Foreign Direct Investment g– Sector specific policy and issues

Amarjeet Singh June 2014

Contents

1 Li it d Li bilit P t hi (‘LLP’)1

2

Limited Liability Partnership (‘LLP’)

Retail Trading – WCCT, SBRT & MBRT 

3 Royalty/ Trademark, Franchise Arrangements

4 Toll Manufacturing

Limited Liability Partnershipp

The LLP Advantage - Summary

Operational flexibility

Perpetual succession and limited liability of Partners

Separate legal entity - can hold property / sue in its own name

LLP agreement - governs ownership, control and management

Flexibility to transfer ‘economic interest’ while retaining management rights under LLP Act, 2009Flexibility to transfer economic interest while retaining management rights under LLP Act, 2009

LLP may prepare financial statements on cash or accrual basis

Relative flexibility for multiple infusion and withdrawals of capital vis-à-vis Company

Easy and multiple repatriation of profits For contribution by resident partners it is possible to repatriateEasy and multiple repatriation of profits. For contribution by resident partners, it is possible to repatriate profits through payment of interest on capital

No Corporate Social Responsibility (‘CSR’) obligation

Lower Compliance vis-à-vis Companies Act, 2013

No board meeting / shareholders’ approval for business conduct

Limited restrictions on related party transactions

Limited reporting requirements

The LLP Advantage - Summary

Tax Benefits

Not liable to Dividend Distribution Tax (‘DDT’), facilitating tax free profit repatriation

N t li bl t d d di id d i iNot liable to deemed dividend provisions

Not liable to Minimum Alternate Tax (‘MAT’) on book profits [subject to Alternate Minimum Tax (‘AMT’)]

Not liable to Wealth tax

Change in profit sharing ratio / admission of new Partner does not restrict carry forward of lossesdoes not restrict carry forward of losses

Possible to migrate existing operations being undertaken by a Company into LLP in a tax efficient manner, if certain conditions are met Post migration LLP shall becertain conditions are met. Post migration, LLP shall be entitled for above tax and commercial advantage

FDI in LLP

Foreign Direct Investment (‘FDI’)/ Reserve Bank of India (‘RBI’) Guidelines

FDI in LLP is permitted only in sectors which are eligible to accept 100 per cent FDI under automatic route and fnot subject to FDI-linked performance related conditions

FDI in LLP requires prior Government of India (‘GoI’) approval

Pricing of partner’s interest in LLP as per Internationally accepted pricing method

Capital contribution from non-residents allowed only by way of cash/ except in case of conversion of existing company to LLP

Investment by way of ‘profit share’ will fall under the category of reinvestment of earnings

LLP to report to RBI, the details of receipt of consideration for capital contribution/ profit shares in prescribed form

Investment in LLP not permitted by FII/FVCI/QFI/FPI

External Commercial Borrowings (‘ECB’) not permitted

LLP with FDI not eligible to make any downstream investments

Downstream investment by an Indian Company with FDI into a LLP permitted if Indian Company and LLP bothDownstream investment by an Indian Company with FDI, into a LLP permitted, if Indian Company and LLP both operate in sectors where 100 per cent FDI is permitted under Automatic Route and there are no FDI-linked performance related conditions

Conversion of existing company into LLP is permissible under approval route, subject to satisfaction of above diticonditions

FDI in LLP

Points of interest Key Challenges

Multiple cash infusions with relatively lower GoI approval may be time consuming. In addition, f fcompliances

Easy and multiple repatriation of profits within a year

O ti l fl ibilit d l li

detailed factual information about activities proposed to be undertaken and draft LLP agreement would need to be provided/ filed upfront

Limited funding options - not ideal for capital intensive Operational flexibility and lower compliances (vis-à-vis Companies Act, 2013)

Limited restriction on related party transactions

sectors

Willingness of Indian banks to extend loans/ funding to LLP

Limited reporting requirements

Relaxed pricing guidelines

S i t f f id i i

ECB’s not allowed

Assets (Tangible/ Intangible) contributed by non-resident partner may not be capitalized

Savings on account of fee paid on increase in authorized share capital (in case of companies)

