Setting Up An IT Company A+ A-


Setting up IT software and services operations in India are governed by certain rules and regulations. A brief list of guidelines for individuals/ companies interested in setting up such operations is given below:

Setting up of operations in India by an Indian Citizen/ Company
An Indian citizen can set up IT software and services operations in India in the following manner:

as an Individual/ Proprietor; or
as a Partnership Firm/ Trust; or
as a Company registered under the Companies Act, 1956 ("Co Act").
No prior permission of Government of India is required to set up IT/ software units in India.

Moreover, to encourage units in this sector, Government of India has announced many schemes ie:

Export Promotion Capital Goods ("EPCG") Scheme: This scheme allows import of capital goods at a concessional customs duty rate of 5 percent, where the importer as a condition is required to achieve a specified export obligation. The export obligation and the period within which the same is required to be achieved vary based on the nature of the unit and value of imported capital goods.
Special Economic Zones ("SEZs"): SEZs are designated areas dedicated towards growth of exports, having full flexibility of operations that are permitted to import duty free capital goods and raw material. The movement of goods to and fro between ports and SEZ are unrestricted. The units in SEZ have to export the entire production subject to permitted sales in the DTA. Currently, there are 11 operational SEZs in India which include the Santacruz Electronic Export Promotion Zone, Kandla Export Promotion Zone, Vizag Export Promotion Zone and Cochin Export Promotion Zones which have been converted to SEZs. Fiscal incentives available to SEZ units have been discussed ahead in detail.
100 Percent Export Oriented Unit ("EOU"): In terms of the benefits available, the EOU scheme, on a general basis, is similar to SEZ scheme. But in this scheme, there is no need to be physically located in the designated area (as in the case of SEZs). This scheme offers zero import duty on import of all capital goods, special 10 years income tax rebate (however, such rebate will not be available for Assessment Year 2010-2011 and onwards). The incentives provided to EOUs are generally similar to those provided to SEZ units, except the exemption from central sales tax on purchases.
Software Technology Park ("STP"): This is a special scheme under the Ministry of Information Technology, similar to EOU scheme, which is specific for the software industry. STPs are located at Noida, Navi Mumbai, Pune, Gandhinagar, Hyderabad, Bangalore, Chennai, Bhubaneshwar, Jaipur, Mohali and Thiruvanathapuram. This scheme offers zero import duty on import of all capital goods, special 10 years income tax rebate (however, such rebate will not be available for Assessment Year 2010-2011 and onwards), availability of infrastructure facilities like high-speed data communication links, etc. The incentives provided to EOUs are generally similar to those provided to SEZ units, except the exemption from central sales tax on purchases.
Setting up of operations in India by Overseas Company/ Non-Resident



A foreign company or a non-resident planning to set up business operations in India can do so in the following manner:

As a foreign company through a Liaison Office/ Representative Office, Project Office or a Branch Office; or
As an Indian company through a Joint Venture or a Wholly Owned Subsidiary.
A foreign company is one that has been incorporated outside India and conducts business in India. These companies are required to comply with the provisions of Co Act.

Liaison Office/ Representative Office
A liaison office is not allowed to undertake any business activity in India and earn any income in India. The role of liaison office is limited to collecting information about possible market opportunities and providing information about the company and its products to prospective Indian customers.

The Foreign Exchange Management Act ("FEMA") regulates the opening and operation of liaison offices. Prior approval of Reserve Bank of India ("RBI") is required for opening of such offices. Permission for such offices is typically granted for a period of three years initially and may be extended from time to time. These offices have to ensure compliance with the following conditions:

Expenses are met entirely through inward remittances of foreign exchange from Head Office abroad.
These offices do not undertake any trading or commercial activities. Activities should be limited to collecting and transmitting information between overseas Head Office and potential Indian customers.
Such offices should not charge any commission or receive other income from Indian customers for provision of liaison services.
A person resident outside India permitted by RBI to establish a liaison office in India may carry out the following activities:

Represent in India the parent company/ group companies.
Promote export import from/ to India.
Promote technical/ financial collaborations between parent/ group companies and companies in India.
Act as a communication channel between the parent company and the Indian companies.
Further, liaison/ representative offices are required to furnish an annual compliance certificate, from their auditors, with the RBI.



Project Office
Foreign companies planning to execute specific projects in India can set up temporary project/ site offices in India. Under the earlier provisions of FEMA, specific approval was required to be obtained from RBI for establishment of a Project Office. Recently, the RBI has accorded general permission to foreign companies for establishment of Project Offices in India subject to following conditions:

It has secured from an Indian company a contract to execute a project in India;
The project is funded by inward remittance from abroad or bilateral/ multilateral International Finance Agency or the project has been cleared by an appropriate authority or the contracting entity has been granted term loan by a Public Financial Institution or a bank in India for the project; and
Intimation is required to be filed with the regional office of RBI in the prescribed manner.
Further, until recently an approval from the RBI was required for:

opening of foreign currency accounts by Project Offices in India; and/ or
intermittent remittances to be made by such Project Offices.
In order to further liberalize the procedure for Project Offices, the Authorized Dealers (bankers) have been empowered to open foreign currency accounts for the Project Offices as well as permit intermittent remittances by Project Offices without an approval from the RBI, subject to fulfillment of certain conditions.



