By Justin Bharucha and Donnie Dominic George

Bharucha & Partners

During the last decade, China has emerged as India's largest trading partner, with US$75 billion in bilateral trade for the financial year ended March 31 2012 and US$40 billion trade deficit in China's favour.

Paradoxically, Chinese foreign direct investment in India is comparatively small at US$239 million from April 2000 to November 2012, especially when compared to investments made by other Asian countries. For example, Japan invested US$13 billion during the same period.

Opportunities exist to correct this imbalance. With the changing environment and labour demographic in China, there are considerable incentives for manufacturers to set up centres in India, with reduced labour costs. India also estimates to spend US$1 trillion on infrastructure development over the next five years, creating many avenues for Chinese companies to invest in and increase trade with India. The two countries are also working together to ensure greater Chinese investment in India to correct the trade deficit.

Some Chinese companies have already established an India presence and are looking to capitalise on the opportunities the country has to offer. Huawei, the Chinese telecom equipment maker, will invest US$2 billion in India over the next four years, which includes setting up an R&D centre. Chinese companies are already implementing highway projects worth over US$2.5 billion and this is set to increase three-fold over the next few years.

Chinese investments in India are treated the same as investments from other countries. In sectors like power, telecommunications and infrastructure, which have implications on national security, foreign investment is subject to a higher degree of scrutiny and this applies equally to any Chinese investment in these sectors. A lot of historical adverse perception on Chinese investment falls into this space, but opportunities subsist and have increased.

Establishing an India presence

Foreign investors can establish an Indian presence by setting up a branch office or incorporating a company. The decision will be based on the specifics of the proposed business in India.

Branch or liaison office

A branch or liaison office can be opened in India only with prior approval from the Reserve Bank of India (RBI), unless it is established in a special economic zone to carry out manufacturing or service activities. It is not possible to carry on a fully-fledged business with a branch office, as only certain activities prescribed by the RBI are permitted. Also, only one branch office can be opened in each zone of the country. India is divided into four zones, namely north, south, east and west.

A foreign investor may also open a project office if it has secured a contract from an Indian company to carry out a project in India, provided that execution of the project meets the prescribed criteria. This is an office at the project site and is appropriate if the business in India is limited to executing infrastructure projects. A project office cannot conduct marketing activities nor engage in any other business development.

Investing in a company

A foreign investor may also enter India by directly investing into an existing company or by incorporating a new company, effectively foreign direct investment.

The World Bank Group in its Doing Business Report 2013 ranked India 173 out of 185 economies in respect of ease of starting a business. As the ranking suggests, the process of incorporating a company can be cumbersome. This is particularly true in cases where the company is incorporated with only foreign investors. For this reason, companies are often incorporated by Indian nationals and subsequently transferred to foreign investors. The transfer can be made at par so that it is tax neutral for all parties concerned.

Foreign direct investment

Foreign direct investment (FDI) is administered by the RBI and the Indian government. The government acts through various departments including the Department of Industrial Policy and Promotion (DIPP), which formulates policy on foreign direct investment (FDI Policy). The FDI Policy prescribes inter alia the percentage of investment possible in each sector, specific conditions to which the foreign investment is subject and whether prior government approval is required. This is referred to as the approval route or when not applicable the automatic route, which applies equally to external commercial borrowings.

Foreign investment up to 100% of the Indian company is permitted in many sectors and in sectors where foreign investment is capped, like telecommunications and insurance, prior permission of the FIPB is required to invest in excess of that cap. Only in a few sectors like lottery business, gambling and betting, real estate business or construction of farm houses, manufacturing of cigars, cheroots, cigarillos and cigarettes, is foreign investment completely prohibited.

FDI may be effected only through: (i) vanilla equity shares; (ii) compulsorily convertible preference shares; and (iii) compulsorily convertible debentures. The principle is that FDI must be effected through equity or instruments which mandatorily convert to equity at a conversion ratio which is established at the time of issue. In each case, the subscription or secondary acquisition of such instruments must be effected in accordance with applicable pricing guidelines, which stipulate a floor price when a foreign investor is the acquirer and a cap on the sale consideration when the foreign investor is selling to an Indian entity.

FDI can be effected through a wholly-owned subsidiary or joint venture. Joint ventures and wholly-owned subsidiaries have met with varying degrees of success. Much depends on the requirements of the business and in a joint venture, each party's intent to genuinely cooperate. The advantages and disadvantages of each model are similar to those obtained in other jurisdictions and impose restrictions on foreign exchange transactions. The differences relate to matters of process and procedure with issues like enforcement. The foreign investor must make the choice based on specifics of the investment. However, in sectors where foreign investment up to 100% of the Indian company is prohibited, setting up a joint venture is the only option.

Financial investment

A foreign investor can also choose to establish a presence in India through financial investments. Foreign institutional investors (FIIs) and foreign venture capital investors (FVCIs) are permitted to make financial investments in India subject to applicable rules and regulations.

Foreign institutional investors

FIIs are permitted to invest in the capital of a company incorporated in India under the Portfolio Investment Scheme. According to Indian law, an FII is an entity established or incorporated outside India and which meets the criteria prescribed by the Securities and Exchange Board of India (SEBI) and is registered with it.

The SEBI is the securities market watchdog and regulates the functioning of FIIs. It also prescribes the criteria which an entity must fulfil in order to be registered as an FII with the SEBI.

