Foreign Direct Investment in India: A

Roadmap

India, as an investment destination, has attracted a considerable amount of interest in recent times. According to a recent survey conducted by global management consulting firm, AT Kearney, India is now the ‘second-most attractive destination’ (after China) for foreign direct investment (‘FDI’), relegating the United States to third place. This article will try to highlight certain significant aspects of the legal and regulatory regime relating to foreign direct investments into India.

Policy on Foreign Investment in India

Continuing its steady policy of economic liberalisation which started in 1991, India has now opened up almost all sectors of its economy to foreign investment. Except for certain sectors/activities which require the prior approval of the government and some which have investments ceilings, foreign investment up to 100 per cent is permitted in all other sectors/activities.

Proposals requiring prior government approval

A proposal for FDI would require the prior approval of the government in certain cases. These are:

1   investment in activities/items requiring an industrial licence;

2   where the foreign collaborator has an existing financial/technical collaboration in the same field;¹

3   where the foreign investor wants to acquire shares in an existing Indian company in:

a   the financial services sector; and

b   where the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 1997 is attracted; and

4   where the proposed FDI falls outside the notified sectoral policies/caps or is in sectors in which FDI is not permitted.

The applications are considered by the body called the Foreign Investment Promotion Board (‘FIPB’), a specially constituted board (now under the Ministry of Finance) set up solely for the purpose of considering foreign investment proposals. The FIPB is now part of the Department of Economic Affairs (‘DEA’), Ministry of Finance.

The FIPB is chaired by the Secretary of the DEA, and comprises members from the Department of Industrial Policy and Promotion (which is responsible for industrial licensing), Department of Commerce and the Ministry of External Affairs. The FIPB can, if necessary, co-opt other government officials and top officials of financial institutions, banks and industry professionals.

The FIPB meets once a week to consider applications, and usually decides on foreign investment applications within a period of 30 days. Its meetings are generally closed, and it is not required to give reasons for its decision, nor is it bound by precedent. The government has issued Guidelines for the FIPB to follow for its consideration of foreign investment proposals, in an effort to improve objectivity and transparency.

Applications can be made either in the prescribed forms, or on plain paper applications containing all relevant details. It is critical that external counsel/consultants be hired for the drafting and submission of the FIPB application, given the uncertainty and complex considerations involved.

The Automatic Route: no government approval required

Except for the situations mentioned above, no prior government approval is required for FDI (up to the ‘sectoral caps’ specified for such sectors). Investors are merely required to notify the regional office of the Reserve Bank of India (‘RBI’), within a period of 30 days of receipt of inward remittance, and file certain documents within a period of 30 days of issue of shares to foreign investors.

An illustrative list of sectors in which 100 per cent FDI is permitted under the Automatic Route includes non-banking financial services, drugs and pharmaceuticals, most manufacturing activities, electronic hardware and software development, film industry, exploration and mining of minerals, etc.

Prohibited list

There are certain sectors in which no FDI is currently permitted by the Indian government. This is a list that has dwindled over the years and currently comprises:

1   gambling and betting;

2   lottery business;

3   atomic energy;

4   agricultural or plantation activities or Agriculture² and Plantations (other than tea plantations); and

5   retail.

Incidentally, the blanket restriction on retail was eased recently³ when the government announced that up to 51 per cent FDI would be permitted for ‘single brand retail’. This means that multinational companies can now set up exclusive Indian retail outlets for ‘premium brands like Chanel, Nike, Louis Vuitton, Gucci or Reebok’, by entering into a joint venture with a local partner (who would have to hold the remaining 49 per cent).

It may be noted that under the Automatic Route, 100 per cent FDI in trading has already been permitted⁴ for trading companies which engage in:

1   exports;

2   bulk imports with ex-port/ex-bonded warehouse sales;

3   ‘cash and carry’ wholesale trading; and

4   other import of goods or services, provided at least 75 per cent is for procurement and sale of goods and services among the companies of the same group and for third party use or onward transfer/distribution/sales.

