What You Need to Know About Conducting Due Diligence in India: Q&A

Foreign companies looking to do business in India should perform a due diligence check to identify or prepare against any possible risk exposure. This process is typically carried out in various scenarios, including mergers and acquisitions (M&A), partnerships, joint ventures (JVs), and initial public offerings (IPOs).

It is crucial to note that companies operating in India must adhere to distinct legal and regulatory compliance requirements, with the tax regime often posing challenges. Therefore, conducting due diligence is essential to ensure that the local company complies with all relevant laws and regulations, and provides accurate information to the foreign company interested in its business.

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We interviewed the business advisory team at Dezan Shira & Associates’ India Offices, who shared key considerations for foreign companies embarking on a due diligence check prior to entering the Indian market.

When is it necessary for a foreign company to conduct due diligence?

Dezan Shira & Associates India: There are several situations in which a foreign company should carry out due diligence. If it is engaged in an M&A, due diligence is necessary for both the buyer and the seller. It is also crucial in cases of strategic alliances, business partnerships, joint ventures, or IPOs.

Additionally, due diligence is conducted when the foreign company intends to perform a background check on individuals such as partners, suppliers, or country heads.

Why should a foreign company conduct due diligence before entering into a business deal in India?

Dezan Shira & Associates India: It is important to conduct due diligence to avoid a bad transaction, identify issues within the company, and verify that the business is what it appears to be. Additionally, this process provides valuable insights into the company’s value and assets. It further helps in assessing the reputation and corporate governance of the company.

What types of due diligence should foreign companies consider when investing in India?

Dezan Shira & Associates India: The main types of due diligence that should be considered in India are legal, financial, HR, and commercial due diligence. Legal due diligence involves examining the legal aspects of the transaction, including a thorough analysis of documents, existing contracts, agreements, and ongoing or pending litigation.

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During the investment process, it is crucial to understand the past financial statements, book of accounts, and compliance adherence. This provides a comprehensive understanding of the company’s financial health, including any hidden liabilities and their potential impact on the business.

HR due diligence, which is particularly important in India, encompasses the country’s system of employment contracts, labor laws, labor relations, regulatory policies, work culture, and industry standards. Factors such as class, caste, gender, ideology, religion, and tribe significantly influence labor relations in different regions of India and must be thoroughly understood before entering the market.

Commercial due diligence helps in understanding the target company’s market. It provides an overview of internal and external environmental factors, highlighting the target company’s market position and its ability to achieve forecasted goals and objectives.

Other types of due diligence may focus on areas such as operations, information technology, intellectual property, and vendor relationships, among others.

How crucial is it for firms to conduct pre-investment due diligence?

Dezan Shira & Associates India: Pre-investment due diligence plays a vital role in mitigating risks and facilitating informed decision-making. It helps in minimizing the impact of unknown risks or liabilities associated with a business. By conducting due diligence, potential issues can be identified before finalizing a deal, allowing for adjustments in pricing and other crucial terms and conditions.

Additionally, it provides a comprehensive understanding of the business and enables an assessment of its compatibility with existing operations. Overall, pre-investment due diligence provides practical insights for conducting business in India. Based on the findings of the due diligence process, parties can proceed with the deal, engage in further negotiations, or decide to withdraw from the transaction.

Should due diligence only apply to certain types of business dealings?

Dezan Shira & Associates India: While due diligence is recommended in various cases, it holds particular significance in the context of joint ventures. Given that each company is unique, it is essential to gather and uncover any information that may impact the sale and purchase of a company or its assets.

However, the need for conducting due diligence can sometimes depend on the structure of the JV. If two companies are merging to establish a new entity for a fresh business activity, due diligence may or may not be necessary.

Conversely, if the JV involves the acquisition of an existing company, conducting due diligence is always advisable.

What tax and regulatory compliance areas should foreign companies prioritize in India during a due diligence check?

Dezan Shira & Associates India: In a due diligence check, it is crucial for foreign companies to focus on tax-related aspects. Tax due diligence in M&A deals is essential for identifying potential tax issues and leakages. Additionally, it can uncover any unutilized tax benefits that the target company may not be availing.

Understanding the nuances of taxation also aids in structuring the M&A deal in a tax-efficient manner.

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Key documents such as the balance sheet, related schedules, and profit and loss statements provide relevant tax information about the target company. These documents disclose aggregate taxes paid, current tax charges, deferred tax charges, tax disputes, demands against the company, and contingent liabilities, among other important details.

It is advisable to analyze the effective tax rate, deferred tax rate, and review the Minimum Alternate Tax (MAT) status. The master data from the corporate affairs ministry should be examined to assess the details of the target company established under the Companies Act, 2013. This includes reviewing the certificate of incorporation, articles of association, memorandum of association, authorized capital, paid-up capital, and the quantum of secured loans, which provide insights into the company’s status during the due diligence process.

Furthermore, compliance with India’s Foreign Direct Investment (FDI) policy is essential during M&A transactions. Certain sectors and activities have restrictions or prohibitions under the FDI policy. It is also crucial to ensure compliance with the Foreign Exchange Management Act (FEMA). Compliance with the annual return on foreign liabilities and assets (FLA Return) and annual performance report helps shed light on the company’s assets, liabilities, and any overseas direct investments made.

Foreign companies should prioritize these tax and regulatory compliance areas to ensure a thorough due diligence check in India.

Why is it crucial for foreign companies to conduct HR due diligence in India?

Dezan Shira & Associates India: Conducting HR due diligence is of utmost importance as it allows for a comprehensive evaluation of the company’s HR procedures, processes, and human capital. This type of due diligence helps in understanding the following:

• HR policies, governance, and code of conduct guidelines.
• Any cultural differences between organizations that may lead to future conflicts.
• Payroll contractual obligations of the target company towards its employees. This includes analyzing salary structures, cost-to-company details, lock-in periods, non-compete contracts, and severance packages.
• Identification of potential fraud in employee background details.
• Evaluation of labor issues, social security obligations, and compliance with labor regulations.
• Examination of the relationship with trade unions and the level of bonding among employees.
• Identification of any pending litigation involving employees or the company.

By conducting HR due diligence, foreign companies can gain crucial insights into the HR aspects of the target company in India, helping them make informed decisions and mitigate risks associated with human resources.

Why is it beneficial to engage a local professional services firm for conducting due diligence?

Dezan Shira & Associates India: When considering an investment in India, it is advisable to conduct a thorough due diligence of the target company to proactively identify potential risks and opportunities. Engaging an experienced due diligence team ensures that all aspects are meticulously examined, leaving no stone unturned. At Dezan Shira & Associates, we are well-positioned to assist you with your due diligence requirements.

Our team of experts and associates possess an in-depth understanding of the unique challenges in India and can provide comprehensive support for various types of due diligence, including financial, legal, tax, vendor, HR, commercial, and more.

For guidance on doing business in India and exploring investment opportunities in this market, please don’t hesitate to reach out to us at india@dezshira.com.

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