Invest in India FDI and Profit Repatriation – IT Sector
Introduction – FDI In India
India is considered as Technology Development hub for many multinational companies due its unique positioning of having abundant Talent with economic efficiency. And this continues to be a growing trend where many US based, and European Companies are incorporating technology back office as well and developing ultra-sophisticated applications for end use customers. India will continue to pay a pivotal role in development of Artificial Intelligence (AI), Education Technology (Ed - Tech), Finance Technology (Fin - Tech), Block Chain, ITES- BPM, Health Tech for western economies.
Some of the significant FDI announcements made recently in the Tech Sector are as follows:
• On September 08, 2020, BYJU’s (an Indian education technology firm) raised US$ 500 million in a new round of funding led by Silver Lake, a US-based private equity company; this move pushed the company’s valuation to US$ 10.8 billion.
• In September 2020, Unacademy, an EdTech platform, raised US$ 150 million from SoftBank Group (a Japanese conglomerate), boosting its valuation to US$ 1.45 billion.
• On 14 August 2020, Israel-based Coralogix, provider of machine-learning based log analytics and monitoring solution, announced a strategic expansion into India with a commitment to invest over US$ 30 million in the next five years.
FDI or Foreign Direct Investment in India is permitted through two routes: -
• Automatic Route
Under the Automatic Route, the non-resident investor or the Indian company does not require any approval from Government of India for the investment.
• Government Route
Under the Government Route, prior to investment, approval from the Government of India is required. Proposals for foreign direct investment under Government route, are considered by respective Administrative Ministry/ Department.
Up to 100% FDI is allowed in Data processing, Software development and Computer consultancy services; Software supply services; Business and management consultancy services, Market research services, Technical testing and Analysis services, under automatic route. 100% FDI in the IT sector in India is permitted in B2B E-commerce.
Type of Entities to choose for FDI
As per Reserve Bank of India (RBI), FDI or Foreign Investment means any investment made by a person resident outside India on a repatriable basis in capital instruments of an Indian company or to the capital of an LLP. Hence only 2 types of entities are allowed to receive FDI:
• Limited Company
Companies are broadly classified as private limited companies, public limited companies, small companies and OPCs. Companies may have limited or unlimited liability. A limited liability company can be limited by shares (the liability of a member is limited to the amount unpaid on the shares held) or by guarantee (the liability of a member is limited to the amount for which a guarantee is given). Companies limited by shares are a common form of business entity. Public limited companies can be closely held, and unlisted or listed on a stock exchange.
In case of Listed Company, foreign investor acquiring 10% or more shares in the listed Indian Company will be treated as FDI. Whereas in Unlisted Companies any amount of investment by Foreign Investor is treated as FDI.
• Limited Liability Partnership
An LLP is a body corporate that is a separate legal entity distinct from its partners. An LLP is required to be registered under the Limited Liability Partnership Act, 2008 (LLP Act) with the ROC. Any individual or body corporate (including an LLP, a foreign LLP and an Indian or foreign company) can be a partner in an LLP. An LLP must have at least two partners, and there is no upper limit on the maximum number of partners. An LLP also must have at least two designated partners (DPs) who are individuals, and at least one of them must be resident in India (for bodies corporate, an individual who is a partner or nominee may act as a DP). DPs are liable for compliance under the LLP Act, and in the event of noncompliance they will be liable for penalties. Every DP must obtain a DIN before becoming a DP.
Types of Instruments in FDI
‘Capital Instruments’ means equity shares, debentures, preference shares and share warrants issued by the Indian company.
• Equity shares: Equity shares are those issued in accordance with the provisions of the Companies Act, 2013 and will include partly paid equity shares issued on or after July 8, 2014.
• Share warrants: Share warrants issued on or after July 8, 2014 will be considered as capital instruments.
• Debentures: ‘Debentures’ means fully, compulsorily and mandatorily convertible debentures.
• Preference shares: ‘Preference’ shares mean fully, compulsorily and mandatorily convertible preference shares.
Non-convertible/ optionally convertible/ partially convertible preference shares issued as on and up to April 30, 2007 and optionally convertible/ partially convertible debentures issued up to June 7, 2007 till their original maturity are reckoned to be FDI compliant capital instruments. Non-convertible/ optionally convertible/ partially convertible preference shares issued after April 30, 2007 and optionally convertible/ partially convertible debentures issued after June 7, 2007 shall be treated as debt and shall require conforming to External Commercial Borrowings guidelines regulated under Foreign Exchange Management (Borrowing and Lending in Foreign Exchange Regulations), 2000, as amended from time to time.
