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By Rajat Mukherjee, Partner, and Nidhi Killawala, Principal Associate, Khaitan & Co LLP, New Delhi
 
According to the United Nations Conference on Trade and Development (UNCTAD) World Investment Report 2019, India attracted over 77% of the total foreign direct investments that came to the South Asian region. Further, India's mergers and acquisitions (M&A) activity in 2018 reached USD $55.8 billion, with a 77% increase in deal value from USD $31.5 billion in 2017. Given the current economic environment in India and around the world, this trend is expected to continue in the near future as well. In this Top Ten, learn more about key issues that in-house counsel working for a foreign investor may want to consider.
 
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 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 to determine the sector under which it falls and the restrictions imposed on that particular sector. For example, prior government approval is still required in certain sectors such as private security agencies, broadcasting content services, print media, and other sectors.  The documents to be provided and process to be followed for obtaining such government approval would differ on a case-by-case basis.
 

 
2. Know the pricing restrictions
 

The acquisition or transfer of shares of an Indian company by a foreign investor is regulated by prescribed pricing guidelines which limit flexibility. If a foreign investor wants to purchase shares ( any share purchase regardless of the percentage purchased) of an unlisted Indian company from an Indian resident, or wants to subscribe to shares of an Indian company, 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, if an Indian resident wants to purchase shares of an unlisted Indian company from a foreign investor, the Indian resident is required not to pay more than 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 price.

 
3. Evaluate the entry jurisdiction into India
 
Investment into India was often routed through Mauritius because equity investments structured in this manner historically benefited from favourable tax treaty provisions with regard to capital gains (upon an exit, capital gains tax was not imposed in either India or Mauritius). However, in 2016 a number of amendments were 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 or investment in India - this would largely depend on the objectives of the investment and a careful analysis of the tax treaties in effect at the time of investment. Substance in the structure / entity in the investing jurisdiction will be key to be able to benefit from any tax benefit under the tax treaties. 
 
4. Understand the structuring considerations typical to India

(a) Stamp duty: Different structures for investing in India involve different costs. One such potentially significant cost is the payment of a 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.

(b) Asset sale: It is common for companies to acquire or sell entire businesses or undertakings in India, or choose certain key assets and leave others behind. Both forms of business combinations (i.e, business transfers or asset transfers) are popular in India. However, a foreign investor wishing to acquire certain Indian assets or an Indian business may do so only via an Indian entity which acts as the acquirer. The company can be a wholly-owned subsidiary of the foreign investor in sectors where 100% FDI is permitted. Incorporating a company in India is a fairly straightforward process (although occasionally time-consuming).
 

5. Understand acquisition financing in India
 
Indian regulations impose restrictions on the ability of banks in India to provide acquisition financing, prohibiting them from lending to a borrower (whether Indian or non-Indian) for the purchase of shares of an Indian company. This prohibition applies whether the borrower is located offshore or onshore. Furthermore, pure leverage cross-border deals are not common in India. Where a transaction is debt-financed from a lender located outside India, normally an offshore security package is put in place by the offshore acquirer – this is because creating security over Indian assets may require prior approval from the Reserve Bank of India (RBI).
 
6. Know your exit rights

(a) Mergers and Acquisitions (M&A) exit rights: The RBI restricts “downside protection” (a term used by the RBI, which essentially seeks to regulate the manner in which investors attempt to mitigate equity risk) on equity instruments issued by an Indian entity to foreign investors. As a result, guaranteed returns cannot be contractually agreed to in investment agreements involving a foreign investor in India.

(b) Initial Public Offerings (IPOs) or public market exits: In case a foreign investor is contemplating an exit from its Indian investment by way of an initial public offering (“IPO”), a key consideration to be kept in mind by the investing company’s in-house counsel, would be for the interest for the investor not to be classified as a "promoter", and thereby avoid being subjected to the lock-in restrictions (promoters are required to offer a minimum prescribed percentage of their shareholding for a lock-in period of 3 years) and to the disclosure obligations imposed on promoters in India (promoters are responsible and liable for ensuring that all statements and disclosures contained in the offer document are accurate). Further, in case of market exits, pricing is market dependent and may be less attractive than M&A exits, but could be more tax efficient (owing to the applicability of the concessional long term capital gains tax).
 

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, where the target or the assets are based in India, Indian law is preferred as the governing law of transaction agreements. Also, 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 India’s 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 in a new legal action that the claimant would have to bring 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. By contrast, 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 and the procedure for adjudication (including opting for institutional arbitration), makes arbitration an attractive option for foreign investors. It is common to see the Singapore International Arbitration Center (SIAC) or the London Court of International Arbitration (LCIA) being chosen as institutional arbitration centers.
 
9. Understand the consequences of an indirect acquisition of an Indian company

(a) Indirect transfer of Indian shares or interest: As per India’s 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 a share or interest will be taxable in India. The determination of value of the Indian assets as regards to 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 foreign company, there is a legal obligation on the payer (whether resident or non-resident in India) to deduct tax at the source when making any remittance to the payee, if such payment constitutes taxable income under the IT Act. For such purpose, the payer is required to procure certain tax registrations in India (such as a Permanent Account Number and a Tax Deduction Account Number) prior to remittance of the necessary amounts to the payee.
 

10. Know Indian competition law triggers
 

A potential foreign investor should carry out a thorough competition law analysis prior to its investment in India. Acquisitions of shares or voting rights, assets or control, as well as mergers or amalgamations require prior approval by the Competition Commission of India (CCI), if the assets or turnover in India of the acquiring and/or acquired enterprises (individual or combined) exceed specified thresholds

This requirement applies even if the acquirer and target are located outside India. Such application with the CCI must be made within a statutory prescribed time period. The applicable statute prescribes a fine of up to 1% of the total assets or turnover of the combination, whichever is higher, for a failure to notify a transaction to the CCI.  The applicable regulations also provide that certain categories of transactions normally don’t need to be notified to the CCI, such as intra-group restructuring, investment only combinations (subject to certain conditions), and other categories. 

There is also an exemption for acquisitions/mergers/amalgamations involving small targets, namely, targets with assets of not more than 3.5 billion rupees in India or turnover of not more than 10 billion rupees in India. The exemption regarding small targets is available until 28 March 2022, unless extended further. 

Conclusion

While there are certain considerations unique to India that a potential foreign investor should keep in mind, 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 to foreign investors. The government has also initiated reforms on land acquisition and labour laws, to improve the ease of doing business in India. With such measures, it appears likely that M&A activity in India will continue to increase significantly in the future.

 
Region: India
The information in any resource collected in this virtual library should not be construed as legal advice or legal opinion on specific facts and should not be considered representative of the views of its authors, its sponsors, and/or ACC. These resources are not intended as a definitive statement on the subject addressed. Rather, they are intended to serve as a tool providing practical advice and references for the busy in-house practitioner and other readers.
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