Foreign Direct Investment Sector specific policy and issues Amarjeet Singh June 2014
Contents 1 Limited it dliability Partnership ( LLP ) 2 Retail Trading WCCT, SBRT & MBRT 3 Royalty/ Trademark, Franchise Arrangements 4 Toll Manufacturing
Limited Liability Partnership
The LLP Advantage - Summary Perpetual succession and limited liability of Partners Operational flexibility Separate legal entity - can hold property / sue in its own name LLP agreement - governs ownership, control and management Flexibility to transfer economic interest while retaining management rights under LLP Act, 2009 LLP may prepare financial statements on cash or accrual basis Relative flexibility for multiple infusion and withdrawals of capital vis-à-vis Company Easy and multiple repatriation of profits. For contribution by resident partners, it is possible to repatriate profits through payment of interest on capital No Corporate Social Responsibility ( CSR ) obligation Lower Compliance vis-à-vis Companies Act, 2013 No board meeting / shareholders approval for business conduct Limited restrictions on related party transactions Limited reporting requirements
The LLP Advantage - Summary Tax Benefits Not liable to Dividend Distribution Tax ( DDT ), facilitating tax free profit repatriation Not liable to deemed d dividend id d provisions i Not liable to Minimum Alternate Tax ( MAT ) on book profits [subject to Alternate Minimum Tax ( AMT )] Not liable to Wealth tax Change in profit sharing ratio / admission of new Partner does not restrict carry forward of losses Possible to migrate existing operations being undertaken by a Company into LLP in a tax efficient manner, if certain conditions are met. Post migration, LLP shall be entitled for above tax and commercial advantage
FDI in LLP Foreign Direct Investment ( FDI )/ Reserve Bank of India ( RBI ) Guidelines FDI in LLP is permitted only in sectors which are eligible to accept 100 per cent FDI under automatic route and not subject to FDI-linked performance related conditions FDI in LLP requires prior Government of India ( GoI ) approval Pricing of partner s interest in LLP as per Internationally accepted pricing method Capital contribution from non-residents allowed only by way of cash/ except in case of conversion of existing company to LLP Investment by way of profit share will fall under the category of reinvestment of earnings LLP to report to RBI, the details of receipt of consideration for capital contribution/ profit shares in prescribed form Investment in LLP not permitted by FII/FVCI/QFI/FPI External Commercial Borrowings ( ECB ) not permitted LLP with FDI not eligible to make any downstream investments Downstream investment by an Indian Company with FDI, into a LLP permitted, if Indian Company and LLP both operate in sectors where 100 per cent FDI is permitted under Automatic Route and there are no FDI-linked performance related conditions Conversion of existing company into LLP is permissible under approval route, subject to satisfaction of above conditions
FDI in LLP Points of interest Multiple cash infusions with relatively lower compliances Easy and multiple repatriation of profits within a year Operational flexibility and lower compliances (vis-à-vis Companies Act, 2013) Limited restriction on related party transactions Limited reporting requirements Relaxed pricing guidelines Key Challenges GoI approval may be time consuming. In addition, detailed factual information about activities proposed to be undertaken and draft LLP agreement would need to be provided/ filed upfront Limited funding options - not ideal for capital intensive sectors Willingness of Indian banks to extend loans/ funding to LLP ECB s not allowed Assets (Tangible/ Intangible) contributed by nonresident partner may not be capitalized Savings on account of fee paid on increase in authorized share capital (in case of companies) No stamp duty on capital infusion, conversion of Company into LLP etc. (needs to be examined state-wise) Outbound investment by LLP expressly permitted
FDI in LLP Indicative list of sectors in which FDI in LLP is allowed/ not allowed Major sectors in which FDI in LLP is allowed Key sectors in which FDI in LLP is not allowed Service Real estate t Manufacturing Infrastructure Print Media (publishing newspapers, periodicals dealing with news and current affairs, specialty magazines) Retail Telecom Financial Services Wholesale cash and carry Agriculture/ Plantation activity Other sectors where FDI allowed subject to performance related Other sectors where FDI allowed subject to performance related conditions
