Sunil Sethi & Co.
Advocates and Tax Consultants
India's 'strategic autonomy' and 'genuine non-alignment' shall come as a breather when China seeks primacy in a world so far dominated by the West, the world faces a destabilising power tussle.
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India = Investor friendly
Since the 1991, when India began the radical LPG reforms and opened up to the world, foreign investment in India has grown considerably.
The Gated Globe
The forward march of globalisation has paused since the 2008 financial crisis, giving way to a more conditional, interventionist and nationalist models. Many countries are seeing a revival of industrial policy, a previously discredited approach has found new believers. The long trend of falling corporate taxes is being reversed. Enthusiasm for Government regulation, often in areas like the climate, shows no sign of flagging. However justified, more government intervention risks being counterproductive.
India stayed aloof during the Cold War, happy to be the flag-bearer for non-aligned nations. With the rise of China and the retreat of America transforming international relations, and with India’s growing sense of its destiny as a soon-to-be great power. But India has struggled to match the country’s big ambitions with its still-limited capabilities. The relationship with America has grown closer. But there has been little progress on difficult issues. China has made deep inroads in India’s backyard, wooing countries such as Nepal, Sri Lanka and Bangladesh. It has also grown even closer to Pakistan, propping up its economy with billions of dollars worth of arms, infrastructure and investment. China’s navy intrudes with growing frequency into the Indian Ocean, challenging India’s traditional dominance of its own back yard. Yet although the Indian fleet struggles to keep up. So non-alignment has continued. This means that, although it has no real enemies apart from Pakistan, India also has few friends. That would be fine if it were stronger militarily or economically. But among larger powers it stands out as the only one that relies chiefly on imported arms, and whose military budget is spent largely on salaries and pensions.
Lessons from frugal businesses minting money in India
Forget unicorns. To thrive in the subcontinent’s tricky market you are better off with a camel
For foreign investors, India is a puzzle. On the plus side, it is a potentially huge market, recently passing China as the world’s most populous. The imf predicts that India will be the fastest-growing of the world’s 20 biggest economies this year. By 2028 its gdp is expected to be the third-largest, moving past Japan and Germany. The stockmarket is pricing in heady growth. Over the past five years Indian stocks have beaten those elsewhere in the world, including America’s.
The minuses can seem equally formidable. Just 8% of Indian households own a car. Last year the number of individual investors in Indian public markets was a paltry 35m. The smartphone revolution unleashed 850m netizens, but most scroll free apps like WhatsApp (500m users) and YouTube (460m). Blume, a venture-capital (vc) firm, estimates that only 45m Indians are responsible for over half of all online spending. Netflix, the video-streaming giant, which entered India in 2016 and charges Indians less than almost anyone else, has attracted just 6m subscribers.
The tension between tomorrow’s promise and today’s reality is reflected in India’s tech scene. Over the past decade giddy projections of spending by hundreds of millions of consumers led investors to pour money into young tech firms. According to Bain, a consultancy, between 2013 and 2021 total annual vc funding ballooned from $3bn to $38.5bn. Now the easy money is running out. In 2022 startups received $25.7bn. In the first half of this year they got a measly $5.5bn.
Some of India’s brightest tech stars have fallen to earth. The valuation of Byju’s, an ed-tech darling, has plummeted from $22bn to $5.1bn in less than a year. Oyo, an online hotel aggregator, has delayed its public listing even as investors slashed its value by three-quarters, to $2.7bn. Moneycontrol, an online publication, estimates that since 2022 Indian startups have shed more than 30,000 jobs. Investors now worry that companies in their portfolio will never make money. Heavy losses by Indian “unicorns” (unlisted companies worth $1bn or more) bear this out. According to Tracxn, a data firm, of the 83 that have filed financial results for 2022, 63 are in the red, collectively losing over $8bn.
Yet some Indian tech firms manage to prosper. Rather than promise mythical future riches, they are practical and boring, but profitable. Call them camels. Zerodha, a 13-year-old discount brokerage, clocked $830m in revenue and $350m in net profits in 2022. In 2021, the latest year for which data are available, Zoho, a Chennai-based business-software firm founded in the dotcom boom of the late 1990s, made a net $450m on sales of $840m. Info Edge, a collection of online businesses that span hiring, marrying and property-buying, has been largely profitable throughout its 20-year existence. Their success is built on an idea that seems exotic to a generation of Indian founders pampered by indulgent investors: focus on paying customers while keeping a lid on costs.
