With a projected growth rate of almost 9% and a population of 1.2 billion, India is a truly dynamic marketplace. Whilst the economic rationale for doing business in or with India may be sound, entering new geographical markets is never easy, particularly one as challenging as India. The broad parameters of the foreign investment framework and the process of establishing a business presence in India are set out below.
Foreign investment framework
With respect to bringing foreign investment into India, the Foreign Direct Investment Policy (FDI Policy) provides for two routes:
- the automatic route (where no prior Government approval is required); and
- the approval route (where prior Government approval is required), which inter-alia depends on the sector in which foreign investment is to be brought.
The FDI Policy also outlines the limits of foreign investment in specified sectors like insurance and telecommunications. However, several sectors in India are now free for 100% foreign investment. This obviates the need to rope in a local partner for regulatory and logistical reasons. In addition, there are exchange control regulations, which determine the price at which shares in an Indian company can be acquired by a foreign investor.
Business entity formation
A number of alternative structures can be adopted for carrying out business activities in India including:
- liaison/representative office;
- branch office;
- limited liability partnership;
- subsidiary company, being either a public limited company or a private limited company.
The type of office that is appropriate will depend on the nature of the activities being carried out. In most circumstances, prior approval for the office is required from the Reserve Bank of India. An office has the advantages of being easier to close down, although branch offices are subject to strict exchange control guidelines and have unlimited liability so they may not be appropriate in all circumstances.
Companies provide greater flexibility and benefit from limited liability. The decision as to the type of company will be based on the ongoing compliance requirements, which are slightly more onerous for a public limited company, and the end objectives of the entity. By way of illustration, a private limited company is not permitted to raise additional monetary resources from members of the public. In the event that a foreign investor establishes an entity in India solely for the purpose of making downstream investments in the country, any foreign investment in such a holding company would require the prior approval of the Government.
Often, strong local domain expertise will be needed for a foreign investor to penetrate several market sectors, and accordingly a joint venture is often a recommended business tool for market entry. Although several joint ventures have ended in tears, others have stood the test of time and have become case studies for cultural and business integration. For example, the Maruti-Suzuki joint venture brought the first rush of Japanese technology to the Indian automobile sector.
Due diligence and entity selection
Prior to embarking on a joint venture arrangement, a thorough due diligence exercise on legal, tax and accounting fronts is essential. This allows the parties to identify and understand the issues and risks and put in place appropriate risk mitigation measures. Investing in existing Indian companies can expose investors to hidden liabilities and most investors prefer to incorporate a new limited liability company to serve as the joint venture vehicle. The business vehicle used for the joint venture will depend on the benefits and drawbacks of each type of entity, and the local laws, tax and commercial environment in which they operate.