India has solidified its position as one of the world's fastest-growing major economies, boasting a growth rate that ranked second highest among G20 nations and nearly double the average for emerging market economies. Testament to its appeal, India attracted its highest-ever Foreign Direct Investment (FDI) inflow of USD 83.57 billion during the Financial Year 2021-22. This growth trajectory is underscored by the country's impressive Q1 GDP performance, evident in cross-country comparisons. Cumulatively, FDI inflows reached USD 919.633 billion between April 2000 and March 2023, with the fiscal year 2022-23 witnessing total FDI inflows of USD 70.97 billion, including FDI equity inflows of USD 46.03 billion. Moreover, annual Private Equity (PE) and investment in India surged to USD 56.5 billion, facilitated by over 1200 deals.

Modes of Foreign Investments in India :

Foreign investment in India is governed by the Foreign Exchange Management Act, 1999, ensuring a regulated and conducive environment for international capital inflows. Foreign investment in India operates through three primary modes: Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI) and Foreign Venture Capital Investment (FVCI).

Foreign Direct Investment (FDI) plays a pivotal role in India's economic growth, involving strategic investments in Indian entities, whether listed or unlisted. For listed companies, FDI is permissible for holdings exceeding 10% of post-issue paid-up equity. FDI regulations in India are structured to delineate between prohibited and permitted sectors. Prohibited sectors, as specified by the Government of India, encompass areas such as atomic energy, railways, nidhi companies, gambling, chit funds, transferrable development rights, and lotteries. Conversely, permitted sectors allow for FDI through either the Automatic Route or the Government Route. The Automatic Route facilitates investments up to 100% depending on sectoral limits without the need for prior approval from the Reserve Bank of India or the Central Government. Conversely, the Government Route mandates prior approval, and investments must adhere to conditions stipulated by the Government.

Downstream investment involves indirect foreign investment into Indian entities, where FDI received by one Indian company is used to invest in another Indian company's capital instruments. Sectoral conditions applicable to the initial investment remain relevant, and share issuance, transfer, pricing, and valuation must comply with SEBI and RBI guidelines.

FDI can be made through various instruments such as equity shares, compulsorily convertible preference shares (CCPS), compulsorily convertible debentures (CCD), equity instruments containing options, and swap options, providing foreign investors with diverse avenues for participation in India's economy.

Foreign Portfolio Investment (FPI) allows for investments in listed securities and is governed by both SEBI Regulations and the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, often abbreviated as FEM (DI) & (NDI) Rules. In the case of listed companies, FPIs are limited to holding less than 10% of post-issue paid-up equity, and their investments are also subject to sectoral foreign ownership caps. FPI regulations categorize investors into two groups: Category I includes government-related investors, pension funds, and other regulated entities like insurance companies and banks, while Category II encompasses regulated funds not eligible for Category I, i.e., family offices, corporate bodies, trusts, and charitable organizations. There are limits on individual and aggregate holdings for FPIs to ensure balanced investment distribution. FPIs are permitted to invest in various instruments, including listed or to-be-listed shares, derivatives, government securities, commercial papers, and units of mutual funds, real estate investment trusts, infrastructure investment trusts, and applicable Alternative Investment Funds (AIFs). This comprehensive framework provides a structured approach for foreign investors to participate in India's capital markets while ensuring regulatory compliance and stability.

Foreign Venture Capital Investment (FVCI) facilitates non-resident investments in venture capital funds within India and is regulated by the Securities and Exchange Board of India (SEBI). Under SEBI regulations, Category I Venture Capital Funds (VCFs) are permitted to raise 100% of funds from SEBI-registered FVCI entities. Various instruments are available for investment in FVCI, including equity instruments, equity-linked instruments such as those optionally or mandatorily convertible into equity shares, debt instruments, as well as other financial instruments like Optionally Convertible Redeemable Preference Shares (OCRPS), Optionally Convertible Debentures (OCDS), Non-Convertible Debentures (NDCS), and Non-Convertible Preference Shares (NCPS).

Corporate Structures for Foreign Investors :

Foreign investors or entities have the option to establish business presence in India through either incorporated or unincorporated structures. Incorporated entities, such as Private Limited companies or Limited Liability Companies, operate independently and fall under this category. On the other hand, unincorporated entities, including Liaison Offices, Branch Offices, or Project Offices, serve as extensions of the parent entity and allow foreign entities to commence operations in India. Each of the aforementioned structures warrants meticulous evaluation based on criteria including permissible activities, income tax rates, repatriation of funds feasibility, and exit strategies. This assessment is imperative to determine the most suitable structure aligned with the investment objectives and requirements of the foreign investor.