FDI in LLP Key watch outs RBI guidelines on FDI in LLP issued but following issues not specifically addressed Restrictions on withdrawal of Partner s contribution Payment of Interest on Partner s Capital Repatriation of accumulated profits on conversion of Company to LLP Key challenges on conversion of Company to LLP Prior approval required from FIPB Existing ECB s need to be re-paid Treatment of past reserves of Company in books of account of LLP Treatment of existing downstream investments in India/ preference share capital and Compulsory Convertible debentures
Retail Trading Whole sale cash and carry trading ( WCCT ) Whole sale cash and carry trading ( WCCT ) Single Brand Retail Trading ( SBRT ) Multi Brand Retail Trading ( MBRT )
Evolution of FDI Policy in retail trading The policy of FDI in retail trading was liberalized in a phased manner: Year Description about policy change 1997 WCCT with 100 % ownership allowed under approval route 2006 WCCT brought under automatic route 2006 FDI upto 51 % in SBRT under approval route allowed 2010 Discussion paper on FDI in MBRT introduced by GoI 2012 (Jan) FDI upto 100 % allowed in SBRT under approval route subject to certain conditions 2012 (Sep) FDI upto 51 % allowed in MBRT under approval route subject to certain conditions and significant relaxation in SBRT 2013 Further relaxations brought in conditions for FDI in retail trading
WCCT Meaning WCCT means sale of goods/ merchandise to retailers, industrial, commercial, institutional or other professional business users, etc. WCCT implies sale for the purpose of business and not for personal consumption to ultimate consumers. The yardstick to determine whether the sale is wholesale or not would be the type of customers to whom the sale is made and not the size and volume of sales. 100% FDI allowed in WCCT under Automatic Route Obtain requisite licenses/ registration/ permits as specified by respective State Government(s) Conditions Except in case sale made to Government, sales made by wholesaler to be considered as WCCT only when WCCT are made to the entities that fulfill conditions to hold valid registration/ licenses/ permits etc issued by prescribed authorities Records indicating all the details of sales to be maintained on a day to day basis WCCT to group companies* taken together should not exceed 25 per cent of the total turnover of the wholesale entity WCCT may be undertaken as per normal business practice, including extending credit facilities subject to applicable regulations A WCCT trader not to undertake retail trading to sell to the consumer directly *Group Company means two or more enterprises which, directly or indirectly, are in a position to: p p y p, y y, p (i) exercise twenty-six per cent or more of voting rights in other enterprise; or (ii) appoint more than fifty per cent of members of board of directors in the other enterprise.
SBRT 100% FDI allowed in SBRT Automatic up to 49%, Government approval beyond 49% Products to be sold should be of a single brand only Conditions Products should be sold under the same brand internationally Products should be branded during manufacturing A non-resident entity or entities, shall be permitted to undertake SBRT, for a specific brand, through a legally tenable agreement with the brand owner onus on compliance on the Indian entity Retail Trading, in any form, by means of E-commerce, would not be permissible for companies with FDI, engaged in the activity of SBRT Additional Mandatory to source 30% of the value of goods purchased from India, preferably from:- Conditions in Micro, Small and Medium Enterprises (MSMEs), village and cottage Industries, artisans and case of craftsmen, in all sectors FDI > 51% Indian Company, which is the recipient of FDI for undertaking SBRT, needs to comply with sourcing requirement The procurement requirement has to be met, in the first instance, within an average period of 5 years beginning 1st April of the year during which the first tranche of FDI is received and to be met on annual basis thereafter
SBRT Key Considerations Products to be sold should be of a Single Brand only Whether separate approval of sub-brands required? For instance in case of Amway, whether its sub-brands brands like Nutrilite, Artistry, Satinique, etc requires separate approval? Will such companies qualify as MBRT or SBRT? Whether conditions stipulated in the FDI policy for SBRT apply to FDI in an Indian company that owns an Indian Brand (for instance Fab India)? Products should Be sold under the Same brand internationally Would it be necessary to establish a physical presence/subsidiary/ joint venture in the overseas jurisdiction for selling the product for satisfaction of this condition? E-commerce Whether prohibition on account of E-commerce also restricts selling through Online Market Place Modals* (like Snapdeal, Flipkart etc)? * An online marketplace (or online e-commerce marketplace) is a type of E-commerce site where product and inventory information is provided by multiple third parties, whereas transactions are processed by the marketplace operator.