Industrial licensing

The Statement on Industrial Policy dated 24 July 1991, which actually began the process of liberalisation of the Indian economy, substantially abolished industrial licensing (except for a few industries), announced measures for enabling foreign investment and transfer of technology, and opened most areas which were earlier reserved for the public sector.

Now, the requirement of obtaining an industrial licence for any manufacturing activity is limited only to the following:

1   industries that require compulsory licensing;

2   manufacture of items reserved for the small-scale sector by non small-scale industrial units or units in which foreign equity is more than 24 per cent; and

3   where the proposed location of the industry does not adhere to certain ‘locational restrictions’⁵ in metropolitan areas.

Industrial licensing is compulsory for investing in certain industries of strategic, social or environmental importance.⁶ These are:

1   distillation and brewing of alcoholic drinks;

2   cigars/cigarettes of tobacco and manufactured tobacco substitutes;

3   electronic aerospace and defence equipment of all types;

4   industrial explosives including detonating fuses, safety fuses, gun powder, nitrocellulose and matches; and

5   hazardous chemicals.

All other industries are exempt from the requirement of licensing.

Transfer of Shares

Earlier, the transfer of shares (as opposed to investment by direct subscription to shares issued by a company) required approval from both the FIPB and the RBI. Now, the following transfers of shares are exempted from the requirement of prior government approval:

1   Generally, transfer of shares from a resident to non-resident, other than investments in the financial services sector, provided it does not attract the provisions of the Substantial Acquisition of Shares and Takeovers Regulations 1997 (‘SEBI’).⁷

2   Conversion of an external commercial borrowing/loan into equity.

3   Cases of increase of foreign equity participation by fresh issue of shares, and conversion of preference of shares into equity capital.

There are certain additional conditions imposed for the above exemption to apply, such as:

1   the activity of the company 
 would need to be covered under the 
      Automatic Route;

2   the non-resident holding, after the 
    transfer, should fall within the 
   relevant sectoral cap; and

3   The price at which the transfer 
        takes place should also comply with 
    the prescribed pricing guidelines of 
       the SEBI/RBI.

Any other transfer of shares would normally require the approval of the government.

Starting Another Venture in Same or Allied Field: Restrictions Eased

Before, even for FDI that was in an Automatic Route sector, foreign investors who entered into a joint venture with a domestic Indian party were faced with an additional hurdle when they wanted to start another joint venture in the ‘same’ or ‘allied’ field – that of a ‘no objection certificate’ from their Indian joint-venture partner. Though the rationale behind this policy was to protect the Indian joint-venture partner, in reality, such a policy was counter-productive as the foreign investor was at the mercy of the Indian partner before it could start any other venture in India.

Now, the controversial Press Note 18 (1998 series) has been replaced with Press Note 1 (2005 series), which makes the conditions less restrictive. Now, government approval will be required only for new investments by the foreign investor in the ‘same’ field.⁸ Further, even such an approval shall not be required in certain cases: if the investment is being made by a venture capital fund registered with the SEBI; where, in the existing joint venture, the investment by either of the parties is less than three per cent; or where the existing venture/collaboration is defunct or sick.

It may be noted that proposals in the information technology sector, investments by multinational financial institutions and certain investments in the mining sector are exempted from the ambit of this regulation.

Other Modes of Foreign Direct Investments

Global Depository Receipts (‘GDR’)/American Deposit Receipts (‘ADR’)/Foreign Currency Convertible Bonds (‘FCCB’)

A foreign investment through the issue of GDR/ADR and FCCB by Indian companies is also treated as FDI. An Indian company is allowed to raise equity capital in the international market through the issue of GDR/ADR/FCCB. However, these are not subject to any ceilings on investment. The only conditions for this are: the ADR/GDR should be issued in accordance with the guidelines issued in this regard; the Indian company needs to secure an approval from the Ministry of Finance; and the company should not be ineligible to issue shares to persons resident outside India.