Branch Office
Foreign companies may set up Branch Offices in India, with prior permission of RBI, for the following purposes:

To represent parent company/ other foreign companies in various matters in India e.g. acting as buying/ selling agents in India.
To conduct research work in the area in which parent company is engaged.
To undertake export and import.
To promote possible technical and financial collaborations between Indian companies and parent/ overseas group companies.
To render professional or consultancy services.
To render services in Information Technology and development of software in India.
To render technical support to products supplied by the parent/ overseas group companies.
A Branch Office is not permitted to carry out manufacturing activities on its own. A Branch Office is required to file an annual compliance letter, from their auditors, with the RBI. Remittance of profits of the Branch Office is permissible by furnishing requisite documents with an authorized dealer.

Further, RBI has granted general permission to foreign companies to establish Branch Offices/ units in SEZs to undertake manufacturing/ service activities subject to the following conditions:

such units function in those sectors where 100 percent FDI is permitted;
such units comply with prescribed requirements of the Co Act;
such units function on a stand-alone basis; and
in the event of winding-up of business and for remittance of winding-up proceeds the branch/ unit shall approach an Authorized Dealer with the prescribed documents.


As an Indian Company
A foreign company can commence operations in India through incorporation of a company under the provisions of Co Act. Foreign equity in such Indian companies can be up to 100 percent depending upon the business plan of the foreign investor, prevailing foreign investment policies of the Government and receipt of requisite approvals.

Joint Venture with an Indian Partner
Foreign companies can set up their operations in India by forming strategic alliances with Indian partners. Setting up of operations through Joint Venture may entail the following advantages to a foreign investor:

Already established distribution/ marketing set up of the Indian partner. Ava
ilable financial resources of the Indian partner.
Already established contacts of the Indian partner that help smoothen the process of setting up operations.
Foreign investments are approved through two routes as under:

Automatic Route: Approvals for foreign equity up to 26 percent, 50 percent, 51 percent, 74 percent and 100 percent are given on an automatic basis subject to fulfillment of prescribed parameters in certain industries as specified by the Government. RBI accords automatic approval to all such cases.
Government Approval: Approval in all other cases where the proposed foreign equity exceeds 26 percent, 50 percent, 51 percent or 74 percent in the specified industries or if the industry is not in the specified list, it requires prior specific approval from Foreign Investment Promotion Board ("FIPB").
Establishing A Presence Outside India
Direct Investment outside India by Indian Corporates
Under the exchange control regulations, Indian corporates are permitted to invest in entities outside India. The investments could be made either under the automatic approval route or the specific prior approval route. Where the proposed investment does not satisfy the conditions of the automatic approval route, the same would require prior approval of RBI.

Some of the key conditions to be satisfied so as to qualify for the automatic approval route are a follows: Terms and conditions for outbound investment under the automatic route


Investment is made in an overseas Joint venture ("JV") or Wholly owned subsidiary ("WOS") engaged in a bona fide business activity.
Total financial commitment of Indian entity does not exceed 200 percent of net worth of the Indian entity as on the date of last audited balance sheet.
Indian entity is not on RBI's caution list or under investigation by Enforcement Directorate.
Indian entity has to comply with certain filing requirements with RBI.
Indian entity routes all transactions relating to such investments through only one branch of an Authorised Dealer designated by it.


Modes of funding the above investment
The investment outside India may be funded out of the following sources:

Balance held in EEFC account of Indian entity maintained with an Authorized Dealer.
Withdrawal of foreign exchange from an Indian banker upto 200 percent of net worth of Indian investor as on the date of last audited balance sheet.
Utilization of proceeds of ADR/ GDR issues raised by Indian entity.
Acquisition of shares of a foreign company engaged in similar core activity in exchange of ADR/ GDRs issued to the latter, subject to certain terms and conditions.
Capitalization of receivables in respect of export of plant, machinery, equipment and other goods/ software to the foreign entity or fees, royalties, commissions or other entitlements for supply of technical know-how, consultancy, managerial or other services. Prior approval of RBI would be required where receivables are more than six months old.
Export of goods/ software/ plant and machinery from India towards equity contribution in a JV/ WOS outside India subject to certain compliances.
ADR/ GDR Linked option for employees of software companies in India
Authorised Dealers may permit resident employees (including working directors) of an Indian software company to purchase foreign securities under ADR/ GDR Linked Stock Option Schemes provided consideration for such purchase does not exceed USD 50,000 or its equivalent in a block of 5 calendar years per eligible employee.

Purchase/ acquisition of foreign securities under Employee Stock Option Plan ("ESOP")
An individual who is an employee or a director of the Indian office or branch of a foreign company or of a subsidiary of a foreign company or an Indian company in which foreign equity holding is not less than 51 percent, may remit any amount towards purchase of equity shares offered by the said foreign company provided that the shares are offered at a concessional price. This relaxation is subject to further notice in this regard by RBI.

In order to further liberalize overseas investment, it has been decided that even in cases where the foreign company is offering its shares under ESOP and has an indirect shareholding in the Indian company, ie through a Special Purpose Vehicle or a step down subsidiary, no prior permission of RBI is required, as long as such holding is not less than 51 percent.



Investments abroad by a firm in India
Firms in India registered under the Indian Partnership Act, 1932 and having a good track record, have been permitted under the automatic route, to make direct investments outside India in an entity engaged in bonafide business activity provided such investment is upto 100 percent of its net worth or USD 10 million or its equivalent, whichever is less, in one financial year. Firms intending to undertake financial services activities would, however, have to satisfy certain additional requirements.

Investments by Proprietary concerns
A proprietary concern may accept shares of a company outside India, with prior approval of RBI, in lieu of professional services rendered to such company subject to following conditions:

Value of shares does not exceed 50 percent of fees receivable; and
The concern's shareholding in one company by virtue of acquisition as above does not exceed 10 percent of paid up capital of such company.
Permission is typically accorded by the RBI for a period of one year.