FDI Compliances and Process
Initial Investment process
Documents for Form FC-GPR (Foreign Currency - Gross Provisional Return) SMF
• CS Certificate
• Declaration by the Authorized Representative of the Indian Company/LLP
• Pre and post shareholding pattern in the Indian company
• Copy of government approval (if applicable)
• Copy of the order of the High Court on the scheme of merger/ demerger/ amalgamation (if applicable)
• RBI approval on the amount of refund with respect to the amount of the issue (if applicable)
• Valuation certificate from Chartered Accountant
• FIRC/ Debit statement
• Know Your Customer (KYC)
• Board Resolution
Non Repatriable Foreign Investment
Non-Resident Indians and Overseas Citizen of India have an option to invest in Indian Startups through Non Repatriable Mode. This investment will be treated on par with domestic Investment and there is no need to comply with reporting requirements prescribed by RBI for FDI. However, the profits generated by the Indian Company cannot be transferred to the NRI or OCI overseas but will remain in India.
Filing FLA Returns
The annual return on Foreign Liabilities and Assets (FLA) is required to be submitted directly by all the Indian companies which have received FDI (foreign direct investment) in the previous year(s) including the current year i.e. who holds foreign Assets or Liabilities in their Balance Sheets, by July 15 every year.
In case of non-filing of FCGPR or FLA filings within prescribed period, shall attract a general penalty as per Section 13 of FEMA,1999:-
1. thrice the sum involved in such contravention where such amount is quantifiable, or
2. up to two lakh rupees where the amount is not quantifiable,
3. and where such contravention is a continuing one, further penalty which may extend to five thousand rupees for every day after the first day during which the contravention continues
However, to avoid penalties, applicant can apply for compounding of violation by paying following amounts
|1] AAC/ APR/ Share certificate delays In case of non-submission/ delayed submission of APR/ share certificates (FEMA 120) or AAC (FEMA 22) or FCGPR (B) Returns (FEMA 20) or FLA Returns (FEMA 20 (R))||Rs.10000/- per AAC/APR/FCGPR (B) Return delayed. Delayed receipt of share certificate – Rs.10000/- per year, the total amount being subject to ceiling of 300% of the amount invested.|
|2] Allotment/Refunds Para 8 of FEMA 20/2000-RB (non-allotment of shares or allotment/ refund after the stipulated 180 days)||
Rs.30000/- + given percentage:
1st year: 0.30%
1-2 years: 0.35%
2-3 years: 0.40%
3-4 years: 0.45%
4-5 years: 0.50%
>5 years: 0.75%
(For project offices the amount of contravention shall be deemed to be 10% of the cost of project).
Tax Planning in FDI Transactions
Tax effect on FDI transactions is at 3 stages under Indian Income Tax Act
With regard to FDI in Limited Company, investor can acquire shares of the Indian Company by investing in Equity shares or Convertible Debentures either at premium or at Par/ Face value. As per Income Tax Act, private limited companies receiving money towards equity share capital at a premium is taxable if the issue price is above the fair value determined by merchant banker however this provision is not applicable for FDI as the investment is by Non-resident.
Financial Year End
At the end of every financial year the company has 3 stages of tax implications
Net Profit is nothing but Profit before Taxes which every business generates. Tax Rates on profits differ based on nature of entity usually Limited Companies attract 22-25% tax rate and LLP attracts 30% tax rate excluding surcharge and Cess.
What is important to note here is that if the Indian Company generates revenue from its foreign Parent Company or pays for direct cost to foreign Parent Company then such transactions have to be benchmarked to arm’s length pricing as per Transfer Pricing Guidelines which is in line with OECD.
Refer our Newsletter and Booklet on International Transfer pricing for more information.
Dividend is a mode of distribution of profits generated by the business to its shareholders. This is applicable only for limited Companies and not to LLP.
As per Indian Income Tax Act, Dividends are no longer taxable in the hands of the companies as the Dividend Distribution Tax has been removed. Now the shareholder has to pay the tax on receiving dividend as per applicable dividend tax rates.
However as per Section 195 every foreign remittance from India attracts withholding of taxes at applicable rates in conjunction with DTAA. Usually withholding on dividends range from 10% - 20%. Dividends are taxable in the country of residence or source depending on the provisions of DTAA and taxes withheld is available for set off in the country of residence of the investor
However, for LLP Profit after Tax is freely repatriable to partners overseas.
Tax Planning Note: Here you may note that even though LLP attract higher taxes on profits, the effective tax is actually lower than Limited Companies (including dividend).
