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Regulatory Frameworks of India's Industrial Policies

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CHAPTER 3

THE REGULATORY FRAMEWORK

3.1 INTRODUCTION: THE PARADIGM SHIFT

The industrial policy pursued in India for the first four decades after independence was based on the socialist school of thought that India embraced, partly to alienate itself from the colonial past and more so owing to the obvious achievements of the socialist movement in the post world-war two period. Thus, through a Resolution dated April 6, 1948 the government set out the policy to be pursued in the Industrial field, wherein to secure continuous increase in production and equitable distribution, the country opted for a centrally planned development strategy, with the state playing a major role. For this purpose, the National Planning Commission was established for planning, co-ordination, integration of national economic activity and to formulate programmes of development and to secure their execution.

On October 30, 1956, at the beginning of the Second Five Year Plan, the Government adopted a New Industrial Policy Resolution, which reiterated the above objective and classified industries into three categories as follows:

Schedule A were those industries whose future development was the exclusive responsibility of the state. Schedule B consisted of industries which would be progressively state-owned, wherein the state would take initiative in establishing new undertakings and private enterprise would be expected to supplement the effort of the state. Schedule C included all remaining industries whose further development was left to the initiative and enterprise of the private sector. This led to the expansion of the public sector in India, whose share in GDP increased from 9.91% in 1960-61 to 27.12% in 1988-89. However, the cause of concern was that a large number of public sector enterprises - particularly the Non-departmental non-financial enterprises were making losses and had to be subsidized.

Industrial undertakings in the private sector were subject to control and regulation like the Industries Development and Regulation (IDR) Act (1951) and were expected to align their business strategy and goals with the broad economic and social objectives of the State. The IDR vested with the government necessary powers to regulate and control existing and future undertakings in a number of specified industries. A license was necessary for establishing a new undertaking, taking up the manufacture of a new article in an existing unit, effecting substantial expansion, carrying on the business of an existing undertaking and changing the location of an existing unit. A Letter of Intent (LOI) was issued for sectors/activities under compulsory license under the IDR Act, 1951. The LOI was converted into Industrial License on completion of specified formalities.

Further, to prevent monopolies and concentration of economic power in the hands of private sector, in 1969, the Monopoly and Restrictive Trade Practices Act (MRTP) was enacted. All these regulations and controls led to increase in bureaucracy, inhibiting enterprise and industry.

Also, given the state of the economy with limited resources, scarce capital and vast population base, the development ideology revolved around the notion of conservation and optimum utilization of capital so as to maximize 'employment' (and not necessarily output). Deployment of new capital was strictly controlled and regulated so as to meet social needs and maximize employment. Further, once the capital was committed to any activity and a certain employment was created, it was protected at any cost - even if it was non-viable in the face of market forces.

Labour intensive technology and employment generation were also the rationale behind the initial advocacy of small-scale industry. However, later, when it was realized that modern small scale industry was not necessarily labour intensive, the argument turned to encouraging the entry of new entrepreneurs in industry. A range of products were reserved for exclusive production in the small-scale sector, eliminating potential competition from medium and large firms. There were no pressures on the smaller firms to improve technology, update production techniques or reduce cost modernize or specialize. There was an inherent disincentive to grow beyond a certain size, if they had to continue production of a reserved product. Thus economies of scale could not be leveraged and market distortions were widespread.

Until 1991, the guiding principle of India's industrial policy was self reliance, which focused on indigenous production and reduced dependence on foreign capital and foreign technology - irrespective of the cost and/or quality. This did lead to the creation of a large industrial base, diversification of products, ownership and location. But in the absence of domestic competition, export rivalry and competition of imports, industry grew with a lack of cost and quality consciousness, leading to slow growth, increasing deficits and debt and finally the crisis in 1991 which paved the way for economic reforms in India. Some of the components of the reform package include:

  • Reforms in Industrial Policies in terms of delicensing of most industries and deregulation of industries earlier monopolized by the public sector
  • Liberalisation of foreign trade through steady reduction in tariffs and freeing up of the foreign investment limits in most industries combined with measures to attract FDI into the country
  • Macroeconomic stabilization through substantial reduction in fiscal deficits and government's draft on the private sector's savings
  • Other reforms including those in taxation, financial sector, insurance sector, public sector, etc.

During the last decade and half, these reforms have reoriented India from a slow-paced, centrally directed and highly controlled economy to a strong, vibrant, fast-growing and 'market-friendly' one. There now exists an internationally competitive private sector with varied scope for collaborations and joint ventures and a facilitating regulatory framework that is evolving to match the international standards.

This Chapter seeks to give an overview of the broad framework of regulations governing business in India particularly in the context of:

    • Industrial Policy

    • Foreign Investment Policy

    • Anti Trust Regulations

    • Labour Laws

    • Protection of Intellectual Property Rights

    • Other Economic Laws & Procedures

3.2 INDUSTRIAL POLICY

The Industrial Policy Resolution 1956, substantially augmented through the Statement of Industrial Policy 1991 and subsequent announcements - which liberalized the economy - provides the basic framework for the overall industrial policy of the Government of India.

3.2.1 Industrial Licensing

The requirement of obtaining an industrial license for manufacturing has been abolished for all projects except for a short list of industries connected with security and strategic concerns (reserved for public sector), social reasons, hazardous chemicals and overriding environmental concerns. The list of items requiring compulsory licensing is reviewed on an ongoing basis. The stage of LOI has been dispensed with for all sectors/activities except for items reserved for SSI sector and an Industrial License is now issued without going through the stage of LOI. The following industries require compulsory license:-

  1. Alcoholics drinks

  2. Cigarettes and tobacco products

  3. Electronic, aerospace and defense equipment

  4. Explosives

  5. Hazardous chemicals such as hydrocyanic acid, phosgene, isocynates and di-isocynates of hydro carbon and derivatives, etc.

