Investment prospects for Japanese enterprises in India: Part 2

By Gaurav Dani, Saurav Kumar and Swathi Sreenath, IndusLaw in New Delhi
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India and Japan share a deep-rooted history and a robust partnership marked by strategic, economic and political alignment, and grounded in cultural and spiritual ties. Over time, their economic interdependence has strengthened, with India’s proactive efforts to enhance its business environment, foster innovation, and spur manufacturing and investment. Despite challenges, India has emerged as one of the world’s fastest-growing economies, propelled by record-high exports, rising foreign investment and expanding global collaborations.

The previous article of this series discussed investment opportunities, policy initiatives and upcoming sectors of interest for Japanese investors. This article provides a brief outline of the key structuring, operational and tax considerations when entering India, as well as imminent opportunities for investment.

Structuring and operational issues

Gaurav Dani
Gaurav Dani
Founding and Senior Partner
IndusLaw
New Delhi
Email: gaurav.dani@induslaw.com

India’s foreign investment framework has been articulated by the Reserve Bank of India (RBI) through the issuance of a variety of rules, regulations, press notes and master directions. There are certain guidelines and conditions that investors should be mindful of when engaging in transactions with Indian entities. These include compliance with norms regarding pricing, deferred consideration, indemnity arrangements, downstream investments, and restrictions on assured returns.

New investment structures have emerged providing increased operational flexibility for parties, while also ensuring compliance with the law. Some of these are discussed below.

Deferred consideration
In cases of the transfer of equity instruments between a resident and non-resident, Indian regulations permit payment of consideration on a deferred basis as long as it does not exceed 25% of the total, and is paid within 18 months from the date of the transfer agreement. To overcome these restrictions, alternatives such as a deposit of shares with an escrow agent, along with an obligation to purchase such shares based on time milestones, can be considered. Earn-out structures are also widely popular, where a part of the consideration is paid to the promoter as manager compensation based on performance metrics.

Transactions by foreign-owned and controlled companies (FOCCs)
For foreign investors with a presence in India, and that intend to expand through acquisitions, downstream investment (i.e. investments through an entity set up in India) may be a better proposition considering that investments undertaken through Indian subsidiaries attract relatively less compliance. However, certain nuances regarding deferred consideration and reporting arrangements should be considered. With respect to deferred consideration on transfers to or by FOCCs, there is no specific guidance provided by the RBI regarding pricing. Therefore, reliance is placed on the view of authorised dealer (AD) banks that process such transactions. The common view is that a consideration at least equal to the fair market value of the securities should be paid up front, while the rest may be deferred (while adhering to other norms for deferred consideration).

Layering
To prevent the misuse of complex corporate structures, Indian company law restricts firms from having more than two layers of subsidiaries. That said, one layer that consists of one or more wholly owned subsidiaries is not considered while computing the number of layers.

However, it is unclear whether this exemption for a wholly owned subsidiary will apply to only the first layer of subsidiaries, or whether it can be applied to any layer of the structure. So far, the prevalent view on this is that the exemption may be granted only to the wholly owned subsidiary of the ultimate holding company, and further layers will not be allowed the benefit of this exemption.

Tax considerations

Saurav Kumar
Saurav Kumar
Partner
IndusLaw
New Delhi
Email: saurav.kumar@induslaw.com

There are several tax considerations that may affect the structuring of investment in India, including corporate taxes and capital gains taxes. Below is a snapshot of the key tax considerations that may affect the structuring of the investment.

Double tax avoidance agreements (DTAAs)
Investments in India are often structured through holding companies in various jurisdictions for a number of strategic and tax reasons. In such cases, the risk of double taxation may be avoided by investing through an intermediary holding company in a favourable jurisdiction. Previously, the Indian DTAAs with Mauritius, Cyprus and Singapore allowed for a beneficial framework for capital gains taxation leading to many Indian companies or investors in Indian companies structuring their intermediary holding company in these jurisdictions. However, these DTAAs have since been amended and some of these benefits are no longer available.