SBRT Key Considerations Whether FDI limit of 51 percent to trigger the sourcing rule is to be considered on a fully diluted basis in case of issuance of compulsorily convertible instruments? Sourcing Rule Whether sourcing rule is to be tested against the value of imports (excluding taxes and freight and other incidental expenses) undertaken by the Indian company or the value of products locally sourced is also to be included for this purpose? Whether products sourced from India should only be utilized for retail operations of the Indian company or the same can be exported to overseas customers (including group companies of the foreign investor)?
SBRT Case Study - IKEA Press Note 3 (2006 Series) [February 2006] allowed FDI upto 51% in retail trade under approval route subject to the following conditions: Products to be sold should be of a Single-Brand only Products should be sold under the same brand internationally Single brand product-retailing would cover only products which are branded during manufacturing. Press Note 1 (2012 Series) [January 2012]- FDI upto 100 % allowed in SBRT under approval route subject to following additional conditions apart from the ones mentioned above: The foreign investor should be the owner of the brand Mandatory to source 30% of the value of products sold from from small industries IKEA formally filed an application before DIPP highlighting the IKEA s business model, nature of its operation and discussed conditions of SBRT at length. Furthermore, also requested to provide flexibility in 30% mandatory sourcing requirement. Brand Ownership - Arrangement between brand owner and investor entity Sourcing and some other issues Ambit and computation issues, Sourcing for exports and nexus with Indian entity, sourcing plan to be submitted, treatment of business promotion schemes, Incidental sale of food products/ beverages etc Press Note 4 (2012 Series) [September 2012]- FDI upto 100 % allowed in SBRT under approval route and following conditions are relaxed: Brand Ownership relaxed - Only one non-resident entity, shall be permitted to undertake single brand product retail trading in the country, for a specific brand, through a legally tenable agreement with the brand owner onus on compliance on the Indian entity Sourcing from small industries relaxed Gestation period of 5 years allowed
SBRT Case Study - IKEA Ikea s impending entry is expected to herald further large investments in India Ikea s entry could mark a transformation in the retail industry in India Ikea will invest nearly USD 2 bn to set up 25 stores over 2 phases This will represent the largest foreign direct investment in the Indian retail sector This will create confidence among global investors that India has a positive environment for investors "The government is committed to playing a constructive role in encouraging [foreign direct investment], especially in areas which create jobs and provide technological advancement Anand Sharma, Trade Minister January 2013 The proposal has received Foreign Investment Promotion Board approval of the Cabinet Committee on Economic Affairs The government has displayed exemplary flexibility in approving the investment Ikea was initially permitted to retail only Ikea branded furniture products in India The company requested permission to replicate its global store model in India, including retail of textiles, toys, books, etc., as well as food and beverages The government reconsidered this and provided approval The government also showed flexibility with regards to a 30% mandatory local sourcing clause The terms for sourcing from local small and medium enterprises were relaxed after discussions
SBRT Case Study A world renowned jewellery and accessory maker ( F.Co ) proposed to set up a Joint Venture ( JV ) with resident investors in ration of 51:49. The JV so formed would engage in SBRT for goods manufactured by F.Co. Amongst others, F.Co. sought an approval to sell precious stones and antiques. The clarification was sought as to how the condition of branding of product during manufacturing is satisfied for such products. Sale of precious stones and antiques as such were not allowed. Sale of Jewellery containing precious stones was allowed. F.Co. proposed to have non-exclusive arrangement with JV to sell products Exclusive arrangement between F.Co and JV was insisted
MBRT 51% FDI allowed in MBRT subject to Government Approval Fresh agricultural produce, fresh poultry, fishery and meat products may be unbranded Conditions Retail sales outlets may be set up in those States/ Union territories which have agreed or agree in future to allow FDI in MBRT. Retail sales outlets may be set up only in cities with a population of more than 1 million as per the 2011 census or any other cities as per the decision of the respective State Governments. Minimum amount to be brought in, as FDI, by the foreign investor, would be US$ 100 million. At least 50 per cent of total FDI brought in the first tranche of US$ 100 million shall be invested in `back-end infrastructure` within three years. Back-end infrastructure to exclude cost of front end units, land and rentals. At least 30% of the value of procurement of manufactured/ processed products purchased shall be sourced from Indian micro, small and medium industries, which have a total investment in plant & machinery not exceeding US$ 2 million. ( Sourcing Rule ). Self-certification by the company to ensure compliance of the conditions. Investors to maintain accounts, duly certified by statutory auditors. The procurement requirement has to be met, in the first instance, as an average period of 5 years beginning 1st April of the year during which the first tranche of FDI is received and to be met on annual basis thereafter. R t ilt di i f b f ld t b i ibl f i Retail Trading, in any form, by means of e-commerce, would not be permissible for companies with FDI, engaged in the activity of MBRT.
