Foreign Investment Manufacturing Incentives in India

July 26, 2013 Posted by India Briefing Reading Time: 5 minutes

Using Special Economic Zones To Your Advantage

By Gunjan Sinha, Dezan Shira & Associates, Delhi

Jul. 26 – Increasing numbers of foreign investors are establishing operations in India, with many undertaking the combined activities of manufacturing and assembly for both the Indian domestic and global export markets. A recent example of this is the U.S. auto manufacturer Ford, who have announced that their facility in Gujarat, on India’s northwest coast, will commence production next year. This facility will produce three types of vehicle, with production of each split roughly 50-50 for sale in India and in overseas markets.

This is a trend that will continue, as smaller component manufacturers enter the Indian market to support their larger multinational corporation customers. This same phenomena occurred in China in the late 1990s.

Key to this is understanding the role that India’s special economic zones (SEZs) have to play, as many provide incentives and tax breaks of significant benefit to the foreign investor.

India’s SEZs closely follow the successful Chinese SEZ model. To promote economic competitiveness and easier exporting, they function as growth engines to boost manufacturing and create new job opportunities. Foreign-owned business entities may be established in SEZs for the manufacturing of goods, the provisioning of services, and other activities including processing, assembling, trading, repairing and reconditioning.

The legal definition of manufacturing in India is: “To make, produce, fabricate, assemble, process or bring into existence a new product having a distinctive name, character or use; including processes such as refrigeration, cutting, polishing, blending, repairing, remaking and re-engineering.”

SEZs in India provide a number of investment incentives. However, let’s first examine the different types of Indian SEZs and the different sectors they cater for:

Special Economic Zones for Multiple Sectors
Multi-sector SEZs are areas where units may be set up for the manufacturing, trading and warehousing of multiple products.

Special Economic Zones for Specific Sectors
Sector-specific SEZs are set up exclusively for products or services within a particular sector. Preferential policies for these zones depend on the industry.

Special Economic Zones for Free Trade and Warehousing (FTWZs)
FTWZs aim to facilitate the import and export of goods and the conducting of trade transactions in a free currency. FTWZs are “deemed foreign territory” and are essentially integrated bonded zones used as international trading hubs. Benefits for these zones include special storage infrastructure and high-quality transportation.

Alternative Special Economic Zones
Alternative SEZs can cover the information technology, information technology enabled service or handicraft industries, and they also deal with companies operating in the bio-technology, non-conventional energy, gems and jewelry sectors. Companies in Alternative SEZs typically enjoy tax benefits and reductions in rent and utility bills. Again, these benefits may vary by zone and industry.

Permitted FDI Activities
Foreign direct investment up to 100 percent is allowed through the automatic route for all manufacturing activities in SEZs, except for the following areas:

Arms and ammunition, explosives and allied items of defense equipment, aircraft, and warships;
Atomic substances;
Narcotics and psychotropic substances and hazardous chemicals;
Distillation and brewing of alcoholic drinks;
Cigarettes/cigars and manufactured tobacco substitutes; and
Sector norms as notified by the government as applicable to foreign investment in services.

What this means is that in nearly all manufacturing cases, investment is permitted with 100 percent equity ownership by the foreign party in India.

Investment Incentives for Foreign Investors in India
Incentives and facilities offered to foreign businesses located within an SEZ include:

Duty free import and domestic procurement of goods for the manufacturing and assembly of its products within the SEZ;
100 percent valued-added tax (VAT) rebates upon export of components sourced in India; and
Income tax exemptions (these vary dependent upon the business scope and location in India, but can be substantial).

SEZ Application Procedures
All proposals for setting up a business within an SEZ in India are approved at the zone level by the approval committee, consisting of the development commissioner, customs authorities and representatives of state government. All post-approval clearances, including the granting of an importer-exporter code number, the change in the name of the company or implementing agency, broad banding diversification, etc., are supervised at the zone level by the development commissioner.

In addition to this, the legal and administrative procedures for establishing a wholly owned enterprise (WOE) apply.

Setting Up A Wholly Owned Enterprise in India
WOEs are fully owned subsidiaries of foreign companies. They are the most suitable and widely used form of business enterprise for foreign investors in India because they allow total control over business operations, provide limited liability, and have fewer restrictions on business activities than liaison offices and project offices. They have independent legal status as Indian companies distinct from the foreign parent company.

Foreign investment in India is regulated under the Foreign Exchange Management Act, 1999, and is allowed under two routes: the automatic route and the government approval route. With the increasing relaxation of India’s FDI policies, the majority of foreign manufacturers intending to use SEZ’s in India will be able to use the easier automatic route.

A WOE requires a minimum of two directors, has a minimum of two shareholders and has limited liability. No track record is required for the shareholders, and they can be other legal entities. The minimum paid-up capital requirement is INR100,000 (approx US$2,000). No approvals of other regulatory authorities are needed. A wholly owned subsidiary is subject to Indian laws and regulations as applicable to other domestic Indian companies, and is treated as an Indian company for taxation purposes (albeit one that may take advantage of income tax breaks as applicable and VAT rebates as mentioned above).

Summary
The use of tax incentives to attract investment into India is not new, yet is dependent upon a number of factors such as the type of business activity, as well as the differing policies towards incentives provided by different states across India. This means that advice needs to be sought over the best locations for foreign investment in manufacturing, processing, assembly and the optimum tax breaks available. Tax is a fast evolving issue in India and policies can and do change on a regular basis.

Some of the most popular SEZs in India include Kandla SEZ (Gujarat, northwest coast) SEEPZ (Mumbai, west coast), Noida EPZ (Delhi, export processing), Falta SEZ (Kolkata, Bay of Bengal), Madras SEZ (Chennai, east coast) and Visakhapatnam SEZ (southeast coast).

When dealing with these zones, and examining pertinent tax breaks, tax planning and the legal structure, professional advice should be sought from firms experienced in handling the needs of foreign investors in India.

Dezan Shira & Associates assists foreign investors to establish operations throughout India. The firm was established in 1992 and handles pre-incorporation, international tax planning, legal structuring, and on-going accounting, payroll and compliance services. Please email india@dezshira.com or visit the practice at www.dezshira.com.

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Our 156-page business guide to India, the second fastest growing economy in the world, provides a thorough and in-depth analysis of India, its history, key demographics and overviews of the states and union territories highlighting business opportunities and infrastructure in place in each region. A comprehensive guide to investing in India is also included with information on FDI trends, business establishment procedures, economic zone information, labor and tax considerations, as well as an analysis of Indian business etiquette and culture.