Bloomberg Tax
Nov. 11, 2022, 8:00 AM

India’s Changing Landscape for Foreign Direct Investment and Tax

Anshu Khanna
Anshu Khanna
Nangia Andersen LLP

Foreign direct investment has grown at a phenomenal rate since the early 1980s, and the global market for it is has become increasingly competitive. Developing countries, including India, have been emerging as attractive investment destinations.

Certain factors and strategies contribute to attracting FDI to a country: open, transparent and reliable conditions for foreign or domestic businesses; ease of doing business; access to imports; relatively flexible labor markets; and protection of intellectual property rights. The presence of a central agency to address investors’ requirements and act as a one-stop shop helps. Adequate, easily accessible, reliable, and efficient infrastructure is extremely important. Most crucial is a government’s stance and willingness. Government can allow for multiple forms of direct assistance to foreign entrants, such as training, help with setting up production lines, financing, assistance with quality control, and introduction to export markets.

FDI Current Landscape

India was ranked as the fifth-largest recipient of FDI in 2020, according to the World Investment Report 2021, released by the United Nations Conference on Trade and Development. India’s FDI was bolstered due to key acquisitions in information and communication technology and the construction sector. Between 2015 and 2019, India received a cumulative FDI inflow of $173.3 billion, and the stake of the top five investing countries in India stood at 76.7%, with three major sectors being manufacturing, communication, and financial services.

In FY 2020–21, India recorded FDI of $81.72 billion, 10% higher than in the previous financial year. Computer software and hardware has emerged as the top sector, with a 55% share of the total FDI inflow and with construction infrastructure at 16% and the services sector at 11%. Singapore is the key contributor of FDI in India, followed by the US and Mauritius. FDI from Singapore increased by 25% in 2020–21 as compared to 2019–20.

Tax Implications for FDI in India

India has a three-tier federal structure for tax; main levies by the central government and state governments and some by local municipal bodies. Domestic tax implications for foreign investors are discussed below.

Tax on Foreign Companies

A foreign company is only taxed on the income earned within India from any source, i.e. being accrued or received in India, at 40% (excluding surcharge). Some other income on pure investments in India, such as royalty, interest, and capital gains, is taxed at a different rate. Taxability also needs to be viewed with respect to double taxation agreements with the foreign investor’s country.

Tax on Nonresident Individuals

  • Rental income from a property owned and situated in India: Income from a property that is situated in India is taxable in the hands of a nonresident individual. An NRI can claim a standard deduction of 30%, deduct property taxes, and benefit from interest deduction of a home loan. A deduction for principal repayment, stamp duty, and registration charges paid on purchasing a property is also allowed. Income from house property is taxed at slab rates as applicable. A tenant who pays rent to an NRI owner has to withhold tax at 30% on rental payments.
  • Income from capital gains: Any capital gain on transfer of a capital asset (including investment in shares) situated in India is taxable in India. If the individual sells a house property and has a long-term capital gain, the buyer shall be subject to withholding of tax at 20%. However, there are a few exemptions on reinvestment of that gain in India.

Goods and Services Tax

GST, since its introduction in 2017, has replaced all indirect taxes that were previously levied on goods and services by the central and state governments. GST is a comprehensive indirect tax which is charged on the manufacture, sale, and consumption of goods and services at the national level. GST is a dual model adopted by the country, in which both the central and and state government levy taxes.

Abolishing Dividend Distribution Tax

Primarily because of economic double taxation, dividend distribution tax has been the bane of every foreign investor looking to repatriate profits from India. Irrespective of the shareholder’s country and status, the tax of 20.56% on dividend distributed results in lower availability of distributable surplus for a foreign investor. As DDT is a tax on the Indian company and not on the shareholder; credit for such DDT was generally denied by the investor’s home country. However, DDT has been abolished. The foreign shareholder may now potentially claim credit against its tax liability in its home country. The abolition of DDT with the advantage of favorable tax treaties may reduce the effective tax rate on business income.

The cascading effect is also abolished—dividend income will be exempt in the hands of an Indian company to the extent it itself declares dividends. Moreover, if it does not declare dividends, it will be taxed under normal or minimum alternate tax, depending on the opted-for tax regime.

Regulatory Considerations for FDI

FDI can be made through two routes:

  • Automatic route: Foreign investors can invest up to 100% of their paid-up capital in Indian companies without any specific prior approval.
  • Government approval route: Certain activities that are not covered under the automatic route require prior government approval for FDI:
    • Category 1—Sectors in which FDI is permitted up to 100% under the automatic route;
    • Category 2—Sectors in which FDI is permitted up to 100% under the government route;
    • Category 3—Sectors in which FDI is permitted beyond a certain limit with government approval;
    • Category 4—Sectors wherein FDI is permitted up to a certain limit under both government and automatic routes subject to applicable laws and regulations, security, and other conditions.

The Foreign Exchange Management Act, 1999, governs foreign investment in India. Foreign investors can directly invest in India, either on their own or through joint ventures, in virtually all sectors except for a very small number of prohibited activities or sectors. FDI in most sectors is under the automatic route.

Any NRI/entity or company, trust or partnership firm incorporated outside India and owned and controlled by NRIs can invest. NRIs resident in and citizens of Nepal and Bhutan are allowed to invest on a repatriation basis (the amount of consideration for such investment shall be paid only by way of inward remittances through normal banking channels). Foreign institutional investors (FIIs) and foreign portfolio investors (FPIs) can freely invest. Registered FIIs/FPIs/NRIs as per Schedules 2, 2A and 3 of the Foreign Exchange Management Regulations, 2000, (transfer or issue of security by a person resident outside India) can invest or trade through a registered broker of Indian companies on recognized stock exchanges: A Security Exchange Board of India-registered foreign venture capital investor in any activity mentioned in Schedule 6 can invest.

Reporting Requirements

An entity needs to meet certain reporting and compliance requirements on account of receipt of funds from a foreign jurisdiction. Reporting to the central bank of India—the Reserve Bank of India—is crucial. The Indian company will report to the RBI under whose jurisdiction its registered office is located within 30 days of receipt of money from the foreign investor. Such reporting is done via form FC-GPR, enclosing a copy of the foreign inward remittance certificate, know-your-customer from the authorized dealer bank, the board resolution by the company for the allotment of shares, certificate from the company secretary accepting investment from persons resident outside India, a certificate from a statutory auditor or chartered accountant indicating the manner of arriving at the price of the shares issued to the persons resident outside India, and the business user registration with the RBI FIRMS portal.

The Road Ahead

India has anticipated attracting FDI of $120 billion to160 billion per year by 2025. Over the past decade, the country witnessed a 6.8% rise in GDP. At this rate, three years from now, an annual inflow of upwards of $120 billion is feasible. The statistical figures are justified by considering India’s favorable business landscape, supportive government policymaking, and increased ease of doing business.

India, although still in the developing nation category, holds immense potential for rapid growth. Investor confidence has improved on account of a strong vaccination rate, recovery stimulus packages, and foreign investment programs. Moreover, the nation is committed to a serious sustainability agenda. Global rankings show India remains an interesting investment destination, and this has been reinforced in the course of the post-Covid recovery. India also has an ever-growing consumer base, making it one of the world’s largest markets for manufactured goods and services.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Anshu Khanna is a partner with Nangia Andersen LLP, a member firm of Andersen Global.

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