Opportunities for foreign investment – telecommunications, computers and IT

Author: | Published: 12 Jul 2001
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Introduction

An attractive investment policy and incentives for foreign investment in the telecommunications and software sectors have made India an investment destination for major telecom operators, equipment manufacturers, suppliers and service providers. With the implementation of the Information Technology Act 2000, the privatization of the National Long Distance (NLD) service, the reconstitution of the Telecom Regulatory Authority of India, the phasing out of VSNL's monopoly, etc, India's telecommunications and information technology (IT) sectors are undergoing rapid changes, to propel India to the centre-stage of global telecom and IT markets.

Telecommunications

Liberalization has been the key political objective of the Government of India (GoI) that has underpinned the change in the Indian telecommunications industry over the past decade. Encouraged by the rapid pace of global technological development, the GoI has gradually opened up the telecommunications sector for private participation and foreign investment. Traditional protectionist policies were dismantled in 1992, ushering in a process of deregulation and reregulation which has extended to almost every area, including value-added services and the telecommunications hardware sector such as the manufacture of switching and transmission equipment, etc. The GoI also announced a New Telecom Policy 1999 (NTP) aimed at creating an ideal investment environment.

Foreign investment

Highlights of the foreign investment norms in the telecommunications sector are as follows:

  • Foreign Direct Investment (FDI) for Internet Service Providers (ISPs) (not providing gateways, either for satellite and submarine cables), infrastructure providers providing dark fibre (IP Category I), e-mail and voice mail, is permitted up to 100%, subject to licensing and security requirements, and requirements that the project company should divest 26% of its equity in favour of the Indian public within five years, if listed in other parts of the world.
    Proposals for FDI up to 49% for such activities are permitted through the automatic route of the Reserve Bank of India (RBI), that is, without any need for prior approval. Proposals beyond 49% are considered, on a case-by-case basis, by the Foreign Investment Promotion Board/Secretariat for Industrial Assistance (FIPB/SIA), which is the nodal authority for approval of proposals for foreign investment in India;
  • FDI up to 74% is permitted by the FIPB/SIA for ISPs with gateways, radio paging and end-to-end bandwidth, subject to licensing and security requirements. Proposals for FDI up to 49% in this area is permitted through the automatic route of the RBI;
  • FDI up to 49% is permitted by the FIPB/SIA in the case of basic, cellular mobile, paging, value-added services and Global Mobile Personal Communication by Satellite (GMPCS), subject to licensing. Companies are permitted to assign/transfer their licences for basic telephone services for the limited purpose of securitizing project debt;
  • FDI up to 49% is permitted by the FIPB/SIA for Very Small Aperture Terminal (VSAT) services for operations in the Ku-band to provide data (or voice) connectivity in Closed User Group (CUG) between sites throughout India using VSATs and a central hub; and
  • Up to 100% FDI is permitted in manufacturing activities.

Basic telephony service

Basic telephone service is open to private participation, and foreign investment (including Non-Resident Indians (NRIs) /Overseas Corporate Bodies (OCBs) up to 49% is permitted. A company can hold a licence in more than one telecom circle subject to fulfillment of certain conditions of entry. Licences for basic telephone service are issued on a non-exclusive basis for a period of 20 years, extendable for another 10 years, without any restriction on the number of operators in a telecom circle within the territorial jurisdiction of a licensed telecom circle.

NLD service

NLD service is also open to private participation without any restriction on the number of operators. The total foreign/NRI/OCBs/international funding agencies equity permitted in NLD service is 49%. A company seeking an NLD licence can apply only for one licence and needs to have a minimum paid-up capital of Rs. 2.5 billion (approximately US$ 531,600) (US$1 = Rs. 47.03) The promoters of such a company should have a combined net worth of Rs. 25 billion (approximately US$ 5,316,000). The applicant company needs to pay a one-off entry fee of Rs.1 billion (approximately US$ 212,500) together with four bank guarantees of Rs.1 billion each, which will be released on the fulfillment of network roll-out obligations. An NLD licence is issued for a period of 20 years, extendable for another 10 years. A licence fee in the form of revenue sharing @ 10% plus prescribed contributions towards the Universal Service Obligations Fund, within a total cap of 15% revenue share, is payable. Private participation is also permitted for the setting-up of infrastructure, divided into two categories: (i) those who provide infrastructure, for example, towers, buildings, dark fibre etc, and (ii) those who provide end-to-end bandwidth.

Cellular service

In 1992, the GoI opened up cellular mobile telephone services for private participation. India has adopted the global system of mobile communication for the provision of cellular services. Cellular services in India operate in the frequency band 890-902.5 MHz/935-947.5 MHz. In metro cities, operators have been allocated a frequency spectrum of 6.2+6.2 MHz (except Chennai where 5.8+5.8 MHz spectrum has been allocated), while for other telecom circles a spectrum of 4.4+4.4 MHz has been allocated. National and international automatic roaming facility has been permitted for cellular subscribers.

GMPCS

Participation by private operators in GMPCS service is allowed without any restriction on the number of operators, subject to guidelines on entry fee, revenue sharing, eligibility criteria, etc. Licences are issued on a first come first served basis, and there are no restrictions on the number of licencees. The licence fee includes both a fixed component as well as a variable component as a percentage of the revenue.