Non-small-scale industrial units or units in which foreign equity is more than 24% require license to manufacture items reserved from small scale sector. All other industries are exempt from licensing and no industrial approval is required. Entrepreneurs are only required to file an Industrial Entrepreneurs' Memorandum (IEM) with the Secretariat for Industrial Assistance (SIA), providing information on new projects and substantial expansions.

There are however, certain locational restrictions in metropolitan areas. No industrial approval is required from the Government for locations outside 25 kms of the periphery of cities having a population of more than one million except for those industries where industrial licensing is compulsory. Non-polluting industries such as electronics, computer software and printing can be located within 25 kms of the periphery of cities with more than one million population. Permission to other industries is granted in such locations only if they are located in an industrial area so designated prior to 1991. Zoning and Land Use Regulations as well as Environmental Legislations have to be followed.

Appropriate incentives and investments in enabling infrastructure are provided to promote dispersal of industry particularly to the rural and backward areas and to reduce congestion in cities. Recently, the Government approved a package of fiscal incentives and other concessions for the North East Region namely the 'North East Industrial and Investment Promotion Policy (NEIIPP), 2007', effective from 1.4.2007.

Also, under the broad framework of the national industrial policy, different Indian States announce their respective Industrial Policies periodically, which highlight the areas in which the State would focus on and provide incentives to attract investment, the various sector & location specific schemes offered to private investors, the plans for development of enabling infrastructure, opportunities for public-private-partnership, etc.

3.2.2 Policies for Privatisation

The post 1991 liberalisation process brought with it deregulation of trade and industry, dismantling of bureaucratic controls, technological development and financial sector reforms. Privatising some of the activities which heretofore were the exclusive domain of public sector also became part of this initiative to boost enterprise and professional management of resources to enhance economic growth and competitiveness. Revolutionary policy measures were undertaken to encourage private participation in sectors like telecom, information & broadcasting, power, ports, airports, banking, etc. Over the years, the government has reduced the number of industries reserved for the public sector to the two which are deemed significant from security and strategic perspective, viz., Atomic energy and Railways.

However, in the last few years the railways announced opening up of its containerized operations to other private and public sector companies, thereby ending the monopoly enjoyed by the Container Corporation of India (CONCOR). Interested companies could avail of the route-specific or all-India permission by paying a registration fee which is valid for an operation period of 20 years (further extendable by 10 years). There is freedom to decide the tariffs to be charged to the customers for various services and also the exit norms involve transfer of the operational writes to another eligible operator with the railway approval.

3.2.3 Policies for Small Scale Sector

The provisions in the Industrial Policy Statement of 1991 and the subsequent policies are aimed at supporting the Small Scale Industries (SSI) sector though various measures and packages focusing - not only on policy of reservation - but also on price and purchase preference policy for marketing SSI products, credit and fiscal support to SSIs, support for cluster based development, technology upgradation, etc.

The IDR Act 1951 provided for the reservation of items for exclusive manufacture in SSI sector primarily with the objectives of increasing production of consumer goods in the small scale sector and widening of employment opportunities. In 1967, 47 items were reserved for exclusive manufacture in the small scale sector. This number was increased to 836 items in 1989. However, since 1997, a large number of items were dereserved from the list in the phased manner. As of March 2007, only 114 items are reserved for exclusive manufacture in the small scale sector.

In addition to the policy of reservation, the Government has initiated various measures offering support for Cluster based Development, Technologies and Quality Upgradation, Marketing, Entrepreneurial and Managerial Development and Schemes for Empowerment of Women Owned Enterprises.

Further, with a view to facilitate the development of micro, small and medium enterprises (MSME), the Micro, Small and Medium Enterprises Act 2006, was implemented. The Act provides the new classification of each category of enterprises. As per the Act, MSME are defined as follows:

    • in the case of the enterprise engaged in the manufacture or production of goods pertaining to any industry specified in the first schedule to the IDR Act 1951 -

    • a micro enterprise is the one where the investment in plant and machinery does not exceed twenty five lakh rupees.

    • a small enterprise is one where the investment in plant and machinery is more than twenty five lakh rupees but does not exceed five crore rupees; or

    • a medium enterprise is one in which the investment in plant and machinery is more than five crore rupees but does not exceed ten crore rupees;

      • in the case of enterprises engaged in providing or rendering of services -

  • a micro enterprise is one where the investment in equipment does not exceed ten lakh rupees;

  • a small enterprise is one in which the investment in equipment is more than ten lakh rupees but does not exceed two crore rupees; or

  • a medium enterprise is where the investment in equipment is more than two crore rupees but does not exceed five crore rupees

In February 2007, the Government announced a package for promotion of the SSI sector as follows:

  • Credit Support: The package aims at increasing the number of beneficiaries of the credit provided by the Small Industries Development Bank of India (SIDBI) by 50 lakhs, over five years beginning from 2006-07. For this purpose, the Government has provided grant to SIDBI to augment its Portfolio Risk Fund. Besides, in an attempt to increase demand-based small loans to micro enterprise, the Government announced a provision of grant to SIDBI to create a Risk Capital Fund (as a pilot scheme in 2006-07). The eligible loan limit under the Credit Guarantee Fund Scheme has been raised to Rs. 50 lakh. The credit guarantee cover has also been raised from 75% to 80% for micro enterprises for loans upto Rs. 5 lakhs.

  • Fiscal support: The Government has increased the General Excise Exemption (GEE) limit from Rs. 100 lakh to Rs. 150 lakhs since April 2007. It further proposes to examine the eligibility of extending the time limit for payment of excise duty by micro and small enterprises; and extending the GEE benefits to small enterprises on their graduation to medium enterprises for a limited period.

3.3 FOREIGN INVESTMENT POLICY

In recognition of the importance of of foreign direct investment as an instrument of technology transfer, augmentation of foreign exchange reserves and globalization of the Indian economy, the Government of India revamped its foreign investment policy as part of the reform process.