Repatriation of Funds :

Repatriation of funds in India is regulated by Foreign Direct Investment (FDI) and Foreign Exchange Management Act (FEMA) regulations, stipulating that investments must be made on a repatriation basis. However, repatriation is subject to lock-in conditions set by regulatory authorities. Common modes of repatriation include dividends, buybacks, royalties, fees for technical services, and profit repatriation. Dividends, sourced from a company's free reserves, require prior approval from the Reserve Bank of India (RBI) and are subject to a 20% withholding tax (WTH) rate, along with applicable surcharges and cess, for shareholders. Buybacks, restricted to 25% of share capital and free reserves annually, incur no tax for shareholders but entail a 20% tax liability, plus surcharge and cess, for the company. Remittances for royalties and fees for technical services are governed by agreement terms, subject to a 20% WTH rate, with potential treaty-based tax benefits. It is imperative that remittances adhere to the arm's length principle, especially in the case of transactions involving associate enterprises, ensuring fair market value is maintained. Profit repatriation involves transferring profits earned by Indian branches of foreign companies, excluding banks, contingent upon paying applicable taxes. Repatriation of profits by the LLP to the partners is exempt in the hands of the partner.

Corporate Taxation :

In India, corporate taxation applies to resident corporations on their worldwide income, while non-resident corporations are taxed solely on income earned through a business connection in India, any source within the country, or the transfer of a capital asset situated in India. The concept of "business connection" is broader than Permanent Establishment (PE), and in the case of non-residents, Further, for non-residents, the provisions of the Income tax Act or the provisions of applicable Double Taxation Avoidance Agreement (DTAA), whichever is more favourable is applicable. Such benefit is conditional to the availability of requisite documentation as specified by the Income Tax Act. For the fiscal year 2022-23, the base tax rates applicable to domestic companies in India varied between 15% to 30%, while foreign companies were subject to a base tax rate of 40% and Limited Liability Partnerships (LLPs) were taxed at a base rate of 30%. Both domestic and foreign companies are liable to pay taxes based on their total income at the specified rates. Additionally, the base tax rate is augmented by applicable surcharges and health and education cess. Surcharge rates for the fiscal year 2022-23 ranged between 2% to 12% for domestic companies, foreign companies, and LLPs, applied based on the total income., Further, the Withholding Tax (WTH) rates in India vary based on the nature of income and the type of company. Domestic companies are subject to WTH rates of 10% for dividends, 10% for interest income, 2%/10% for royalty income, and 2%/10% for fees for technical services (FTS) as maybe applicable. Foreign companies face higher WTH rates of 20% for dividends, 5%/20% for interest income, and 10% for royalty income and FTS. These rates may be increased by applicable surcharge and cess. Starting FY 2023-24, the WTH rate for royalty and FTS will increase to 20% as per domestic laws’ Further, treaty benefits are available for WTH on payments outside India based on the availability of requisite documentation.

Other important tax considerations in India include indirect transfers of shares of domestic companies, subject to capital gains tax under applicable treaties; Minimum Alternate Tax (MAT), triggered when taxes paid fall below 15% of book profits, with credits available for 15 years; the Equalization Levy, introduced in 2020, imposes a 6% tax on non-resident service providers and 2% on non-resident e-commerce operators; Advance Ruling Authority (AAR) for certainty on tax liabilities in transactions exceeding INR 1000 million with non-residents; General Anti-Avoidance Rule (GAAR) targeting tax avoidance agreements, with a focus on cases where tax benefits exceed INR 30 million; Transfer Pricing regulations covering secondary adjustments and interest deduction limits; and Foreign Tax Relief allowing credits for taxes paid abroad, either at the Indian effective tax rate or the foreign country's tax rate, depending on which is lower.

Indirect Taxation :

Indirect taxation in India underwent a significant transformation with the introduction of the Goods and Services Tax (GST) on July 1, 2017. This comprehensive tax system operates on a dual levy model, empowering both the central and state governments to collect taxes. Leveraging automated systems, GST is digitally driven, streamlining tax collection and compliance processes. Additionally, the introduction of the Authority for Advance Rulings (AAR) under GST has provided businesses with clarity on tax implications, facilitating smoother operations. In parallel, Customs Duty continues to be levied by the central government, with rates depending on the classification of goods. This dual taxation framework ensures a structured approach to indirect taxation, promoting transparency and efficiency in the tax regime.

FEMA :

The Foreign Exchange Management Act (FEMA) has introduced new regulations to acknowledge Cross Border Mergers & Acquisitions, covering both inbound and outbound mergers. These rules are expected to extend to the listing of Indian Companies outside of India, potentially bringing about liberalized listing norms. Concurrently, changes in Inbound and Outbound Policy are foreseen, including adjustments in the Automatic Route and Government Route, as well as revisions in the Foreign Direct Investment (FDI) policy.

In conclusion, India's robust economic growth, supported by significant inbound investment inflows, reflects its attractiveness as a global investment destination. With favourable regulatory frameworks governing FDI, FPI, and FVCI, alongside streamlined taxation systems like GST and corporate tax structures, India offers a conducive environment for international investors. The anticipated regulatory changes, particularly in Cross Border Mergers & Acquisitions and Overseas Investment, signal the country's commitment to further bolstering its investment landscape. As India continues to emerge as a key player in the global economy, opportunities for foreign investors are poised to expand, driving growth and prosperity for all stakeholders involved.