The Japanese Overseas Investment Report 2017: India

Author: | Published: 29 Mar 2017
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SECTION 1: Market outlook

1.1 How would you summarise your jurisdiction's attitude towards the influence of Japanese corporate culture in its industries?

Japan has a tremendous cultural and traditional influence over business in India. Both countries are very relationship focused rather than deal focused, which is evidenced by the long success enjoyed by companies like Suzuki (since 1982) and Honda (since 1984) which have become household names in India and whose products still dominate the markets. In the words of Prime Minister Narendra Modi, "Japan in India is a benchmark of quality, excellence, honesty and integrity". Signing of the historic India-Japan Comprehensive Economic Partnership Agreement (CEPA) in August 2011 accelerated economic and commercial relations between the countries.

1.2 What is the outlook for Japanese investment into your jurisdiction over the next 12 months?

India remains one of the most attractive investment destinations globally, including for Japanese companies. India has been ranked as the most attractive investment destination in a survey of Japanese manufacturing companies, conducted by the Japan Bank for International Cooperation.

Foreign direct investment (FDI) by Japan has increased in recent years. Based on the data released by the Department of Industrial Policy and Promotion, with a cumulative inflow of $18.9 billion from April 2000 to June 2015, Japan has emerged as the fourth largest contributor to FDI, contributing seven percent of the total FDI invested into India. Japanese FDI has mainly been in the automobile, electrical equipment, telecommunications and pharmaceutical sectors. Japan has financed many infrastructure projects in India, most notably providing investment and critical technology for the metro system in Delhi, which has transformed the transport infrastructure of the Indian capital. The countries have signed a Memorandum of Understanding introducing Japan's high speed railways technologies (the Shinkansen or bullet train system), between Mumbai and Ahmadabad.

Both governments have taken various steps to bolster Japanese investments in India such as the Act East policy, Japan Plus and the development of Japan industrial townships by various state governments. Japan has been and will continue to be an important partner in India's progressive journey. Prime Minister Modi visited Japan for the Annual India-Japan Bilateral Summit held in November 2016, where several major pacts were signed.

Japan has been associated with Vibrant Gujarat Global Summit (VGGS) since 2003. In the VGGS held in January 2017, Japan indicated intent to establish a dedicated industrial park for Japanese companies. Gujarat is a favoured investment destination, with above 100 Japanese companies having established business in Gujarat.

The government is undertaking various initiatives such as Make in India, Digital India, Smart City and Start-Up India, which, along with Japan's continued interest in providing technological information and financing is bound to see progress across various sectors including, nuclear energy, defence, food industries and trade.

SECTION 2: Approving foreign investments

2.1 Explain the foreign investment approval process and approval timetable.

India has made substantial changes to its FDI policy. FDI can be of two types: greenfield FDI and brownfield. Greenfield FDI is investment by a foreign investor in a new venture in India while brownfield FDI is investment by a foreign investor in existing companies. The government of India has substantially eased inflow of FDI in both greenfield and brownfield projects. FDI is allowed in virtually all sectors under the Automatic Route, meaning without requiring prior approval either of the government or the Reserve Bank of India (RBI) and is subject only to sectoral caps. A limited list of sectors fall under the Government Route, for example where FDI is subject to prior approval of the government.

Under the Government Route, the proposal would need to be approved by the Foreign Investment Promotion Board, which is an inter-ministerial body and follows a single window model for clearing proposals. Recently, in the federal budget 2017, the government announced its intent to abolish this body, while stating its intent to further liberalise the FDI policy. These are all very welcome changes.

2.2 Are there any investment restrictions in specially regulated sectors and is the government entitled to any special rights in these sectors?

FDI is prohibited in a few sensitive sectors such as atomic energy, lottery and gambling businesses, cigarette manufacturing and railway operations (other than certain permitted activities).

In certain key sectors (which are perhaps prone to political influence) such as retail (wholesale and single-multi brand), defence, civil aviation, financial services, brownfield pharmaceuticals, telecommunications services and others, FDI will have to be made through the Government Route.