3.3.1 Foreign Direct Investment

Foreign Direct Investment (FDI) regime in India was increasingly liberalized during 1990s (more particularly post 1996) and today India has the most liberal and transparent policies on FDI among the emerging economies, with restrictions on foreign investments being removed and procedures simplified. Some of the prominent features of the FDI policy in India are elucidated below:

  • The approval mechanism for FDI has a two tier system.

    • Under the automatic approval route, companies can issue shares and receive inward remittances for investment in areas identified and upto the limits of foreign equity prescribed, with a reporting requirement, within a period of 30 days. In these sectors, investment could be made without prior approval of the central government.

    • Although, in case of the automatic route, it is no longer necessary to obtain the 'in principle' permission from Reserve bank of India (RBI) before receiving overseas investment or for issuing shares to foreign investors, the company, would, however, have to make a report to the RBI within 30 days after issue of shares to the foreign investors.

    • Proposals for investment in public sector units and also for Special Economic Zones (SEZs) / Export Oriented Units (EOUs)/ Export Processing Zones (EPZs) qualify for automatic approval subject to satisfaction of certain prescribed sector specific parameters.

    • FDI upto 100% is permitted under the automatic route for setting up Industrial Parks. Proposals for FDI/NRI investment in Electronic Hardware Technology Park (EHTP) and Software Technology Park (STP) Units are eligible for approval under the automatic route, except for those requiring prior approval of the Central Government (as discussed below).

    • FDI in sectors that are not covered under the automatic route requires prior approval of the Central Government. Activities/sectors require prior approval of the Government for FDI in the following circumstances:-

  • Activities/items that require an industrial license

  • Proposals in which the foreign collaborator has an existing financial/technical collaboration in India in the same field (except in IT and mining sector)

  • All proposals falling outside notified sectoral policy/CAPS

  • Proposals in which more than 24% foreign equity is proposed to be inducted for manufacture of items reserved for the Small Scale Sector

    • The approval is granted by Foreign Investment Promotion Board (FIPB), which is a specially empowered board set up for the purpose, chaired by the Secretary, Union Ministry of Finance.

    • Proposals for FDI could be sent to the FIPB Unit, Department of Economic Affairs, Ministry of Finance or through any of India's diplomatic missions abroad. FIPB has the flexibility to examine all proposals in totality, free from predetermined parameters.

    • Recommendations of FIPB regarding all proposals falling in the non-automatic route and involving an investment of Rs.6 billion or less are considered and approved by the Finance Minister. Projects with investment greater than this value are submitted by the FIPB to the Cabinet Committee on Economic Affairs for approval.

    • Necessary regulatory approvals from the state governments and local authorities for construction of building, water, environmental clearance, etc. need to be acquired after the grant of approval for FDI by FIPB or for the sectors falling under automatic route. 'Single window' clearance facilities and 'investor escort services' are available in various states to simplify the approval process for new ventures.

    • Decisions on all foreign investments are usually taken within 30 days of submitting the application.

    • In cases where original investment is made in convertible foreign exchange, free repatriation of capital investment and profits thereon is permitted.

    • Sectors prohibited for FDI include:

  • Retail trading (except Single Brand Product retailing)

  • Atomic Energy

  • Lottery Business

  • Gambling and Betting

3.3.1.1 Investment in SEZs

In order to enhance competitiveness of Indian exports and attract investment in these sectors, India's Foreign Trade Policy promotes the setting up of SEZs and thus provides for a hassle-free environment with world-class institutional and physical infrastructure and supporting logistics. Some of the existing EPZs/FTZs have also been converted into SEZs. All the State Governments have been advised to give priority to waste and barren land for acquisition purposes. According to the total Waste Land area surveyed by the Ministry of Forest, 5,52,692.26 hectares was available for such purpose.

FDI upto 100% is permitted under the automatic route for setting up of SEZ. Proposals not covered under automatic route require approval from FIPB. The policy provides for setting up of SEZ in the public, private or joint sectors or by state governments. These could be product specific or multi-product SEZs. Designated duty-free enclaves are treated as foreign territory for trade operations and duties and tariffs, and duty-free goods need to be utilised within the approved period. The permitted activities cover an array of manufacturing and services like production, processing, assembling, reconditioning, re-engineering, packaging, trading, etc.

Proposals for setting up units in SEZ, other than those requiring industrial license are approved by the Development Commissioner (DC). The approval for those requiring industrial license is granted by the DC after receiving clearance from the Board of Approval. The Letter of Permission (LOP)/Letter of Intent (LOI) issued by the DC is construed as a license for all purposes, including procurement of raw material and consumables either directly or through a canalising agency. The LOP/LOI needs to specify the items of manufacture/service activity, annual capacity, projected annual export for the first year in dollar terms, Net Foreign Exchange Earnings (NFE), limitations, if any, regarding sale of finished goods, by products and rejects in the DTA and such other matter as may be necessary and also impose such conditions as may be required.

According to the policy, SEZ units have to be positive net foreign exchange earners and the performance of these units would be monitored by a unit approval committee consisting of the DC and the Customs Authority.

3.3.2 Entry Options for Foreign Investors

A foreign company has the option to set up business operations in India as an Incorporated Entity or as an Unincorporated Entity.

An Incorporated Entity would be a company registered under Companies Act, 1956, through joint ventures or wholly owned subsidiaries. Foreign equity in such Indian companies can be up to 100% depending on the requirements of the investor, subject to any equity caps prescribed in respect of area of activities under the FDI policy. Funding could be via equity, debt (both foreign and local) and internal accruals.

For registration and incorporation, an application has to be filed with the Registrar of Companies (ROC). Once a company has been duly registered and incorporated as an Indian company, it is subject to Indian laws and regulations as applicable to other domestic Indian companies. Companies in India can be incorporated as a private company or a public company.

In comparison with branch and liaison offices (discussed subsequently), a subsidiary company provides maximum flexibility for conducting business in India. However, the exit procedure norms of such companies are relatively more cumbersome.