No stamp duty on capital infusion, conversion of Company into LLP etc. (needs to be examined state-wise)

Outbound investment by LLP expressly permitted

FDI in LLP

Indicative list of sectors in which FDI in LLP is allowed/ not allowed

Major sectors in which FDI in LLP is allowed Key sectors in which FDI in LLP is not allowed

S i R l t tService

Manufacturing

Infrastructure

Real estate

Print Media (publishing newspapers, periodicals dealing with news and current affairs, specialty magazines)

R t ilRetail

Telecom

Financial Services

Wholesale cash and carry

Agriculture/ Plantation activity

Other sectors where FDI allowed subject to performance relatedOther sectors where FDI allowed subject to performance related conditions

FDI in LLP

Key watch outs

RBI guidelines on FDI in LLP issued but following issues not specifically addressed

Restrictions on withdrawal of Partner’s contribution

Payment of Interest on Partner’s Capital

Repatriation of accumulated profits on conversion of C t LLPCompany to LLP

Key challenges on conversion of Company to LLP

Prior approval required from FIPB

Existing ECB’s need to be re-paid

Treatment of past reserves of Company in books of account of LLP

Treatment of existing downstream investments in India/ preference share capital and Compulsory Convertible debentures

Retail Trading• Whole sale cash and carry trading (‘WCCT’)• Whole sale cash and carry trading ( WCCT )• Single Brand Retail Trading (‘SBRT’)• Multi Brand Retail Trading (‘MBRT’)

Evolution of FDI Policy in retail trading

The policy of FDI in retail trading was liberalized in a phased manner:

Year Description about policy change

1997 WCCT with 100 % ownership allowed under approval route

2006 WCCT brought under automatic route

2006 FDI upto 51 % in SBRT under approval route allowed

2010 Discussion paper on FDI in MBRT introduced by GoI

2012 (Jan) FDI upto 100 % allowed in SBRT under approval route subject to certain conditions( ) p pp j

2012 (Sep) FDI upto 51 % allowed in MBRT under approval route subject to certain conditionsand significant relaxation in SBRTg

2013 Further relaxations brought in conditions for FDI in retail trading

WCCT

• WCCT means sale of goods/ merchandise to retailers, industrial, commercial, institutional or other professional business users, etc. WCCT implies sale for the purpose of business and not for personal consumption to ultimate consumers. The yardstick to determine whether the sale is wholesale or not would be the type of customers to whom the sale is made and not the size

Meaning

100% FDI allowed in WCCT under Automatic Route

is wholesale or not would be the type of customers to whom the sale is made and not the size and volume of sales.

• Obtain requisite licenses/ registration/ permits as specified by respective State Government(s)

• Except in case sale made to Government, sales made by wholesaler to be considered as WCCT only when WCCT are made to the entities that fulfill conditions to hold valid registration/Conditions WCCT only when WCCT are made to the entities that fulfill conditions to hold valid registration/ licenses/ permits etc issued by prescribed authorities

• Records indicating all the details of sales to be maintained on a day to day basis

WCCT t i * t k t th h ld t d 25 t f th t t l t• WCCT to group companies* taken together should not exceed 25 per cent of the total turnover of the wholesale entity

• WCCT may be undertaken as per normal business practice, including extending credit facilities subject to applicable regulationsj pp g

• A WCCT trader not to undertake retail trading to sell to the consumer directly

*Group Company’ means two or more enterprises which, directly or indirectly, are in a position to: p p y p , y y, p(i) exercise twenty-six per cent or more of voting rights in other enterprise; or (ii) appoint more than fifty per cent of members of board of directors in the other enterprise.

