In India, the regulatory environment for foreign investment
has undergone a sea change in the last decade. Until 1990, the
foreign investment regime was rather restricted. Indian
companies today are increasingly entering into joint ventures
involving equity participation by the foreign partner and/or
the transfer of technology. The government has permitted equity
participation in almost all areas (see below). On May 21 2001,
the government allowed foreign participation in certain closed
sectors like defence production, civil aviation and real
The Foreign Exchange Management Regulations 2000 (Security
Regulations) prescribes the rules on foreign investments in
India. An Indian company not engaged in the manufacture of
items listed in Annexure A is permitted to issue shares to
non-residents to the extent specified in Annexure B. Annexure B
imposes certain sectoral caps on non-resident investments. For
example, in the field of telecommunication services, a maximum
of 74% FDI is allowed. In the drugs and pharmaceuticals sector,
100% FDI is permitted as long as the activity does not need a
compulsory licence or involve the use of recombinant DNA
technology etc. (Annexures A and B appear at the end of this
paper.) Investments in most areas are permitted on an
'automatic route'. This entails making an application to the
Reserve Bank of India on a certain format.
Investments in the following areas, however, cannot be made
on the automatic route and special permission from the Foreign
Investment Promotion Board (FIPB) of the Government of India is
- Industries which are reserved for the public sector, ie
arms and ammunition and allied items of defence equipment
(the government has recently allowed private participation in
defence production subject to industrial licence and
prescribed a minimum investment norm of Rs 1,000 million.
Foreign investment is also permitted with an investment cap
of 26% subject to FIPB approval), atomic energy and railway
transport (the government has recently allowed 100% FDI in
Mass Rapid Transport System (MRTS) in metro cities through
the automatic route)
Industries where industrial licensing is compulsory:
- distillation and brewing of alcoholic drinks;
- cigars and cigarettes of tobacco and manufactured
- electronic aerospace and defence equipment, all
- industrial explosives including detonating fuses,
safety fuses, gunpowder, nitro cellulose and
- hazardous chemicals; and
- drugs and pharmaceuticals (the government has
recently allowed 100% FDI and also put it under the
automatic route, except those drugs which fall under the
licence category, eg. drugs under DNA technology).
- Proposals where the foreign collaborator has a previous
venture/tie up in the country (through investment or
technical collaboration or trade mark agreement) in the same
or allied field.
- Proposals relating to the acquisition of shares in an
existing Indian company in favour of a foreign/non-resident
Indian (NRI)/overseas corporate body (OCB).
- Proposals falling outside notified sectoral policy/caps
or under sectors in which FDI is normally not permitted.
Locational policy for setting up industries
Polluting industries cannot be set up in urban areas. For
cities with a population of more than one million, industry
should be at least 25 kilometres away. However, certain
designated industrial areas are still located within the 25
kilometres zone. Non-polluting industries such as electronic
and computer software may be set up anywhere subject to
municipal or zoning byelaws.
Procedure where industrial licensing is not required
An Industrial Entrepreneurs Memorandum (IEM) in the
prescribed form is to be filed with SIA in such cases. The
prescribed form is divided into Part A, which is required to be
filed at the time of setting up the unit. Part B is required
only after the start of commercial production. No further
approvals are necessary.
Regulatory approvals for foreign collaboration
The agreements may be made through either of the following
Automatic approval route – when an investment falls
within the parameters given below, an application in a certain
format can be made to the RBI who would normally grant the
approval within a month and sometimes earlier:
- it should not relate to a product specified in the
negative list (see Annexure A);
- it should be within the sectoral caps (see Annexure B);
- it should not exceed the following limits on
Not exceeding $2 million
Not exceeding 5% on domestic sales and 8% on exports
for seven years from the date of commencement of
commercial production, or 10 years from the date of
agreement, whichever is earlier.
|Technology transfers in
respect of hotel and tourism related industries
The limits of payment are as under:
technical and consultancy services including fees
for architects, designers etc, up to 3% of the capital
cost of the project (less the cost of land and
franchising and marketing/publicity support fee up
to 3% of the net turnover (net turnover is gross
receipt less credit card charges, travel agents'
commission, sales tax);
management fees (including incentive fees) up to 10%
of gross operating profits.
