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Foreign Direct Investments

By
Prof. Augustin Amaladas
M.Com., AICWA.,PGDFM.,DIM.,B.Ed.

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definition
• FDI is defined as a company from one
country making a physical investment into
building a factory in another country. Its
definition can be extended to include
investments made to acquire lasting interest
in enterprises operating outside of the
economy of the investor.[1]

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Minimum Requirements
In order to qualify as FDI the investment
must afford the parent enterprise control
over its foreign affiliate. The UN defines
control in this case as owning 10% or more
of the ordinary shares or voting power of an
incorporated firm or its equivalent for an
unincorporated firm; lower ownership
shares are known as portfolio investment.
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Reasons for FDI
• economic growth, de-regulation, liberal
investment rules, and operational
flexibility.All the factors that help
increase the inflow of Foreign Direct
Investment.

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Types of Foreign collaboration
agreements
• Joint ventures
• Technical collaborations
• Setting up of branches/project office
• FDI- investment by non-residents and
overseas corporate bodies.

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Foreign collaboration agreements
• 1. Technical collaboration agreements
• 2.Financial and technical collaboration
agreements

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1. Technical collaboration
agreements

Initial Payment for


Lump sum Supply of machinery

Payment for
With transfer Drawings/
Of rights design

Royalty for use of Fees for tech.


patent Services/managerial

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2. Financial and technical
collaboration agreements
• In addition to technical agreements makes
investment in the capital of the Indian
collaborator besides transfer of technology
• The collaborator receives payments and also
dividend on shares/Interest on money lent.
• Such collaboration should match with
policies of Government of India.

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Tax Implications of foreign
collaboration
• 1. In the hands of Foreign collaborator
• 2. In the hands of Indian collaborator

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Important sections as per IT Act
• Section 44AD-computation of income who is engaged in the business of
civil construction if gross receipt does not exceed Rs.40 lakhs-8% of the
gross receipts paid /payable to the tax payer.
• Section 44DA-Computation of income by way of royalties and technical
service fees in the case of foreign companies if agreements made after
March 31st, 1976 but before 1-4-2003., -ia-10% tax on royalty
payable/paid.
• If agreement after March 31, 2003 where royalty or technical fees is
effectively connected to Permanent establishment(PE) in India-10%
• 30% -agreement made before june 1, 1997
20% after May 31, 1997 but before June 1, 2005.

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115A, 115AB, 115AC, 115AD,
115BBA and 115D

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Foreign Collaborator Indian Collaborators

1.Non residents-Income received, 1.Revenue expenditure-deduction is


deemed to be received and accrued, allowed.
or deemed to accrue in India- 2. Capital expenditure-depreciation
taxable u/s 32 is allowed.
2.Exempted income U/S 10 of IT 3. Payment to foreign personnel in
Act. India-installation of equipment-
3. Special computation of Income capitalised-depreciation allowed.
u/s 44DA, 115A, 115AB, 115AC
and 115AD 4.Training expenditure-allowed
deduction
4.Double taxation avoidance
agreements. 5.Payment for acquisition of plant
and machinery-depreciation allowed
6.Interest-allowed deduction u/s
36(1)(iii)
6. Interest paid to acquire capital
asset-capitalised upto the date of put
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into use/ready to use.
Tax planning
• 1. Do not allot shares as dividend paid outside India tax to be deducted at source
and deemed to receive in India.
• 2. Foreign collaborator should be a company registered outside India as they
become non-resident in India. If it is a partnership firm entire control and
management should be outside India.
• 3. Separate contract for separate work. Each job like supply of plant and
machinery, installation, supply of design, patents, trade mark.
• 4.Property in goods to pass on outside India- foreign collaborator need not pay
tax in India as the ownership passed outside India.The goods shipped in the name
of the Indian company.
• 5.Make payments abroad. Acceptance of payments through banks in India should
be avoided. But tax liability can not be reduced for the payments of royalty,
dividend, Interest, technical services .
• 6.Spare parts –there should be a separate agreement and should be supplied only
after the year of commissioning of plant and machinery
• 7.Salary to foreign technicians- paid in India is taxable but daily allowances and
living allowances are exempt u/s10(14) to the extent expended.
• 8.The foreign technician should not stay more than certain number of days in
India
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Tax planning for Indian
collaborators
• 1.Capitalisation of installation expenses provided
the business setup before such expense incurred
• 2.Treating purchase of spares as revenue
expenditure-make separate contract and receive
such spares only in the year subsequent to the year
of commissioning.
• 3. Claim depreciation on plans and drawings.

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Important Notes
• 1. Technical collaboration fees attract-20% TDS
u/s 115A.Otherwise it is 40% tax.
• 2.If total income of a foreign company does not
exceed 1 crore-no surcharge.
• 3.TDS paid by Indian company on behalf of
foreign company for royalty payable under the
terms of an agreement entered before 1st June 2002
relating to matter included in Industrial policy is
exempt from tax u/s 10(6A)[Grossing the income
is not required.]
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Case study-1
• 1. S Ltd a foreign company entered into an agreement with K ltd. an
Indian company.This agreement is related to industrial policy of the
central government and is in accordance with the policy. The royalty paid
by K ltd is 100 lakh to S ltd.compute the tax payable by S ltd.under the
following circumstances.
• A) K ltd pays Income tax payable by S ltd.as per the terms of agreement
entered before 1st June 2002.
• B) The agreement does not provide that K ltd will bear the tax but
understanding that 100 lakh is net of tax.
• C) The agreement entered on 1st June 2006.