The Portfolio Investment Scheme permits FIIs to purchase shares and convertible debentures on a recognised stock exchange through a registered broker. An FII can hold up to 10% of the paid-up equity capital or paid-up value of each series of convertible debentures issued by an Indian company subject to an overall cap of 24% on all FII holdings. However, the overall cap of 24% can be increased up to the sectoral cap prescribed by the FDI Policy in certain circumstances.

Foreign venture capital investors

Considering the FDI Policy, FVCIs looking to invest must be registered with the SEBI. As with FIIs, the SEBI prescribes the eligibility criteria for FVCIs and only those entities which match the prescribed criteria will be granted registration.

An SEBI registered FVCI is permitted to invest in: (i) an Indian venture capital undertaking; (ii) a domestic venture capital fund which is registered with the SEBI; (iii) in equity, equity linked instruments, debt, debt instruments and debentures issued by an Indian venture capital undertaking or venture capital fund and in units of schemes and, or, funds set up by a venture capital fund; and (iv) securities listed on a recognised stock exchange. FVCI's are also permitted to make foreign direct investments into Indian companies.

FVCI investment differs from FDI in that there are certain exemptions and tax benefits available to FVCIs. However, the FVCI route is not suitable for strategic investment.

Lending to an Indian company

Indian companies are also permitted to access offshore funds by way of external commercial borrowings (ECBs). ECBs are heavily regulated and the specifics of each ECB will determine whether the permission of the RBI is required.

Companies eligible to raise ECBs can do so only from internationally recognised sources like international banks, international capital markets, multilateral financial institutions, export credit agencies, suppliers of equipment, foreign collaborators and foreign equity holders.

Under the automatic route, the maximum amount of an ECB is US$750 million, but for hotels, hospitals and software companies, the limit is US$200 million in a financial year. To raise amounts greater than the limits prescribed under the automatic route, eligible borrowers will have to approach the RBI under the approval route.

ECBs can only be raised for a permitted end-use which must be specified upfront. Permitted uses include import of capital goods, funding new plant and machinery, or modernising and expanding an existing plant, creating real physical assets in the hotel, hospital, and software businesses, and most importantly, funding infrastructure projects.

ECBs cannot be raised for investment in the real estate sector nor for working capital, general corporate finance or repayment of existing Indian rupee-denominated credit facilities.

Chinese banks hold a significant ECB portfolio. For example, China Development Bank has advanced facilities for over US$2 billion to Reliance Communications.

Complying with Indian law

Companies in India are regulated by both the Central (federal) and the State (provincial) governments.

Over the past few years, foreign investors in India have been affected by the aggressive positions taken by the Indian Revenue. The issue first arose with Vodafone's acquisition of the company that is today Vodafone India. This US$11.2 billion transaction was structured offshore, where the vendor and the purchaser were both foreign investors. However, the Indian Revenue sought to assess the transaction to income tax in India. When this levy was rejected by the Supreme Court of India, the Indian Revenue persuaded the government to amend the Income Tax Act to assess such transaction to tax with retrospective effect from 1962, when the present act was brought on the statute book.

Since then, the Indian Revenue has consistently signalled its aggressive position, most recently by raising a claim of US$1 billion with respect to an equity infusion in Shell India by Shell Gas in 2008. Shell Gas invested INR10/- per share while the Indian Revenue assessed the value of each share at INR183/- and accordingly raised a claim which is presently being challenged.

Employee legislation in India is cumbersome and compliance is a big issue, especially for labour intensive businesses engaged in manufacturing or infrastructure. Labour in India is highly politicised, which complicates matters further and low mobility of labour and difficulties in relocating facilities are common issues.

Nonetheless, a concerted effort to streamline existing labour laws is underway and hopefully the changes will become apparent in the near future.

Environment protection is an increasingly important issue and every foreign investor must ensure that the Indian company in question complies with applicable law. This is increasingly important in the Indian context as inadequate compliance can have adverse consequences.

India offers tremendous opportunities for foreign investors and is actively seeking foreign investment in areas where Chinese businesses hold a market-leading advantage. However, the importance of carefully structuring an investment to be tax efficient and compliant with Indian law cannot be over emphasised. Chinese investment into India should ensure that these issues are considered at inception before actually remitting capital to India.

Justin Bharucha and Donnie Dominic George

Partner and Associate

Justin Bharucha is a partner and Donnie Dominic George is an associate at Bharucha & Partners. Justin and Donnie advise on transaction mandates principally relating to mergers and acquisitions where foreign investors (strategic as well as financial investors like private equity firms) are involved and also financing mandates including external commercial borrowings.

Their practice also includes corporate restructuring, corporate compliance, regulatory compliance, telecommunications, structured finance, employment laws, corporate criminal litigation, power and real estate.

Justin and Donnie have worked extensively on mandates involving Chinese clients – illustratively, advising Reliance Communications with respect to external commercial borrowings availed from China Development Bank and Industrial and Commercial Bank of China.

在印度投资:充满机遇与陷阱

Justin Bharucha 和 Donnie Dominic George

Bharucha & Partners

在过去的十年中，中国已经成为印度最大的贸易伙伴，截至2012年3月31日的财政年度，双边贸易总额达到750亿美元，印度对中国的贸易逆差达400亿美元。