An Unincorporated Entity could be Liaison Office/Representative Office or Project Office or Branch Office. Such offices can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office of other place of business) Regulations, 2000. They are also governed by the Companies Act 1956, which contains special provisions for regulating such entities.

3.3.2.1 Liaison Office/Representative Office

The role of a liaison office is primarily to:

  • Collect information about the market

  • Disseminate information about the company and its products to prospective Indian customers

  • Promote exports/imports from/to India

  • Facilitate technical collaboration between parent company and companies in India

A liaison office cannot undertake any commercial activity directly or indirectly and cannot, therefore, earn any income in India. Approval for establishing a liaison office in India is granted by the RBI.

3.3.2.2 Project Office

Foreign Companies planning to execute specific projects in India can set up temporary project/site offices in India. RBI has granted general permission to foreign entities to establish Project Offices subject to specified conditions. Such offices cannot undertake or carry on any activity other than the activity relating and incidental to execution of the project. Project Offices may remit outside India the surplus of the project on its completion, general permission for which has been granted by the RBI.

Since a Project Office is an extension of the foreign incorporation in India, it is taxed at the rate applicable to foreign corporations.

3.3.2.3 Branch Office

Foreign companies engaged in manufacturing and trading activities abroad are allowed to set up Branch Offices in India for the following purposes :

  • Export/Import of goods

  • Rendering professional or consultancy services

  • Carrying out research work, in which the parent company is engaged.

  • Promoting technical or financial collaborations between Indian companies and parent or overseas group company

  • Representing the parent company in India and acting as buying/ selling agents in India

  • Rendering services in Information Technology and development of software in India

  • Rendering technical support to the products supplied by the parent/ group companies

  • Foreign airline/shipping company

Branch Offices established with the approval of RBI, are allowed to remit outside India profit of the branch - net of applicable taxes (which are at rates applicable to foreign companies) - however, subject to RBI guidelines. Permission for setting up branch offices is granted by the RBI.

Branch Offices could also be on stand alone basis in SEZ. Such Branch Offices would be isolated and restricted to the SEZ alone and no business activity/transaction would be allowed outside the SEZs in India, which include branches/subsidiaries of its parent office in India. No approval shall be necessary from RBI for a company to establish a branch/unit in SEZs to undertake manufacturing and service activities, subject to the conditions that:

  • they function in sectors in which 100% FDI is permitted

  • they comply with part XI of the Company's Act (Section 592 to 602)

  • function on a stand alone basis

  • in the event of winding up of business and for remittance of winding-up proceeds, the branch should approach an authorized dealer in foreign exchange in the with documents required as per FEMA.

A Branch Office provides the advantage of ease in operations and an uncomplicated closure. However, since the operations are strictly regulated by exchange control guidelines, a Branch may not provide a foreign corporation with most optimum structure for its expansion/diversification plans.

Box 3.1

Investment in a firm or a Proprietary Concern by NRIs

A Non-Resident Indian or a Person of Indian Origin (PIO) resident outside India may invest by way of contribution to the capital of a firm or a proprietary concern in India on non-repatriation basis provided:

i) Amount is invested by inward remittance or out of NRE/FCNR/NRO account maintained with Authorised Dealers of RBI (AD)

ii) The firm or proprietary concern is not engaged in any agricultural/plantation or real estate business i.e. dealing in land and immovable property with a view to earning profit or earning income there from.

iii) Amount invested shall not be eligible for repatriation outside India.

NRIs/PIO may invest in sole proprietorship concerns/ partnership firms with repatriation benefits with the approval of Department of Economic Affairs, Government of India /RBI.

Box 3.2

Investment in a firm or a Proprietary Concern by Other than NRIs

No person resident outside India other than NRIs/PIO shall make any investment by way of contribution to the capital of a firm or a proprietorship concern or any association of persons in India. The RBI may, on an application made to it, permit a person resident outside India to make such investment subject to such terms and conditions as may be considered necessary.

3.3.3 Financing Options for Corporates

Companies registered in India can raise finances through Share Capital or Debentures and Borrowings.

3.3.3.1 Share Capital

The Companies Act, 1956 allows for two kinds of share capital, viz., Preference share capital (preferred stock) and Equity share capital (with/without voting rights). Apart from this, private companies which are not subsidiaries of public company have the option of raising funds through Venture Capital.

The issue of shares to the public is governed by the guidelines issued by the Securities & Exchange Board of India (SEBI) - the body that regulates and oversees the functioning of Indian Stock markets and the RBI.

A company issuing shares or debentures has to comply with SEBI disclosure requirements with regards to its prospectus. The prospectus has to be approved by the stock exchange and scrutinized by SEBI and then filed with the Registrar of Companies.

Indian companies having foreign investment approval through FIPB route do not require any further clearance from RBI for receiving inward remittance and issue of shares to the foreign investors. The companies are required to notify the concerned Regional office of the RBI of receipt of inward remittances within 30 days of such receipt and within 30 days of issue of shares to the foreign investors or NRIs.

Equity participation by international financial institutions such as ADB, IFC, CDC, DEG, etc., in domestic companies is permitted through automatic route, subject to SEBI/RBI regulations and sector specific cap on FDI.

In all other cases a company may issue shares as per the RBI regulations. Other relevant guidelines of SEBI and RBI, including the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, wherever applicable, would need to be followed.

The Companies Act does not specify the nominal value of shares. According to RBI/SEBI Guidelines, in case of listed companies, the issue price shall be either at the average of the weekly high and low of the closing prices of related shares quoted on the stock exchange during the six months preceding the relevant date, or the average of the weekly high and low of the closing prices of related shares quoted on the stock exchange during the two weeks preceding the relevant date.

Existing companies can issue shares at par or at a premium or at a discount rate. However, issuing shares at a discount, under specific circumstances requires prior permission from regulatory authorities.

The amount of capital issued is limited to the specified authorized capital in the memorandum of association and can be increased if provided it is allowed by the articles of association.

