Setting up and operating a joint venture

Structure

Are there any particular drivers in your jurisdiction that will determine how a joint venture is structured?

The drivers for determining the structure of a joint venture are a combination of commercial considerations and regulatory requirements. The most common factors are:

  • the proposed business activities of the joint venture company in India, such as manufacturing, project execution, services and trading;
  • the intended time frame for the collaboration by the joint venture parties;
  • the limitation of liability exposure to the joint venture parties, depending upon the nature of the business of the joint venture companies and the degree of risk associated therewith;
  • the intended management structure and involvement by the joint venture parties in the management of the joint venture;
  • the need for capital and flexibility for accessing financing options;
  • the intended exit mechanisms from the joint venture and ease of exit for the joint venture parties;
  • tax considerations; and
  • regulatory requirements.

 

Based on the above considerations, if the parties intend to create a separate legal entity, have long-term operational objectives and require a formal structure with limited liability, incorporated joint ventures are preferred because of their corporate characteristics. Incorporated joint ventures are also preferred from a governance and accounting perspective. However, if the parties have a limited objective – for example, to execute a project – they may opt for an unincorporated structure in the form of a consortium, as this gives them flexibility at the time of conclusion of their objectives.

Tax considerations

When establishing a joint venture, what tax considerations arise for the joint venture parties and the joint venture entity? How can tax charges be lawfully mitigated?

The primary tax considerations for a foreign joint venture party while establishing a joint venture in India and investing therein are income tax, dividend tax, withholding tax, capital gains tax and provisions of double taxation avoidance agreements signed between India and the investor’s country. A joint venture is subject to corporate income tax on prescribed slabs for taxation calculated on the basis of its income. The joint venture parties themselves will be subject to income tax in the case of declaration of a dividend by the joint venture company in India. Capital gains tax is payable on the sale of shares of the joint venture. If any of the joint venture parties is a non-resident, withholding tax is applicable for any payments made to such a party by the Indian joint venture company.

As India is a signatory to double taxation avoidance agreements (DTAAs) with various countries, non-resident parties from such countries will be allowed to claim beneficial tax treatment, thereby lowering their tax liability. The DTAAs are typically in line with the United Nations model of double taxation avoidance agreements. However, DTAAs with a few countries – such as Singapore, Mauritius and Cyprus – offer a more preferential tax treatment for the investment received from such countries. However, limitation of benefits clauses in such DTAAs will restrict parties from claiming beneficial tax treatment if it is found that the affairs of the non-resident party are arranged with the primary purpose of claiming beneficial treatment under a DTAA or the parties are engaged in treaty shopping for tax avoidance.

Asset contribution restriction

Are there any restrictions on the contribution of assets to a joint venture entity?

Generally, joint venture parties are allowed to contribute assets to the joint venture entity in India subject to compliance of valuation methods and prescribed accounting treatments for non-cash consideration. The Companies Act, 2013 (the Companies Act) provides for the issuance of shares to the joint venture parties for consideration other than cash. In the case of a foreign joint venture party, there are certain additional regulations under the Foreign Exchange Management Act, 1999 pertaining to pricing guidelines, and reporting and compliance requirements. Such regulations may vary depending on the nature and business of the joint venture entity, type of asset and the resident status of the joint venture party contributing the asset.

Interaction between constitution and agreement

What is the interaction between the constitution of the joint venture entity and the agreement between the joint venture parties?

The constitution documents (memorandum and articles of association) of a joint venture company, when registered, become binding on the company and the shareholders as if they had been signed by the company and by each shareholder. In the event that the agreement between the joint venture parties conflicts with the provisions of the constitution documents, the constitution documents supersede and take precedence over the joint venture agreements. Where any restriction is incorporated in the joint venture agreement, but not specified in the constitution documents, such restriction is not binding on either the company or the shareholders. This legal principle was upheld by the Supreme Court of India and reiterated through numerous judicial pronouncements over the years. However, the courts, in recent times, have been making a concerted effort to uphold the sanctity of joint venture agreements and treat them as valid, binding and enforceable between the parties, so long as such agreements are in accordance with the law and not in contradiction with the constitution documents of the company; the joint venture agreement should not be held unenforceable merely because its provisions are not incorporated in the constitution documents. This was observed by the Supreme Court of India in January 2012 in the matter of Vodafone International Holdings BV v Union of India (UOI) and Ors.

Nonetheless, to bolster the enforceability of such agreements between the joint venture parties, it is common practice and also recommended that the key provisions under such agreements are expressly incorporated in the constitution documents of the joint venture company. Further, it is pertinent to note that the Companies Act (section 58(2)) provides that any contract or arrangement between two or more persons in respect of the transfer of securities shall be enforceable as a contract. Therefore, a contract between shareholders and the company is binding on the company with respect to the transfer of securities in the event that the constitution documents are silent on the matter. Registration of the agreement is not mandatory; however, the requisite stamp duty is payable on the agreement between the joint venture parties.