ISPs

With over 400 licences already issued and over 98 ISPs already in operation, the ISP industry in India is growing fast. ISPs are permitted to establish their own international gateways for carrying internet traffic. Clearances have been given for the establishment of about 120 internet gateways (using satellite) in various parts of the country. Private ISPs have now been allowed to set up their own landing stations (a landing station is the first point at which a submarine cable is terminated/connected in India. The landing station is to be used as an international gateway for internet traffic by an ISP) for international gateways for the internet. However, internet telephony is still not permitted.

Value-added services

The GoI has allowed Indian companies to provide value-added services including:

  1. electronic mail;
  2. voice mail;
  3. closed user group domestic satellite system;
  4. videotex services; and
  5. video conferencing, on a non-exclusive basis.

VSAT service

The Department of Telecommunications, GoI is now offering licences to VSAT service providers on a non-exclusive basis using INSAT satellite system transponders in the Ku-band instead of C band, for either commercial or captive VSAT services, by setting up a CUG, within the territorial boundaries of India. Total foreign equity (including investment by NRIs/OCBs and international fund agencies) is limited to 49%.

The earlier permitted data rate of 64 Kbps has now been increased to 512 Kbps per VSAT (including all carriers) to facilitate faster data communication. With increased bandwidth availability, VSAT services are likely to expand in India, thus making investment opportunities in this sector even more attractive.

Telecom equipment manufacturing

The manufacture of cellular switches, cellular phones, radio trunking handsets, VSAT terminals, ATM, frame relay, WLL, optical fibre equipment, card pay-phones, feature phones, ISDN terminals, data terminals, etc, provide excellent opportunities to domestic and foreign investors as these activities no longer require industrial licensing.

Tax incentives

Telecommunication undertakings in India are offered a tax holiday for 10 assessment years. Pursuant to amendments made by the Finance Act 2001 to the Income Tax Act 1961 (ITA), (section 80-IA of the ITA), with effect from April, 1st, 2002, a 100% deduction is available for profits and gains of telecommunications undertakings (including basic, cellular, radio paging, domestic satellite service, network of trunking, broadband network and internet) for the first five assessment years, and thereafter a deduction of 30% of such profits and gains is available for a further five assessment years. To avail this deduction, such undertakings should have started providing telecommunication services between April, 1st 1995 and March 31st, 2003. The assessee has the option of choosing the initial assessment year for the commencement of the tax holiday, subject to the condition that such initial year commences at any time within a period of 15 years beginning from the year in which the undertaking starts providing telecommunication services.

In terms of section 35ABB of the ITA, any licencee fee paid by a telecommunications service provider for acquiring any right to operate telecommunication services, is eligible for a deduction equal to the appropriate fraction of the amount of such expenditure where the appropriate fraction means the fraction the numerator of which is one and the denominator of which is the total number of the relevant previous years.

As for indirect taxes, pursuant to the Finance Act, 2001, basic customs duty on specified items of IT, telecom and entertainment, eg line telephone sets with cordless handsets, fax machines, teleprinters telephonic or telegraphic switching equipment and set top boxes etc, has been reduced from 25% to 15%. Basic customs duty on optic fibre for the manufacture of fibre cables has also been reduced from 25% to 15%. Further, the concessional rate of 5% duty on specified equipment and parts for basic telephone, cellular, radio paging VSAT, PMRTS and internet services has been extended to March 31st, 2002.

Computers and IT

India, with its favourable regulatory framework, offers many advantages as an IT-enabled services destination for major global companies. The comparative advantage enjoyed by India is the enormous availability of a world-class skilled manpower, well-versed in English and highly sophisticated software systems at a significantly lower cost than elsewhere.

With an increasing number of Fortune 500 companies sourcing software/hardware and software services from India, the Indian software and IT industries have been averaging a 100% growth rate since 1991. By energizing the Indian IT sector with an influx of funds, venture capitalists have also provided the much-needed impetus to the new economy.

Presently, the total investments in the computer software and hardware sectors put together exceed investments in industrial products and machinery. This is a clear indication that investment in the IT industry as a whole is attracting greater attention, compared to other industries. A major reason for such substantial investments is the investor-friendly regulatory framework and attractive tax benefits put in place by the GoI.

Foreign investment

Realizing the huge potential of the IT sector, the GoI has substantially liberalized investment norms in the IT sector. FDI up to 100% is permitted through the automatic route of the RBI for e-commerce activities (except business-to-consumer (B2C) e-commerce), subject to the condition that such companies (i) divest 26% of their equity in favour of the Indian public in five years in the case that these companies are listed in other parts of the world, and (ii) engage only in business-to-business (B2B) e-commerce and not in retail trading. Further, the condition that the automatic route for FDI and/or technology collaboration would not be available to those who have or had any previous joint venture or technology transfer/trade mark agreement in the same or allied field in India, does not apply to the FDI proposals in the IT sector.