2.3 Which authority oversees competition clearance? Please give a brief overview of the merger clearance process.

The Competition Commission of India (CCI) is the nodal agency established under the Competition Act 2002, which oversees merger clearances.

The substantive provisions of the Indian merger control regime are set out under the Competition Act and the Competition Commission of India (procedure in regard to the transaction of business relating to combinations) Regulations 2011 (Combination Regulations).

The Competition Act requires mandatory notification in case of acquisition of assets, shares, control or voting rights of an enterprise or in case of a merger or amalgamation of enterprises, if the assets or turnover thresholds prescribed under the Competition Act are exceeded.

The Competition Act states that the notifying parties cannot consummate the transaction prior to receiving the CCI's approval or until the 210-day period lapses. The Competition Act empowers the CCI to impose a penalty of up to one percent of the combined assets and turnover, whichever is higher, for violating the suspensory regime and consummating a transaction prior to the CCI's approval. The CCI can also impose this penalty in case of failure or delay in notifying a transaction.

Competition Act extends to combinations taking place outside India, even when the target enterprise/business/unit or the transacting parties are located outside India. Given the suspensory regime, a global transaction cannot be consummated in territories outside India, until the CCI's approval.

The notification is required to be filed with the CCI within 30 days of:

  • The board approval of the proposal relating to the merger or amalgamation; or
  • Execution of an agreement or other document (in case of an acquisition). Other document, in terms of the Combination Regulations, includes the public announcement made in terms of the Indian Takeover Code. However, binding term-sheets would not be considered a trigger for notification provided it is subject to further conditions such as receipt of regulatory approvals.

2.4 Are there further approval requirements that foreign investors should be aware of?

Certain sectors have specific FDI linked performance entry conditions, such as minimum capitalisation norms for FDI in non-banking finance companies. Foreign investors should also be mindful of the immediate business compliance requirements relating to incorporation of a new company, appointment of directors and tax registrations. Further, depending on the business of the company, additional compliances and license requirements for a manufacturing unit may become applicable.

SECTION 3: Investment techniques

3.1 What are the most common legal entities used for Japanese investment in your jurisdiction?

Foreign strategic investors, including Japanese investors, intending to set up substantial business operations in India most commonly choose to set up a wholly owned subsidiary (WOS) or a joint venture (JV) in India.

Foreign investors are increasingly exploring the option of incorporating a limited liability partnership (LLP), which has the hybrid characteristics of a limited liability company and a partnership. FDI is permitted in LLPs, undertaking activities in sectors in which 100% FDI is allowed without any approval and there are no entry conditions. However, LLPs are not yet very common.

Unincorporated entities such as a liaison office, branch office or project office can be established, by seeking approval from an Authorised Dealer Category-I Bank. An approval from the RBI is only required in certain specific cases. These are useful for representing the parent company/group companies in India, promoting export/imports from/to India, promoting technical/financial collaborations.

3.2 What are the key requirements for establishment and operation of these legal entities?

A company can be incorporated according to the procedure under the Companies Act, 2013 and needs to be registered with the Registrar of Companies (ROC). A company will also be required to obtain Director Identification Numbers and Digital Signature Certificates for its directors, registrations for Service Tax, Value Added Tax and Professional Tax. It may be noted that a company incorporated in India requires at least one director to be resident in India.

An LLP can be incorporated by two or more persons (including by a company) by obtaining a Certificate of Incorporation from the ROC, in accordance with the procedure under the Limited Liability Partnership Act, 2008 (LLP Act). Every LLP is required to nominate at least two designated partners, one of whom should be resident in India.

A branch office must be registered with the ROC and should normally be engaged in the same activity as the parent company, unless otherwise specifically permitted by RBI. A liaison office is permitted to carry on liaison activities only and cannot carry on any commercial, trading or industrial activity either directly or indirectly.

They are required to obtain a permanent account number from the Indian tax authorities and file an annual activity certificate (AAC) with the RBI.

A project office is typically set up by foreign companies undertaking large projects such as major construction, civil engineering and infrastructure projects. Securing a contract from an Indian entity to execute a project is a pre-requisite for setting up a project office. A project office is also required to file an AAC.

