Author: Dhruv Suri, http://www.psalegal.com/
The process of economic reforms in India was initiated in 1991. Since then there has been a constant endeavour to create a foreign investor friendly climate by simplifying procedures for entry and operations. This chapter provides a brief overview of Indian laws that should aid German startups to evaluate their India strategy from a legal and compliance perspective.
A foreign investor may establish an entity in India depending on the nature of activities envisaged and the prevailing government policy in the proposed sector of investment. Broadly there are two types of vehicles that can be used for carrying on business (a) incorporated entities, namely, wholly owned subsidiaries and joint venture companies which may be either public or private companies; and (b) unincorporated entities, namely, liaison and branch offices.
Incorporated entities (subsidiaries and joint ventures)
These include corporations duly incorporated under the Companies Act, 2013. The government permits setting up of a wholly owned subsidiary (WOS) in certain sectors like mining and exploration, petroleum and natural gas, greenfield civil aviation projects, non-scheduled air transport services, information technology, development of integrated township, establishment and operation of satellites, cash & carry wholesale trading, e-commerce activities, greenfield pharmaceutical activity, mass rapid transport services under the automatic route. In certain other sectors such as private sector banking, multi-brand retailing, foreign direct investments (FDI) up to 100 percent foreign equity may be inducted with prior approval of the concerned administrative ministry/department. The obvious advantages of a WOS are, total control over funding, management and profit share of the business. However, the flip side is that in a WOS, where the total management is foreign, advantage of local knowledge is absent.
A joint venture is a popular route for FDI into India either because of the existing sectoral caps in certain areas of investment or it may be the preferred strategy for the foreign investor on account of local knowledge and expertise available through a domestic partner. The joint venture company into which investment is proposed may be an existing Indian company already in business or a new company in which both the foreign investor and the Indian partner acquire an equity stake. Joint venture agreements typically include provisions for resolving deadlocks between venture partners, exit options, equity participation by local and foreign investors, composition of the board and management.
Unincorporated entities (liaison and branch offices)
These include the entities duly formulated for specific purposes and are regulated by the Indian federal bank i.e. the Reserve Bank of India (“RBI”). In certain situations, where the foreign entity would like to assess the market in India, it may consider establishing a liaison/representative/branch office. A liaison office requires light structural setup and represents a place of business in India for the parent company. The liaison office can facilitate technical/financial collaboration between the foreign parent and Indian companies as well as promote exports to and imports from India. Such an office is not permitted to engage in any trading or commercial activity and the overseas head office, through remittances, meets all its expenses. German entities having a profit-making track record for preceding 3 years are eligible for establishing a liaison office.
If the foreign entity envisages a greater presence in India and is keen to undertake activities (manufacturing/trading) of the head office in India, then it may consider setting up a branch office. A branch office is not a separate legal entity unlike a company and any liability of the branch would be the liability of the foreign entity. The purpose for which a branch office can be established includes export-import of goods, rendering professional/consultancy services, carrying out research work for the parent company, promoting technical/financial collaboration, representing and acting as the buying and selling agent for the parent company, rendering information technology, software development and other technical services. Although a branch office is not allowed to carry out manufacturing activities on its own, it is permitted to subcontract.
All companies in India are incorporated under and governed by the Companies Act 2013 (named as “the Act” in this section).
The Act provides for incorporation of different types of companies, the most popular ones engaged in commercial activities being the private limited and public limited companies (liability of members being limited to the extent of their shareholding). Since private companies have lesser day-to-day compliances, it is usually the most preferred mode of doing business in India. India also has entity forms like limited liability partnerships, one-person company, etc., but these are not preferred in the startup ecosystem, especially where the founders are looking to raise external capital. Therefore, a private company is the ideal entity structure for most foreign startups looking to do business in India.
To incorporate a private limited, a minimum of 2 shareholders and 2 directors are required. However, it cannot have more than 200 shareholders and 15 directors. In case these thresholds are crossed, a private company would be deemed as a public company. Further, at least 1 director has to be an Indian resident. This is an important aspect for German startups to keep in mind.
Broadly, a private company:
- Restricts the right to transfer its shares;
- Prohibits any invitation to the public to subscribe for any of its shares or debentures.
The balance sheet and profit and loss account of the company has to be filed with the Registrar of Companies (“ROC”). Any person can inspect the profit and loss accounts of the company filed with the ROC upon payment of prescribed inspection fees.
A public company has a minimum of 7 shareholders and 3 directors. Like a private company, there cannot be more than 15 directors and at least 1 of them must be an Indian resident. A private company, which is a subsidiary of another company, not being a private company, shall be a public company and accordingly, must comply with the requirements of the Act that are applicable to a public company.
The profit and loss accounts, balance sheet, along with the reports of the directors and auditors, of a public company, are required to be filed with the ROC and are available for inspection to the public by paying prescribed inspection fees. Listed public companies are additionally regulated by SEBI and have listing agreements with the respective stock exchange(s) on which they are listed.
Similar to Germany, Private Limited are the most popular forms of business entities used by foreign investors. Investors have to follow several procedures to incorporate a company in India. The process is depicted in the following graphic:
Source: Startup India
Once registered with an office on Indian soil, startups can also register with the Startup India Hub and avail all the benefits the program is offering to startups. For this purpose, the startup has to make an online application via the mobile app or the portal set up by the Department for Promotion of Industry and Internal Trade.