While there are no restrictions on the number of GDR/ADR/FCCB to be floated by a company in a financial year, a company likely to exceed the FDI percentage limits under the Automatic Route after a proposed GDR/ADR/FCCB issue, or one which is implementing a project falling under the government approval route, is also required to obtain the prior government clearance 
through FIPB.

Apart from an express ban on investment in real estate and stock markets, there are no restrictions on the use of GDR/ADR issue proceeds. The FCCB issue proceeds need to conform to external commercial borrowing end-use requirements.

The Singapore Exchange (‘SGX’) had recently announced the proposed listing rules for its forthcoming GDR programme, and this should be of interest to Indian companies looking to globalise and access institutional funds from Singapore.

Exchange Control in India

The RBI, which is the central bank in India, regulates all aspects of exchange control in India, and administers the Foreign Exchange Management Act 1999 (‘FEMA’) which, inter alia, governs the repatriation of investment capital and profits earned in India.

All foreign investments are fully repatriable, subject to the sectoral policies. Dividends declared on foreign investments can be freely remitted through the authorised dealers. Sale of shares on stock exchanges can be effected without the prior approval of the RBI, and sale proceeds may be repatriated through a bank. For sale of non-listed shares, the regional offices of the RBI are empowered to grant permission for sale of such shares, the sale price being determined according to the relevant regulations prescribed in this regard.

Routing Investments: Singapore as an Alternative to Mauritius?

Foreign investment into India is often routed through Mauritius, to take advantage of the benefits of a long-standing tax-treaty between India and Mauritius, wherein a holding company in Mauritius gets the benefit of capital gains tax exemption on sale of shares in the Indian subsidiary. 

As per the recent protocol to the Singapore-India Double Tax Avoidance Agreement (‘DTAA’), tax residents of Singapore are given the same capital gains tax exemption upon divestment of their investments in India, subject to certain conditions.⁹ Interestingly, the protocol is co-terminus with the DTAA between India and Mauritius. Accordingly, Singapore could also be considered as an alternative to Mauritius for routing investments into India.

Conclusion

Fifteen years after the Indian government commenced the process of economic liberalisation, India is increasingly being acknowledged as a preferred investment destination. Having registered a growth rate of 8.2 per cent in 2004/2005, India was dubbed the ‘fastest growing free market economy’ and showcased as the ‘focus country’ at the World Economic Forum held recently in Davos, Switzerland.

Widely acknowledged as the world’s largest democracy, India is also the second most populous country in the world. Other factors in India’s favour include: a legal system based on English common law, an independent and pro-active judiciary, a free press, and the predominant use of English as the main language for business and administration. In addition, India offers a burgeoning domestic market and an abundant, highly skilled work-force – factors that cannot be ignored by foreign investors. India has now become a major player in the world economy and stands on the threshold of unprecedented economic growth in the years to come.

Azmul Haque

Baker & McKenzie.Wong & Leow

E-mail: azmul.haque@bakernet.com

Notes

1   As amended by Press Note 1 (2005 Series), issued by the SIA, Department of Industrial Policy and Promotion. This replaces the earlier Press Note 18, which was more stringent and applied to both ‘same’ and ‘allied’ fields.

2  Excluding floriculture, horticulture, animal husbandry, pisiculture and cultivation of vegetables, etc under controlled conditions, or services related to agro or allied sectors.

3   ‘Govt allows 51% FDI in single brand retail showrooms’, The Economic Times, 26 January 2006.

4   ‘Sector Specific Guidelines for Foreign Direct Investment, Comprehensive Manual for FDI – Policy and Procedures’, (November 2005) Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.

5   The proposed location should not be within 25 kilometres of the standard urban limits of 23 Indian cities having a population of one million or more as per the 1991 census.

6   Until recently, ‘drugs and pharmaceuticals’ were also on this list, and have been removed by a recent notification dated September 2005.

7   ‘SEBI’ refers to the Securities and Exchange Board of India, the capital markets regulator in India.

8   Subject to the existing sectoral policies in place.

9   Please see ‘The Comprehensive Economic Cooperation Agreement: Strengthening India-Singapore Relations’, Singapore Law Gazette, October 2005.