1. INTRODUCTION
With the dynamic and ever-evolving landscape of global markets in the post-pandemic world, global players are looking for new destinations to relocate their supply chains and manufacturing hubs. Many Asian countries have emerged as top contenders for the spot of the alternate 'factory of the world', but markets seem inclined towards eliminating such concentration and creating 'factories' instead. While countries like Vietnam, with a single ruling communist party, and Malaysia and Thailand with constitutional monarchies present themselves as worthy options with higher predictability on policy decisions for businesses, India remains one of the favourite picks for a wide variety of reasons. The past few decades have witnessed a huge boom in multinationals housing manufacturing and supply chains outside their jurisdictions for a wide variety of goods, including consumer electronics, rare earth metals, semiconductors, energy products, batteries, textiles, apparel, automotive, machinery, equipment, steel and metal products.
With a vast population of more than 1.3 billion and an unparalleled labour force with technical abilities, India boasts of a large consumer base for many such products. Coupled with a favourable geopolitical, economic and regulatory environment for foreign investments, further bolstered by sector-specific policies and subsidies, India presents a favourable environment for doing business. Each business is different and has unique needs for undertaking its manufacturing activities and India fares well in its ability to meet most of such needs. Apart from the large consumer base and cost-efficient labour, its strategic geographic location on the world map paves the way for its geopolitical influence on global matters. India has existing expertise in large manufacturing sectors including pharmaceuticals, steel, automotive, textiles, IT-ITES for all segments, IT hardware, gems and jewellery, large and growing energy sector. It also has the largest English-speaking population outside the United States of America ("USA"), unexplored territories with cheaper real estate, the largest coastlines amongst the contender nations with mega ports, strong road, and rail infrastructure, along with vast natural resources for both renewable and non-renewable energy to power the manufacturing facilities.
While each facet listed above makes India the destination of choice for foreign entities looking to set up business operations in India, understanding the Indian legal system's hybrid nature and variations across states is essential. With careful planning, the right advisors, strategic partnerships, and a keen understanding of the Indian market, businesses can leverage India's potential as a key player in their global supply chain network.
This article aims to highlight certain key legal considerations a foreign entity, looking to shift its supply chain to India, must assess at the relevant checkpoints and stages of setting up a business in India.
2. THE INDIAN LEGAL SYSTEM
The Indian legal system can best be described as a 'hybrid', incorporating elements of civil law, common law, customary law and international law1, which range from the Constitution of India, 1950 ("Constitution"), various statutes promulgated by the central and state legislatures, municipal laws, judicial precedents and international sources of law, including customary principles. For instance, while an agreement between two parties in India will be interpreted in accordance with the law governing the agreement, the Indian Contract Act, 1872 which is based on English common law principles, will continue to apply to all contracts uniformly.
The Constitution also lays down the framework for the division of legislative powers between the centre and the states. The 'union (central)' list comprises of subjects, such as defence, railways, incorporation, regulation and winding up of companies, on which only the central legislature is empowered to legislate. The 'state list' on the other hand consists of subjects such as trade and commerce within the state, production, supply and distribution of goods, on which only the relevant state legislature has the power to legislate. Given the nature and availability of resources within the state's territory, its geographical location and the demographics of its population, the laws formulated by the state legislatures also vary from state to state. The Constitution also provides for a third list, i.e., the 'concurrent list' with subjects such as contracts, bankruptcy and insolvency, social security and social insurance and welfare of labour, on which both the central and the state legislature can legislate. In the event of any conflict between the centre and the state with respect to matters listed in the concurrent list, the central law shall prevail.
3. MODES OF ENTRY
Among the various channels available to foreign entities looking to enter the Indian market, the most prominent ones are setting up of either: (i) a liaison office; (ii) a branch office; (iii) a project office; (iv) a limited liability partnership ("LLP"); (v) a wholly owned subsidiary ("WOS"); or (vi) a joint venture.
