Decoding investments in India: Top 10 considerations to bear in mind while investing in India
Feb 09, 2017 Top Ten Download PDF
According to UNCTAD’s World Investments Prospects Survey, India is the third most attractive destination for foreign direct investment (FDI) after China and the US, globally. Further, India’s mergers and acquisitions (M&A) activity in 2016 hit a five year high with a record 1,002 deals having a corresponding deal value of USD 61.4 billion. Given the current economic environment in India and around the world, this trend is expected to continue in the near future as well and in this regard, we have put together a list of certain key issues which we believe should be kept in mind by a potential foreign investor while investing in India:
1. Understand the regulatory landscape
India has an elaborate exchange control regulatory regime. The Department of Industrial Policy and Promotion under the Ministry of Commerce and Industry formulates the Foreign Direct Investment policy (FDI Policy) and promotes, approves and facilitates FDI by prescribing entry routes (automatic or approval), sectoral caps and conditionality. Acquisition of or investment in an Indian company is primarily guided by the FDI Policy. The FDI Policy has now been considerably liberalised to allow 100% foreign ownership in most sectors of the economy, barring a small negative list where foreign investment is prohibited. In certain sectors, the government has prescribed foreign shareholding caps and in some sectors foreign investment is subject to conditions which may require prior written approval of the regulatory authority. As a first step therefore the business of the investee company must be examined so as to determine the sector under which it falls and the restrictions imposed on that particular sector.
2. Know the pricing restrictions
Acquisition / transfer of shares of an Indian company by a foreign investor is regulated by prescribed pricing guidelines which limit flexibility. In case of purchase of shares of an unlisted Indian company by a foreign investor from an Indian resident or subscription to shares of an Indian company by a foreign investor, the foreign investor is required to pay at least the fair market value of the shares (floor price) calculated using an internationally accepted pricing methodology. However, in case of purchase of shares of an unlisted Indian company by an Indian resident from a foreign investor, the Indian resident is required to pay a maximum of the fair market value (ceiling price) calculated using the same methodology set out above. The parties to a transaction involving shares of an Indian company should therefore be mindful of such pricing guidelines while agreeing to the purchase consideration.
3. Evaluate the entry jurisdiction into India
Investment into India was, in the past, often routed through Mauritius because equity investments structured in this manner historically benefited favourable tax treaty provisions with regard to capital gains (upon an exit, capital gains tax was not imposed in either India or Mauritius). However, a number of recent amendments have been made to the Indo-Mauritian tax treaty which are unhelpful as far as equity investments are concerned. A potential foreign investor looking to invest in India should therefore carefully consider the entry jurisdiction into India prior to any acquisition / investment in India.
4. Understand the structuring considerations typical to India
(a) Stamp duty: Different structures for investing in India involve different costs and one such potentially significant cost which should be borne in mind is the payment of stamp duty. The stamp duty payable on documents varies across different states in India and is payable prior to or at the time of execution of the document.
5. Understand acquisition financing in India
Indian regulations impose restrictions on the ability of banks in India in relation to acquisition financing, prohibiting them from lending to a borrower (whether the borrower is located offshore or onshore) for the purchase of shares of an Indian company. Furthermore, pure leverage cross-border deals are also not common in India. Where a transaction is debt-financed outside India, normally an offshore security package is put in place by the acquirer as creating security over Indian assets may need prior approval from the Reserve Bank of India (RBI).
6. Know your exit rights
(a) M&A exit rights: The RBI restricts downside protection on equity instruments issued to non-resident investors. As a result, guaranteed returns cannot be contractually agreed to in investment agreements involving a non-resident investor in India.
(b) IPOs / public market exits: In case a foreign investor is contemplating an exit from its Indian investment by way of an IPO, a key consideration to be kept in mind would be for the investor to not be classified as a “promoter” and thereby avoid being subjected to the lock-in restrictions and disclosure obligations imposed on promoters in India. Further, it would also be pertinent to note that pricing in case of market exits are market dependent and may be less attractive than M&A exits but could potentially be more tax efficient.
7. Choose your governing law wisely
Broadly speaking, Indian law recognizes the freedom of parties in an international contract to choose the governing law, the forum (arbitration/courts) and the jurisdiction for settling disputes. However, typically, Indian law is preferred as the governing law of transaction agreements where the target is based in India or the assets are based in India. It would be important to keep in mind that foreign judgments passed in other jurisdictions are enforceable in India as a decree if such a country is one of the “reciprocating territories” as notified by the central government. If such a country is not recognised as a “reciprocating territory”, then the judgment passed by such a foreign court would merely have evidentiary value while suing afresh before an Indian court of law.
8. Determine the dispute resolution mechanism
Typically, foreign investors are advised to use arbitration rather than rely on local courts for dispute resolution. This is primarily due to the long, drawn out court process in India which is both time and resource consuming. In contradistinction to that, arbitration is a speedier method of dispute resolution, and the scope of judicial review and interference by the local courts is somewhat limited. Further, the freedom given to the parties to choose the arbitrators, the procedure for adjudication, including opting for institutional arbitration, makes arbitration an attractive option for foreign investors.
9. Understand the consequences of an indirect acquisition of an Indian company
(a) Indirect transfer of Indian shares / interest: As per the Income Tax Act, 1961 (IT Act), any share or interest in a foreign company is deemed to be situated in India if its value is derived, directly or indirectly, substantially from Indian assets. Accordingly, transfer of such share or interest will be taxable in India. The determination of value of the Indian assets as regards global assets of the foreign company is to be calculated in the manner prescribed under the IT Act; and
(b) Withholding tax obligations: Where the payee is a non-resident or a foreign company, there is a legal obligation on the payer (whether resident or non-resident) to deduct tax at source when making any remittance to the former, if such payment constitutes income which is chargeable to tax under the IT Act. For such purpose, the payer is required to procure certain tax registrations in India prior to remittance of the necessary amounts to the payee.
10. Know Indian competition law triggers: Acquisitions of shares or voting rights or assets or control or mergers or amalgamations where the assets / turnover in India of the acquiring and / or acquired enterprises (individual or combined) that exceed specified thresholds would need prior approval of the Competition Commission of India (CCI) (which application is to be made within a statutory prescribed time period), even if the acquirer and target are located outside India. The applicable regulations also provide for certain categories of transactions which need not normally be notified to the CCI. There is also an exemption for acquisitions involving small targets, namely, targets with assets of less than 3.5 billion rupees in India or turnover of less than 10 billion rupees in India. The applicable statute prescribes a fine up to 1% of the combined assets or turnover of the combination, whichever is higher, for a failure to notify a transaction to the CCI. A potential foreign investor should therefore carry out a thorough competition law analysis prior to its investment in India.
As a conclusion, we can state that while there are certain considerations unique to India to be borne in mind by a potential foreign investor, India has become increasingly coveted as an M&A destination. The current government in India is undertaking initiatives to boost the confidence of foreign investors in India. For instance, the government has opened up the railways, defence and insurance sectors for foreign investors and land acquisition reforms and labour law reforms have been initiated to improve the ease of doing business in India. With all these measures, we strongly feel that M&A activity in India will continue to increase significantly in the future.
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