3.3.3.1.1 Preference Shares

Foreign investment through preference shares is treated as FDI. Issue of preference shares has to conform with the guidelines prescribed by the SEBI and RBI and other statutory requirements. Preference shares could be issued through automatic route or government approval depending upon the activity/sector of the company. These are considered as part of the share capital and fall outside the External Commercial Borrowings (ECB) guidelines/cap. In cases where they carry a conversion option, these are also considered while calculating equity cap. The duration of conversion is as per the maximum limit prescribed under the Company's Act or as agreed to in shareholder's agreement, whichever is less. There are limits prescribed by the Ministry of Finance over the dividend rates for preference shares.

3.3.3.1.2 Rights/Bonus Shares

General permission of the RBI is available to Indian companies to issue right/bonus shares, subject to certain conditions. Entitlement of rights shares is not automatically available to investors who have been allotted such shares as Overseas Corporate Bodies (OCBs). Such issuing companies need to seek specific permission from the Foreign Exchange Department, Foreign Investment Division of the RBI for issue of shares on right basis to erstwhile OCBs.

3.3.3.1.3 Merger/Amalgamation and Acquisition

In case of a Scheme of merger or amalgamation of two or more Indian companies has been approved by a court in India, the transferee company may issue shares to the shareholders of the transferor company resident outside India, subject to ensuring that the percentage of shareholding of persons resident outside India in the transferor new company does not exceed the percentage specified in the approval granted by the Central Government or the RBI. This entitlement of rights shares is not automatically available to investors who have been allotted such shares as OCBs. For this specific permission from RBI is necessary.

In the event, an acquisition of shares of the company listed on a stock exchange together with the shares already held, results in a holding of 15% or more of the voting capital or a change in management control, the SEBI (Substantial Acquisition of Shares and Takeovers) Guidelines, 1997 (also known as the Takeover Code) gets activated. This code aims at protecting the interests of small investors and also strengthens the regulatory framework for takeovers.

3.3.3.1.4 Buy-Back of Shares

The Companies Act, 1956 permits a company to buy-back up to 10% of the paid-up equity capital and free reserves provided it is sanctioned in the company's board meeting. By a special resolution of the shareholders, this limit can be extended to 25%. The Companies Act also prescribes certain conditions regarding reserves & debt-equity ratio as eligibility criteria for buy-back of shares. The procedure is relatively simple and does not involve any court process. SEBI has prescribed certain guidelines in this regard for Companies listed on a stock exchange in India.

Companies buying back shares cannot - for a period of six months following the buy-back - issue shares of the same class or other specified securities.

3.3.3.1.5 Capital Reduction

Capital Reduction is a process whereby a company can pay off its shareholders by canceling or reducing capital or by canceling the share capital against accumulated losses. It requires sanction by the jurisdictional High Court. This power is being gradually transferred from the High Courts to the National Company Law Tribunal (NCLT) which is in the process of being formed. Sanctions from various parties whose interests are likely to be affected are also necessary.

3.3.3.1.6 Reorganisation

Reorganisation of a company by a compromise or by arrangement between the company and its creditors requires the sanction by the jurisdictional High Court. This power too is being transferred to the National Company Law Tribunal (NCLT).

3.3.3.1.7 Demerger

To separate core and non-core businesses, companies could resort to demerger. This too requires sanction by the jurisdictional High Court. Again, this power will be eventually shifted from High Courts to the National Company Law Tribunal (NCLT).

3.3.3.2 Debentures and Borrowings

Debentures, bonds and other debt securities can be issued or deposits from the public could be accepted by companies to raise finances. Debentures could be redeemable or perpetual, bearer or registered and convertible or non-convertible. According to the Companies Act 1956, debentures cannot carry voting rights. The sources from which deposits can be accepted are prescribed in the Act.

Box 3.3

Transfer of Shares/Debentures

Transfer of shares in the following categories of cases is allowed under automatic route:

  1. Transfer of shares from resident to non-resident (including transfer of subscribers' shares to non-residents) other than in financial services sector provided the investment is covered under automatic route, does not attract the provisions of SEBI's (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, falls within the sectoral cap and also complies with prescribed pricing guidelines.

  2. Conversion of ECB/Loan into equity provided the activity of the company is covered under automatic route, the foreign equity after such conversion falls within the sectoral cap and also complies with prescribed pricing guidelines.

  3. Cases of increase in foreign equity participation by fresh issue of shares as well as conversion of preference shares into equity capital provided such increase within the sectoral cap in the relevant sectors, are within the automatic route and also complies with prescribed pricing guidelines.

 

General permission of the RBI has been granted to non-residents/NRIs for transfer of shares and convertible debentures of an Indian company as under:

  1. A person resident outside India (Other than NRI and OCB) may transfer by way of sale or gift shares or convertible debentures to any person resident outside India (including NRIs); provided transferee has obtained prior permission of SIA/FIPB, in terms of Press Note No.1 & 3 (2005 Series) to acquire the shares if he has an existing venture or tie-up in India in the same field in which the Indian company whose shares are being transferred is engaged.

  2. NRI or OCB may transfer by way of sale or gift the shares or convertible debentures held by him or it to another nonresident Indian; provided transferee has obtained prior permission of Central Government in terms of Press Note No.1 & 3 (2005 Series) to acquire the shares if he has an existing venture or tie-up in India in the same field in which the Indian company whose shares are being transferred, is engaged.

  3. The person resident outside India may transfer any security to a person resident in India by way of gift.

  4. A person resident outside India may sell the shares and convertible debentures of an Indian company on a recognized Stock Exchange in India through a registered broker.