These norms are applicable provided the
collaboration is proposed with companies
running/managing hotel(s) with at least 500 rooms.
Agreements envisaging foreign investment besides the
transfer of technology are also covered under the
automatic approval procedure of RBI.
Government approval route – outside the above
parameters, an application must be made to the FIPB which
normally gives its decision within six weeks. There is no form
for this and an application must give full particulars of the
project, partners, technology, foreign exchange inflow and
outflow, and proposed location.
Certain schemes have been devised to attract foreign
investments by offering tax and other concessions and
facilities. Four of these are:
- software technology park scheme;
- 100% export-oriented unit scheme;
- special economic zones; and
- electronic hardware technology park scheme.
Each of the above are briefly dealt with below.
Software technology park (STP) scheme
This scheme is managed by an autonomous organization
– Software Technology Park of India (STPI) –
set up by the Government of India under the Ministry of
Information and Technology. It has the objective of the
development and promotion of the undertakings engaged in the
export of computer software. The highlights of the policy
framed by the government in this regard are as follows:
- approvals are given under a single window clearance
- a STP may be set up anywhere in India;
- the jurisdictional director of the STPI is authorized to
clear projects costing less than Rs100 million
- 100% FDI is permitted;
- capital goods purchased from the domestic tariff area
(DTA) are entitled to benefits such as no excise duty and
reimbursement of central sales tax; and
- STP units are exempted from income tax for 10 consecutive
years beginning with the year in which the unit begins to
manufacture or produce articles or things or computer
software. Effective April 1 2002, the tax holiday in respect
of sales made by the STPs in the DTA is no longer
100% export-oriented unit (EOU) scheme
A 100% EOU is obliged to export all the items it produces
except for permitted levels of rejects and domestic sales in
the DTA, which must not exceed 5% and 25% respectively in most
cases. The scheme was introduced to provide duty-free enclaves,
which would enable entrepreneurs to concentrate on production
exclusively for exports.
For automatic approval, the proposals must meet the
- The payment for foreign technology, if any, should not
exceed a lump sum of $2 million or 8% royalty (net of taxes)
on exports and 5% on DTA sales (net of taxes) over a period
of five years from the date of commercial production.
- The application for setting up the units should be
submitted to the development commissioner of the export
processing zones (EPZ) concerned. Approval is granted within
15 days if the proposal meets the criteria for automatic
- If the proposal envisages foreign investment, the
applicants are required to seek separate approval from RBI
and/or SIA, as the case may be.
The government has delegated wide powers to the development
commissioner for making post-approval amendments. These powers,
among other things, include the following:
- enhancement in the value of imported capital goods
required for project;
- additional location for the project;
- revision in export obligation; and
- disposal of obsolete capital goods, import of office
For units approved as EOUs, there is a tax holiday for ten
years. Effective April 1 2002, a tax holiday in respect of
sales made by the EOUs in the DTA is no longer available.
Special economic zones (SEZ)
SEZs are permitted to be set up in the public, private or
joint sector, or can be set up by state governments. The
purpose of SEZs is to augment infrastructure facilities for
export production. The highlights of the policy are:
- no licence is required for imports;
- exemption from customs duty on imports of capital goods,
raw materials, consumables etc;
- exemption from central excise duty on procurement of
capital goods, raw materials, etc from the domestic
- supplies from DTA to SEZs will be treated as deemed
- reimbursement of central excise duty in inter-state
- no restriction on FDI investment;
- fast-track clearance of imports and exports; and
- tax holiday for 10 years. Effective April 1 2002, the tax
holiday in respect of sales made by the SEZs in the DTA is no
Electronic hardware technology park (EHTP) scheme
This scheme has as its objective the development and
promotion of 100% export-oriented undertakings engaged in the
manufacture of electronic hardware equipments/components and
other items. The highlights of the policy in this regard are as
- zero customs duty on all imports made for use in the
- zero central excise duty on all indigenous purchases for
use in the manufacturing process;
- reimbursement of central sales tax on the above
indigenous purchases is permissible;
- cases involving FDI will be cleared by FIPB; and
- EHTP units are exempted from payment of income tax for 10
consecutive years beginning with the year in which the unit
begins to manufacture or produce articles or things or
computer software. Effective April 1 2002, the tax holiday in
respect of sales made by the EHTPs in the DTA is no longer
Form of joint venture agreement
A collaboration agreement is essentially a commercial
contract between an Indian and a foreign party. All incidents
of a valid contract under the Indian Contract Act 1872 would
attach to this. A foreign collaborator would want to carefully
study the Indian markets, select the partner, if any, weigh the
partner's strength and be mindful of the regulatory environment
in India and endeavour to address almost all the partnership
issues in a joint venture agreement and/or Articles of the
joint venture company where the company is intended to be
bound. These issues will usually include:
- definition and interpretation;
- conditions precedent;
- further issue of shares;
- board of directors;
- matter reserved for affirmative vote and special voting
- technical support from X Co to Y Co;
- representation and covenants of the parties;
- performance of the company;
- transfer of shares;
- term and termination;
- effect of termination;
- books, accounts and information;
- cooperation and consents;
- mutual covenants;
- indemnification; and
- governing law/dispute Resolution/arbitration.
