Procedure For Incorporating a Subsidiary in India

INTRODUCTION

In today’s world, every company’s goal is to expand its business, whether within their home country or internationally. Foreign companies often achieve this by establishing subsidiary companies in other countries. These subsidiaries enable them to operate and carry out business functions in foreign markets, ultimately helping to expand their reach and strengthen their global presence.

Foreign companies typically set up subsidiaries in two forms: joint venture subsidiaries or wholly owned subsidiaries. The primary difference between the two lies in ownership. In a joint venture subsidiary, the foreign company holds at least a 51% stake, while in a wholly owned subsidiary, the foreign company owns 100% of the subsidiary’s shares. In the latter case, the parent company has full control over the subsidiary’s management, operations, and decision-making.

Incorporating a subsidiary in India presents an opportunity for foreign businesses to enter one of the world’s most dynamic and rapidly growing economies. The process of setting up a subsidiary in India requires careful planning and adherence to local laws, which ensure legal and financial transparency. A subsidiary is a separate legal entity, in which the parent company holds a controlling stake, typically at least 50% of the shares. This structure allows foreign companies to tap into the Indian market while operating under Indian regulations.

To fully understand the procedures and strategies involved, it’s important to explore the specific steps required for incorporating a subsidiary. This blog will provide a comprehensive overview of the process, from obtaining regulatory approvals to filing necessary documents with the Ministry of Corporate Affairs (MCA). By delving into these steps, businesses will gain insight into how they can effectively expand their operations in India and beyond.

WHAT ARE SUBSIDIARY COMPANIES

As per Section 2(87) of the Companies Act, 2013, a “subsidiary company” or “subsidiary” in relation to any other company (the holding company) refers to a company in which the holding company either controls the composition of the Board of Directors or exercises or controls more than one-half of the total voting power, either on its own or together with one or more of its subsidiary companies. This definition establishes the relationship between a parent company and its subsidiary, where the parent holds significant control over the subsidiary’s governance and decision-making.

In India, the process of incorporating a subsidiary is largely similar to that of incorporating any other company, with the key distinction being the additional documentation required. The parent company must own at least 50% of the subsidiary’s shares, making it the majority shareholder. If the parent company owns 100% of the subsidiary, it is considered a wholly owned subsidiary. The required documentation typically includes proof of the parent company’s identity, details of its directors, and a declaration of foreign investment.

The most crucial aspect of a subsidiary is that, while it is controlled by the parent company, it remains a separate legal entity. This means the subsidiary is obligated to operate under the laws and regulations of the country in which it is incorporated. In the case of a foreign subsidiary in India, it must comply with the Indian Companies Act, 2013, along with any other applicable legal provisions. While the subsidiary is under the control of the parent company, it has its own legal responsibilities and must function independently in terms of legal and regulatory compliance.

Key Features of a Subsidiary:

1. Separate Legal Entity: A subsidiary is a distinct legal entity from its parent company, meaning it can enter into contracts, own assets, and incur liabilities in its own name.

2. Liability: The liability of the parent company is limited to the extent of its shareholding in the subsidiary.

3. Regulations: A subsidiary must comply with the Indian Companies Act, 2013, and other regulations relevant to its specific business activity.

ADVANTAGES OF SETTING UP A SUBSIDIARY

Foreign companies seek to establish subsidiaries in India for several key reasons, including the following:

1. Access to a Major Market: India, with a population of over 1.3 billion people, offers foreign companies access to a vast and rapidly developing market. The growing middle class drives demand for a wide range of products and services, making India an attractive location for business expansion.

2. Lower Production Costs: India is renowned for its low-cost labor, enabling foreign companies to significantly reduce their production costs. Additionally, subsidiaries in India can benefit from tax incentives, subsidies, and other government benefits designed to attract foreign direct investment (FDI).

3. Skilled Workforce: India boasts a highly educated and skilled workforce, especially in fields like science, technology, engineering, and mathematics (STEM). Foreign companies can leverage this talent to drive growth, innovation, and competitiveness.

4. Favorable Business Environment: Recent reforms have made India’s business environment more attractive by simplifying regulations and reducing bureaucratic obstacles. This makes India a more appealing destination for foreign businesses compared to other emerging markets.

5. Strategic Location: Positioned at the crossroads of Asia, India offers foreign companies a strategic location to expand their operations, providing easy access to other high-growth markets in Southeast Asia and beyond.

In addition to these benefits, establishing an Indian subsidiary also provides several key advantages from a business compliance perspective:

Independent Legal Structure: The Indian subsidiary operates as a separate legal entity under Indian commercial laws, offering distinct legal status from its parent company.

Transfer of Shares: Shares in the Indian subsidiary can be easily transferred or exchanged between parties, making it a flexible structure for ownership changes.

Property Acquisition: As an independent legal entity, the subsidiary can acquire properties in India, enabling it to own real estate or other assets within the country.

Foreign Direct Investment (FDI): Indian subsidiaries can receive FDI, which is permitted in most economic sectors, making it easier for foreign companies to establish a presence and invest in the country’s growing economy.

