This case study seeks to explore the complicated FDI regulations applicable when an existing foreign joint venture company in India seeks to establish a new joint venture company jointly with a third foreign venture partner in India. As there can be differing views and more than one solution to an issue, the author seeks comments and feedback from the readers.
1. Facts :
(i) XYZ is an Italy-based manufacturer and seller of premium quality luxury bathroom fittings and accessories.
(ii) ABC, Spain and an Indian business family have established a joint venture company, namely, ABC (India) Pvt. Ltd. in which ABC, Spain holds 75% equity shares and the balance 25% is held by the Indian promoters. The company has obtained due permission of FIPB in 2003 for import and distribution in India of ceramic tiles and sanitaryware products of ABC, Spain on wholesale cash and carry basis and act as their indenting agents in India.
(iii) It is desired to establish a new JV company in India jointly with XYZ, Italy, ABC Spain and the Indian promoters. The business of the new JV company shall be to import and distribute in India, on wholesale cash and carry basis, various products of XYZ, Italy, whether manufactured in Italy or by XYZ’s subsidiaries, joint ventures and associates worldwide and also to act as XYZ’s indenting agents in India. The new JV company shall also procure and sell, on wholesale cash and carry basis, such other ancillary products from Indian manufacturers/dealers or from other overseas parties as may be permissible in law. The shareholding pattern is subject to negotiations between the parties.
(iv) Alternatively, ABC (India) Pvt. Ltd. may invest in the equity capital of the proposed new JV company. Thus, the existing JV company, namely, ABC (India) Pvt. Ltd. may be a partner in the new JV company along with XYZ, Italy.
2. Issues :
In this connection, the following issues arise for consideration :
(i) Whether FIPB’s permission is required for setting up such a new joint venture company ?
(ii) What are the implications in terms of Press Note No. 1 (2005 series), dated 12-1-2005 ?
(iii) Which is the preferable mode of investment — Whether ABC (India) Pvt. Ltd. should have a stake in the proposed new JV company or ABC, Spain and the Indian promoters should hold direct equity stake in the proposed new JV company ?
(iv) What are the tax implications ?
3. Analysis of legal provisions :
On analysis and consideration of Press Note 1 of 2005, dated 12-1-2005, Press Note 3 of 2005, dated 15-3-2005, Press Note 7 of 2008, dated 16-6-2008, and Press Note 2 (2009 series), dated 13-2-2009 and Press Note 4 (2009 series), dated 25-2-2009, the following conclusions emerge :
3.1 Whether FIPB’s permission required :
(a) Item No. 29 (a) of Press Note 7 of 2008, dated 16-6-2008 clearly states that wholesale trading on cash and carry basis is allowed under automatic route up to 100% foreign equity. In view of the same, the proposed new JV company can engage in wholesale trading on cash and carry basis without FIPB permission.
(b) However, trading of items sourced from ‘Small Scale Sectors’ would require FIPB’s approval. Thus, the proposed JV company cannot procure and sell such items sourced from SSI Units without FIPB’s approval. It appears that this condition is applicable only to those items which are reserved for manufacture by small scale sectors. Therefore, this point needs to be looked into with reference to Industrial Policy for small scale sector. If the product does not fall in the reserved product list of small scale sector, the same can be procured locally without FIPB approval and can be further traded on wholesale cash and carry basis in India.
3.2 Implications in terms of Press Note No. 1 of 2005 :
The next issue arises whether FIPB’s permission is required by the proposed new JV company in view of the fact that ABC, Spain, already has an existing JV company in India, as noted above. The matter has to be examined in light of Press Note # 1 of 2005, dtd. 12-1-2005 r/w Press Note # 3, dtd. 15-3-2005.
3.2.1 The operative part of Press Note 1 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India is reproduced below :
“Guidelines pertaining to approval of foreign/technical collaborations under the automatic route with previous ventures/tie-ups in India.
Press Note No. 1 (2005 Series), dated 12-1-2005
The Government has reviewed the guidelines notified vide Press Note 18 (1998 series) which stipulated approval of the Government for new proposals for foreign investment/technical collaboration where the foreign investor has or had any previous joint venture or technology transfer/trademark agreement in the same or allied field in India.