3.3.3.3 ECBs

External Commercial Borrowings (ECBs) are debts raised in foreign currency and are regulated by the Ministry of Finance and the RBI. ECB can be accessed under two routes, viz., automatic route and approval route and can be availed by corporates registered under the Companies Act except for financial intermediaries. An empowered Committee of RBI decides all cases falling outside the purview of the automatic route. Finances have to be availed from internationally recognised sources, export credit agencies, suppliers of equipment, foreign collaborators and foreign equity holders (subject to certain minimum equity holding requirements in the borrower's company). The proceeds cannot be used for on-lending, investment in capital markets, working capital and real estate.

3.3.3.4 FCCBs

The Scheme for issue of Foreign Currency Convertible Bonds (FCCBs) and Ordinary Shares (Through Depository Receipt Mechanism) was initiated in 1993 to allow the Indian Corporate Sector to have access to the Global capital markets through issue of FCCBs / Equity Shares under the Global Depository Receipts (GDR) Mechanism and American Depository Receipts (ADR) Mechanism.

Under this scheme, companies with consistent track record of good performance (financial or otherwise) for minimum period of three years could access international capital market. The three year track record requirement has been relaxed for companies making FCCB issues for financing projects in infrastructure sectors like power generation, telecommunication, petroleum exploration and refining, ports, airports and roads.

FCCBs are issued in accordance Scheme, and subscribed to by a non-resident in foreign currency and are convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments.

An issuing company desirous of raising foreign funds by issuing FCCBs or ordinary shares for equity issues through Global Depositary Receipt can issue FCCBs, subject to certain limit (currently US$50 million) under the automatic route. For FCCBs beyond this limit RBI approval is necessary and for substantially higher amounts (currently more than US$100 million) prior permission of the Department of Economic Affairs, Ministry of Finance, Government of India is required.

3.3.3.5 ADRs / GDRs

An Indian corporate can raise foreign currency resources abroad through the issue of American Depository Receipts (ADRs) or Global Depository Receipts (GDRs) by issuing its Rupee denominated shares to a person resident outside India being a depository for the purpose of issuing GDRs and/ or ADRs, subject to the conditions that:

  • The ADRs/GDRs are issued in accordance with the Scheme for issue of FCCBs and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the Central Government there under from time to time

  • The Indian company issuing such shares has an approval from the Ministry of Finance, Government of India to issue such ADRs and/or GDRs or is eligible to issue ADRs/ GDRs in terms of the relevant scheme in force or notification issued by the Ministry of Finance, and

  • The Indian company is not otherwise ineligible to issue shares to persons resident outside India in terms of these Regulations.

There is no limit up to which an Indian company can raise ADRs/GDRs. However, the Indian company has to be otherwise eligible to raise foreign equity under the extant FDI policy. The FCCB issue proceeds need to conform to ECB end use requirements. Regulation 4 of Schedule-I of FEMA Notification No. 20 deals with the issue of ADR/GDR by an Indian company.

In case a company is engaged in manufacturing items covered under the automatic route, whose FDI after a proposed GDRs/ADRs/FCCBs issue is likely to exceed the equity limits under the automatic route, or the company is implementing a project falling under Government approval route, then it would need to obtain prior Government clearance through FIPB before seeking final approval from the Ministry of Finance.

3.3.4 Foreign Portfolio Investments

Foreign Institutional Investors (FIIs) registered with SEBI and NRIs are eligible to purchase/sell securities traded in the primary and secondary capital markets in India under the Portfolio Investment Scheme. These securities include shares, convertible debentures, warrants, units of mutual funds, government securities and derivative instruments.

FIIs include Asset Management Companies, Pension Funds, Mutual Funds, Investment Trusts as Nominee Companies, Incorporated/Institutional Portfolio Managers or their Power of Attorney holders, University Funds, Endowment Foundations, Charitable Trusts and Charitable Societies. Besides these, other foreign investors are also eligible for registration as sub-accounts. These could be collective investment funds and institutions, proprietary funds or foreign corporations and individuals.

Investment by FIIs is regulated under SEBI (FII) (Amendment) Regulations 2007 and the Foreign Exchange Management (Transfer or issue of Security by a Person Resident outside India) Regulations, 2000 (Notification No. FEMA 20/2000-RB dated 3rd May 2000) and its subsequent amendments.

SEBI acts as the nodal point in the entire process of FII registration. It also examines whether the grant of registration is in the interest of the development of the Indian securities market. FIIs are required to apply to SEBI in a common application form in duplicate. RBI approval is also required under FEMA to buy/sell securities on Stock Exchanges in India. The FII needs to apply to the designated Authorised Dealer (AD) of the RBI for opening a foreign currency account and/or a Non Resident Rupee Account.

The SEBI guidelines and RBI Regulations prescribe certain investment limits to regulate the investment by FIIs. If investments are made by an FII through offshore funds, GDRs, ADRs or Euro-convertible Bonds, these restrictions do not apply. However, as mentioned earlier, in cases where issue of ADRs, GDRs or FCCBs by a company would lead to increase in the permissible investment limits of FDI under the automatic route or if such an investment is in a project that requires prior government approval, the company raising such capital overseas needs to seek approval from the FIPB.

Box 3.4

Portfolio Investments by NRIs

NRIs/PIOs are permitted to purchase/sell shares/convertible debentures of Indian companies on Stock Exchanges under Portfolio Investment Scheme. For this purpose, the NRI/PIO has to apply to a designated branch of a Bank which deals in Portfolio Investment. All the sale/purchase transaction are routed through the designated branch.

Investment can be made both on repatriation basis or nonrepatriation basis. The sale of shares will be subject to payment of applicable taxes.

3.3.5 Foreign Technology Agreements

For promoting technological capability and competitiveness of the Indian industry, acquisition of foreign technology is encouraged through foreign technology collaboration agreements. Induction of know-how through such collaborations is permitted either through automatic route or with prior Government approval. The terms of payment under foreign technology collaboration, which are eligible for approval through the automatic route and by the Government approval route, include:

  • Technical know how fees

  • Payment for design and drawing

  • Payment for engineering service

  • Royalty payments

Payments for hiring of foreign technicians, deputation of Indian technicians abroad, and testing of indigenous raw material, products, indigenously developed technology in foreign countries are governed by separate RBI procedures and rules pertaining to current account transactions and are not covered by the foreign technology collaboration approval.