Party interaction

How may the joint venture parties interact with the joint venture entity? Are there any restrictions?

Generally, joint venture parties interact with the joint venture company by way of management participation or by exercising their rights as shareholders of the company. Management participation is done by nominating key managerial personnel or directors to the board of the joint venture company. Although the directors’ primary responsibility is towards the company, the nominating shareholders exercise their control over the management of the company provided that such control does not result in an adverse effect on the company.

As shareholders, the joint venture parties are statutorily entitled to have access and the right to inspect certain records of the company, such as the constitution documents, audited financial statements, statutory registers and minutes books of shareholders’ meetings. The said statutory rights are limited in nature and do not give the shareholders a right to access day-to-day information about the affairs of the company. However, joint venture agreements between parties may provide for additional information and inspection rights to the shareholders, and the same may be incorporated in the constitution documents of the joint venture company to make it binding on the parties and the company.

Exercising control

How may the joint venture parties exercise control over the joint venture entity’s decision-making?

Joint venture parties may exercise their control in the joint venture company’s decision-making at the board level and at the shareholder level. Certain decisions are made by the board and certain other decisions are made only with the approval of the shareholders (ie, the joint venture parties). The decision-making process and the rights of the board members and shareholders over decision-making are provided under the Companies Act. Generally, the said statutory rights prescribe decision-making by a majority of the votes at the board level. At the shareholders level, certain decisions need to be approved by an ordinary resolution (ie, by simple majority) and certain important matters are required to be approved by special resolution (ie, by approval of a three-quarters majority of the shareholders present and voting). However, the joint venture agreement between the parties and the constitution documents of the joint venture company may provide for stricter requirements for decision-making at the board level and at the shareholder level than prescribed under the Companies Act.

Accordingly, joint venture parties, especially minority investors, may exercise control over the decision-making of the joint venture company by way of having veto rights, creating a list of reserved matters or affirmative vote matters that can be passed only with the approval of the directors nominated by a specific investor, or requiring the affirmative vote of a specific shareholder at the shareholders’ meeting. Further, the agreements and the constitution documents may also provide for special quorum requirements for meetings of the board or shareholders, ensuring representation of the minority investor. In the case of limited liability partnerships and unincorporated joint ventures, there is more flexibility for the joint venture parties to agree on the degree of control and the process to exercise such control.

Governance issues

What are the most common governance issues that arise in connection with joint ventures? How are these dealt with?

The common governance issues in connection with joint ventures in India arise in relation to the management of the joint venture company, the conflicting business goals and interests of the joint venture parties, and differences of business culture.

Regarding management of the joint venture company, improper or irresponsible functioning of the board and individual directors acting in the sole interest of their nominating shareholder, rather than the company itself, are of primary concern. Thus, conflicts between the duties of management and shareholders’ interests in the company are significant from the perspective of corporate governance. Conflicting business goals and interests of the joint venture partners hinder the smooth functioning of the joint venture company. Such conflicts often result in deadlock situations in decision-making that prevent any further constructive action being taken by the company. Further, differences in business cultures, especially in the context of foreign joint venture parties, also pose a challenge for good corporate governance. Disagreements between the parties, especially with regard to business ethics, can be a matter of concern for joint venture parties, as this may have implications not only for the joint venture company but also for the foreign joint venture party in its home jurisdiction.

Effective ways to deal with such governance issues are to establish robust mechanisms of internal control through formal policies and procedures, constituting committees at the board level with a variety of functions and responsibilities to oversee day-to-day operations, and adopting best corporate practices. The parties must also have effective procedures for the resolution of deadlock situations. There must also be proper alignment of the interests and goals of the joint venture parties prior to establishing the joint venture. An important way to tackle corruption-related governance issues is incorporating strict anti-corrupt practice clauses in the joint venture agreements between the parties. Such internal measures can be guided by the corporate governance framework of the Ministry of Corporate Affairs and the Securities and Exchange Board of India.

Nominee directors

With an incorporated joint venture, what controls exist in your jurisdiction in relation to nominee directors? How should a nominee director balance the potentially conflicting interests of the joint venture company and the appointing shareholder?

Directors nominated by shareholders are vested with the power of oversight over the business operations of the company, are responsible for any cases of non-compliance, and are statutorily bound to act in the best interests of the company at all times and in good faith to promote the company’s objectives. Directors are not supposed to act as representatives of shareholders on the board; they have a fiduciary duty towards the company itself. Nominated directors are obligated to avoid situations in which the interests of the company may be in conflict with the shareholders’ interests. However, in practice, there are situations where such conflicts arise, particularly when a shareholder has business dealings with the joint venture company. To deal with situations of conflict, the Companies Act enables directors to excuse themselves from participating in meetings where such conflicted transactions or matters are proposed to be considered. Further, significant decisions may be reserved for approval by the shareholders taking away any decision-making powers of the directors, thereby avoiding any possible conflict at the board level. However, while deciding the items that may be reserved for decision-making at the shareholder level, it should be noted that some items can only be resolved at the board level.