The foreign exchange laws of India ("Forex Regulations")2 stipulate that a person resident outside India, looking to establish a liaison, branch, or project office within India will require the approval of an authorized dealer bank ("AD Bank"), (i.e., state banks, commercial banks, cooperative or urban cooperative banks, authorized by the Reserve Bank of India which is the central bank of India ("RBI")). Such approval shall be provided by the AD Bank in accordance with the guidelines issued by the RBI.3 The prior approval of RBI is required in certain instances when the principal business of the applicant falls under one of the four sectors namely defence, telecom, private security and information and broadcasting.4
Approval of RBI is not necessary if a government specific approval or permission by the concerned ministry/regulator of the sector has already been granted.5 General permission is also available to non-resident entities looking to establish: (i) project offices in India if they have secured a contract from an Indian company to execute a project in India and such project has received necessary regulatory clearances and is funded by inward remittance or by a bilateral or a multilateral international financing agency such as the World Bank or International Monetary Fund; or (ii) branch offices in a Special Economic Zone ("SEZ") to undertake manufacturing and service activities, subject to the branch office: (a) functioning in a sector where 100% (one hundred percent) foreign direct investment ("FDI") is permitted; (b) complying with the requirements of the Companies Act, 2013 ("Act"), as applicable to companies incorporated outside India. These requirements include delivering a copy of various documents including its charter documents, list of directors, a declaration that none of the directors or authorized representatives have been convicted or debarred from the formation or management of companies in India or abroad6 ; and (c) functioning on a stand-alone basis, with no business activity being permitted outside the SEZ in India, which shall include branches/subsidiaries of its parent office in India.7
Additionally, the Forex Regulations provide that a branch or liaison office can only undertake certain activities, which range from export/import of goods to rendering technical support to the products supplied by parent/group companies (for branch offices) and representing the parent/group company in India to acting as a communication channel between the parent company and Indian companies (for liaison offices), to name a few, but does not include manufacturing.8 Accordingly, the prior approval of RBI shall be necessary to undertake or carry on any other activity other than those listed above, including to undertake manufacturing.9 Thus, establishing a liaison, branch or project office poses certain notable challenges as modes of entry for foreign entities looking to re-locate their supply chains to India. A favourable mode of entry would be the establishment of a WOS, LLP, or joint venture in India, given that they are set up as independent legal entities having perpetual existence, and hence can accord greater flexibility.
4. MANUFACTURING UNDER THE FDI FRAMEWORK
Foreign entities must assess the requirements prescribed under the Foreign Exchange Management Act, 1999, the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 and the Consolidated FDI Policy, 2020 (collectively, the "FDI Framework"), which detail the various investment routes and the applicable sectoral caps. Under the FDI Framework, foreign investments may be made under 2 (two) categories, i.e., the 'automatic route' (not requiring governmental approval) or the 'approval route' (requiring the approval of the relevant government department prior to the investment). Which of the routes apply and the antecedent conditions that need to be complied with will vary depending on the nature of the sector.
Generally, the FDI Framework permits foreign investment in the 'manufacturing' sector under the automatic route. However, there are certain sectors in which, manufacturing is completely prohibited or is under the approval route beyond a certain threshold. For instance, FDI is completely prohibited in the manufacturing of cigars, cheroots, cigarillos, and cigarettes of tobacco or of tobacco substitutes, and sectors such as atomic energy and railway operations.10 In the defence sector, the government has liberalized and allowed FDI under the automatic route up to 74% (seventy-four percent) and up to 100% (one hundred percent) through government route wherever it is likely to result in access to modern technology.11 Further, in the pharmaceutical sector, investments have been categorized into 'brownfield' and 'greenfield' investments. FDI up to 100% (one hundred percent) is permitted under the automatic route in the case of greenfield investments and FDI up to 74% (seventy-four percent) is permitted under the automatic route for brownfield investments, with FDI up to 100% (one hundred percent) being permitted under the approval route.12 While the terms 'greenfield' and 'brownfield' have not been defined under the FDI Framework, greenfield investments typically pertain to building a new venture from the ground-up, whereas brownfield investments pertain to investing in already existing pharmaceutical manufacturing units in India.
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Footnotes
1. Legal Systems in India: Overview, available at https://uk.practicallaw.thomsonreuters.com/w-017-5278?transitionType=Default&contextData=(sc.Default).
2. In this case the applicable Forex Regulations shall mean the Foreign Exchange Management (Establishment in India of a branch office or a liaison office or a project office or any other place of business) Regulations, 2016 and the Master Direction - Establishment of Branch Office (BO)/ Liaison Office (LO)/ Project Office (PO) or any other place of business in India by foreign entities.
3. Ibid.
4. Ibid.
5. Ibid.
6. Section 380, Companies Act, 2013.
7. Supra n. 2.
8. Supra n. 2.
9. Supra n. 2.
10. Rule 6(a) read with Schedule I of the Foreign Exchange Management (Non-Debts Instruments) Rules, 2019; Para 5.1 (Prohibited Sectors) of the Consolidated Foreign Direct Investment Policy, 2020 available at https://dpiit.gov.in/sites/default/files/FDI-PolicyCircular-2020-29October2020_0.pdf.
11. Ibid.
12. Ibid.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
