish a branch office, the foreign company should have a net worth of USD 100,000 and a five-year track record of making profits in the home country where it belongs.
The branch office has to be involved in the same business activities as its parent company. The branch office cannot conduct any retail activities in India. Further, the branch office also cannot conduct manufacturing or processing activities on its own, in India.
As per FEMA Act, a branch office can engage in the following activities:
- Export/import of goods.
- Rendering professional or consultancy services.
- Carrying out research work, in areas in which the parent company is engaged.
- Promoting technical or financial collaborations between Indian companies and the parent or overseas group company.
- Representing the parent company in India and acting as buying/selling agent in India.
- Rendering services in information technology and development of software in India.
- Rendering technical support to the products supplied by parent/group companies.
- Foreign airline/shipping company.
However, there’s one major exception to the above rules. A branch office, if it is located in Special Economic Zone, can conduct manufacturing or processing activities in India, without RBI approval, if all conditions are met satisfactorily.
These conditions include:
- such units are functioning in those sectors where 100 per cent Foreign Direct Investment is permitted;
- such units comply with part XI of the Companies Act,1956 (Section 592 to 602);
- such units function on a stand-alone basis.
Unlike the liaison office, a branch office is liable to pay taxes in India, on the profits earned in India. They are treated as a Foreign Company for tax purposes. After paying applicable taxes, the branch office is free to remit the amount to its foreign counterpart.
Project Offices (PO)
If you are planning to conduct business in India for a specific project limited by time or an objective, a Project office is a suitable option for the purpose. Project offices are essentially a branch office, and therefore, all conditions and features apply as is, except that it is set up for executing a specific project to be completed within a specific time. The primary requirement for establishing a project office is securing a contract from an Indian Company to execute a project in India.
A project office must generally comply with the following requirements:
- is funded directly by inward remittance from abroad; or
- is funded by a bilateral or multilateral International Financing Agency; or
- the project has been cleared by an appropriate authority; or
- a company or entity in India awarding the contract has been granted term loan by a public financial institution or a bank in India for the project.
If you are unable to comply with the conditions above, specific approval from RBI would be required.
Wholly Owned Subsidiary (WOS)
Wholly owned subsidiaries are the most widely used form of business structure for foreign investments in India. The reason being, total control over the business operations, limited liability and fewer restrictions when compared to a liaison office or branch office. Further, they have independent legal status in India distinct from its foreign counterpart.
Following are some of the features and requirements with respect to a wholly-owned subsidiary:
- Requires a minimum of two directors and a minimum of two shareholders (maximum fifty shareholders)
- Minimum paid-up capital is INR 100,000 (converts to USD 1,500)
- Treated an Indian company and liable to comply with all applicable laws and regulations in India, like any other company.
As per FEMA, foreign investments are classified into three categories to regulate the same.
- Automatic Route: The FEMA act specifies certain activities/sectors where foreign investment is allowed without any prior approval from the Government of India or the Reserve Bank of India. This is called the Automatic Route. The details of these sectors are available here[b].
- Government Route: For any activity/sector not covered by the automatic route, the business entity has to obtain prior approval from Government of India which is called as Government Route. The details of these sectors are available here[c].
- Prohibited Sectors: There are certain sectors where foreign investment is prohibited or is subject to certain conditions and the same can be read here[d].
Limited Liability Partnerships (LLP)
The concept of LLP is modern for the Indian economy and has been popular since its introduction in 2008. Reason being the benefit of limited liability at a relatively low cost and minimal compliances. Foreign investment through LLP is permitted in India since 2015 when the Government opened up this option to foreign investors, subject to fulfilment of conditions specified under FEMA law.
Foreign Investment through LLPs is permitted in the following two ways:
- LLPs in sectors where 100% FDI is allowed through automatic route
- LLPs investing in companies or another LLPs which operate in sectors where 100% FDI is allowed under the automatic route.
So, in brief, the sector in which LLP operates must be one of those where 100% FDI is permitted through the automatic route, under the Foreign Direct Investment Policy in India.
The investments in LLPs can be only through cash considerations i.e. inward remittances in foreign denominations through banking channels, or debit to Non-Resident Rupee (NRE) or Foreign Currency Non-repatriable (FCNR) accounts. Non-cash or intangible investments are not generally permitted and would require specific approval.
Further, Foreign Institutional Investors (FIIs) and Foreign Venture Capital Investors (FVCIs) are also prohibited from investing in India through LLPs.
Other conditions
There are some other common conditions:
- A person who is a citizen of, or is incorporated in Pakistan, Bangladesh, Sri Lanka, Afghanistan, Iran, China, Hong Kong or Macau can establish a Liaison/Branch/Project Office in India only after specific approval from Reserve Bank of India. Entities from Nepal are allowed to establish only Liaison Offices in India.
- Branch/Project Offices of a foreign entity are permitted to acquire immovable property, if they are used for their own purposes to carry out the permitted activities or activities incidental to the same. However, entities from Pakistan, Bangladesh, Sri Lanka, Afghanistan, Iran, Hong Kong, Macau, Nepal, Bhutan or China shall require prior approval from Reserve Bank of India.
- Liaison/Branch/Project Offices can carry out permitted/incidental activities from a leased property in India without any specific approval. However, the lease period cannot exceed five years.
- Liaison/Branch/Project Offices can open current accounts in India denominated in INR, however, the same must be non-interest bearing.
- The branch office before remitting profits has to submit a certified copy of the audited balance sheet and profit & loss statement for the relevant year. Further, they must also submit a certificate from Chartered Accountant certifying the manner of calculating the profit being remitted, that the activities carried out were permitted activities, and the profit is not on account of revaluation of assets.
Look before you leap!
Foreign investments are already riskier and the number of regulations around them makes them more complicated. Non-compliance can evoke harsh penalties and revocation of licenses, leading to major business disruptions. Therefore, it is always advisable to pursue independent professional advice at the business planning stage itself, to evaluate the compliances and understand the path ahead.