Refer Profit Repatriation section below for more options on transferring earnings
The Foreign Investor may exit from Investment in Indian Company by way of sale of stake i.e., Equity Shares in case of Limited Company or Partnership in case of LLP. Equity Shares are considered as Capital Asset as per Income Tax Act and hence transfer attracts Capital Gain Tax.
• In case of listed equity shares holding period more than 12 months is considered as long-term capital asset
Tax Planning Note:
Capital Gains is arrived at by reducing Cost of Acquisition from the Sales Consideration. Cost of Acquisition includes all allied cost of acquiring the shares like Share premium, Legal Costs and other relevant costs, apart from this this cost can be expanded by applying the inflation index relevant to the year of sale there by reducing tax impact. Hence proper documentation will help in minimizing tax impact.
Remitting Money from India – Choosing the Right Profit Repatriation Strategy
As discussed in the tax planning section, transferring profits generated by the Indian Business to the foreign promoter or investor can be expensive due to incidence of Income Tax at dual stages in case of Private Limited Company.
Many companies use following strategies to transfer profits from Indian Entity
Commonly, Indian companies pay a royalty to either a holding company or the foreign owner company for technological collaboration. The payment is made for the right to use manufacturing processes, technical expertise, design, drawings, trademarks, and brand names.
If the Indian company uses a technology or process or brand name that is patented or trademarked by the parent foreign company, then the Indian company is liable to pay royalties to the foreign company for using the foreign company’s intellectual property.
Royalty payments to a foreign company usually attracts withholding of taxes at 10-15% Under the Income Tax Act, plus any applicable surcharge and education cess. The tax is calculated on a gross basis on the total royalty payments. Taxability of royalty may also differ based on DTAA with recipient country.
Such payments are deductible expense for the Indian company under section 37 as it a business expense, hence reduces the tax outflow for the Indian Company. The Foreign parent company can claim credit of the withholding of taxes paid in India, while filing Income Tax returns in respective country. However, if the Indian Company is a captive unit of the parent company then this mode of payment can be counter intuitive as every cost has to be billed back to the parent company as per Transfer pricing guidelines.
Under FEMA, royalty payments are categorized as current account transactions and are permitted under the automatic route without any limits.
Interest on Loan
RBI allows Investment in Indian Companies through Equity (FDI) as well as Debt. Debt as per FEMA is termed as External Commercial Borrowings (ECB).
ECB even though is not as simple as FDI compliances (read ECB guidelines), it is an effective way of raising finance for capital intensive businesses. The Compliances include initial reporting of ECB and monthly ECB returns to be filed with RBI. It is important to note that ECB is allowed only for investment in Machinery and Capital assets and not for working capital purposes like salaries.
Advantages of ECB are that
• the capital invested is not locked like FDI forever and it can be repaid by the Indian Company along
• Interest on ECB can be paid by Indian company which is tax deductible
Another option if you find ECB route as complicated would be to issue convertible debentures, which are considered as FDI under the FEMA however can carry interest on the same which is payable by the Indian Company.
Under FEMA, Loan Repayment and Interest is allowed under automatic route only monthly reporting is required
The parent company can charge management fees for the Indian Company for deputing management staff like Group CFO will take care of finances of all subsidiaries, similarly HR policies may be framed at the group level, headed by Group HR and similarly certain other management fees like the training and ERP deployment consulting as well as marketing strategic services might be provided as group level which is benefiting the Indian Company business. The Indian Company can pay for such service fees.
Payments for services, such as management and consultancy fees or IT services by Indian company may or may not attract withholding of taxes, depending on the nature of payments and definitions as per DTAA. Withholding of taxes may range from 0% to 10% plus surcharge, cess. Such payments are deductible expenses for the Indian Company as per Income Tax. Captive centers will attract provisions similar to Royalties.
Meanwhile, under FEMA, payments for services qualify as current account transactions. Service fees up to US$1,000,000 per project (US$10,000,000 per infrastructure project) can be remitted under the automatic route. However, any remittance exceeding this amount requires RBI approval.
Due to the removal of dividend distribution tax (DDT), now the profits distributed by a private limited company is fully taxable in the hands of the recipient and many Indian companies are looking at different options through which they can distribute the profits generated by the company. One of the ways is that Company can explore the share buyback option. Here the company can utilize reserves by offering to buy the shares at a pre-defined price. Usually, this price will be at a premium, that is more than the acquisition price. After the buyback of shares, the company will cancel the shares and reduce their share capital so the share holding pattern will remain unchanged.
However, there is a withholding tax of 20 percent on distributed income at the time of buyback. Distributed income is the difference between the amount paid at the time of buyback and amount received by the company at the time of issue of shares.
