Regulatory Frameworks of India's Industrial Policies

CHAPTER 3

THE REGULATORY FRAMEWORK

3.1 INTRODUCTION: THE PARADIGM SHIFT

The industrial policy pursued in India for the first four decades after independence was based on the socialist school of thought that India embraced, partly to alienate itself from the colonial past and more so owing to the obvious achievements of the socialist movement in the post world-war two period. Thus, through a Resolution dated April 6, 1948 the government set out the policy to be pursued in the Industrial field, wherein to secure continuous increase in production and equitable distribution, the country opted for a centrally planned development strategy, with the state playing a major role. For this purpose, the National Planning Commission was established for planning, co-ordination, integration of national economic activity and to formulate programmes of development and to secure their execution.

On October 30, 1956, at the beginning of the Second Five Year Plan, the Government adopted a New Industrial Policy Resolution, which reiterated the above objective and classified industries into three categories as follows:

Schedule A were those industries whose future development was the exclusive responsibility of the state. Schedule B consisted of industries which would be progressively state-owned, wherein the state would take initiative in establishing new undertakings and private enterprise would be expected to supplement the effort of the state. Schedule C included all remaining industries whose further development was left to the initiative and enterprise of the private sector. This led to the expansion of the public sector in India, whose share in GDP increased from 9.91% in 1960-61 to 27.12% in 1988-89. However, the cause of concern was that a large number of public sector enterprises – particularly the Non-departmental non-financial enterprises were making losses and had to be subsidized.

Industrial undertakings in the private sector were subject to control and regulation like the Industries Development and Regulation (IDR) Act (1951) and were expected to align their business strategy and goals with the broad economic and social objectives of the State. The IDR vested with the government necessary powers to regulate and control existing and future undertakings in a number of specified industries. A license was necessary for establishing a new undertaking, taking up the manufacture of a new article in an existing unit, effecting substantial expansion, carrying on the business of an existing undertaking and changing the location of an existing unit. A Letter of Intent (LOI) was issued for sectors/activities under compulsory license under the IDR Act, 1951. The LOI was converted into Industrial License on completion of specified formalities.

Further, to prevent monopolies and concentration of economic power in the hands of private sector, in 1969, the Monopoly and Restrictive Trade Practices Act (MRTP) was enacted. All these regulations and controls led to increase in bureaucracy, inhibiting enterprise and industry.

Also, given the state of the economy with limited resources, scarce capital and vast population base, the development ideology revolved around the notion of conservation and optimum utilization of capital so as to maximize ’employment’ (and not necessarily output). Deployment of new capital was strictly controlled and regulated so as to meet social needs and maximize employment. Further, once the capital was committed to any activity and a certain employment was created, it was protected at any cost – even if it was non-viable in the face of market forces.

Labour intensive technology and employment generation were also the rationale behind the initial advocacy of small-scale industry. However, later, when it was realized that modern small scale industry was not necessarily labour intensive, the argument turned to encouraging the entry of new entrepreneurs in industry. A range of products were reserved for exclusive production in the small-scale sector, eliminating potential competition from medium and large firms. There were no pressures on the smaller firms to improve technology, update production techniques or reduce cost modernize or specialize. There was an inherent disincentive to grow beyond a certain size, if they had to continue production of a reserved product. Thus economies of scale could not be leveraged and market distortions were widespread.

Until 1991, the guiding principle of India’s industrial policy was self reliance, which focused on indigenous production and reduced dependence on foreign capital and foreign technology – irrespective of the cost and/or quality. This did lead to the creation of a large industrial base, diversification of products, ownership and location. But in the absence of domestic competition, export rivalry and competition of imports, industry grew with a lack of cost and quality consciousness, leading to slow growth, increasing deficits and debt and finally the crisis in 1991 which paved the way for economic reforms in India. Some of the components of the reform package include:

• Reforms in Industrial Policies in terms of delicensing of most industries and deregulation of industries earlier monopolized by the public sector
• Liberalisation of foreign trade through steady reduction in tariffs and freeing up of the foreign investment limits in most industries combined with measures to attract FDI into the country
• Macroeconomic stabilization through substantial reduction in fiscal deficits and government’s draft on the private sector’s savings
• Other reforms including those in taxation, financial sector, insurance sector, public sector, etc.