Where the joint venture is on an equal partnership basis,
invariably a lot of time may be spent on resolving the issues
of control and in agreeing on the deadlock provisions. There
are no easy solutions and the attempts are essentially a
combination of the bargaining power of the two parties.
Taxation of incomes of foreign collaborator
A foreign collaborator will earn income from the joint
venture under various headings, most of which would come in for
taxation. These are briefly described below:
Royalty means (explanation 2 to section 9(1)(vi) of the
Income Tax Act 1961 (the Act)), among other things, the
consideration for the right to use any copyright, patent or
trade mark, design, model formula, process etc relating to any
scientific or technical or industrial process.
Where the total income (section 115A of the Act) of a
foreign company includes any income by way of royalty from an
Indian concern in pursuance of an agreement made by a foreign
company with an Indian concern after March 31 1976 and the
agreement is approved by the central government, or where it
relates to a matter included in the Industrial Policy for the
time being in force, of the Government of India and the
agreement is in accordance with that policy, then, subject to
the provisions of sub-section (1A) and (2), the income tax
payable shall be the amount of income tax calculated on the
income by way of royalty, if any, included in the total income,
@ 30%, if such royalty is received in pursuance of an agreement
made on or before May 31 1997 and @ 20% where such royalty is
received in pursuance of an agreement made after May 31
India has entered into double taxation avoidance treaties
with various countries. Most of these treaties set the
effective rate of taxation of royalty income to 10% or 15%, as
the case may be.
Fees for technical services
Fees for technical services means (explanation 2 to section
9(1)(vii) of the Act), among other things, payment of any
amount in consideration for the service of a managerial,
technical or consultancy nature.
Where the total income (section 115A of the Act) of a
foreign company includes any income by way of fees for
technical services from an Indian concern in pursuance of an
agreement made by a foreign company with an Indian concern
after March 31 1976 and the agreement is approved by the
Central Government, or where it relates to a matter included in
the Industrial Policy for the time being in force, of the
Government of India and the agreement is in accordance with
that policy, then, subject to the provisions of sub-section
(1A) and (2), the income tax payable shall be the amount of
income tax calculated on the income by way of fees for
technical services, if any, included in the total income, @
30%, if such fees for technical services are received in
pursuance of an agreement made on or before May 31 1997 and @
20% where such fees for technical services are received in
pursuance of an agreement made after May 31 1997. India has
entered into double taxation avoidance treaties with various
countries. Most of these treaties set the effective rate of
taxation of fees for technical services to 10% or 15%, as the
case may be.
Dividend income earned by a foreign company
Dividend is not taxable (section 10(33) of the Act) in the
hands of the shareholder if the dividend paying company is an
Indian domestic company.
The term "domestic company" has been defined (section 2(22A)
of the Act) as an Indian company, or any other company, which,
in respect of its income liable to tax under this Act, has made
the prescribed arrangements for declaration and payment, within
India, of the dividends (including dividends on preference
shares) payable out of such income.
Notwithstanding anything contained in any other provision of
the Act, a domestic company shall pay tax @ 10% on dividend
distributed by it to its shareholders plus a surcharge @ 2% on
such tax (section 115-O of the Act).