2. New proposals for foreign investment/technical collaboration would henceforth be allowed under the automatic route, subject to sectoral policies, as per the following guidelines :
(i) Prior approval of the Government would be required only in cases where the foreign investor has an existing joint venture or technology transfer/trademark agreement in the ‘same’ field. The onus to provide requisite justification as also proof to the satisfaction of the Government that the new proposal would or would not in any way jeopardise the interests of the existing joint venture or technology/trademark partner or other stakeholders would lie equally on the foreign investor/technology supplier and the Indian partner.
(ii) Even in cases where the foreign investor has a joint venture or technology transfer/trademark agreement in the ‘same’ field, prior approval of the Government will not be required in the following cases :
(a) Investments to be made by Venture Capital Funds registered with the Securities and Exchange Board of India (SEBI); or
b) Where in the existing joint venture investment by either party is less than 3%; or
c) Where the existing venture/collaboration is defunct or sick.
iii) Insofar as joint ventures to be entered into after the date of this Press Note are concerned, the joint venture agreement may embody a ‘conflict of interest’ clause to safe-guard the interests of joint venture partners in the event of one of the partners desiring to set up another joint venture or a wholly-owned subsidiary in the ‘same’ field of economic activity.”
3.2.2 The term ‘same field’ has been clarified by the Government of India in Press Note No. 3 of 2005 series as under :
“Subject: Clarification regarding guidelines pertaining to approval of foreign/technical collaborations under the automatic route with previous ventures/tie-ups in India.
1. The Government, vide Press Note 1 (2005 Series), dated 12-1-2005, notified fresh guidelines for approval of new proposals for foreign/technical collaboration under the automatic route with previous venture/tie up in India. According to these guidelines, prior approval of the Government would be required for new proposals for foreign investment/ technical collaboration, in cases where the foreign investor has an existing joint venture or technology transfer / trademark agreement in the same field in India.
2. The Government had, earlier vide Press Note (1999 Series) notified the definition of ‘same field’ as the 4-digit National Industriai Classification (NIC) 1987 Code. It is hereby reiterated that for the purposes of Press Note 1 (2005 Series), the definition of ‘same’ field would continue to be 4-digit NIC 1987 Code.
3. It is also clarified that proposals in the information technology sector, investments by multi-national financial institutions and in the mining sector for same area/mineral were exempted from the application of Press Note 18 (1998 series) vide Press Note 8 (2000), Press Note 1 (2001) and Press Note 2 (2000), respectively. Investment proposals in these sectors would continue to be exempt from Press Note 1 (2005 series).
4. From Para 2(i) of guidelines notified vide Press Note 1 (2005 series), it is clear that prior Government approval for new proposals would be required only in cases where foreign investor has an existing joint venture, technology transfer / trademark agreement in ‘same’ field, subject to provisions of Para 2(ii) of Press Note 1 (2005 series).
5. For the purpose of avoiding any ambiguity, it is reiterated that joint ventures, technology transfer / trademark agreements existing on the date of issue of the said Press Note i.e., 12-1-2005 would be treated as existing joint venture, technology transfer / trademark agreement for the purposes of Press Note 1 (2005 Series).”
3.2.3 On reference to National Industrial Classification (NIC), 1987 Code it is found that the products of proposed new JV company have different NIC Code. In other words, the NIC Code allotted to tiles and sanitarywares is completely different from the NIC Code allotted to bathroom and toilet fittings and accessories. In view of the same, the proposed new JV company would not be required to obtain prior approval of FIPB in terms of the said Press Note 1 r /w Press Note 3 of 2005.
3.3 Preferable mode of investment:
To determine the preferable mode of investment we have to understand the applicability of Press Notes – 2 and 4 of 2009.
The opening Para of Press Note # 4 (2009 series), dated 25-2-2009 reads as under:
“The Policy for downstream investment by Indian companies seeks to lay down and clarify about compliance with the foreign investment norms on entry route, conditionalities and sectoral caps. The ‘guiding principle’ is that downstream investment by companies ‘owned’ or ‘controlled’ by non-resident entities would require to follow the same norms as a direct foreign investment i.e., only as much can be done by way of indirect foreign investment through downstream investment in terms of Press Note 2 (2009 series) as can be done through direct foreign investment and what can be done directly can be done indirectly under the same norms.”