SECTION 4: Dispute resolution

4.1 How effective are local courts' enforcement and dispute resolution proceedings, and what should Japanese investors be particularly aware of?

The enforcement and dispute resolution proceedings of local courts depend on the nature of action pursued. Due to recent changes to arbitration law and setting up of commercial courts and the National Company Law Tribunal in India, the jurisprudence has shifted towards the speedy (strict timelines prescribed) and efficient (technical qualifications prescribed) resolution of commercial matters, especially involving international entities. It should be noted that in almost all cases till date, Japanese investors have preferred to contend their claims against Indian parties via offshore seated arbitration with Indian governing law, usually in Singapore.

Investors should, however, be particularly aware of the various appellate stages that a particular dispute may need to go through before the same is finally resolved, including any regulatory hurdles, as the same may result in varying time and cost impacts. The main concern for all litigants continues to be the substantial time taken to resolve their cases.

4.2 Does your jurisdiction have a bilateral investment protection treaty with Japan and is that commonly used by investors?

Due to the socio-economic situations in both countries, the CEPA has not been fully utilised for the purpose of facilitating inter-country investments. Consequently, the development of jurisprudence, if any, with respect to any dispute resolution under the CEPA has been impeded.

It remains to be seen if the recent steps taken by the countries to improve bilateral relations and promote cross-border investments will trigger greater utilisation of the CEPA.

4.3 Do local courts respect foreign judgments and are international arbitration awards enforceable?

Japan is a non-reciprocating country with respect to India and therefore, in order to enforce a judgment passed by a competent court in Japan a fresh civil action (suit) needs to be filed in a competent court in India, showing that the foreign decree satisfies certain statutory tests. Courts will not examine the sufficiency of evidence on merits or test the correctness of the decision, and proceed with the execution of the same.

International arbitration awards made in Japan are enforceable in India under the New York and the Geneva Conventions. Courts would merely interfere in the execution of the same to satisfy itself that the prescribed conditions for the enforcement of such awards are met.

SECTION 5: Forex controls and local operations

5.1 What foreign currency or exchange restrictions should foreign investors be aware of?

In an issue or transfer of shares of a private company to foreign investors, the pricing should not be less than the fair value determined through internationally accepted pricing methodology on arm's length basis. Consequently, the pricing for transfer of shares from a non-resident to a resident cannot exceed the minimum price as determined above. Pricing of shares of a listed company issued to or purchased by a person resident outside India under the FDI Policy should not be less than the price determined in accordance with the Securities Exchange Board of India (SEBI) guidelines.

SECTION 6: Tax implications

6.1 Are there tax structures and/or favourable intermediary tax jurisdictions that are particularly useful for Japanese investors into the country?

There are no intermediary tax jurisdictions that are particularly useful for Japanese investors, as compared to others. Moreover, Japanese investors do not usually route investments into India through other jurisdictions as the India-Japan Double Taxation Avoidance Agreement (DTAA) is quite favourable.

Intermediary tax jurisdictions such as Mauritius, Singapore and Cyprus were typically used to route FDI investments in India due to a low capital gain taxation regime combined with a favourable DTAA with India. However, these agreements have now been re-negotiated in order to make them more stringent and plug taxation loopholes that were being misused.

6.2 What are the applicable rates of corporate tax and withholding tax on dividends?

The corporate taxation rate for foreign companies in financial year 2016-17 is 40% and for domestic companies is 30%. For domestic companies whose gross receipt or turnover is less than INR500 million ($7.66 million) in the financial year 2015-16, the Finance Bill, 2017 proposes the tax rate to be 25% in the financial year 2017-18 for such companies, subject to certain conditions. A company incorporated in India by Japanese investors will be considered as domestic company.

A dividend distribution tax (DDT) of 15% is payable by companies. Dividends received by foreign shareholders are not taxable in India and dividends are not subject to withholding tax.

Tax rate are further increased by surcharge, education cess and secondary and higher education cess, which varies based on the total income of the taxpayer.