Competition law

What competition law considerations are engaged by the formation and operation of the joint venture? Is approval needed?

The Competition Act, 2002 (the Competition Act), read with the Competition Commission of India (procedure in regard to the transaction of business relating to combinations) Regulations, 2011, requires mandatory pre-notification of all acquisitions of shares, voting rights, assets or control and mergers and amalgamations (combinations) that cross prescribed thresholds to the Competition Commission of India for its approval prior to completion of the transaction. The thresholds for mandatory pre-notification are set out in terms of assets or turnover in India and abroad. These thresholds are:

  • at the enterprise level, the parties to the combination jointly have:
    • in India, assets valued at more than 20 billion rupees or turnover of more than 60 billion rupees; or
    • in India or outside India, in aggregate, assets valued at more than US$1 billion with at least 10 billion rupees in India, or turnover of more than US$3 billion with at least 30 billion rupees in India; and
  • at the group level, the group acquirer to the combination jointly has:
    • in India, assets valued at more than 80 billion rupees or turnover of more than 240 billion rupees; or
    • in India or outside India, in aggregate, assets valued at more than US$4 billion with at least 10 billion rupees in India or turnover of more than US$12 billion with at least 30 billion rupees in India.

 

A de minimis exemption, or a small target exemption, for a transaction is available and such transactions do not qualify as a combination under the Competition Act. Accordingly, enterprises that are a party to a combination where the value of assets being acquired, taken control of, merged or amalgamated is not more than 3.5 billion rupees in India, or where the turnover is not more than 10 billion rupees in India, are exempted from the pre-notification requirement under the Competition Act. The de minimis exemption is presently available until 26 March 2022. In general, the Competition Act prohibits combinations that cause, or are likely to cause, an appreciable adverse effect on competition within the relevant market in India. Any such combination is void.

Provision of services

What are the key considerations in your jurisdiction in structuring the provision of services to the joint venture entity by joint venture parties?

A transaction for rendering services between the joint venture entity and joint venture parties is likely to qualify as a transaction between associated enterprises under the tax laws in India and, thus, would be required to be conducted on an arm’s-length basis. The said transaction may also fall within the ambit of a related party transaction under the Companies Act, requiring compliance with the relevant provisions of the Companies Act. The supply of services by the joint venture party to the joint venture entity would also be exigible to goods and services tax, depending upon the rule of place of supply.

Therefore, subject to the above, a transaction for provision of services between the joint venture party and the joint venture entity is flexible to be structured based on the commercial consideration of the parties.

Employment rights

What impact do statutory employment rights have in joint ventures?

India’s legal framework for employment consists of various laws, codes and regulations formulated by the central and state governments. Such framework needs to be complied with in the case of employees of the joint venture entity, including employees seconded or transferred to the joint venture entity. For the purposes of applicability of employment laws, employees are broadly categorised as workmen and non-workmen. A workman is a person who is employed in any industry to do any manual, unskilled, technical, clerical or supervisory work and their employment is strictly governed by India’s labour laws. Any person working in a managerial or administrative capacity falls under the category of non-workmen and their terms of service are primarily governed by employment agreements. In the case of secondment, the secondee’s employment will be governed by the employment laws applicable for the category in which the secondee falls.

It is not uncommon for foreign joint venture parties to send their employees on secondment to their Indian joint venture company. Generally, secondee employees possess high technical and managerial skills. Employment visa conditions for foreign secondees prescribe a minimum salary of US$25,000 per year as an annual floor limit (except for a few categories of employees, such as ethnic cooks, language teachers and translators). Further, the employment arrangement for secondees is generally structured in such a way that while the secondee maintains an employment relationship with the foreign joint venture party, the secondee also enters into an employment relationship with the joint venture entity. This is to mitigate the risk of creating a permanent establishment or place of business of the foreign joint venture party in India.

Intellectual property rights

How are intellectual property rights generally dealt with on the creation, operation and termination of a joint venture in your jurisdiction?

Intellectual property (IP) rights are generally licensed by the joint venture parties to the joint venture entity, if required. In some instances, the IP is also assigned to the joint venture entity. The terms and conditions of such licensing arrangements and assignments can be commercially decided by the parties. At present, there is no restriction on the payment of royalties by the Indian joint venture company to the foreign joint venture IP owners. The joint venture parties may retain ownership rights on their background IP and license the same to the joint venture entity.

Typically, on termination of the joint venture, the implications for the IP rights – including for transferred IP, developed IP or foreground IP – are dealt with in the joint venture agreement itself and the parties may agree on various options, such as a buyout of the IP from the joint venture, obtaining a licence for use or a sale of the foreground IP to a third party and distribution of the proceeds.