During the last decade and half, these reforms have reoriented India from a slow-paced, centrally directed and highly controlled economy to a strong, vibrant, fast-growing and ‘market-friendly’ one. There now exists an internationally competitive private sector with varied scope for collaborations and joint ventures and a facilitating regulatory framework that is evolving to match the international standards.

This Chapter seeks to give an overview of the broad framework of regulations governing business in India particularly in the context of:

• • Industrial Policy

  • Foreign Investment Policy

  • Anti Trust Regulations

  • Labour Laws

  • Protection of Intellectual Property Rights

  • Other Economic Laws & Procedures

3.2 INDUSTRIAL POLICY

The Industrial Policy Resolution 1956, substantially augmented through the Statement of Industrial Policy 1991 and subsequent announcements – which liberalized the economy – provides the basic framework for the overall industrial policy of the Government of India.

3.2.1 Industrial Licensing

The requirement of obtaining an industrial license for manufacturing has been abolished for all projects except for a short list of industries connected with security and strategic concerns (reserved for public sector), social reasons, hazardous chemicals and overriding environmental concerns. The list of items requiring compulsory licensing is reviewed on an ongoing basis. The stage of LOI has been dispensed with for all sectors/activities except for items reserved for SSI sector and an Industrial License is now issued without going through the stage of LOI. The following industries require compulsory license:-

1. Alcoholics drinks

2. Cigarettes and tobacco products

3. Electronic, aerospace and defense equipment

4. Explosives

5. Hazardous chemicals such as hydrocyanic acid, phosgene, isocynates and di-isocynates of hydro carbon and derivatives, etc.

Non-small-scale industrial units or units in which foreign equity is more than 24% require license to manufacture items reserved from small scale sector. All other industries are exempt from licensing and no industrial approval is required. Entrepreneurs are only required to file an Industrial Entrepreneurs’ Memorandum (IEM) with the Secretariat for Industrial Assistance (SIA), providing information on new projects and substantial expansions.

There are however, certain locational restrictions in metropolitan areas. No industrial approval is required from the Government for locations outside 25 kms of the periphery of cities having a population of more than one million except for those industries where industrial licensing is compulsory. Non-polluting industries such as electronics, computer software and printing can be located within 25 kms of the periphery of cities with more than one million population. Permission to other industries is granted in such locations only if they are located in an industrial area so designated prior to 1991. Zoning and Land Use Regulations as well as Environmental Legislations have to be followed.

Appropriate incentives and investments in enabling infrastructure are provided to promote dispersal of industry particularly to the rural and backward areas and to reduce congestion in cities. Recently, the Government approved a package of fiscal incentives and other concessions for the North East Region namely the ‘North East Industrial and Investment Promotion Policy (NEIIPP), 2007’, effective from 1.4.2007.

Also, under the broad framework of the national industrial policy, different Indian States announce their respective Industrial Policies periodically, which highlight the areas in which the State would focus on and provide incentives to attract investment, the various sector & location specific schemes offered to private investors, the plans for development of enabling infrastructure, opportunities for public-private-partnership, etc.

3.2.2 Policies for Privatisation

The post 1991 liberalisation process brought with it deregulation of trade and industry, dismantling of bureaucratic controls, technological development and financial sector reforms. Privatising some of the activities which heretofore were the exclusive domain of public sector also became part of this initiative to boost enterprise and professional management of resources to enhance economic growth and competitiveness. Revolutionary policy measures were undertaken to encourage private participation in sectors like telecom, information & broadcasting, power, ports, airports, banking, etc. Over the years, the government has reduced the number of industries reserved for the public sector to the two which are deemed significant from security and strategic perspective, viz., Atomic energy and Railways.

However, in the last few years the railways announced opening up of its containerized operations to other private and public sector companies, thereby ending the monopoly enjoyed by the Container Corporation of India (CONCOR). Interested companies could avail of the route-specific or all-India permission by paying a registration fee which is valid for an operation period of 20 years (further extendable by 10 years). There is freedom to decide the tariffs to be charged to the customers for various services and also the exit norms involve transfer of the operational writes to another eligible operator with the railway approval.

3.2.3 Policies for Small Scale Sector

The provisions in the Industrial Policy Statement of 1991 and the subsequent policies are aimed at supporting the Small Scale Industries (SSI) sector though various measures and packages focusing – not only on policy of reservation – but also on price and purchase preference policy for marketing SSI products, credit and fiscal support to SSIs, support for cluster based development, technology upgradation, etc.