6.3 Does the government have any tax incentive schemes in place?

There are various tax incentive schemes available for setting up businesses in India. Some business activities are subject to certain conditions, entitled to tax holidays from income tax including:

  • Developing, operating and maintaining infrastructure facility;
  • Generating/transmitting/distributing power;
  • Setting up of a unit in a special economic zone (SEZ) for undertaking permitted activities;
  • Processing, preserving and packaging fruits or vegetables, meat and meat products, poultry, marine or dairy products or the integrated business of handling, storing and transporting food grains; and
  • Setting up and operating a cold chain facility, warehousing facility for agricultural produce, laying and operating a cross country natural gas or crude or petroleum oil pipeline network.

India has a Minimum Alternate Tax (MAT) which is payable by companies which have high profits but negligible tax liability. However, subject to conditions, MAT is not applicable to foreign companies that do not have a Permanent Establishment (PE) in India. Further, it also provides for concessional tax treatment for capital gains arising on transfer of listed and unlisted securities.

6.4 Are there any reciprocal tax arrangements between your jurisdiction and Japan? If so, how can they aid investors?

India has a DTAA with Japan along with the CEPA. There is also an agreement between Japan and India on Social Security, 2012.

Key Takeaways for investors:

  • The profits of an enterprise of Japan shall be taxable only in Japan unless the enterprise carries on business in India through a PE situated therein. In many cases activities that are preparatory or auxiliary to the main business activities will not create a PE even if these are carried out in India. For example, a liaison office will not create a PE.
  • Interest, royalties and fees for technical services earned by resident of Japan from sources in India are subject to a lower withholding tax rate of ten percent.
  • Interest arising in India and derived by the Japanese Government, the Central Bank of Japan or any financial institution wholly owned by Japan (for example the Bank of Japan, Japan Bank for International Co-operation and Japan International Co-operation Agency) is exempt.
  • The Agreement on Social Security exempts employees posted to the host country under short term contracts (up to five years) from making social security payments in such host country as long as social security contributions have been made in the home country and certificate of coverage in respect of the same has been obtained.
About the author

Cyril Shroff
Managing partner, Cyril Amarchand Mangaldas

Mumbai, India
T: 91 22 2496 4455

Cyril Shroff has over 34 years of experience in a range of areas, including corporate laws, securities markets, banking, infrastructure, private client practice and others. He is regarded and has been consistently rated as India's top corporate, banking and project finance lawyer by several international surveys, including those conducted by International Financial Law Review and Chambers Global.

Shroff heads the firm's Japan desk, and in addition to advising on India – Japan transactions, he regularly travels to Japan to speak at India-focused seminars. Shroff has been recognised as a "legendary figure in the Indian legal community". He is often regarded as the "M&A king of India". He is a member of the advisory board of the Centre for Study of the Legal Profession established by Harvard Law School, the advisory board of the National Institute of Securities Markets and the board of IIM, Trichy. Shroff is also part of various committees of the Confederation of Indian Industry (CII) – the national council on corporate governance, the national committee on capital markets, private equity and venture capital, commodities markets, financial investors and regulatory affairs. Shroff was admitted to the Bar in 1982 after receiving his BA LLB degree from the Government Law College in Mumbai. He is a solicitor, High Court of Bombay, since 1983.

About the author

Rishabh Shroff
Partner, Cyril Amarchand Mangaldas

Tokyo, Japan
Mumbai, India
T: 91 22 2496 4455

Rishabh Shroff joined the firm's Mumbai office in 2007, after completing his LLB from the London School of Economics, London. He was admitted as an advocate in the bar council of Maharashtra & Goa in 2007, and is also a solicitor, Supreme Court of England and Wales.

Rishabh is a member of the firm's corporate team and has been involved in a number of cross-border and domestic transactions. He is the co-head of the firm's Japan desk, and works very frequently with Japanese clients. He has been part of the Japan desk for over eight years, and during this time has advised a number of leading Japanese and international companies on their investments into India. He specialises in foreign investments into India, private mergers and acquisitions, domestic and foreign joint ventures, and insurance. He has also worked in the firm's projects and project finance team for two years (2007–2009). He regularly travels to Japan for India focused seminars and Japan – India transactions. He is the general editor of Shinkansen to India, the firm's bespoke in-house publication for its Japanese clients.

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