M L S Chase

solicitors

Establishing a joint venture in india

An Overview

Manoj Ladwa & Vaibhav Shukla

© MLS Chase 2007

The information in this document is provided for general information purposes only and does not
constitute legal or professional advice. Relevant legal or professional advice should be sought before
taking any decision based on the contents of this document.

This article was first published by the Practical Law Company – www.practicallaw.com

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 Establ ishin g A Joint Ven ture in India

Establishing an Equity Joint Venture in India – an Overview

India’s foreign direct investment (FDI) rules have been substantially liberalised since the country first allowed
foreign investment in the early 1990s. Most sectors are now open to 100% FDI. However, many foreign investors
still prefer to set up a joint venture with an Indian partner company as this can, for instance, give them access to
the Indian partner’s pre-established market and distribution channels, local management and know-how.

This article examines the following key factors involved in establishing a joint venture between a foreign investor
and an Indian partner:

• Early considerations.
• Understanding FDI rules.
• Conducting appropriate due diligence.
• Structuring the joint venture vehicle.
• Company formation.
• Obtaining regulatory licences and approvals.
• Employee issues.
• Taxation and duties.
• Protecting intellectual property rights (IPR).
• Joint venture documents.
 
Early Considerations
Establishing a joint venture in India can be a relatively straightforward process if planned properly, but potential
investors must take account of cultural differences and expectations from the outset. Some differences in approach
to be aware of include those in relation to the drafting of documents. While documents in Western jurisdictions
tend to be very detailed and prescriptive, Indian documents are usually more general and open ended in nature.

Negotiations in India tend to be an “ongoing” activity and not simply a stage in a transaction. As a result, even
after a document has been executed, there is a perception among Indian parties that if circumstances change, the
document can naturally be amended, which can be frustrating to their foreign counterparts.

In addition, the Indian decision-making process can be very hierarchical, and so it is important to determine who
the ultimate decision maker is and involve him in the negotiations early on. If this is not done, a great deal of time
can be wasted in negotiating at the wrong level.

Other issues to be considered early on in the process include how any disputes during the life of the joint venture
will be dealt with, and how the foreign investor will be able to withdraw its investment from India if it chooses
to exit the venture.

Litigation in India is relatively slow as there is a large backlog of cases. As a result, many foreign investors
prefer to have an arbitration or alternative dispute resolution clause in their joint venture agreement
(see below, Documents). The relevant legislation concerning both international and domestic arbitrations
is the Arbitration and Conciliation Act 1996. The act gives flexibility to conduct arbitration in various
jurisdictions and the awards passed in a foreign jurisdiction are recognised and enforceable in India.

Repatriation of dividends and capital is a relatively straightforward process. Under the “automatic approval route”
(applicable to FDI within the prescribed limits set by the Reserve Bank of India (RBI)), as long as the equity

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investment enters India through normal banking channels, and the RBI is informed in prescribed form within 30
days of the inward remittance, then repatriation is permitted without the need for any further approval.
 
Understanding FDI rules
Although most sectors of the Indian economy are fully open to FDI, there are certain sectors where
FDI is either capped (for example, telecoms, insurance and defence manufacturing) or totally prohibited
(such as multi-brand retail, atomic energy and agriculture). (Prior government approval is also required
in relation to FDI in defence manufacturing.) Other sectors, such as real estate development, are subject
to certain investment criteria; if these are not met, FDI is prohibited. As a result, it is important to
check the rules on foreign investment at the outset of any joint venture to confirm what is and is not
permitted. FDI rules can be found on the Department of Industrial Policy and Promotion website (see
http://dipp.nic.in).

If an investment falls within the rules, it is deemed to have received “automatic approval” from the RBI, which is
the institution responsible for gate-keeping foreign investments into India. The RBI must be notified in prescribed
form within 30 days of share subscription. All other equity investments require the prior approval of the RBI.

Conducting due diligence

As with any joint venture, the foreign (and, for that matter, the Indian) partner should be fully aware of any
underlying legal or commercial issues that may affect the other party and the proposed joint venture. While a
great deal of information on Indian companies is available publicly, in some cases (for example, in relation to
smaller companies) a formal due diligence exercise may be the only way of finding the necessary information.

Due diligence exercises are relatively rare in India, and a foreign investor may need to “sell” the process
as standard practice in its own jurisdiction. The replies provided by the Indian partner are normally
warranted by it in a subsequent joint venture agreement and possibly backed by indemnities in the event
that the answers later prove to be misrepresentations (see below, Documents).
 
Corporate structure
The corporate vehicles that foreign investors usually consider establishing for a joint venture are the private
limited company and the public limited company. The private limited company is more commonly used. The
information provided in the rest of this article is based on the assumption that the joint venture vehicle used is a
private limited company.