MBRT Key Considerations Whether investment in back-end infrastructure (for instance for storage, warehouses, agricultural produce) in non-fdi approved states will be counted towards investment in back-end infrastructure? Back-end Infrastructure If the same foreign investor is an investor in various companies for logistics, services etc., will the back-end investment made by such investor be aggregated? Can back-end and front-end infrastructure be held by separate entities? Can the back-end entity be 100% owned by a foreign entity since 100% FDI is permitted ed under the automatic a route for a company engaged in back-end infrastructure related? Sourcing rule would be satisfied if Indian Co purchase from an entity with no or minimal investment in Plant & Machinery, which in turn procures from various SME s Requirement to infuse USD 50 million in back end would be satisfied by any of the combination i.e. settingup new back end infrastructure and/or acquiring existing infrastructure from other Indian entity(s)/acquiring 100 per cent capital of other Indian Company(s) undertaking BI Single entity or multiple entity Can a WCCT and MBRT business be undertaken in single entity? Source Rule & E-commerce Same as SBRT
MBRT Case Study UK based retailer ( UK Co ) approached Government for an approval for undertaking MBRT in India in JV with India partner ( I.Co ). UK Co. has another subsidiary in India undertaking WCCT business. I.Co already operates stores in India (in various states) undertaking MBRT. UK Co proposes to acquire 50 per cent stake in I.Co. Based on the information available in public domain, the approval was granted subject to: UK Co would invest USD 110 million in this venture. 50 per cent of which would be invested in Back end infrastructure JV entity to sell/close stores operating in states which has not given assent to MBRT JV entity to sell/close stores operation in areas which does not satisfy the population criteria WCCT and MBRT business can be operated in one entity
Royalty/ Trademarks/ Franchise Arrangement
Royalty/ Trademarks FDI Policy on payment for foreign technology collaboration was liberalized in 2009 which covers: Payments for Royalty/ lump sum fee for technology transfer Payments for use of trademark/ brand name Prior to 2009 liberalization, prior approval was required for payments beyond certain limits/ ceilings Head Nature Past ceilings Existing Ceilings Royalty Lump sum Upto USD 2 Million Nil Royalty Recurring 5% of domestic sales 8% of export sales Trademarks Recurring 1% of domestic sales 2% of export sales Nil Nil Payment on account of Royalty/ use of trademarks qualify as current account transactions Current account transactions are permissible without any restrictions (except in certain cases)
Franchise Arrangements Most of the foreign companies/brands operates in India under Franchise model. Under this model, foreign company generally enters into an arrangement with Indian resident essentially for a) sale of goods on WCCT basis b) right to use brand name. Such Indian resident sells goods to end customer using such brand name. Payments on account of franchise Arrangements qualify as current account transactions Current account transactions are generally permissible without any restriction (except in certain cases) With recent relaxations in SBRT policy, commercially, foreign companies are now evaluating options to set up their own stores in India. This is essentially for following reasons: To have absolute control on business No sharing of profits To mitigate risk of law suits and loss of reputation To undertake business with specialized business skills
Toll Manufacturing Toll manufacturing is an arrangement whereby a company ( M 1 ) with specialized equipment, processes raw materials or semi-finished goods for another company ( M 2 ). The existing FDI policy permits 100 per cent foreign investment in companies undertaking manufacturing (subject to certain restrictions in relation to items reserved exclusively for MSME sector) activities and hence the guidelines/ restrictions relating to trading (in any form) ought not to apply to such entities. Accordingly, in case the business operations proposed to be undertaken by M2 qualifies as manufacture it will be eligible ibl to raise FDI under automatic ti route (subject to certain procedural compliances). Thus, the key criteria is whether M 2 qualifies as manufacturer for the purpose of FDI Policy. The term manufacturer has not been defined under the FDI policy, and hence would need to be interpreted/ understood based on the meaning assigned under the Income-tax Act, 1961, Excise and other fiscal laws. In case, M 2 does not qualify as manufacturer, the conditions as mentioned in previous slides relating to SBRT and MBRT would apply.
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