Consider revenue first. Some founders privately grumble that getting the Indian user to pay for anything is hard. But Nithin Kamath, founder of Zerodha, disagrees. He believes that though the wallet size of Indian consumers is small, they are willing to pay for products that offer value. Zerodha charges 200 rupees (around $2.50) to open a new account when most of its competitors do so for nothing. Mr Kamath believes that even this small amount forces the company to ensure that its users find its platform useful enough to pay that extra fee.
India’s technology dromedaries are also ruthlessly capital-efficient. Zerodha and Zoho have not raised any money from investors. Info Edge was self-funded for five years before raising a small amount, its only outside financing before going public in 2006. Sanjeev Bikhchandani, who founded Info Edge, advises founders to treat each funding round “as if it is your last”.
One way to extend the runway (as vc types call the time before a firm needs fresh funds) is by keeping costs down. Take employee salaries. Richly funded startups throw money at pedigreed developers from top-ranked universities. Zoho enlists graduates of little-known colleges and rigorously trains recruits before bringing them into the fold. The company says that its approach results in a wider talent pool and more loyal employees.
Zerodha, meanwhile, in another contrast to profligate unicorns, does not spend any money on advertising, discounts and other freebies to lure customers. It also uses free open-source alternatives to paid software for its technology infrastructure. The company’s tech-support system for its more than 1,000 employees costs just a few hundred dollars a month to run; an external tool would set it back a few million. Despite being a technology-heavy trading platform, it spends just 2% of revenues on software. Keeping overheads low has the added bonus of allowing companies like it to sell their products profitably at bargain prices, reaching many more customers in the price-sensitive subcontinent.
Reboot, not copy-paste
The slow, measured approach taken by the camels is the opposite of the Silicon Valley playbook of capturing market share first and worrying about profits later. Karthik Reddy of Blume argues that such a model may be better suited for India, where businesses can take many years to find their feet.
One hurdle for companies choosing steady profits over blitzscaling growth remains: the investors themselves. Venture capitalists typically operate on a ten-year clock, bankrolling startups in the first five and cashing out their stakes in the second. This gives investors an incentive to push portfolio firms to pursue growth at all cost. Sridhar Vembu, Zoho’s boss, likens venture capital to steroids—it can boost short-term performance but damage the business in the long run. His may be an extreme view. Still, if investors want big returns on their Indian bets, they are better off backing sturdy camels over sexy unicorns.
Laws governing Foreign Investment in India
Foreign Investment in India, is primarily governed and regulated by Foreign Exchange Management Act, 1999. Presently, the FDI framework in India is primarily governed by:
The Consolidated Foreign Direct Investment Policy Circular dated 15-Oct-2020, issued by the Department for Promotion of Industry and Internal Trade (DPIIT).
Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 dated 17-Oct-2019 notified by the Department of Economic Affairs (DEA), Ministry of Finance, Government of India which superseded the erstwhile Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017. An investor has to follow the sectoral cap or limit that is specified for each sector in the table of Schedule I of FEM (NDI) Rules, 2019.
The payment of inward remittance and reporting requirements are stipulated under the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 issued by the Reserve Bank of India (RBI).
FDI, FPI and FII: The 10% Rule
Excerpts from Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019:
§2(r) Foreign Direct Investment (FDI) means investment through 'equity instruments' by a person resident outside India in an unlisted Indian company, or in ten percent or more of the post-issue paid-up equity capital on a fully diluted basis of a listed Indian company. Through FDI, the investors have a good amount of management control over the operations of the business in the host country.
§2(t) Foreign Portfolio Investment (FPI) means less than 10 percent of the post-issue paid-up equity capital on a fully diluted basis of a listed Indian company or less than 10 percent of the paid-up value of each series of capital instruments of a listed Indian company
§2(g) Foreign Institutional Investment (FII) means an institution registered under the Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995. FII refers to the investment made by the investors by infusing capital into the 'financial assets' of any foreign country. FIIs generally have no control over the management of any companies in the host country in which they are investing. The investments are usually in banks, hedge funds, pension funds, mutual funds, insurance bonds, debentures, etc.
Foreign Investment in India - Procedure
Non-residents can make investments in capital instruments of an Indian company which includes equity shares, debentures, preference shares, and share warrants via the Automatic Route or the Government Route. Under the Automatic Route, no prior approval of the government is required, whereas in Government Route, prior approval of the government is required. The appropriate Administrative Ministry/Department evaluates proposals for foreign investment under the Government route. Foreign Investment Facilitation Portal (FIFP) is the Government of India's new online single-point interface for investors to enable Foreign Direct Investment. This portal is intended to ease the single-window clearance of applications that are in the approval process.
