MLS Chase solicitors Establishing a joint venture in india An Overview Manoj Ladwa & Vaibhav Shukla MLS Chase 2007 The information in this document is provided for general information purposes only and does not constitute legal or professional advice. Relevant legal or professional advice should be sought before taking any decision based on the contents of this document. This article was first published by the Practical Law Company www.practicallaw.com MLS Chase, 2nd Floor, Berkeley Square House, Berkeley Square, Mayfair, London W1J 6BD T +44 (0)20 7222 5966 E info@mlschase.com
Establishing an Equity Joint Venture in India an Overview India s foreign direct investment (FDI) rules have been substantially liberalised since the country first allowed foreign investment in the early 1990s. Most sectors are now open to 100% FDI. However, many foreign investors still prefer to set up a joint venture with an Indian partner company as this can, for instance, give them access to the Indian partner s pre-established market and distribution channels, local management and know-how. This article examines the following key factors involved in establishing a joint venture between a foreign investor and an Indian partner: Early considerations. Understanding FDI rules. Conducting appropriate due diligence. Structuring the joint venture vehicle. Company formation. Obtaining regulatory licences and approvals. Employee issues. Taxation and duties. Protecting intellectual property rights (IPR). Joint venture documents. Early Considerations Establishing a joint venture in India can be a relatively straightforward process if planned properly, but potential investors must take account of cultural differences and expectations from the outset. Some differences in approach to be aware of include those in relation to the drafting of documents. While documents in Western jurisdictions tend to be very detailed and prescriptive, Indian documents are usually more general and open ended in nature. Negotiations in India tend to be an ongoing activity and not simply a stage in a transaction. As a result, even after a document has been executed, there is a perception among Indian parties that if circumstances change, the document can naturally be amended, which can be frustrating to their foreign counterparts. In addition, the Indian decision-making process can be very hierarchical, and so it is important to determine who the ultimate decision maker is and involve him in the negotiations early on. If this is not done, a great deal of time can be wasted in negotiating at the wrong level. Other issues to be considered early on in the process include how any disputes during the life of the joint venture will be dealt with, and how the foreign investor will be able to withdraw its investment from India if it chooses to exit the venture. Litigation in India is relatively slow as there is a large backlog of cases. As a result, many foreign investors prefer to have an arbitration or alternative dispute resolution clause in their joint venture agreement (see below, Documents). The relevant legislation concerning both international and domestic arbitrations is the Arbitration and Conciliation Act 1996. The act gives flexibility to conduct arbitration in various jurisdictions and the awards passed in a foreign jurisdiction are recognised and enforceable in India. Repatriation of dividends and capital is a relatively straightforward process. Under the automatic approval route (applicable to FDI within the prescribed limits set by the Reserve Bank of India (RBI)), as long as the equity 5 www.mlschase.com 1
investment enters India through normal banking channels, and the RBI is informed in prescribed form within 30 days of the inward remittance, then repatriation is permitted without the need for any further approval. Understanding FDI rules Although most sectors of the Indian economy are fully open to FDI, there are certain sectors where FDI is either capped (for example, telecoms, insurance and defence manufacturing) or totally prohibited (such as multi-brand retail, atomic energy and agriculture). (Prior government approval is also required in relation to FDI in defence manufacturing.) Other sectors, such as real estate development, are subject to certain investment criteria; if these are not met, FDI is prohibited. As a result, it is important to check the rules on foreign investment at the outset of any joint venture to confirm what is and is not permitted. FDI rules can be found on the Department of Industrial Policy and Promotion website (see http://dipp.nic.in). If an investment falls within the rules, it is deemed to have received automatic approval from the RBI, which is the institution responsible for gate-keeping foreign investments into India. The RBI must be notified in prescribed form within 30 days of share subscription. All other equity investments require the prior approval of the RBI. Conducting due diligence As with any joint venture, the foreign (and, for that matter, the Indian) partner should be fully aware of any underlying legal or commercial issues that may affect the other party and the proposed joint venture. While a great deal of information on Indian companies is available publicly, in some cases (for example, in relation to smaller companies) a formal due diligence exercise may be the only way of finding the necessary information. Due diligence exercises are relatively rare in India, and a foreign investor may need to sell the process as standard practice in its own jurisdiction. The replies provided by the Indian partner are normally warranted by it in a subsequent joint venture agreement and possibly backed by indemnities in the event that the answers later prove to be misrepresentations (see below, Documents). Corporate structure The corporate vehicles that foreign investors usually consider establishing for a joint venture are the private limited company and the public limited company. The private limited company is more commonly used. The information provided in the rest of this article is based on the