A company paying dividends to a non-resident shareholder is
not required to deduct tax at source (section 195(1) of the
Act) while making payment of dividend to such shareholder, if
the dividend is paid in accordance with the provisions of
If a non-resident shareholder gets income by way of dividend
(other than those referred to in section 115O), then such
dividend shall be included in the aggregate income of the
non-resident and shall be taxed @ 20% (section 115A of the
List of activities or items for which automatic route of
Reserve Bank for investment from Persons Resident outside India
is not available
- NBFC's activities in Financial Services Sector
- Civil Aviation1
- Petroleum including exploration/refinery/marketing
- Housing & Real Estate Development sector for
investment from persons other than NRIs/OCBs.
- Venture Capital Fund & Venture Capital Company
- Investing companies in Infrastructure & Service
- Atomic Energy & Related projects
- Defence and Strategic Industries2
- Agriculture (Including plantation)
- Print Media
- Postal Services
Sectoral cap on Investments by Persons Resident Outside
CapDescription of Activity/Items/Conditions
- In basic, Cellular Mobile, paging and Value Added
Services, and Global Mobile Personal Communications
by Satellite subject to the licence from Department
of Telecommunication of Government of India.
- In manufacturing activities.
|2.Housing and Real
Only NRIs/OCBs are allowed to invest in the areas
- Development of serviced plots and construction of
- Investment in real estate covering construction
of residential and commercial premises including
business centres and offices.
- Development of townships.
- City and regional level urban infrastructure
facilities, including both roads and bridges.
- Investment in manufacture of building
- Investment in participatory ventures in (a) to
- Investment in Housing finance institutions.
3.Coal and Lignite
- in Public Sector Undertakings (PSUs) and
- in other than PSUs
- Where private Indian companies are setting up or
operating power projects as well as coal or lignite
mines for captive consumption;
- For setting up coal processing plants provided
the company shall not do coal mining and shall not
sell washed coal or sized coal from its coal
processing plants in the open market and shall supply
the washed or sized coal to those parties who are
supplying raw coal to coal processing plants for
washing or sizing.
- For exploration or mining of coal or lignite for
- For bulk drugs, their intermediaries and
formulations (except those produced by the use of
recombinant DNA technology).
- In manufacturing activities.
- Hotels include restaurants, beach resorts, and
other tourist complexes providing accommodation
and/or catering and food facilities to tourists.
- Tourism related industry includes travel
agencies, tour operating agencies and tourist
transport 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
100% Exploration and mining of diamonds and precious
Exploration and mining of gold and silver and
minerals other than diamonds and precious stones,
metallurgy and processing.
Film industry (i.e., film financing, production,
distribution, exhibition, marketing and associated
activities relating to film industry) subject to the
- Companies with an established track record in
films, TV, Music, finance and insurance.
- The company should have a minimum paid up capital
of US $ 10 million if it is the single largest equity
shareholder and at least US $ 5 million in other
Minimum level of foreign equity investment would be
US $ 2.5 million for the single largest equity
shareholder and US $ 1 million in other cases.Debt
equity ratio of not more than 1:1 i.e., domestic
borrowings shall not exceed equity.
Provisions of dividend balancing would apply.
|9. Any other
sector/activity (other than those included in Annexure
- In the civil aviation sector, 100% FDI is now permitted
in Airports, with FDI above 74% requiring prior Government
- FDI in Defence production is now allowed upto 26% subject
to a license being obtained from the Government.
FDI upto 74% is now permitted for the following telecom
services subject to licensing and security requirements:
- Internet service provider with gateways.
- Radio paging.
- End to end bandwidth.
- FDI is now permitted upto 100% on the automatic route for
manufacture of drugs and pharmaceuticals provided the
activity does not attract compulsory licensing or involve use
of recombinant DNA technology and specific cell/tissue
- FDI is now permitted upto 100%.
- In the insurance sector, automatic approval upto 26% FDI
is now available for life insurance, general insurance and
reinsurance subject to grant of license by the Insurance
Regulatory and development Authority.
Rajinder Narain & Co
F14 Connaught Place
New Delhi-110 001
Tel: 91 11 331 3232
Fax: 91 11 332 8319
New Delhi-110 037
Tel: 91 11 331 3232
Fax: 91 11 332 8319