Proposals envisaging foreign technology agreements are approved under the automatic route subject to:

  • the lump sum fee not exceeding US$2 million

  • royalty payable being limited to 5% for domestic sales and 8% for exports, without any restriction on the duration of the royalty payments. The royalty limits are net of taxes and are calculated according to standard conditions.

Use of foreign brand names/trademarks for the sale of goods in India is permitted. Payment of royalty up to 2% for exports and 1% for domestic sales is allowed under automatic route for use of trademarks and brand name of the foreign collaborator without technology transfer. Royalty on brand name/trade mark is to be paid as a percentage of net sales, viz., gross sales less agents'/dealers' commission, transport cost, including ocean freight, insurance, duties, taxes and other charges, and cost of raw materials, parts and components imported from the foreign licensor or its subsidiary/affiliated company. In case of technology transfer, payment of royalty includes the payment of royalty for use of trade mark and brand name of the foreign collaborator.

Authorised Dealers (ADs) appointed by the RBI allow remittances for royalty, payment of lump-sum fee and remittance for use of Trade mark/Franchise in India within the limits prescribed under the automatic route. RBI's prior approval is required for remittance towards purchase of trade mark/franchise.

Proposals for foreign technology collaboration not covered under the automatic route are considered by the Project Approval Board (PAB) in the Department of Industrial Policy and Promotion. Application in such cases should be submitted in Form FC-IL to the Secretariat for Industrial Assistance. Proposals where both financial & technical collaboration are proposed, application is to be submitted to FIPB. No fee is payable.

3.3.6 Foreign Exchange Controls

The RBI's Exchange Control Department, administers Foreign Exchange Management Act, 1999, (FEMA) which has replaced the earlier - more stringent - Foreign Exchange Regulation Act (FERA), with effect from June 1, 2000. This replacement signaled a shift in the objective of the Indian Government from conservation of foreign exchange to promotion of systematic development and maintenance of foreign exchange market in India. The legislation aims at facilitating external trade and promoting an orderly development and maintenance of foreign exchange market in India.

Except for certain specified restrictions where RBI approval is necessary, foreign currency can be freely purchased for trade and current account and the Indian rupee is now fully convertible for the purpose. Capital Account transactions are permitted in specific cases only on satisfaction of certain prescribed conditions. The broad coverage areas of FEMA regulations are as follows:

  • Postal orders/Money orders

  • Export of goods and services

  • Receipts from & payments to a person resident outside India

  • Manner of receipt and payments

  • Investment in firm or proprietary concern in India

  • Establishment in India of branch or office or other place of business

  • Insurance

  • Deposits

  • Export and import of currency from/into India by a person resident outside India

  • Possession & retention of foreign currency

  • Foreign currency accounts by a person resident in India

  • Exchange Earners Foreign Currency (EEFC) Account

  • Foreign currency accounts in India of a person resident outside India

  • Borrowing and lending in rupees

  • Borrowing or lending in foreign exchange

  • Realisation, repatriation and surrender of foreign exchange

  • Guarantee by a person resident outside India in favour of - or on behalf of - a person resident in India and payment on invocation of guarantee

  • Acquisition and transfer of immovable property outside India

  • Acquisition and transfer of immovable property in India by a person resident outside India

  • Transfer or issue of security by a person resident outside India

  • Issue of security by a branch, office or agency of a person resident outside India

  • Foreign exchange derivatives contract

  • Transfer or issue of any foreign security

  • Remittances outside India of capital assets in India of a person resident outside India

  • Remittances abroad that require prior approval arrangements, such as joint venture and technical transfer agreements

  • Remittance of interest, dividends, service fees, royalties, repayment of overseas loans, etc.

The provisions in respect of repatriation of investment capital and profits earned in India can be summarized as follows:

  • All foreign investments are freely repatriable, subject to sectoral policies and except for cases where NRIs choose to invest specifically under non-repatriable schemes. Dividends declared on foreign investments can be remitted freely through an Authorised Dealer

  • Non-residents can sell shares on stock exchange without prior approval of RBI and repatriate through a bank the sale proceeds if they hold the shares on repatriation basis and if they have necessary NOC/tax clearance certificate issued by Income Tax authorities

  • For sale of shares through private arrangements, Regional offices of RBI grant permission for recognized units of foreign equity in Indian company in terms of guidelines indicated in Regulation 10.B of Notification No. FEMA.20/2000 RB dated May 2000. The sale price of shares on recognized units is to be determined in accordance with the guidelines prescribed under Regulation 10B(2) of the above Notification

  • Profits, dividends, etc. (which are remittances classified as current account transactions) can be freely repatriated

3.3.7 Bilateral Investment Promotion Agreement

As part of the Economic Reforms Programme initiated in 1991, the foreign investment policy of the Government of India was liberalised and negotiations were undertaken with a number of countries to enter into Bilateral Investment Promotion & Protection Agreement (BIPAs) in order to promote and protect on reciprocal basis investment of the investors.

Government of India has, so far, signed BIPAs with more than 60 countries out of which around 50 BIPAs have already come into force and the remaining agreements are in the process of being enforced. In addition, agreements have also been finalised and/ or being negotiated with a number of other countries.

Some of the important features of BIPA are:

  • National Treatment for foreign investment

  • MFN treatment for foreign investment and investors

  • Free repatriation/ transfer of returns on investment

  • Recourse to domestic disputes resolution and international arbitration for investor-State and State-State disputes

  • Nationalization / expropriation only in public interest on a non-discriminatory basis and against compensation etc.