assumption that the joint venture vehicle used is a private limited company. The following issues arise when establishing a private limited company: Capitalisation. A private limited company requires a minimum paid up capital of INR100,000 (about EUR1,706 or US$2,270). If the company uses certain words such as India or Hindustan in its name then the minimum paid up capital requirement is INR500,000 (about EUR 8,533 or US$11,351). Minimum directors and shareholders. A private limited company requires a minimum of two directors and two shareholders. The directors need not be Indian nationals or residents. However, for practical reasons (for example, signing of routine regulatory or statutory documents), it is advisable that at least one of the directors is resident in India. If investment is taking place in an economic sector where 100% FDI is permitted, then all the shareholders of the Indian joint venture company (Indco) can be foreigners. The requirement of two shareholders must be fulfilled 2 www.mlschase.com
at all times, but there are no restrictions on the proportions of Indco s equity that each shareholder holds. One shareholder can therefore hold a nominal one share. The foreign investor s directors may also consider taking out specific directors and officers liability insurance. Management structure. It is important to agree the proposed management structure and to identify which party has control early in the joint venture process. Ideally, management structure, control and safeguards should be agreed when preparing the memorandum of understanding (see below, Documents). Investing via an offshore entity. The foreign investor may wish to route the investment via an offshore jurisdiction with a favourable double taxation agreement, such as Mauritius. This may be a useful structure if one of the aims of the joint venture partners is to realise their respective investments through an eventual sale of Indco, as it may allow for the minimisation of any capital gains taxes payable in respect of gains which accrue from a sale (see box, Double taxation agreements). Company formation The process of company formation in India is not straightforward or quick. It can, for example, take up to eight weeks to incorporate a private limited company, typically involving the following main steps: Reserving a company name with the Registrar of Companies. Drafting constitutional documents (the memorandum and articles of association) (see below, Documents) and submitting them before the Registrar of Companies for scrutiny. Submitting various prescribed forms (for example, the registered address form). Liaising with the Registrar of Companies. Obtaining the certificate of incorporation. Following this, some further steps to be taken include: Online registration of prospective directors. Opening a bank account. Applying for a permanent account number. Issuing share certificates, and informing the RBI of the investment. Arranging for the seal of the company or rubber stamp. Holding an initial board meeting and passing resolutions. Maintaining a register of members. Regulatory licences and registrations Once Indco has been established, it needs to obtain various licences and registrations including: Shops and establishment licence. Value added tax (VAT) and sales tax registration. Permanent account number and tax deduction account number. www.mlschase.com 3
If the business of the joint venture involves the importation of equipment from abroad, an import and export licence is also required. If manufacturing units are to be established in India, Indco also needs to obtain various industrial approvals based on national and state regulations. These approvals are dependent on the precise nature and location of the activity (for example, environmental clearances may be necessary). Employees Contracts of employment for so-called white-collar employees are generally governed by the Indian Contracts Act, which is essentially a codification of English contract law. The hiring and firing of staff is therefore normally subject to the terms of the contract rather than any stringent employment legislation. Provident Fund (similar to, for example, UK national insurance) payments and gratuity payments are, however, governed by statute, which should be consulted. Many foreign investors have their standard employment contracts amended to the extent that it is necessary to conform with Indian law or cultural norms, such as the provision of casual leave or more benefits in kind rather than cash. A similar approach can be adopted when drafting employee handbooks for Indco. In respect of so-called blue-collar workers, more stringent employment laws apply. The governing legislation includes: The Child Labour (Prohibition and Regulation) Act 1986. The Employees Provident Fund and Miscellaneous Provisions Act 1952. Industrial Disputes Act 1947. The Maternity Benefit Act 1961. Minimum Wages Act 1948. Payment of Bonus Act 1965. Payment of Gratuity Act 1972. Payment of Wages Act 1936. Payment of Wages (Amendment) Act 2005. Factories Act 1948. Employees State Insurance Act 1948. Taxation and duties A company incorporated in India, irrespective of whether it is wholly or partially owned by a foreign company, is considered to be a domestic company for the purposes of income tax. The current rate of corporate income tax, including a temporary surcharge, is effectively 33.66%, subject to allowances. 2 www.mlschase.com 4
