This article has been written by Richa Tejwani pursuing the Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho. This article has been edited by Aatima Bhatia (Associate, Lawsikho) and Dipshi Swara (Senior Associate, Lawsikho).
Table of Contents
Introduction
India is one of the largest emerging markets, hence many foreign companies want to start operating in India. A foreign national or an entity can invest and own a company in India by acquiring shares of the particular company, subject to India’s Foreign Direct Investment Policy. The Economic liberalisation of 1991 acted as a catalyst for the Foreign Direct Investment in India. In most of the sectors, FDI is under the automatic route, i.e., allowed without seeking regulatory approval prior to such investment. Thus, FDI in most sectors does not require prior approval from the government. Various foreign investors can invest in a majority of sectors of the Indian Economy through the automatic route.
After completion of the regulatory formalities with respect to foreign exchange, the investor must choose the type of entity-incorporated or unincorporated, to run its operations in India.
Unincorporated entities
A foreign entity planning to set up business in India as unincorporated entities can do so through the following:
- Liaison office.
- Branch office.
- Project office.
- Partnership.
Liaison office
Liaison Office acts as a mode of communication between the Principal place of business/Head Office and entities in India. However, it is restricted to undertake any commercial, trading or industrial activity, directly or indirectly, and is responsible to maintain itself out of inward remittances sent by the principal place of business (abroad) through normal banking channels.
Prior approval of the Authorised Dealer (AD) is mandatory for sectors that permit 100% FDI under automatic route and prior approval under other sectors is granted after consultation with the Ministry of Finance.
Only liaison activities can be undertaken by a Liaison Office. It can act as a mode of communication between Head Office/Principal place of business abroad and parties in India. It is prohibited from undertaking any business activity in India which generates any revenue. Office of the investor’s Head Office outside India is responsible for all expenses of a Liaison office in India. The Liaison Office, thus, is restricted to gathering market information about possible opportunities and creating awareness about the company and its products to prospective Indian customers. Initially, approval for such offices is granted for a period of 3 years and may be extended as and when required by an “AD Category I bank”.
Branch office
Just like the Liaison office, prior approval of the AD is mandatory for sectors that permit 100% FDI under automatic route and prior approval under other sectors is granted after consultation with the Ministry of Finance. A branch office acts as the representative of its foreign parent company. It performs similar business operations as the foreign parent company which include, providing consultancy services, promoting import-export, encouraging technical or financial collaboration between parent and branch offices, amongst others. A branch office, however, is prohibited from carrying out any manufacturing, retail or processing activities. All the expenses of the Branch office will be incurred using the funds received from abroad or the income generated by the branch.
Project office
A project office is solely set up for a project and hence is completely different in terms of establishment criteria and also operationally. A project office may be opened by a foreign company in India subject to the prerequisite of having secured from an Indian company, a contract to execute a project in India. A project office is permitted to operate a bank account in India. Surplus revenue from the project may be remitted to the foreign parent company . The project office is the preferred choice for companies looking to establish a business presence in India for a limited period of time, as per the duration of the contract which is the case in one-time turnkey or installation projects.
Partnership
A partnership does not give effect to a separate legal entity. The liability of the partners is unlimited which means that the personal assets of the partners may be clawed back to meet debt/tax obligations arising out of the partnership business. A partnership is a relationship created between two or more persons who agree to share the profits of a business carried on either by all of them, or any of them acting for all of them. The partnership firm is bound by the acts of any one or all partners. Partners may enter into an agreement to govern the profit/loss sharing percentage in absence of which all partners have to bear the losses equally. Prior approval of RBI is required for investment by foreign entities in Indian partnership firms.
Incorporated entities
A foreign company planning to set up business operations in India as unincorporated entities can do so through the following:
Limited liability partnership
LLP is a type of business entity that allows individual partners to benefit from the economies of scale by working together at the same time protecting them from the liabilities incurred as a result of wrong decisions or misconduct of other partners. Each partner’s liabilities are limited to the amount they put into the business. Limited liability means that in case of insolvency, the personal assets of partners cannot be sold to meet the debt obligations.
LLPs are governed by the Limited Liability Partnership Act, 2008. LLP has a legal existence separate from its partners.
Companies under the Companies Act
Companies are governed by Companies Act, 2013. Companies can be broadly classified into private and public companies.
Private Limited Company
A private limited company has the following features:
- Members- it should have a minimum 2 and maximum of 200 members.
- Limited liability- The liability of shareholders is restricted to the number of shares they hold in the company. This essentially means that the personal assets of the shareholders are safe.
- Perpetual succession- The company never ceases to exist even in case of the death or insolvency of any of its members.
- Articles of Association of a private limited company must prohibit any invitation to the public to subscribe to the securities of the company.
- Paid-up capital- a minimum paid-up capital of Rs 1 lakh or such a higher amount which may be prescribed from time to time.
- Directors- It should have a minimum of two directors.
- Name- all private limited companies to add the word ‘pvt ltd’ after their name.
Public Limited Company
A public limited company has the following features:
- Members- it should have a minimum of 7 members and don’t have a cap on the upper limit.
- It gives access to more capital by raising money through the issuance of shares in public.
- Limited liability- Just like private limited companies, the liability of shareholders is restricted to the number of shares they hold in the company.
- Paid-up capital- a minimum paid-up capital of Rs 5 lakh or a higher amount which may be prescribed from time to time.
- Directors- It should have a minimum of 3 directors and there is no restriction on the maximum number of directors.
- Name- all public companies are required by law to add the word ‘limited’ after their name.
One of the two minimum directors of a private limited company should be a person who resides in India for 182 days or more in a year. For foreign entities that are new to the market, this can be a challenge for a number of reasons, considering they don’t have a reliable relationship in India to appoint as the resident director.
A local non-executive director service is a potential solution to this problem faced by new foreign entities. In order to resolve this shortcoming, an independent director may be placed on the board of the Indian subsidiary primarily to oversee the compliance aspect of the business.
Conclusion
A foreign company may choose the type of entity- unincorporated or incorporated based on the need and requirement that it aims to meet. The unincorporated entities do not require as many regulatory formalities as compared to the incorporated ones. The scope of unincorporated entities is restricted with respect to earning revenue and if the plan is to establish presence for a longer duration, incorporated entities may be more beneficial.
References
- https://smallbusiness.chron.com/difference-between-incorporated-unincorporated-businesses-57463.html
- https://www.legalnature.com/guides/what-are-the-differences-between-incorporated-and-unincorporated-businesses
- https://www.icsi.edu/media/webmodules/companiesact2013/Incorporation_of_Companies-8-8-2015.pdf.
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