Taxation will depend on the DTAAs, in the event of share buybacks, operate diversely, and the tax liability depends on the specific tenets of each DTAA.
The Companies Act of 2013 also creates several regulatory obligations for companies that want to use share buybacks:
• The Articles of Association (AOA) for the Indian company should be amended to authorize share buybacks.
• Each buyback should be authorized through a special resolution passed at the general meeting of the respective company and completed within 12 months of any such resolution.
• A limit of 25 percent per financial year (FY) applies on equity share buyback. The consideration for such shares is capped at 25 percent of the total paid up capital plus free reserves per FY.
• In addition, no free securities should be issued for six months after a share buyback and the debt-to-equity ratio post buyback should be 2:1.
As per FEMA, pricing of shares should be as per internationally accepted pricing methodologies.
Capital reduction is similar to share buyback however under capital reduction, there is no limit described as per companies act of 25% of share capital and free reserves for the financial year. Hence this method is used when amount exceeds share buyback limit as per Companies Act.
The Companies Act, 2013 states that approval is required from the shareholders (as a special resolution), creditors, and the state High Court for capital reduction.
Under FEMA, the pricing of capital should adhere to RBI guidelines; no approvals are required for non- resident investors for capital reduction, so long as a few procedural compliances are ensured.
Exit from FDI
*Indian here refers to Resident Indian as per definition of residential status provided by RBI
Form FC-TRS or Foreign Currency Transfer of Shares needs to be filed in case of transfer of shares of an Indian Company from a resident to a Non-Resident/Non-Resident Indian and vice versa through its authorized dealer bank.
The form shall be filed with the Authorized Dealer bank within Sixty days transfer of capital instruments or receipt/remittance of funds whichever is earlier.
The penalty for non-filing of FC-TRS is imposed by the way of Late Submission Fee (LSF)
|Amount involved (₹)||LSF as % of amount involved||Maximum amount of|
|Up to ₹10 million||0.05%||300% of the amount involved or ₹1 million, whichever is lower|
|More than ₹10 million||0.15%||300% of the amount involved or ₹10 million, whichever is lower|
* The % of LSF will be doubled every twelve months.
The floor (minimum applicable amount) for LSF will be Rs. 100. Company can apply for compounding of Violation as mentioned in Initial Investment Section
FAQ’s by RBI
Q1. If company issued the shares to non-resident on Non-Repatriable basis, whether that company is required to submit the FLA Return?
Ans.: Shares issued by reporting company to non-resident on Non-Repatriable basis should not be considered as foreign investment; therefore, companies which have issued the shares to non-resident only on Non-Repatriable basis, is not required to submit the FLA Return.
Q2: What is meant by investment on repatriation basis and investment on non-repatriation basis?
Ans.: Investment on repatriation basis means an investment, the sale/ maturity proceeds of which are, net of taxes, eligible to be repatriated out of India. The expression investment on non-repatriation basis may be construed accordingly.
Q3: What are the guidelines on valuation of capital instruments?
Ans.: Please refer to regulation 11 of FEMA 20(R).
Issue by an Indian company or transferred from a resident to non-resident - Price should not be less than
The price worked out in accordance with the relevant SEBI guidelines
The fair value worked out as per any internationally accepted pricing methodology for valuation on an arm’s length basis, duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing Cost Accountant.
Transfer from a non-resident to resident - Price should not be more than
The price worked out in accordance with the relevant SEBI guidelines
The fair value as per any internationally accepted pricing methodology for valuation on an arm’s length basis, duly certified by a Chartered Accountant or a SEBI registered Merchant Banker.
The pricing guidelines shall not be applicable for investment by a person resident outside India on non-repatriation basis.
|Particulars||Listed Company||Un-Listed Company|
|Issue by an Indian company or transferred from a resident to non-resident - Price should not be less than||The price worked out in accordance with the relevant SEBI guidelines||The fair value worked out as per any internationally accepted pricing methodology for valuation on an arm’s length basis, duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing Cost Accountant.|
|Transfer from a non-resident to resident - Price should not be more than||The price worked out in accordance with the relevant SEBI guidelines||The fair value as per any internationally accepted pricing methodology for valuation on an arm’s length basis, duly certified by a Chartered Accountant or a SEBI registered Merchant Banker.|
Disclaimer:“Information contained herein is for informational purposes only and should not be used in deciding any particular case. The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Though utmost efforts have been made to provide authentic information, it is suggested that to have better understanding and obtaining professional advice after thorough examination of particular situation.”