Joint ventures

Author: | Published: 12 Jul 2001
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Introduction

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 estate.

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 needed:

  1. 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)
  2. Industries where industrial licensing is compulsory:
    1. distillation and brewing of alcoholic drinks;
    2. cigars and cigarettes of tobacco and manufactured tobacco substitutes;
    3. electronic aerospace and defence equipment, all types;
    4. industrial explosives including detonating fuses, safety fuses, gunpowder, nitro cellulose and matches;
    5. hazardous chemicals; and
    6. 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).
  3. 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.
  4. 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).
  5. 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 routes.

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); and
  • it should not exceed the following limits on payments:
Lump sum payment

Not exceeding $2 million

Royalty

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 finance);

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.

Other schemes

Certain schemes have been devised to attract foreign investments by offering tax and other concessions and facilities. Four of these are:

  1. software technology park scheme;
  2. 100% export-oriented unit scheme;
  3. special economic zones; and
  4. 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:

  1. approvals are given under a single window clearance mechanism;
  2. a STP may be set up anywhere in India;
  3. the jurisdictional director of the STPI is authorized to clear projects costing less than Rs100 million investment;
  4. 100% FDI is permitted;
  5. 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
  6. 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 available.

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 following criteria:

  1. 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.
  2. 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 approval.
  3. 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 equipment etc.

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:

  1. no licence is required for imports;
  2. exemption from customs duty on imports of capital goods, raw materials, consumables etc;
  3. exemption from central excise duty on procurement of capital goods, raw materials, etc from the domestic market;
  4. supplies from DTA to SEZs will be treated as deemed exports;
  5. reimbursement of central excise duty in inter-state purchases;
  6. no restriction on FDI investment;
  7. fast-track clearance of imports and exports; and
  8. 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 longer available.

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 follows:

  1. zero customs duty on all imports made for use in the manufacturing process;
  2. zero central excise duty on all indigenous purchases for use in the manufacturing process;
  3. reimbursement of central sales tax on the above indigenous purchases is permissible;
  4. cases involving FDI will be cleared by FIPB; and
  5. 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 available.

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;
  • closing;
  • conditions precedent;
  • further issue of shares;
  • board of directors;
  • matter reserved for affirmative vote and special voting provisions;
  • 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;
  • confidentiality;
  • 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 income

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 1997.

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 section 115-O.

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 Act).

ANNEXURE A

List of activities or items for which automatic route of Reserve Bank for investment from Persons Resident outside India is not available

  1. NBFC's activities in Financial Services Sector
  2. Civil Aviation1
  3. Petroleum including exploration/refinery/marketing
  4. Housing & Real Estate Development sector for investment from persons other than NRIs/OCBs.
  5. Venture Capital Fund & Venture Capital Company
  6. Investing companies in Infrastructure & Service Sector
  7. Atomic Energy & Related projects
  8. Defence and Strategic Industries2
  9. Agriculture (Including plantation)
  10. Print Media
  11. Broadcasting
  12. Postal Services

ANNEXURE B

Sectoral cap on Investments by Persons Resident Outside India

Sector Investment

CapDescription of Activity/Items/Conditions

1. Telecommunications3

49%

100%

  1. 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.
  2. In manufacturing activities.
2.Housing and Real Estate

100%

Only NRIs/OCBs are allowed to invest in the areas listed below:

  1. Development of serviced plots and construction of residential premises
  2. Investment in real estate covering construction of residential and commercial premises including business centres and offices.
  3. Development of townships.
  4. City and regional level urban infrastructure facilities, including both roads and bridges.
  5. Investment in manufacture of building materials.
  6. Investment in participatory ventures in (a) to (e) above.
  7. Investment in Housing finance institutions.
3.Coal and Lignite

 

49%

50%

  1. in Public Sector Undertakings (PSUs) and
  2. in other than PSUs
  1. Where private Indian companies are setting up or operating power projects as well as coal or lignite mines for captive consumption;
  2. 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.
  3. For exploration or mining of coal or lignite for captive consumption
4.Drugs & Pharmaceuticals4

74%

  1. For bulk drugs, their intermediaries and formulations (except those produced by the use of recombinant DNA technology).
  2. In manufacturing activities.
5.Hotel & Tourism5

51%

  1. Hotels include restaurants, beach resorts, and other tourist complexes providing accommodation and/or catering and food facilities to tourists.
  2. 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 organisations.
6.Mining

74%

100% Exploration and mining of diamonds and precious stones.

Exploration and mining of gold and silver and minerals other than diamonds and precious stones, metallurgy and processing.

7.Advertising

74%

Advertising sector

8.Films

100%

Film industry (i.e., film financing, production, distribution, exhibition, marketing and associated activities relating to film industry) subject to the following:

  1. Companies with an established track record in films, TV, Music, finance and insurance.
  2. 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 cases.

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 A)6

100% -

Footnotes:

  1. In the civil aviation sector, 100% FDI is now permitted in Airports, with FDI above 74% requiring prior Government approval.
  2. FDI in Defence production is now allowed upto 26% subject to a license being obtained from the Government.
  3. FDI upto 74% is now permitted for the following telecom services subject to licensing and security requirements:
    1. Internet service provider with gateways.
    2. Radio paging.
    3. End to end bandwidth.
  4. 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 targeted formulations.
  5. FDI is now permitted upto 100%.
  6. 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.

Joint Ventures

Rajinder Narain & Co
F14 Connaught Place
New Delhi-110 001
India
Tel: 91 11 331 3232
Fax: 91 11 332 8319

Maulseri House
Kapashera Estate
New Delhi-110 037
Tel: 91 11 331 3232
Fax: 91 11 332 8319