Foreign Direct Investment in India: Evolution & The Legal Regime

1. Foreign Direct Investment in India: Evolution & The Legal Regime Rajiv K. Luthra Managing Partner Luthra and Luthra Law Offices Telephone: 91-11-2335 0633 Fax: 91 11 2372 3909 E-mail: rajiv@luthra.com

2. Evolution of Economic Liberalization Luthra & Luthra Law Offices

3. Phases of Indian Economy1947-1980 • Command and Control Economy • Allocation of resources by the Government (budgetary grants) • Government took active part in setting priorities for the economy • Self-Reliance was the buzz word • Nationalisation of Banks • Limited scope for private participation Luthra & Luthra Law Offices

4. Phases of Indian Economy1991-2000 • Liberalization and Globalization of Indian Economy • Increased emphasis on private sector participation • Limited extent of FDI participation • Gradual improvement in the enabling environment Luthra & Luthra Law Offices

5. Phases of Indian Economypost 2000 • Political Coalitions have started providing stable governments • Government to get out of owning and managing businesses: Disinvestment Policy • Gradual relaxation in the FDI Policy Luthra & Luthra Law Offices

6. Progressive Liberalisation Luthra & Luthra Law Offices

7. Consensus on Economic Liberalisation • Change in perception • Indian Business Houses • Government • Legal Framework: shift from a Positive List to a Negative List (FERA  FEMA) • Gradually all sectors moving to ‘Choice’ and ‘Competition’ (Multiple Player Model) Luthra & Luthra Law Offices

8. Present Picture • India: Fourth largest economy in terms of Purchasing Power Parity • Tenth most industrialized economy • GDP growth rate of 8.1% - Second highest in the world. • Considerable improvement in FDI inflows • FII inflows: • For the period, July 2003 – Jan 2004 FII inflow has exceeded USD 7 bn, which is more than the cumulative FII inflow in the last five years. • Still a big gap between India and China Luthra & Luthra Law Offices

9. Entry Process & Entry Strategies Luthra & Luthra Law Offices

10. The Industrial Policy Industrial Licensing • All Industrial undertakings exempt from obtaining an industrial license to manufacture, except for: • Industries reserved for the Public Sector • Industries retained under compulsory licensing • Items of manufacture reserved for the Small Scale Sector • If the proposal attracts locational restriction • Industrial Entrepreneur Memorandum Luthra & Luthra Law Offices

11. The Industrial Policy • Industries reserved for the Public Sector: (1) Atomic Energy and (2) Railway Transport • Compulsory licensing needed in the following industries: • Distillation and brewing of alcoholic drinks • Cigars and cigarettes and manufactured tobacco substitutes • Electronic aerospace and defence equipment of all types • Industrial explosives including detonating fuses, safety fuses, gun powder, nitrocellulose and matches • Certain hazardous chemicals Luthra & Luthra Law Offices

12. The Industrial Policy Locational Policy • Industrial undertakings are free to select the location • Location to be 25 km away from any city with a million strong population • Exceptions: • When located in an area designated as an “Industrial Area” before the 25th July, 1991. • Electronics, Computer Software and Printing (and any other industry which may be notified in future as ‘non polluting industry’). Luthra & Luthra Law Offices

13. The Industrial Policy Small Scale Industries • Suitable for Foreign Investment? • Cap on Investment in fixed assets (plant and machinery) is Rs. 10 million (approx. SGD 3,70,000) • Not more than 24 per cent of total equity can be held by any industrial undertaking either foreign or domestic • Upon such equity exceeding 24% the SSI status is lost. Carry-on-Business (COB) Licence required. • Various items reserved exclusively for SSIs. Luthra & Luthra Law Offices

14. The Entry Process Investing in India . Automatic Route Prior Permission • General rule • Inform RBI within 30 days of • inflow/issue of shares • Pricing: FEMA Regulations • Unlisted – CCI • Listed – SEBI • Cap of Rs. 600 Crore • (approx SGD 222 million) By exception Approval of Foreign Investment Promotion Board needed. Decision generally within 4-6 weeks Luthra & Luthra Law Offices

15. The Entry Process: Automatic Route • All items/activities for FDI investment up to 100% fall under the Automatic Route except the following: • All proposals that require an Industrial Licence. • All proposals in which the foreign collaborator has a previous venture/ tie up in India. • All proposals relating to acquisition of existing shares in an existing Indian Company by a foreign investor. • All proposals falling outside notified sectoral policy/ caps or under sectors in which FDI is not permitted. Luthra & Luthra Law Offices

16. The Entry Process: Government Approval FIPB Approval • For all activities, which are not covered under the Automatic Route • Composite approvals involving foreign investment/ foreign technical collaboration • Published Transparent Guidelines vs. Earlier Case by Case Approach • Downstream Investment Luthra & Luthra Law Offices