Some other taxes that may impact Indco include: Dividend distribution tax. Withholding tax. Service tax. VAT/central sales tax. Excise duty. Import duty. Octroi (a border tax imposed on goods being transferred between Indian states). If there is likely to be any contract of supply between the foreign investor and Indco, transfer pricing issues also need to be considered. IPR India operates a system of registration for IPR and is a signatory to various international IPR treaties. The perception remains, however, that India is a high-risk area for IPR theft. A foreign investor should conduct an audit to identify what, if any, of its IPR will be exposed to the Indian market, and then consider whether it is worth protecting. Steps that can be taken by a foreign investor to protect its IPR include registration and the making of specific provision in the joint venture agreement. Separate documentation ancillary to the joint venture agreement may also be executed, such as a name and logo licence agreement (also known as a Registered User Agreement) with Indco. There are certain norms laid down by the RBI on the repatriation of royalties that also need to be considered. Documents The documentation that usually has to be put in place when establishing a joint venture company in India includes: Memorandum of understanding. The foreign investor and Indian partner need to establish a clear understanding of each other s objectives for the venture and ensure that they are compatible. The memorandum of understanding (sometimes called the letter of intent or heads of agreement) can help to achieve this. It should be prepared carefully, with thorough discussion and mediation between the parties. The memorandum of understanding should usually address: the parties intentions and likely progression of the venture; commercial terms (such as contributions to the joint venture) in enough detail to ensure that any differences can be identified early in the process; management, control and safeguards; www.mlschase.com 5
division of early costs; exclusivity arrangements; the extent to which the memorandum of understanding is to be legally binding. Joint venture or shareholders agreement. The joint venture agreement establishes the relationship between joint venture partners and the way in which the company will be run. It usually includes clauses on: shares; management structure; withdrawal rights; competition issues; dispute resolution; IPR; any warranties or indemnities. As an example, a joint venture agreement often includes an arbitration clause. This normally addresses, among other things: the place of arbitration; the language in which the arbitration will be conducted; the number of arbitrators; the procedure to be followed by the arbitrator or arbitrators. Constitutional documents. These are the memorandum and articles of association. The articles of association is a binding legal document that formalises the constitution of the new company. It should replicate as far as commercially and technically appropriate the terms of the joint venture agreement. Consistency between the two documents is important. In the event of any dispute between the articles of association and the joint venture agreement, the articles prevail. Registered User Agreement (see above, IPR). Technology licence and know-how agreement (if there is a technology and know-how transfer involved). Directors service agreements. Corporate governance and policy manual. Other agreements commonly negotiated include those relating to supply, distribution, secondments and confidentiality. 42 www.mlschase.com 6
Establishing a Joint Venture in India Double taxation agreements India has entered into Double Taxation Avoidance Agreements (DTAAs) with numerous countries including the UK and the US. The DTAA between the UK and India, for instance, provides for various tax benefits including lower rates of capital gains and withholding tax. In addition, India has entered into a more favourable double taxation agreement with Mauritius. Under normal circumstances, the proceeds of a sale of shares in an Indian company are usually taxed in India, even if the seller is not tax resident in India. However, under the India-Mauritius tax treaty, no capital gains tax in either India or Mauritius is payable on the sale of the shares of an Indian company by a Mauritian company. While there is a lower tax rate on dividends for Mauritius tax residents under the treaty, corporate dividends declared by an Indian company are presently not taxed in the hands of the recipient on payment of a dividend tax by the Indian company declaring the dividend. This dividend tax rate currently stands at 14.02%, although under the recently introduced Finance Bill this would increase to 16.99%. 5 www.mlschase.com 7
The Authors Manoj Ladwa Manoj Ladwa is a recognised expert on cross border investments. He is a practicing English solicitor and Indian advocate. Manoj is the founder and chief executive of the MLS Chase Group, a professional services organisation with offices in London, Mumbai, and Hong Kong. Manoj co-founded and is an Director of Saffron Chase. a leading India focussed corporate and government affairs consultancy. He is an accomplished media commentator, conference speaker, and has authored over 100 published articles. Collectively his clients have contributed to over 5 billion in Indo-UK trade and investment over the past 10 years. In 2003 he established the London office of the Federation of Indian Chambers of Commerce and Industry. Manoj is a consultant on India to the Centre for International Briefing. Manoj is the honorary solicitor to the National Congress of Gujarati Organisations as well as a large number of Indo-British charities. To further his philanthropic activities, Manoj established the MLS Foundation, which works in the fields of education and tackling poverty around the world. Email: manoj.ladwa@mlschase.com Vaibhav Shukla Vaibhav Shukla is a Senior Associate at MLS Chase. He is dual qualified as a solicitor in England & Wales and an advocate of the Supreme Court of India since 1998. He is a corporate lawyer and advises on cross border transactions. Vaibhav relocated to the UK from Mumbai in 2002 to complete his LL.M from the University of Warwick in International Economic Laws. Vaibhav has particular expertise in outsourcing and IT transactions, and has worked for clients from across the globe. He is a frequent speaker at seminars and briefing sessions on doing business in India and contributes regularly to various international legal publications. Vaibhav is vice president of the Global Organisation of People of Indian Origin. Email: vaibhav.shukla@mlschase.com 6428 www.mlschase.com