3.3.1 While issuing Press Note 2 and Press Note 4 of 2009 series as aforesaid, the Government was aware of Press Note 1 of 2005, dated 12-1-2005 r / w Press Note 3 of 2005, dated 15-3-2005. In spite of that, Press Note 4 allows an operating Indian Company to invest in another downstream Indian Company by way of Indirect Foreign Investment without any reference or requirement to comply with Press Note 1 of 2005. Probably, the understanding is that the existing Indian JV partner also becomes an interested party in the downstream investment and his interest is in no way jeopardised which is the purpose and rationale of aforesaid Press Note 1 of 2005 r /w Press Note 3 of 2005.
3.3.2 Therefore, it appears that it would be in order for ABC (India) Pvt. Ltd. to acquire an Equity Holding in proposed new JV company with XYZ, Italy without attracting aforesaid Press Note 1 of 2005 and thus it would not require FIPB’s prior approval.
3.3.3 In this connection, attention is invited to Para-graphs 4, 5 and 6 of Press Note 4 of 2009 series, dated 25-2-2009 reproduced below:
“4.0 Guidelines for downstream investment by investing Indian companies’ owned or controlled by non-resident entities’ as per Press Note 2 of 2009 : Recognising the need to bring in clarity into the Policy for downstream investment by investing Indian companies, the Govt. of India now proposes to clarify the policy in this regard.
4.1 The Policy on downstream investment comprises policy for (a) only operating companies (b) operating-cum-investing companies (c) only investing companies.
4.2 The Policy in this regard will be as below:
4.2.1 Only operating companies: Foreign investment in such companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps with regard to the sectors in which such companies are operating.
4.2.2 Operating-cum-investing companies: Foreign in-vestment into such companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps with regard to the sectors in which such companies are operating. Further, the subject Indian companies into which downstream investments are made by such companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps in regard of the sector in which the subject Indian companies are operating.
4.2.3 Investing companies: Foreign investment in investing companies will require prior Government/FIPB approval, regardless of the amount or extent of foreign investment. The Indian companies into which downstream investments are made by such investing companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps in regard of the sector in which the subject Indian companies are operating.
5.0 For companies which do not have any operations and also do not have any downstream investments, for infusion of foreign investment into such companies, Government/FIPB approval would be required, regardless of the amount or extent of foreign investment. Further, as and when such company commences business(s) or makes downstream investment it will have to comply with the relevant sectoral conditions on entry route, conditionalities and caps.
6.0 For operating-cum-investing companies and investing companies (Para 4.2.2, 4.2.3) and for companies as per Para 5.0 above, downstream investments can be made subject to the following conditions:
a) Such company is to notify SIA, DIPP and FIPB of its downstream investment within 30 days of such investment even if equity shares/CCPS/ CCD have not been allotted along with the modality of investment in new /existing ventures (with/without expansion programme);
b) downstream investment by way of induction of foreign equity in an existing Indian company to be duly supported by a resolution of the Board of Directors supporting the said induction as also a shareholders agreement if any;
c) issue/transfer/pricing/valuation of shares shall be in accordance with applicable SEBI/RBI guidelines;
d) Investing companies would have to bring in requisite funds from abroad and not leverage funds from domestic market for such investments. This would, however, not preclude downstream operating companies to raise debt in the domestic market.”
3.3.4 Thus, ABC (India) Pvt. Ltd. will have to notify SIA, DIPP and FIPB of its downstream investment within 30 days of such investment in terms of Para 6(a) of the aforesaid Press Note-4.
The issue arises whether ABC (India) Pvt. Ltd. should have an equity stake in the proposed JV company or ABC, Spain and the Indian promoters should hold direct equity stake in the proposed new JV company. As discussed above, in terms of FDI Policy, both options are equally open. In other words, FIPB permission is not required in terms of Press Note 1 and 3 of 2005, whatever may be the mode of investment. However, on tax consideration as discussed below, investment by ABC (India) Pvt. Ltd. would not be advisable.