SBRT

• Products to be sold should be of a single brand only

100% FDI allowed in SBRT – Automatic up to 49%, Government approval beyond 49%

• Products should be sold under the same brand internationally

• Products should be branded during manufacturing

Conditions

• A non-resident entity or entities, shall be permitted to undertake SBRT, for a specific brand, through a legally tenable agreement with the brand owner – onus on compliance on the Indian entity

• Retail Trading in any form by means of E-commerce would not be permissible for companies• Retail Trading, in any form, by means of E-commerce, would not be permissible for companies with FDI, engaged in the activity of SBRT

Additi l Mandatory to source 30% of the value of goods purchased from India, preferably from:-‒ Micro, Small and Medium Enterprises (MSMEs), village and cottage Industries, artisans and

craftsmen, in all sectorsIndian Company, which is the recipient of FDI for undertaking SBRT, needs to comply with

AdditionalConditions incase of FDI > 51%

sourcing requirement The procurement requirement has to be met, in the first instance, within an average period of 5 years beginning 1st April of the year during which the first tranche of FDI is received and to be met on annual basis thereafter

SBRT – Key Considerations

Whether separate approval of sub-brands required? For instance in case of ‘Amway’, whether its

sub brands like ‘Nutrilite’ ‘Artistry’ ‘Satinique’ etc requires separate approval ? Will suchsub-brands like Nutrilite , Artistry , Satinique , etc requires separate approval ? Will such

companies qualify as MBRT or SBRT ?’ only

Products to be soldshould be of a

‘Single Brand’ only

Whether conditions stipulated in the FDI policy for SBRT apply to FDI in an Indian company thatWhether conditions stipulated in the FDI policy for SBRT apply to FDI in an Indian company that

owns an Indian Brand (for instance Fab India)?

Would it be necessary to establish a physical presence/subsidiary/ joint venture in the overseas

jurisdiction for selling the product for satisfaction of this condition?Products should Be sold under the ‘Same brand internationally’

Whether prohibition on account of E-commerce also restricts selling through Online Market Place

Modals* (like Snapdeal, Flipkart etc) ?E-commerce

* An online marketplace (or online e-commerce marketplace) is a type of E-commerce site where product and inventory information is provided by multiple third parties, whereas transactions are processed by the marketplace operator.

SBRT – Key Considerations

Whether FDI limit of 51 percent to trigger the sourcing rule is to be considered on a fully diluted basis in

case of issuance of compulsorily convertible instruments ?

Whether sourcing rule is to be tested against the value of imports (excluding taxes and freight and other

incidental expenses) undertaken by the Indian company or the value of products locally sourced is also to Sourcing Rule

be included for this purpose ?g

Whether products sourced from India should only be utilized for retail operations of the Indian company or

the same can be exported to overseas customers (including group companies of the foreign investor) ?

SBRT – Case Study - IKEA

Press Note 3 (2006 Series) [February 2006] – allowed FDI upto 51% in retail trade under approval route subject to thefollowing conditions:‒ Products to be sold should be of a ‘Single-Brand’ only‒ Products should be sold under the same brand internationally‒ ‘Single brand’ product-retailing would cover only products which are branded during manufacturing.Press Note 1 (2012 Series) [January 2012]- FDI upto 100 % allowed in SBRT under approval route subject to followingadditional conditions apart from the ones mentioned above:p‒ The foreign investor should be the owner of the brand‒ Mandatory to source 30% of the value of products sold from from small industriesIKEA formally filed an application before DIPP highlighting the IKEA’s business model, nature of its operation anddiscussed conditions of SBRT at length Furthermore also requested to provide flexibility in 30% mandatory sourcingdiscussed conditions of SBRT at length. Furthermore, also requested to provide flexibility in 30% mandatory sourcingrequirement.– Brand Ownership - Arrangement between brand owner and investor entity

– Sourcing and some other issues – Ambit and computation issues, Sourcing for exports and nexus with Indian entity ,sourcing plan to be submitted, treatment of business promotion schemes, Incidental sale of food products/ beveragesetc

Press Note 4 (2012 Series) [September 2012]- FDI upto 100 % allowed in SBRT under approval route and followingconditions are relaxed:‒ Brand Ownership relaxed - Only one non-resident entity, shall be permitted to undertake single brand product retail

trading in the country, for a specific brand, through a legally tenable agreement with the brand owner – onus oncompliance on the Indian entity