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Answer-
1
A) No grossing up is required as it was entered into an agreement before
1st June 2002 and the agreement indicates the TDS.
Total Income 100 lakhs
Tax on royalty @20.6%(20%+3%) 20.6 lakhs
B) Royalty income 100 lakhs
(net)
Gross income (100 lakhs x 100/(100-20.6)=125.945 lakhs
Tax to be paid (125.945 lakhs x 20.6%) =25.945 lakhs.
(Since the agreement does not indicate the TDS we have to grossing up the
income.)
C) If agreement entered on after 1st June 2002 grossing up of Income is
required.The amount of tax payable by K ltd, on behalf S ltd. will ot
be exempt under section 10(6A).

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Case study-2
Shanthi Ltd.a foreign company entered into a collaboration agreement on 1 st
June 2006 with an Indian company and was in receipt of the following
payments during the previous year 2007-08.
a) Interest on 10% debentures of Rs.100 lakhs issued by Indian company
on 1st January 2008 in consideration of providing of technical
knowhow, manufacturing process and designs.
b) Services charges @ 2.5% of the value of plant and machinery for
Rs.800 lakhs leased out to Indian company payable each year before
31st March,
c) How do you deal with them for computation in case of Shanthi Ltd.

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Answer-2
• Since debentures issued for technical services and service charges amounts
to royalty which is paid by an Indian company it shall be deemed to accrue
or arise in India as per section 9(1)(v),( vi),(vii).It is taxed u/s 115A.It is
taxed at 20% rate. Otherwise they are taxed at 40% rate.
• Income to be taxed-debentures 100 lakhs x20%=10 lakhs
• Interest on debentures (3 months)100 x10% x3/12 x20% = 0.5 lakhs
• Service charges (800 lakhs x 2.5% x20% =4.0 lakhs
• Total tax before education cess =14.5 lakhs
• Educational cess[3% x14.5 lakhs] = 0.435 lakhs
• Total tax liability = 14.935 lakhs

• Note:No surcharge is imposed as the total income does not exceed for the
foreign company rupees 1 crore.

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• FDI or Foreign Direct Investment is any
form of investment that earns interest in
enterprises which function outside of the
domestic territory of the investor.

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• FDIs require a business relationship between a
parent company and its foreign subsidiary.
Foreign direct business relationships give rise to
multinational corporations. For an investment to
be regarded as an FDI, the parent firm needs to
have at least 10% of the ordinary shares of its
foreign affiliates. The investing firm may also
qualify for an FDI if it owns voting power in a
business enterprise operating in a foreign country.
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• Types of Foreign Direct Investment: An
Overview
• FDIs can be broadly classified into two types:
outward FDIs and inward FDIs. This classification
is based on the types of restrictions imposed, and
the various prerequisites required for these
investments.

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Vertical Foreign Direct Investment takes place
when a multinational corporation owns some shares
of a foreign enterprise, which supplies input for it or
uses the output produced by the MNC.

Horizontal foreign direct investments happen when


a multinational company carries out a similar
business operation in different nations.

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• An outward-bound FDI is backed by the
government against all types of associated risks.
This form of FDI is subject to tax incentives as
well as disincentives of various forms. Risk
coverage provided to the domestic industries and
subsidies granted to the local firms stand in the
way of outward FDIs, which are also known as
“direct investments abroad.”

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Economic factors-Inward FDI
• These include interest loans, tax breaks,
grants, subsidies, and the removal of
restrictions and limitations. Factors
detrimental to the growth of FDIs include
necessities of differential performance and
limitations related with ownership patterns.

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real estate sector

• The Government of India in March 2005 amended


existing norms to allow 100 per cent FDI in the
construction business. This liberalization act
cleared the path for foreign investment to meet the
demand into development of the commercial and
residential real estate sectors. It has also
encouraged several large financial firms and
private equity funds to launch exclusive funds
targeting the Indian real estate sector.
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• Until now, only Non Resident Indians
(NRIs) and Persons of Indian Origin (PIOs)
were permitted to invest in the housing and
the real estate sectors. Foreign investors
other than NRIs were allowed to invest only
in development of integrated townships and
settlements either through a wholly owned
subsidiary or through a joint venture
company in India along with a local partner.
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Foreign players
• Lee Kim Tah Holdings,
• CESMA International Pvt Ltd.,
• Evan Lim,
• and Keppel Land from Singapore,
• Salim Group from Indonesia,
• Edaw Ltd., from USA,
• Emaar Group from Dubai,
• IJM, Ho Hup Construction Co., from Malaysia etc.

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Motives
• Foreign Direct Investment is guided by different
motives. FDIs that are undertaken to strengthen
the existing market structure or explore the
opportunities of new markets can be called
“market-seeking FDIs.” “Resource-seeking FDIs”
are aimed at factors of production which have
more operational efficiency than those available in
the home country of the investor.

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• Some foreign direct investments involve the
transfer of strategic assets. FDI activities
may also be carried out to ensure
optimization of available opportunities and
economies of scale. In this case, the foreign
direct investment is termed as “efficiency-
seeking.”

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Real estate is on the high
growth path

In 2003-04, India received total FDI inflow
of US$ 2.70 billion, of which only 4.5%
was committed to real estate sector. In
2004-05 this increased to US$ 3.75 billion
of which, the real estate shares was 10.6%.

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2005-06
• However, in 2005-06, while total FDIs in
India were estimated at US$ 5.46 billion,
the real estate share in them was around
16%. The Study, nevertheless projects that
in 2006-07, total FDIs will touch about US$
8 billion in which the real estate share is
estimated to be about 26.5%.

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