The IDR Act 1951 provided for the reservation of items for exclusive manufacture in SSI sector primarily with the objectives of increasing production of consumer goods in the small scale sector and widening of employment opportunities. In 1967, 47 items were reserved for exclusive manufacture in the small scale sector. This number was increased to 836 items in 1989. However, since 1997, a large number of items were dereserved from the list in the phased manner. As of March 2007, only 114 items are reserved for exclusive manufacture in the small scale sector.

In addition to the policy of reservation, the Government has initiated various measures offering support for Cluster based Development, Technologies and Quality Upgradation, Marketing, Entrepreneurial and Managerial Development and Schemes for Empowerment of Women Owned Enterprises.

Further, with a view to facilitate the development of micro, small and medium enterprises (MSME), the Micro, Small and Medium Enterprises Act 2006, was implemented. The Act provides the new classification of each category of enterprises. As per the Act, MSME are defined as follows:

• • in the case of the enterprise engaged in the manufacture or production of goods pertaining to any industry specified in the first schedule to the IDR Act 1951 –

  • a micro enterprise is the one where the investment in plant and machinery does not exceed twenty five lakh rupees.

  • a small enterprise is one where the investment in plant and machinery is more than twenty five lakh rupees but does not exceed five crore rupees; or

  • a medium enterprise is one in which the investment in plant and machinery is more than five crore rupees but does not exceed ten crore rupees;

    • in the case of enterprises engaged in providing or rendering of services –

• a micro enterprise is one where the investment in equipment does not exceed ten lakh rupees;

• a small enterprise is one in which the investment in equipment is more than ten lakh rupees but does not exceed two crore rupees; or

• a medium enterprise is where the investment in equipment is more than two crore rupees but does not exceed five crore rupees

In February 2007, the Government announced a package for promotion of the SSI sector as follows:

• Credit Support: The package aims at increasing the number of beneficiaries of the credit provided by the Small Industries Development Bank of India (SIDBI) by 50 lakhs, over five years beginning from 2006-07. For this purpose, the Government has provided grant to SIDBI to augment its Portfolio Risk Fund. Besides, in an attempt to increase demand-based small loans to micro enterprise, the Government announced a provision of grant to SIDBI to create a Risk Capital Fund (as a pilot scheme in 2006-07). The eligible loan limit under the Credit Guarantee Fund Scheme has been raised to Rs. 50 lakh. The credit guarantee cover has also been raised from 75% to 80% for micro enterprises for loans upto Rs. 5 lakhs.

• Fiscal support: The Government has increased the General Excise Exemption (GEE) limit from Rs. 100 lakh to Rs. 150 lakhs since April 2007. It further proposes to examine the eligibility of extending the time limit for payment of excise duty by micro and small enterprises; and extending the GEE benefits to small enterprises on their graduation to medium enterprises for a limited period.

3.3 FOREIGN INVESTMENT POLICY

In recognition of the importance of of foreign direct investment as an instrument of technology transfer, augmentation of foreign exchange reserves and globalization of the Indian economy, the Government of India revamped its foreign investment policy as part of the reform process.

3.3.1 Foreign Direct Investment

Foreign Direct Investment (FDI) regime in India was increasingly liberalized during 1990s (more particularly post 1996) and today India has the most liberal and transparent policies on FDI among the emerging economies, with restrictions on foreign investments being removed and procedures simplified. Some of the prominent features of the FDI policy in India are elucidated below:

• The approval mechanism for FDI has a two tier system.

  • Under the automatic approval route, companies can issue shares and receive inward remittances for investment in areas identified and upto the limits of foreign equity prescribed, with a reporting requirement, within a period of 30 days. In these sectors, investment could be made without prior approval of the central government.

  • Although, in case of the automatic route, it is no longer necessary to obtain the ‘in principle’ permission from Reserve bank of India (RBI) before receiving overseas investment or for issuing shares to foreign investors, the company, would, however, have to make a report to the RBI within 30 days after issue of shares to the foreign investors.

  • Proposals for investment in public sector units and also for Special Economic Zones (SEZs) / Export Oriented Units (EOUs)/ Export Processing Zones (EPZs) qualify for automatic approval subject to satisfaction of certain prescribed sector specific parameters.

  • FDI upto 100% is permitted under the automatic route for setting up Industrial Parks. Proposals for FDI/NRI investment in Electronic Hardware Technology Park (EHTP) and Software Technology Park (STP) Units are eligible for approval under the automatic route, except for those requiring prior approval of the Central Government (as discussed below).