Proposals for investment in public sector units and electronics hardware technology park/software technology park (EHTP/STP) units are eligible for approval under the automatic route of the RBI, with the exception of proposals in which the foreign collaborator has a previous venture/tie-up in India.

Regulatory framework

To encourage and promote software exports in the country, the STP of India (STPI) was created to promote India as a global IT destination. The STPI scheme is a 100% export-oriented unit scheme for the development and export of software using data communication links or in the form of physical media, including the export of professional services. STPI acts as a front end on behalf of the GoI to take care of all the project and import approvals, export certification etc, under a single window. Units in the STPI scheme enjoy benefits like duty-free imports of hardware and software, tax holidays, reimbursement of central sales tax and 100% foreign equity participation. STPI also supports new companies by providing incubation and infrastructure support.

The Information Technology Act 2000 (IT Act) provides a legal framework for e-commerce transactions in India by recognizing electronic contracts and computer crimes, and facilitating the electronic filing of documents etc. From the perspective of the corporate sector, the IT Act and its provisions contain the following positive aspects:

  • email will now be a valid and legal form of communication that can be duly produced and approved in a court of law;
  • electronic contracts have been made legal and binding in a court of law;
  • corporates will now be able to use digital signatures to carry out transactions online; and
  • acts such as hacking and damage to computer source code have been declared penal offences punishable with imprisonment and fines under the IT Act.

Tax incentives

As mentioned earlier, STP units enjoy a 10-year tax holiday. In terms of section 10A of the ITA, as amended by the Finance Act 2001, profits and gains derived by an undertaking from the export of computer software is allowed as a deduction from the total income of such undertaking. In the event that the profits and gains derived from domestic sales of computer software by an eligible undertaking is less than 25% of the total sales of such undertaking, then such profits and gains are deemed to form part of the profits and gains from the export of software for the purposes of the tax exemption. However, this condition of domestic sales not exceeding 25% of the total sales will be withdrawn with effect from April 1st, 2002. Tax benefits pursuant to section 10A are available for a period of 10 consecutive assessment years beginning with the assessment year relevant to the previous year in which the STP unit begins to manufacture or produce such computer software. Further, an overall cut-off point is imposed in terms of proviso (4) of section 10A(1) which specifies that no deduction will be available under section 10A, to any unit for the assessment year beginning on April 1st, 2010 and thereafter. Thus, effectively, the benefit of this section will cease to be available from April 1st, 2009. Importantly, in terms of section 10A (9) of the ITA, the benefit available under section 10A will not be available to any undertaking with effect from the year in which the ownership or the beneficial interest in such undertaking is transferred by any means (explanation 1 to 10A(9) provides that for the purposes of this section, in the case of a company, where on the last day of any previous year, the shares of the company carrying not less than 51% of the voting power are not beneficially held by persons who held the shares of the company carrying not less than 51% of the voting power on the last day of the year in which the undertaking was set up, the company is presumed to have transferred its ownership or the beneficial interest in the undertaking). Hence, any change in the ownership pattern leading to a shift in the controlling interest is deemed to be a transfer in ownership.

Similarly, section 10B of the ITA allows profits and gains derived by a 100% export-oriented undertaking (EOU) from the export of computer software to be deducted from the total income of such undertaking for the period of 10 consecutive assessment years beginning with the assessment year in which the undertaking begins to manufacture or produce articles or things or computer software. It may also be noted that all of the above tax benefits, as applicable to an STP unit, are equally applicable to a 100% EOU.

Profits derived from the export of computer software (computer software means any computer program recorded on any disc, tape, perforated media or other storage information device, or any customized electronic data or any product or service of similar nature which is transmitted or exported from India to a place outside India by any means) are also deductible from total income in terms of section 80HHE of the ITA. There are different slabs of permissible deduction prescribed under section 80HHE, depending upon the assessment year in which the deduction is claimed. With effect from April 1st, 2002, the extent of deduction of profits permissible is 80% of the profits of an assessment year beginning on April 1st, 2001, 70% of the profits beginning for an assessment year beginning on April 1st, 2002, 50% of the profits for the assessment year beginning on April 1st, 2003 and 30% of the profits for an assessment year beginning on April 1st, 2004. The deduction available under this section would also include profits and gains derived from the on-site development of computer software (including services for the development of software) outside India. The deduction under section 80HHE is also available to a computer software developer developing and selling computer software to a company for export purposes.

Foreign venture capital investors registered with the Securities Exchange Board of India, and investing in software and IT ventures that qualify as venture capital undertakings in India, can take advantage of certain tax benefits.

Conclusion

As far as the telecommunication sector is concerned, the government has opened up the sector for foreign participation to a large extent, although foreign investment in services such as basic telephony, cellular and paging is still limited to 49%. For the expeditious translation of approved FDI into actual investment it is important to adopt a single window clearance mechanism. On a more positive note, the GoI is also proposing to introduce a Communications Convergence Bill to cover telecommunications, IT, and information and broadcasting in an integrated manner to facilitate better use of infrastructure, lower operating costs, wide service offerings, competitive pricing and greater and easier access to services. As regards the computers and IT sector, the government has adopted the role of facilitator rather than regulator, ensuring that the sector receives the maximum concessions and tax incentives.


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