3.4 Tax considerations:
3.4.1 Under Indian Tax Laws all companies registered in India, whatever be the nature of activities and extent of public participation or foreign share-holding, are liable to tax at the same rate of taxation. Only foreign companies operating in India through a branch are liable to tax in India at a higher rate since they are not liable to pay Dividend Distribution Tax.
3.4.2 When structuring the shareholding pattern, one has to keep in mind the Dividend Distribution Tax levied u/s.115-0. All Indian companies have to pay Dividend Distribution Tax @ 15% +Surcharge thereon + Education Cess (amounting to 16.995%) on the amount of dividend paid in addition to the normal Income-tax liability. If the equity shares in the proposed JV company are held by ABC (India) Pvt. Ltd., it would involve double payment of Dividend Distribution Tax – once when the proposed new JV company declares dividend in future and second time when ABC (India) Pvt. Ltd. declares dividend out of such dividend income.
3.4.3 As ABC (India) Pvt. Ltd. is a subsidiary of ABC, Spain, it would be liable to pay such Dividend Distribution Tax in terms of S. 115-0(lA) reproduced below, which is self explanatory.
“Special provisions relating to tax on distributed profits of domestic companies
Tax on distributed profits of domestic companies.
115-0. (1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this Section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2003, whether out of current or accumulated profits shall be charged to additional income-tax (hereafter referred to as tax on distributed profits) at the rate of fifteen per cent.
(1A) The amount referred to in Ss.(l) shall be reduced by the amount of dividend, if any, received by the domestic company during the financial year, if:
a) such dividend is received from its subsidiary;
b) the subsidiary has paid tax under this section on such dividend; and
c) the domestic company is not a subsidiary of any other company:
Provided that the same amount of dividend shall not be taken into account for reduction more than once.
Explanation – For the purposes of this sub-section, a company shall be a subsidiary of another company, if such other company holds more than half in nominal value of the equity share capital of the company.”
3.7 Ancillary issues:
3.7.1 The proposed new JV company will have to comply with Transfer Pricing Regulations in respect of business dealings with XYZ, Italy and ABC, Spain.
3.7.2 The proposed new JV company will have to comply with all the formalities with RBI through the authorised dealer within 30 days of the receipt of remittance and within 30 days of allotment of shares, as the case may be. It may be noted that RBI is levying heavy Compounding Fees for any delay in filing the relevant forms and intimations.
3.7.3 The JV company should ensure to obtain ‘In-ward Remittance Certificate’ from the bankers in respect of such foreign remittances received with correct and clear mention of the sender and purpose of the remittance.
4. Summation:
The above discussion and reply to queries may be summarised as follows:
4.1 The new joint venture company with XYZItaly can engage in import and distribution of XYZ’s products in India on wholesale cash and carry basis without requiring prior permission of FIPB as such activities are permitted under automatic route on wholesale cash and carry basis.
4.2 Press Note 1 of 2005 r /w Press Note 3 of 2005 are not attracted as NIC Code of both the products dealt by ABC (India) Pvt. Ltd. and proposed new JV company are different.
4.3 Both the modes of investment in JV company are permissible in Law. In other words, ABC (India) Pvt. Ltd. can have an equity stake in the JV company or ABC, Spain and the Indian promoters can hold direct equity stake in the proposed JV company. However, direct holding by ABC, Spain and the Indian promoters would be preferable in view of tax considerations.
4.4 In view of possible double taxation of dividends by way of Dividend Distribution Tax, shareholding by ABC (India) Pvt. Ltd. in the proposed new JV company would not be advisable.
5. Concluding remarks:
The FDI regulations in India have been amended from time to time by various Notifications and Circulars issued by RBI and various Press Notes issued by concerned Ministries in New Delhi. As a result, the FDI regulations have become such a maze that a foreign investor or his local business partner cannot find his way through the maze without the help of experts. Recent Press Notes 2, 3 and 4 of 2009 have further complicated the web of regulations. The matter is further complicated for an investor by the differing and contrary interpretations adopted by the RBI and the concerned ministry on some issues. If FDI in India is to be encouraged, it is high time that a single policy document be issued in lieu of all previous Notifications, Circulars and Press Notes.