‒ Sourcing from small industries relaxedg‒ Gestation period of 5 years allowed

SBRT – Case Study - IKEA

Ikea’s entry could mark a transformation in the retail industry in India

• Ikea will invest nearly USD 2 bn to set up 25 stores over 2 phases

Ikea’s impending entry is expected to herald further large investments in India

• Ikea will invest nearly USD 2 bn to set up 25 stores over 2 phases

− This will represent the largest foreign direct investment in the Indian retail sector

• The proposal has received Foreign Investment Promotion Board approval of the Cabinet Committee on Economic AffairsCommittee on Economic Affairs

The government has displayed exemplary flexibility in approving the investment

“This will create confidence among global investors that India has a positive environment for investors“

• Ikea was initially permitted to retail only Ikea branded furniture products in India

− The company requested permission to replicate its global store model in India, including retail of textiles, toys, books, etc., as well as food and beverages

"The government is committed to playing a constructive role in

− The government reconsidered this and provided approval

• The government also showed flexibility with regards to a 30% mandatory local sourcing clause

encouraging [foreign direct investment], especially in areas which create jobs and provide technological advancement“

− The terms for sourcing from local small and medium enterprises were relaxed after discussions

Anand Sharma, Trade Minister

January 2013

SBRT – Case Study

A world renowned jewellery and accessory maker

(‘F.Co’) proposed to set up a Joint Venture (‘JV’) with

id i i i f 1 49 Th JV f dresident investors in ration of 51:49. The JV so formed

would engage in SBRT for goods manufactured by

F.Co. Sale of precious stones and antiques as such

Amongst others, F.Co. sought an approval to sell

‘precious stones’ and ‘antiques’. The clarification was

and antiques as suchwere not allowed.

Sale of Jewellery sought as to how “the condition of branding of

product during manufacturing” is satisfied for such

products.

containing precious stones was allowed.

F Co proposed to have non-exclusive arrangementExclusive arrangement between F Co and JVF.Co. proposed to have non exclusive arrangement

with JV to sell products

between F.Co and JV was insisted

MBRT51% FDI allowed in MBRT subject to Government Approval

• Fresh agricultural produce, fresh poultry, fishery and meat products may be unbranded

• Retail sales outlets may be set up in those States/ Union territories which have agreed or agree in future to allow FDI in MBRT.

• Retail sales outlets may be set up only in cities with a population of more than 1 million as per the 2011 census or any other cities as per the decision of the respective State Governments

Conditions

the 2011 census or any other cities as per the decision of the respective State Governments.

• Minimum amount to be brought in, as FDI, by the foreign investor, would be US$ 100 million.

• At least 50 per cent of total FDI brought in the first tranche of US$ 100 million shall be invested f f f fin `back-end infrastructure` within three years . Back-end infrastructure to exclude cost of front

end units, land and rentals.

• At least 30% of the value of procurement of manufactured/ processed products purchased shall be sourced from Indian micro, small and medium industries, which have a total investment in , ,plant & machinery not exceeding US$ 2 million. (‘Sourcing Rule’).

• Self-certification by the company to ensure compliance of the conditions. Investors to maintain accounts, duly certified by statutory auditors.

• The procurement requirement has to be met, in the first instance, as an average period of 5 years beginning 1st April of the year during which the first tranche of FDI is received and to be met on annual basis thereafter.

R t il T di i f b f ld t b i ibl f i• Retail Trading, in any form, by means of e-commerce, would not be permissible for companies with FDI, engaged in the activity of MBRT.

MBRT – Key Considerations

If the same foreign investor is an investor in various companies for logistics services etc will the back-end

Whether investment in back-end infrastructure (for instance for storage, warehouses, agricultural produce)

in non-FDI approved states will be counted towards investment in back-end infrastructure ?

If the same foreign investor is an investor in various companies for logistics, services etc., will the back end investment made by such investor be aggregated?Back-end

InfrastructureCan back-end and front-end infrastructure be held by separate entities? Can the back-end entity be 100%

owned by a foreign entity since 100% FDI is permitted under the automatic route for a company engaged in o ed by a o e g e y s ce 00% s pe ed u de e au o a c ou e o a co pa y e gaged

back-end infrastructure related?