The following issues arise when establishing a private limited company:

• C
 apitalisation. A private limited company requires a minimum paid up capital of INR100,000 (about
EUR1,706 or US$2,270). If the company uses certain words such as “India” or “Hindustan” in its name
then the minimum paid up capital requirement is INR500,000 (about EUR 8,533 or US$11,351).

• M
 inimum directors and shareholders. A private limited company requires a minimum of two directors
and two shareholders. The directors need not be Indian nationals or residents. However, for practical
reasons (for example, signing of routine regulatory or statutory documents), it is advisable that at least
one of the directors is resident in India.

If investment is taking place in an economic sector where 100% FDI is permitted, then all the shareholders of the
Indian joint venture company (Indco) can be foreigners. The requirement of two shareholders must be fulfilled

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at all times, but there are no restrictions on the proportions of Indco’s equity that each shareholder holds. One
shareholder can therefore hold a nominal one share. The foreign investor’s directors may also consider taking
out specific directors’ and officers’ liability insurance.

• M
 anagement structure. It is important to agree the proposed management structure and to identify which
party has control early in the joint venture process. Ideally, management structure, control and safeguards
should be agreed when preparing the memorandum of understanding (see below, Documents).

• I nvesting via an offshore entity. The foreign investor may wish to route the investment via an off-
shore jurisdiction with a favourable double taxation agreement, such as Mauritius. This may be a useful
structure if one of the aims of the joint venture partners is to realise their respective investments through
an eventual sale of Indco, as it may allow for the minimisation of any capital gains taxes payable in respect
of gains which accrue from a sale (see box, Double taxation agreements).

Company formation
The process of company formation in India is not straightforward or
quick. It can, for example, take up to eight weeks to incorporate a
private limited company, typically involving the following main steps:

• Reserving a company name with the Registrar of Companies.

• 
Drafting constitutional documents (the memorandum
and articles of association) (see below, Documents) and
submitting them before the Registrar of Companies for
scrutiny.
•  ubmitting various prescribed forms (for example, the
S
registered address form).
• Liaising with the Registrar of Companies.
• Obtaining the certificate of incorporation.

Following this, some further steps to be taken include:

• Online registration of prospective directors.

• Opening a bank account.
• Applying for a permanent account number.
• Issuing share certificates, and informing the RBI of the
investment.
• Arranging for the seal of the company or rubber stamp.
• Holding an initial board meeting and passing resolutions.
• Maintaining a register of members.

Regulatory licences and registrations

Once Indco has been established, it needs to obtain various licences
and registrations including:

• Shops and establishment licence.

• Value added tax (VAT) and sales tax registration.
• Permanent account number and tax deduction account number.

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If the business of the joint venture involves the importation of equipment from abroad, an import and export
licence is also required.

If manufacturing units are to be established in India,

Indco also needs to obtain various industrial approvals
based on national and state regulations. These approvals
are dependent on the precise nature and location of the
activity (for example, environmental clearances may be
necessary).
 
Employees
Contracts of employment for so-called “white-collar”
employees are generally governed by the Indian Contracts
Act, which is essentially a codification of English contract
law. The hiring and firing of staff is therefore normally
subject to the terms of the contract rather than any
stringent employment legislation. Provident Fund (similar
to, for example, UK national insurance) payments and
gratuity payments are, however, governed by statute,
which should be consulted.

Many foreign investors have their standard employment

contracts amended to the extent that it is necessary
to conform with Indian law or cultural norms, such as
the provision of “casual leave” or more benefits in kind
rather than cash. A similar approach can be adopted when
drafting employee handbooks for Indco.

In respect of so-called “blue-collar” workers, more stringent employment laws apply. The governing legislation
includes:

•  he Child Labour (Prohibition and Regulation) Act 1986.

T
• The Employees Provident Fund and Miscellaneous Provisions Act 1952.
• Industrial Disputes Act 1947.
• The Maternity Benefit Act 1961.
• Minimum Wages Act 1948.
• Payment of Bonus Act 1965.
• Payment of Gratuity Act 1972.
• Payment of Wages Act 1936.
• Payment of Wages (Amendment) Act 2005.
• Factories Act 1948.
• Employees State Insurance Act 1948.
 
Taxation and duties
A company incorporated in India, irrespective of whether it is wholly or partially owned by a foreign company, is
considered to be a domestic company for the purposes of income tax. The current rate of corporate income tax,
including a temporary surcharge, is effectively 33.66%, subject to allowances.

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Some other taxes that may impact Indco include:

• Dividend distribution tax.

• Withholding tax.
• Service tax.
• VAT/central sales tax.
• Excise duty.
• Import duty.
• Octroi (a border tax imposed on goods
being transferred between Indian states).

If there is likely to be any contract of supply between

the foreign investor and Indco, transfer pricing
issues also need to be considered.

IPR
India operates a system of registration for IPR and
is a signatory to various international IPR treaties.
The perception remains, however, that India is
a high-risk area for IPR theft. A foreign investor
should conduct an audit to identify what, if any, of
its IPR will be exposed to the Indian market, and
then consider whether it is worth protecting.