Procedure to be followed after Investment
After receiving Inward remittance through normal banking channel or in NRE/FCNR(B)/Escrow account maintained with an authorized dealer or bank in India, the Indian company is required to report to the relevant Regional Office of Reserve Bank of India. All the reporting is required to be done through the Single Master Form (SMF) available on the Foreign Investment Reporting and Management System (FIRMS) platform at https://fi rms.rbi.org.in
Previously, reporting was required in two stages: first, after receiving funds, filling the Advance Reporting Form (ARF), and second, following allotment, using the Form Foreign Currency-Gross Provisional Return (FC-GPR) form. There is now only one reporting that must be done in the form FC-GPR after allotment of shares within 30 days.
Form FC-GPR needs to be accompanied by Foreign Inward Remittance Certificate(FIRC), KYC of Investor, and other additional documents like certificate from Company Secretary accepting investment, valuation report, etc. Also, every company receiving FDI has to fi le an Annual Return of Foreign Liabilities and Assets to the Reserve Bank by 15th day of July of each year. The company will also be required to pay stamp duty on the shares issued based on the state in which it is registered.
After receiving the investment the company has to call the board meeting and allot shares as per the Companies Act, 2013. Shares may be allotted through private placement by passing special resolution. Then, company has to fi le MGT-14 with RoC to enable itself to send the private placement offer letter in FormPAS-4 to the investors. The records of private placement offer letter needs to be maintained in Form PAS-5. A company has to fi le an e-form PAS-3 with the Registrar of Companies within 30 days of allotment.
Further, the company has to issue the Share Certificate within 60 days from the allotment of shares and update the Minutes' book and Registers accordingly. In case company does not issue shares within 60 days of investment, then it has to refund the money to within 15 days from the date of completion of sixty days to respective non-resident investor.
Pricing Guidelines on Valuation of Capital Instruments
Listed Company - In case of an Issue of Shares to non-residents, the price should not be less than the price worked out as per SEBI guidelines. In case of transfer of Shares from a non-resident to a resident, the price should not be more than the price worked out as per SEBI guidelines.
Unlisted Company- In case of Issue of Shares to non-residents, the price should not be less than the fair value worked out as per any internationally accepted pricing methodology on arm's length basis, duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing CostAccountant. In case of transfer of Shares from a non-resident to a resident, the price should not be more than the fair value worked out as per any internationally accepted pricing methodology for valuation of shares on arm's length basis.
Legal Structures for operating in India opted by MNCs
Liaison office (LO): A Liaison Office (LO) is generally not subject to Income Tax in India, as it cannot conduct business activities and earn profits on account of Indian exchange control regulations. It is required to obtain an Indian tax registration number (PAN) and a withholding tax registration number (TAN). It is required to file an annual statement of its financial affairs and an annual activity certificate (AAC). As an LO cannot generally earn any profits, no repatriation taxes are applicable. Even if there are any unutilized funds available at the time of its closure, they can be repatriated without any exit taxes.
Project Office/ Branch Office: A Project Office (PO)/ Branch Office (BO) is treated as an Indian Permanent Establishment (PE) of its Foreign headquarter. Therefore, it is taxable in respect of its Indian profits at 40%. It is required to obtain a PAN and TAN, file an annual return of income and an AAC. Repatriation of surplus or at the time of closure, PO/ BO is not subject to any additional taxes
LLP: An LLP incorporated in India is treated as a tax resident of India and is taxed at 30% of its global income. It is required to obtain a PAN and TAN, and file an annual return of income. When LLP distributes its profits to partners, they are not taxed in the hands of the LLP or its partners. Repatriation of capital contribution (say, upon dissolution) is permissible without any thresholds and is not subject to any additional taxes.
Company formed in India (Wholly owned subsidiary/ Joint Venture): A company incorporated in India is treated as a tax resident of India and is taxed at 30% on its global income. However, if its turnover is up to INR 4,000 mn in FY 2017-18, then the applicable rate of tax is 25%. It is required to obtain a PAN and TAN, and file an annual return of income. W.e.f., Assessment Year 2021-22, the domestic company isn’t required to pay dividend distribution tax on any amount declared, distributed or paid by such company by way of dividend. Dividend received from domestic company is taxable in hands of shareholders.
Outward Direct Investment by Resident Indians
ODI, OPI and OII: The 10% Rule
Govt issued foreign investment rules for Indian firms. Clarity on overseas direct investment (ODI) and overseas portfolio investment (OPI) has been brought in. Various overseas investment txns in IFSCs by a resident under the approval route are now under the automatic route.
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