17. Subsequent Investment in the same or allied field Press Note 18 • No Automatic Route for FDI and/or technology collaboration for those who have or hadany previous joint venture/technology transfer/ trade mark agreement in the same or allied field. • Same field : Four digit NIC 1987 Code • Allied field : Three digit NIC 1987 Code. • IT Sector & International Financial Institutions exempted. • New Trend: FIPB examines objections by the earlier partner objectively. Luthra & Luthra Law Offices

18. Acquisition of shares in a Listed Company Takeover Code • Acquisition of more than specified equity stakes would entail public offer • Pricing: Average of 26 weeks or 2 weeks, whichever is higher • No takeover of management before completion of Takeover Code formalities Luthra & Luthra Law Offices

19. Other modes of Foreign Direct Investment GDR, ADR, FCCB • Indian Companies allowed to raise equity capital in the international market through the issue of GDRs/ ADRs/FCCBs. • No ceiling on investment Luthra & Luthra Law Offices

20. Other modes of Foreign Direct Investment GDR, ADR, FCCB (Contd.) • No end-use restrictions on GDR/ ADR/ FCCB issue proceeds • Except • Investment in real estate • Stock markets. • Government clearance required when sectoral cap is exceeded, or for a project not falling under Automatic Route. • 25% of the FCCB proceeds can be used for general corporate restructuring. Luthra & Luthra Law Offices

21. Foreign Technology Collaboration • Foreign technology collaborations are permitted either through the automatic route or by the Government. Policy for Automatic Approval • To all industries for foreign technology collaboration agreements, irrespective of the extent of foreign equity in the shareholding, subject to: • The lump sum payments not exceeding US $ 2 Million; Luthra & Luthra Law Offices

22. Foreign Technology Collaboration Policy for Automatic approval(contd.) • Royalty payable being limited to 5 per cent for domestic sales and 8 per cent for exports, subject to a total payment of 8 per cent on sales • No restriction on the duration of the royalty payments • The aforesaid royalty limits are net of taxes and are calculated according to standard conditions. Luthra & Luthra Law Offices

23. Foreign Technology Collaboration Policy for Automatic approval(contd.) • Payment of royalty up to 2% for exports and 1% for domestic sales is allowed under automatic route on use of trademarks and brand name of the foreign collaborator without technology transfer. • Registration of FC Agreement with RBI. Luthra & Luthra Law Offices

24. The Entry Strategy • Forms in which Business can be conducted in India • Wholly owned subsidiary • Joint Venture Company • Branch Office • Project Office • India Presence: Liaison Office Luthra & Luthra Law Offices

25. The Entry Strategy: Joint Venture Company • Advantages • Limited liability • Market Penetration • Local Partner’s Expertise and Experience • Vital Considerations • Choice of Joint Venture Partner • Due Diligence Luthra & Luthra Law Offices

26. The Entry Strategy: Joint Venture Company • Vital Considerations(Contd.) • Clearly defined agreement • Terms of the Shareholders’ Agreement should be reflected in the Articles of the Company. • Share Transfer Restriction in a Public Limited Company • Disproportionate voting Rights: Veto • Non-compete Luthra & Luthra Law Offices

27. The Entry Strategy: Joint Venture Company • Vital Considerations(Contd.) • Agreement for future issue of share capital • Dispute Resolution • Non-disclosure of confidential information post termination Luthra & Luthra Law Offices

28. The Entry Strategy: Branch Office • Purpose/Viability of a Branch Office • Represent the business interest of foreign company • For the purpose of execution of the Project • Project Office is in the nature of a Branch Office set up for a particular project. Luthra & Luthra Law Offices

29. The Entry Strategy: Branch Office • Permissible activities for a Branch Office • Export/Import of goods • Professional or Consultancy Services • Carrying out research work in which the parent company is engaged • Promoting technical or financial collaborations between Indian Companies and parent or overseas group companies Luthra & Luthra Law Offices

30. The Entry Strategy: Branch Office • Permissible activities(Contd.) • Representing the parent company in India and acting as Buying and Selling Agent • Rendering Technical Support to the products supplied by parent/group companies. • Foreign Airlines/ Shipping Companies • Issue: Project/ Branch Office – Permanent Establishment Luthra & Luthra Law Offices

31. The Entry Strategy: Liaison Office • Liaison office for • Promotion of business interest; spreading awareness of company’s products; explore opportunities; work as channel of communication etc. • Cannot carry on any commercial, trading or industrial activity or earn any income in India • Is required to maintain itself out of inward remittances received from abroad through normal banking channels. Luthra & Luthra Law Offices

32. The Entry Strategy • Branch Office/Liaison Office can be set up only with prior RBI approval • Profit of the Branch or Surplus of the project after completion can be remitted, after payment of all applicable taxes in India Luthra & Luthra Law Offices