Steps that can be taken by a foreign investor to protect its IPR include registration and the making of specific
provision in the joint venture agreement. Separate documentation ancillary to the joint venture agreement may
also be executed, such as a name and logo licence agreement (also known as a Registered User Agreement) with
Indco.

There are certain norms laid down by the RBI on the repatriation of royalties that also need to be considered.
 
Documents
The documentation that usually has to be put in place when establishing a joint venture company in India
includes:

•  emorandum of understanding. The foreign investor and Indian partner need to establish a
M
clear understanding of each other’s objectives for the venture and ensure that they are compatible.
The memorandum of understanding (sometimes called the letter of intent or heads of agreement)
can help to achieve this. It should be prepared carefully, with thorough discussion and mediation
between the parties.

The memorandum of understanding should usually address:

• the parties’ intentions and likely progression of the venture;

• commercial terms (such as contributions to the joint venture) in enough detail to ensure that any
differences can be identified early in the process;
• management, control and safeguards;

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• division of early costs;

• exclusivity arrangements;
• the extent to which the memorandum of understanding is to be legally binding.

Joint venture or shareholders’ agreement. The joint venture agreement establishes the relationship between
joint venture partners and the way in which the company will be run. It usually includes clauses on:

• shares;
• management structure;
• withdrawal rights;
• competition issues;
• dispute resolution;
• IPR;
• any warranties or indemnities.

As an example, a joint venture agreement often includes

an arbitration clause. This normally addresses, among
other things:

• the place of arbitration;

• the language in which the arbitration will be
conducted;
• the number of arbitrators;
• the procedure to be followed by the arbitrator
or arbitrators.
• C  onstitutional documents. These are the
memorandum and articles of association.
The articles of association is a binding legal
document that formalises the constitution of
the new company. It should replicate as far
as commercially and technically appropriate
the terms of the joint venture agreement.
Consistency between the two documents is
important. In the event of any dispute between
the articles of association and the joint venture
agreement, the articles prevail.
• Registered User Agreement (see above, IPR).
• Technology licence and know-how agreement
(if there is a technology and know-how transfer
involved).
• Directors’ service agreements.
• Corporate governance and policy manual.

Other agreements commonly negotiated include those

relating to supply, distribution, secondments and
confidentiality.

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Double taxation agreements

India has entered into Double Taxation Avoidance Agreements (DTAAs) with numerous countries
including the UK and the US. The DTAA between the UK and India, for instance, provides for various tax
benefits including lower rates of capital gains and withholding tax.

In addition, India has entered into a more favourable double taxation agreement with Mauritius. Under
normal circumstances, the proceeds of a sale of shares in an Indian company are usually taxed in India,
even if the seller is not tax resident in India. However, under the India-Mauritius tax treaty, no capital gains
tax in either India or Mauritius is payable on the sale of the shares of an Indian company by a Mauritian
company.

While there is a lower tax rate on dividends for Mauritius tax residents under the treaty, corporate
dividends declared by an Indian company are presently not taxed in the hands of the recipient on
payment of a dividend tax by the Indian company declaring the dividend. This dividend tax rate currently
stands at 14.02%, although under the recently introduced Finance Bill this would increase to 16.99%.

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The Authors
Manoj Ladwa
Manoj Ladwa is a recognised expert on cross border investments. He is a practicing
English solicitor and Indian advocate. Manoj is the founder and chief executive of the
MLS Chase Group, a professional services organisation with offices in London, Mumbai,
and Hong Kong. Manoj co-founded and is an Director of Saffron Chase. a leading India
focussed corporate and government affairs consultancy. He is an accomplished media
commentator, conference speaker, and has authored over 100 published articles. Collectively his clients have
contributed to over £5 billion in Indo-UK trade and investment over the past 10 years. In 2003 he established
the London office of the Federation of Indian Chambers of Commerce and Industry. Manoj is a consultant
on India to the Centre for International Briefing. Manoj is the honorary solicitor to the National Congress of
Gujarati Organisations as well as a large number of Indo-British charities. To further his philanthropic activities,
Manoj established the MLS Foundation, which works in the fields of education and tackling poverty around
the world.

Email: manoj.ladwa@mlschase.com

Vaibhav Shukla
Vaibhav Shukla is a Senior Associate at MLS Chase. He is dual qualified as a solicitor
in England & Wales and an advocate of the Supreme Court of India since 1998. He
is a corporate lawyer and advises on cross border transactions. Vaibhav relocated to
the UK from Mumbai in 2002 to complete his LL.M from the University of Warwick
in International Economic Laws. Vaibhav has particular expertise in outsourcing and
IT transactions, and has worked for clients from across the globe. He is a frequent speaker at seminars
and briefing sessions on doing business in India and contributes regularly to various international legal
publications. Vaibhav is vice president of the Global Organisation of People of Indian Origin.

Email: vaibhav.shukla@mlschase.com

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