Sourcing rule would be satisfied if Indian Co purchase from an entity with no or minimal investment in Plant

& Machinery which in turn procures from various SME’s& Machinery, which in turn procures from various SME s

Requirement to infuse USD 50 million in back end would be satisfied by any of the combination i.e. setting-

up new back end infrastructure and/or acquiring existing infrastructure from other Indian entity(s)/acquiring

100 per cent capital of other Indian Company(s) undertaking BI100 per cent capital of other Indian Company(s) undertaking BI

Can a WCCT and MBRT business be undertaken in single entity ? Single entity

or multiple entityp y

Same as SBRT Source Rule

&E-commerce

MBRT – Case Study

UK based retailer (‘UK Co’) approached Government for an approval for undertaking MBRT in India in JV with India partner

(‘I.Co’). UK Co. has another subsidiary in India undertaking WCCT business.

I.Co already operates stores in India (in various states) undertaking MBRT. UK Co proposes to acquire 50 per cent stake in

I.Co.

Based on the information available in public domain, the approval was granted subject to:p , pp g j

UK Co would invest USD 110 million in this venture. 50 per cent of which would be invested in Back end infrastructure

JV entity to sell/close stores operating in states which has not given assent to MBRTy p g g

JV entity to sell/close stores operation in areas which does not satisfy the population criteria

WCCT and MBRT business can be operated in one entityp y

Royalty/ Trademarks/Franchise ArrangementFranchise Arrangement

Royalty/ Trademarks

FDI Policy on payment for foreign technology collaboration was liberalized in 2009 which covers:

• Payments for Royalty/ lump sum fee for technology transferP t f f t d k/ b d• Payments for use of trademark/ brand name

Prior to 2009 liberalization, prior approval was required for payments beyond certain limits/ ceilings

Head Nature Past ceilings Existing Ceilings

Royalty Lump sum Upto USD 2 Million Nil

Royalty Recurring 5% of domestic sales8% of export sales

Nil

Trademarks Recurring 1% of domestic sales2% of export sales

Nil2% of export sales

Payment on account of Royalty/ use of trademarks qualify as current account transactionsPayment on account of Royalty/ use of trademarks qualify as current account transactions

Current account transactions are permissible without any restrictions (except in certain cases)

Franchise Arrangements

Most of the foreign companies/brands operates in India under Franchise model. Under this model, foreign company generally

enters into an arrangement with Indian resident essentially for a) sale of goods on WCCT basis b) right to use brand name.

Such Indian resident sells goods to end customer using such brand name.

• Payments on account of franchise Arrangements qualify as current account transactions

• Current account transactions are generally permissible without any restriction (except in certain cases)

With recent relaxations in SBRT policy, commercially, foreign companies are now evaluating options to set up their own stores in India. This is essentially for following reasons:

To have absolute control on business

No sharing of profitsNo sharing of profits

To mitigate risk of law suits and loss of reputation

To undertake business with specialized business skillsTo undertake business with specialized business skills

Toll Manufacturing

• Toll manufacturing is an arrangement whereby a company (‘M 1’) with specialized equipment, processes raw materials or

semi-finished goods for another company (‘M 2’).

• The existing FDI policy permits 100 per cent foreign investment in companies undertaking ‘manufacturing’ (subject to

certain restrictions in relation to items reserved exclusively for MSME sector) activities and hence the guidelines/

restrictions relating to trading (in any form) ought not to apply to such entities. Accordingly, in case the business

ti d t b d t k b M 2 lifi “ f t ” it ill b li ibl t i FDI d t ti toperations proposed to be undertaken by M 2 qualifies as “manufacture” it will be eligible to raise FDI under automatic route

(subject to certain procedural compliances).

• Thus, the key criteria is whether ‘M 2’ qualifies as ‘manufacturer’ for the purpose of FDI Policy.

• The term “manufacturer” has not been defined under the FDI policy, and hence would need to be interpreted/ understood

based on the meaning assigned under the Income-tax Act, 1961, Excise and other fiscal laws.

• In case, M 2 does not qualify as manufacturer, the conditions as mentioned in previous slides relating to SBRT and MBRT

would apply.

Thank You