India has entered into more than 100 bilateral tax treaties to avoid double taxation, including with Japan. A taxpayer may be taxed either under Indian law or an India-Japan DTAA to the extent it is more beneficial. Particularly with respect to taxes on dividend income, on royalties and technical fees, a Japanese investor may take advantage of the beneficial rate under the India-Japan DTAA vis-à-vis the higher domestic Indian taxes.

Carry-forward of losses
The Income Tax Act, 1961, provides businesses the right to carry forward their business losses for eight assessment years until the same can be set off against their business profits. However, the rule provides that the beneficial ownership of shares carrying at least 51% of the voting power of the company must be the same at the end of both the year during which the loss was incurred and the year during which the loss is proposed to be offset (except for certain startups). Therefore, investors should be mindful of the historical and potential tax liabilities of the business, and the ability to carry forward such losses pursuant to their investment. Alternative structures such as mergers may also be considered by investors to deal with such issues as this route allows setoffs for eight successive assessment years.

New opportunities

Swathi Sreenath
Swathi Sreenath
Principal Associate
IndusLaw
New Delhi
Email: swathi.sreenath@induslaw.com

GIFT City
One of the biggest opportunities for Japanese investors exists in the GIFT International Financial Services Centre (GIFT IFSC) in Gujarat International Finance Tec-City (GIFT City). The state-of-the-art financial hub is designed to attract a wide range of financial institutions on the lines of other financial centres such as in Dubai, Singapore and Hong Kong. Entities in GIFT City are regulated by a single unified regulator along with a “light touch” regulatory framework, having several relaxations from domestic law. Apart from regulatory ease, GIFT City also offers incentives such as a tax holiday for 10 years, and nil capital gains and goods and services tax. In less than three years, more than 500 businesses have been set up in GIFT City, including global institutions such as HSBC, Deutsche Bank, Barclays and MUFG Bank.

Incentive schemes
In the past few years, India has issued schemes to promote domestic production of items that were predominantly imported, through direct incentive transfers to manufacturers based on parameters such as annual production and revenue. These production-linked incentive (PLI) schemes have been issued for sectors including automobiles and auto components, solar PV cells and food processing. Bidding under the PLI scheme for advanced chemistry cell (ACC) battery storage and the chemical sector is under way, while schemes for biomanufacturing and biofoundries are expected, in line with the 2024 budgetary announcements.

Real estate
In the recent past, with major legal reforms such as the Real Estate (Regulation and Development) Act, 2016, the introduction of a unified goods and services tax, and the promotion of real estate investment trusts (REITs), the Indian real estate sector has become increasingly attractive for foreign investors. Japanese corporations like Sumitomo, Mitsubishi and Marubeni have made significant investments in the commercial and residential real estate sector. Demand for commercial real estate is especially high, with India’s emergence as an IT destination and consequent need for grade A office space. The real estate business boom also opens opportunities for companies in linkage sectors such as building materials, electricals and sanitaryware, which are known to be Japanese areas of expertise.

Green energy
India is spearheading the Global South’s transition towards clean energy, with significant promotion of technologies such as green hydrogen and ammonia, electric vehicles (EVs), solar and wind energy. India has launched schemes for their promotion, including incentives for EV sales, production of advanced chemistry cells, hydrogen electrolysers, and financial incentives such as green credits, green deposits and tax rebates. India has set targets for renewable energy development, aiming to achieve 500GW of installed renewable energy capacity by 2030, up from about 175GW currently. In line with the objectives of the India-Japan Clean Energy Partnership, India is a preferred destination for Japanese investment in green energy.

Conclusion

The investment prospects for Japanese enterprises in India are promising and multifaceted. These investment prospects find their foundation in the historical friendship between the two nations, which has emboldened their economic ties as well.

With time, investors are considering innovative structuring options to ensure maximum operational efficiency, and to avoid any future legal battles. Collaboration with legal teams and AD banks becomes imperative to understand the nuances of these structures.

Having said that, India remains a lucrative destination for Japanese investors with emerging opportunities in GIFT City, local manufacturing, real estate and green energy. As both nations continue to collaborate, the evolving landscape offers substantial potential for mutually beneficial growth.

IndusLaw-2021

INDUSLAW
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