How can foreign investors venture into the Indian market?
Entering into a foreign market is a meticulous process, involving a series of steps and informed decisions.
1. Unincorporated entities
Entering into a foreign market is a meticulous process, involving a series of steps and informed decisions. For example, after laying the initial groundwork by having conducted in-depth research on the market, compliance landscape and well suited locations, investors must decide what kind of entity fits best for their future business in India. Should one set up an incorporated or unincorporated entity? - Go merely with Indian sales representatives? Or how about utilizing the benefits of partnering up with an already established Indian company through a joint venture or acquisition?
In the case of unincorporated entities, foreign investors usually prefer the option of opening a Liaison, Branch or Project office. A short introduction and explanation of the respective differences will shed some light on these terms.
If a foreign company’s main aim for Indian representation lies in marketing and establishing contacts with Indian partners (e.g. suppliers, service providers or buyers), then a Liaison office (LO) is usually the best and most economical choice. However, there are also some implications. This entity is not allowed to create any income on its own and can’t engage in sales, trading or other related activities.
The Foreign Exchange Management Act (FEMA) demands that foreign enterprises apply for approval from the Reserve Bank of India (RBI) before establishing their office. As a basic requirement, the latest audited balance sheet of the parent company must confirm a minimum net worth of USD 50,000, having generated profit for at least three preceding years in the home country.
Once established, the LO has to obtain a Permanent Account Number (PAN) from the income tax department. This unique identification number is mandatory for any company or private person obligated to pay income tax. Alongside this, the LO also has to be registered online with the Registrar of Companies (RoC) within one month of establishment.
In terms of compliance, the LO provisions are quite simple to follow as the entity is not generating any income of its own. It simply has to submit an Annual Activity Certificate (AAC) and an audited balance sheet every year. Details for the same are provided in section B of the RBI’s Master Circular.
In contrast to a Liaison Office, a Branch office (BO) is permitted to “conduct business” on its own and is therefore a better choice for enterprises that seek to engage in trade or manufacturing in India. While trading is not subject to many restrictions, the option of conducting unrestricted manufacturing with 100% FDI is currently only possible in Special Economic Zones (SEZ). A BO is otherwise not allowed to conduct manufacturing on its own.
Generally, a BO should be active in the same sector as its parent company. Permitted activities range from export & import, consultancy & research, to technical support for the foreign parent company (exact definition can be found in section C of the above mentioned Master Circular).
The basic requirements for a BO are slightly different to those related with setting up an LO: The latest audited balance sheet must confirm a minimum net worth of 100,000 USD, having generated profit for at least five preceding years in the home country. Since a BO is permitted to do business in India, it is also taxable, has to be audited at the end of every financial year (ending on 31st March), and it is allowed to transfer surplus revenue to its parent company.
In case a foreign company enters into a contract with an Indian counterpart to carry out a specific project in India, it can establish a Project office (PO) for the duration. This is the only main factor that distinguishes a PO from a BO, given that all other requirements and regulations are quite similar.
It is also worth noting that apart from foreign companies, a PO can also be funded by international agencies, as shown in section G of the Master Circular.
However, these options only capture part of the picture. Partnerships, Joint Ventures, Sales Representations, and Limited Companies will be introduced in the next article.