PROCEDURE OF SETTING UP A SUBSIDIARY

The process of incorporating a subsidiary in India typically involves several key steps, each crucial for compliance with local regulations:

1. Choose the Type of Entity: The first step is to decide on the type of entity for the subsidiary. Most foreign companies opt for a Private Limited Company due to the limited liability protection it offers. However, the choice will depend on the business objectives and investment plans.

2. Obtain DIN and DSC: Each director must acquire a Director Identification Number (DIN) from the Ministry of Corporate Affairs (MCA), and a Digital Signature Certificate (DSC) to sign electronic documents. Both can be obtained by submitting an application on the MCA portal with necessary documents like identity proof and photographs.

3. Choose and Approve the Name: Selecting a suitable name for the subsidiary is the next step. The name must comply with the Companies Act, 2013, and must not resemble the name of an existing company. It should include the suffix “Private Limited” for private companies or “Limited” for public companies. The name approval can be sought through the RUN (Reserve Unique Name) service on the MCA portal.

4. Draft MOA and AOA: The Memorandum of Association (MOA) and Articles of Association (AOA) define the company’s objectives and internal rules. For foreign subsidiaries, these documents must adhere to the Foreign Exchange Management Act (FEMA) and other relevant laws.

5. File Incorporation Documents: After name approval and drafting the MOA and AOA, the next step is to submit the incorporation documents through the MCA portal. These documents include Form SPICe+, MOA, AOA, proof of registered office, identity and address proofs of directors and shareholders, and a signed declaration confirming legal compliance.

6. Obtain PAN and TAN: Once incorporated, the subsidiary must apply for a Permanent Account Number (PAN) for tax purposes and a Tax Deduction and Collection Account Number (TAN) for deducting tax at source (TDS) from payments to employees and contractors.

7. Comply with FEMA: Foreign investors must ensure compliance with FEMA, which governs foreign investments in India. Approval from the Reserve Bank of India (RBI) may be necessary depending on the investment structure and business sector.

8. Register with Other Authorities: Depending on the nature of the business, the subsidiary may need additional registrations such as Goods and Services Tax (GST), Employees’ Provident Fund (EPF) and Employees’ State Insurance (ESI), or Import-Export Code (IEC) for trading activities.

This structured process ensures that foreign companies adhere to legal and regulatory requirements when setting up a subsidiary in India.

IMPORTANT CASE LAWS

Tata Sons Ltd. v. State of West Bengal (1954)

This case examined the distinction between a parent company and its subsidiary. The Supreme Court held that a subsidiary company is a separate legal entity from the parent company, although the parent controls the subsidiary. It clarified that the subsidiary’s operations and liabilities are distinct from that of the parent company, which is crucial when dealing with foreign investments and the legal structure of subsidiaries.

Vodafone International Holdings B.V. v. Union of India (2012)

While this case primarily dealt with tax issues related to cross-border mergers and acquisitions, it is relevant to foreign companies incorporating subsidiaries in India. The Supreme Court held that foreign investments in Indian companies are subject to Indian laws and tax regulations. This case highlighted the importance of complying with the Foreign Exchange Management Act (FEMA) when foreign companies invest in subsidiaries.

Foreign Exchange Regulation Act (FERA) vs. Foreign Exchange Management Act (FEMA)

Although not a single case, the transition from FERA to FEMA has led to several rulings by Indian courts that affect foreign companies establishing subsidiaries in India. For example, in ICICI Bank Ltd. v. Reserve Bank of India (2002), the court ruled that foreign entities must comply with FEMA regulations, particularly concerning the repatriation of profits from Indian subsidiaries. This ruling clarified the regulations surrounding foreign investments and the transfer of profits.

Standard Chartered Bank v. Directorate of Enforcement (2012)

This case dealt with the enforcement of foreign exchange rules related to foreign companies operating in India. The court reinforced the importance of compliance with FEMA when setting up subsidiaries in India. It also emphasized the legal consequences for foreign companies failing to comply with the necessary documentation and reporting required by the Reserve Bank of India (RBI).

SEBI v. PNB Finance Ltd. (2001)

In this case, the Securities and Exchange Board of India (SEBI) addressed the issue of transparency and disclosure for companies, including subsidiaries. The case clarified the regulatory framework for subsidiaries in India, particularly concerning their financial reporting and the responsibility of the parent company to ensure compliance with Indian securities regulations.

CONCLUSION

In conclusion, setting up a subsidiary is a vital strategy for a company looking to expand its operations and broaden its global reach. However, the process involves several intricate steps, including obtaining the necessary licenses and adhering to regulatory requirements, which continue to apply even after the subsidiary is established. Despite these complexities, the benefits of setting up a subsidiary extend beyond the parent company, as it brings advantages to the host country, such as the transfer of technology, new expertise, and foreign investment, ultimately contributing to the host country’s economic growth.

Incorporating a subsidiary in India, while legally complex, provides foreign companies with access to a dynamic and rapidly growing market. By following the prescribed steps and ensuring compliance with relevant laws, foreign businesses can successfully establish a presence in India. To navigate this process efficiently and avoid potential pitfalls, it is highly recommended that foreign companies seek the guidance of legal and financial experts.