33. Exit Issues • Transfer of shares from non-resident to non-resident does not require RBI approval for pricing • Transfer of shares from non-resident to resident does not require any FIPB Approval, though RBI approval is required for pricing • Pricing as per FEMA – listed and unlisted securities • RBI permission not required if sale through Stock Exchange • Mauritius Route: Capital Gain Advantage Luthra & Luthra Law Offices

34. Legal Structures facilitating FDI Luthra & Luthra Law Offices

35. Facilitating FDI in India Emergence of Independent Regulators: Electricity, Telecom, Insurance, Capital Market and Competition Law • Ensuring level playing field vis-à-vis Government Corporations and inter se private players • Expertise in the subject matter involved • Expeditious resolution of dispute Luthra & Luthra Law Offices

36. Facilitating FDI in India Emergence of Independent Regulators (Contd.) • Regulators under consideration: Petroleum, Railways, Information and Broadcasting • Regulator to curb Anti-Competitive Practices • Government Directives Luthra & Luthra Law Offices

37. Facilitating FDI in India Labour laws – a more contractual approach. • Move towards: hire and fire • Progressive use of discretionary executive powers • Permissions granted for closure of unviable units • Inspections only upon workers’ grievances • Voluntary Retirement Schemes • EPZs, SEZs etc may be exempted from application of certain labour laws • Amendment to Industrial Disputes Act under consideration • Amendment to Contract Labour (Regulation & Abolition) Act, 1970 under consideration. Luthra & Luthra Law Offices

38. Investment Incentives Luthra & Luthra Law Offices

39. Incentives for investment in Telecom Sector • Movement towards technology neutral Unified Licensing Regime • Permission for Inter-Circle & Intra-Circle Mergers • Exemplary growth in teledensity, subscriber base etc. • Companies commencing operations before 31st March, 2004, would enjoy tax benefits: • 100% deduction for first five years • 30% deduction for next five years • Exemption from tax on interest income and long term capital gains in certain cases • Import duty rates have been reduced for various telecom equipment Luthra & Luthra Law Offices

40. Investment Incentive for IT Industry • Software companies have a ten year tax holiday on their export income • In 1998 the Government set up a new Ministry of Information Technology • The Information Technology Act, 2000 was passed to tackle cyber crimes and facilitate e-commerce Luthra & Luthra Law Offices

41. Incentives for Investment in Power Sector • New Legal Regime: Electricity Act, 2003 • The Act provides for: Multiple Buyer Model, Independent Regulatory Body, Open Access, Power Trading as an independent business, delicensing of generation • 100% FDI Automatic Route in: • Hydro-electric power plants; • Coal/lignite based thermal power plants; • Oil/gas based thermal power plants. Luthra & Luthra Law Offices

42. Incentives for Investment in Power Sector • Other investment incentives: • New Power Projects eligible for 100% tax holiday in any block of ten years, within first fifteen years of operation. • The Deadline for income tax exemption for new power projects extended from 2006 to 2012. • Various indirect tax incentives: • Concessional rate of import duties • Special project import scheme • Deemed export benefit for certain categories of power projects. Luthra & Luthra Law Offices

43. Reforms in Financial Sector • FIIs allowed in Capital Market, can invest both in Debt and Equity • FDI cap in private sector banks raised to 74% • 10% cap on voting rights • The Mutual Fund market is also open now to foreign players. • Equity issue pricing is market determined Luthra & Luthra Law Offices

44. FDI in Real Estate: Policy & Issues • Press Note 4 (2002 Series) • 100% FDI under Automatic Route PERMITTED FOR Integrated Townships, subject to following conditions: • Foreign company to be registered as Indian company under Companies Act, 1956 • Core Business - Integrated Township Development with a successful track record. • Minimum area of development: 100 acres as per local bylaws/rules. In absence of such by laws/rules, minimum of 2000 dwelling houses for about 10,000 population to be developed by the investor. • Conditions post acceptance of FDI proposal • Minimum capitalization norms • Upfront payment • Minimum lock-in period • Time bound completion of project Luthra & Luthra Law Offices

45. FDI in Hotel and Tourism:Policy and Issues • 100% FDI under Automatic Route • “Hotel” includes Restaurant, beach resorts and other tourist complexes providing accommodation and/or Catering • “Tourism related industries” includes travel agencies, tour operating agencies, units providing facilities for cultural, adventure and wild life experience to tourists; surface, air and water transport facilities to tourists; leisure, entertainment, amusement, sports and health units for tourists and Convention/ Seminar units and organizations. • Automatic approval for Technical, Consultancy, Marketing, Publicity, Managerial services subject to specified limits. Luthra & Luthra Law Offices

46. Conclusion • Economics occupies centre stage in 2004 elections • Rising expectations; rising prosperity • Legal regime: more stable and predictable • Bureaucracy: changing with the times • The Future beckons Luthra & Luthra Law Offices

47. Thank You Luthra & Luthra Law Offices