3.4 ANTI TRUST REGULATIONS

With the objective of preventing concentration of economic power in the hands of private sector, in 1969, the Monopoly and Restrictive Trade Practices (MRTP) Act was enacted. As part of the various initiatives to align our systems with the global norms, this Act is now in the process of being replaced by the Competition Act, 2002 (No. XII of 2003), aimed at preventing practices restraining trade or commerce and facilitating competition. The Anti-trust regulatory framework in India, basically revolves around:

  • Monopoly & Restrictive Trade Practices Act, 1969

  • Competition Act, 2002

  • Certain provisions under the Companies Act, 1956

  • Consumer Protection Act, 1986

3.4.1 The MRTP Act

The MRTP Act governs the activities/practices of all industrial undertakings being enterprises engaged in production, storage, supply, distribution, acquisition/control of articles/goods or the provision of services of any kind, either directly through one or more of its units or divisions, irrespective of the divisions being located in one place or being dispersed. However, government undertakings do not come under the purview of MRTP Act. The provisions of the Act relate to prohibition of monopolistic trade practice, unfair trade practice and restrictive trade practices.

The Monopolies and Restrictive Trade Practices Commission is the regulatory body under the MRTP Act. The Director General of Investigation and Registration assists the Commission in carrying out investigations, maintaining a register of agreements to be regulated under the Act and undertakes carriage of proceedings during the enquiry before the Commission.

3.4.2 The Competition Act

Against the backdrop of the overall reform process, the fast pace of India's economic growth and the various developmental initiatives, the Competition Act 2002 (as amended in 2007) was introduced to provide for the establishment of a Commission to prevent practices having adverse effect on competition, to promote and sustain competition in markets, to protect the interests of consumers and to ensure freedom of trade carried on by other participants in markets, in India, and for matters connected therewith or incidental thereto.

The major provisions of the Competition Act relate to Prohibition of Anti-competitive Agreements, Prohibition of abuse of Dominant Position, Regulation of Combinations and the Competition Commission of India.

3.4.2.1 Prohibition of Anti-Competitive Agreements

An agreement between enterprises/associations/individuals engaged in similar trade of goods or provision of services would be considered as anti-competitive if it:

  • directly or indirectly determines the purchase or sale prices

  • limits/controls production, supply, markets, technical development

  • shares the market or source of production or provision of services by way of allocation of geographical area of market, or type of goods or services, or number of customers in the market

  • directly or indirectly results in collusive bidding or elimination or reduction of competition or manipulation in the process of bidding

Any agreement entered into by way of joint venture, which has the above impact, may still not be considered to have an adverse effect on competition provided it leads to an increase in efficiency in production, supply, distribution, storage, acquisition or control of goods or provision of services. On the other hand, tie-in arrangements, exclusive supply agreements, exclusive distribution agreements, refusal to deal, resale price maintenance could be regarded as anti-competitive.

3.4.2.2 Prohibition of Abuse of Dominant Position

Dominant position implies a position of strength, enjoyed by an enterprise, in the relevant market, which enables it to operate independently of competitive forces prevailing in the relevant market or affect the players in the relevant market in its favour.

An enterprise would be regarded as abusing its dominant position if:

  • it directly or indirectly imposes unfair or discriminatory condition or price in the purchase/sale of goods/service - which is not necessary to meet the competition.

  • limits or restricts - (i) production of goods or provision of services or market thereof; or

(ii) technical or scientific development relating to goods or services to the prejudice of consumers; or

  • indulges in practices resulting in denial of market access; or

  • makes conclusion of contracts subject to acceptance by other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts; or

  • uses its dominant position in one relevant market to enter into, or protect other relevant market

3.4.2.3 Regulation of Combinations

Section 6 of the Competition (Amendment) Act, 2007 has a number of regulations dealing with mergers and acquisitions - in India or outside. The provisions of this section, would not apply to share subscription or financing facility or any acquisition, by a public financial institution, foreign institutional investor, bank or venture capital fund, pursuant to any covenant of a loan agreement or investment agreement. However, the public financial institution, foreign institutional investor, bank or venture capital fund would have to file in the form as may be specified by the regulations, with the Commission the details of acquisition including details of control, the circumstances of exercise of such control and the consequences of default arising out of such loan agreement or investment agreement, as the case may be - within seven days from the date of acquisition.

3.4.2.4 Competition Commission of India

The Ministry of Corporate Affairs has notified the constitution of the Competition Commission of India, which would be the regulatory body to be established under the Competition Act. The Commission would consist of a Chairperson and two to six Members to be appointed by the Central Government. There would be a Director General to assist the Commission in conducting enquiries. There would also be an Appellate Tribunal to hear and dispose of appeals against any direction issued or decision made or order passed by the Commission or to adjudicate on claim for compensation that may arise from the findings of the Commissions.

The provisions of the Competition Act dwell upon the Powers, Functions and Duties of the Competition Commission of India.

3.4.3 Certain Provisions in the Companies Act

Certain provisions in the Companies Act, 1956, regulating with acquisition and transfer of shares to concentration of economic power, are connected with the provisions of MRTP and the Competition Act and necessitate prior approval of the Central government (Competition Commission). Also the provisions in Companies Act with regards to inspection, production & seizure of documents for investigation, etc., apply to sections dealing with the duties of Director General in the Competition Act.

3.4.4 The Consumer Protection Act

The Consumer Protection Act is a legislation enacted for protection of consumer interest and to provide for cheap, speedy and simple redressal to consumer disputes. The Act provides for establishment of Consumer Protection Councils at the Centre and State levels - under the respective Ministry of Consumer Affairs; and quasi-judicial machinery at each District, State and National levels called District Forums, State Consumer Disputes Redressal Commission and National Consumer Disputes Redressal Commission respectively.

The provisions of this Act cover 'Products' as well as 'Services'. The products are those which are manufactured or produced and sold to consumers through wholesalers and retailers. The services are of the nature of transport, telephones, electricity, constructions, banking, insurance, medical treatment etc. The services are, by and large,include those provided by professionals such as Doctors, Engineers, Architects, Lawyers, etc. Any entity providing any good/service in India is required to avoid any p


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