  • FDI in sectors that are not covered under the automatic route requires prior approval of the Central Government. Activities/sectors require prior approval of the Government for FDI in the following circumstances:-

• Activities/items that require an industrial license

• Proposals in which the foreign collaborator has an existing financial/technical collaboration in India in the same field (except in IT and mining sector)

• All proposals falling outside notified sectoral policy/CAPS

• Proposals in which more than 24% foreign equity is proposed to be inducted for manufacture of items reserved for the Small Scale Sector

  • The approval is granted by Foreign Investment Promotion Board (FIPB), which is a specially empowered board set up for the purpose, chaired by the Secretary, Union Ministry of Finance.

  • Proposals for FDI could be sent to the FIPB Unit, Department of Economic Affairs, Ministry of Finance or through any of India’s diplomatic missions abroad. FIPB has the flexibility to examine all proposals in totality, free from predetermined parameters.

  • Recommendations of FIPB regarding all proposals falling in the non-automatic route and involving an investment of Rs.6 billion or less are considered and approved by the Finance Minister. Projects with investment greater than this value are submitted by the FIPB to the Cabinet Committee on Economic Affairs for approval.

  • Necessary regulatory approvals from the state governments and local authorities for construction of building, water, environmental clearance, etc. need to be acquired after the grant of approval for FDI by FIPB or for the sectors falling under automatic route. ‘Single window’ clearance facilities and ‘investor escort services’ are available in various states to simplify the approval process for new ventures.

  • Decisions on all foreign investments are usually taken within 30 days of submitting the application.

  • In cases where original investment is made in convertible foreign exchange, free repatriation of capital investment and profits thereon is permitted.

  • Sectors prohibited for FDI include:

• Retail trading (except Single Brand Product retailing)

• Atomic Energy

• Lottery Business

• Gambling and Betting

3.3.1.1 Investment in SEZs

In order to enhance competitiveness of Indian exports and attract investment in these sectors, India’s Foreign Trade Policy promotes the setting up of SEZs and thus provides for a hassle-free environment with world-class institutional and physical infrastructure and supporting logistics. Some of the existing EPZs/FTZs have also been converted into SEZs. All the State Governments have been advised to give priority to waste and barren land for acquisition purposes. According to the total Waste Land area surveyed by the Ministry of Forest, 5,52,692.26 hectares was available for such purpose.

FDI upto 100% is permitted under the automatic route for setting up of SEZ. Proposals not covered under automatic route require approval from FIPB. The policy provides for setting up of SEZ in the public, private or joint sectors or by state governments. These could be product specific or multi-product SEZs. Designated duty-free enclaves are treated as foreign territory for trade operations and duties and tariffs, and duty-free goods need to be utilised within the approved period. The permitted activities cover an array of manufacturing and services like production, processing, assembling, reconditioning, re-engineering, packaging, trading, etc.

Proposals for setting up units in SEZ, other than those requiring industrial license are approved by the Development Commissioner (DC). The approval for those requiring industrial license is granted by the DC after receiving clearance from the Board of Approval. The Letter of Permission (LOP)/Letter of Intent (LOI) issued by the DC is construed as a license for all purposes, including procurement of raw material and consumables either directly or through a canalising agency. The LOP/LOI needs to specify the items of manufacture/service activity, annual capacity, projected annual export for the first year in dollar terms, Net Foreign Exchange Earnings (NFE), limitations, if any, regarding sale of finished goods, by products and rejects in the DTA and such other matter as may be necessary and also impose such conditions as may be required.

According to the policy, SEZ units have to be positive net foreign exchange earners and the performance of these units would be monitored by a unit approval committee consisting of the DC and the Customs Authority.

3.3.2 Entry Options for Foreign Investors

A foreign company has the option to set up business operations in India as an Incorporated Entity or as an Unincorporated Entity.

An Incorporated Entity would be a company registered under Companies Act, 1956, through joint ventures or wholly owned subsidiaries. Foreign equity in such Indian companies can be up to 100% depending on the requirements of the investor, subject to any equity caps prescribed in respect of area of activities under the FDI policy. Funding could be via equity, debt (both foreign and local) and internal accruals.

For registration and incorporation, an application has to be filed with the Registrar of Companies (ROC). Once a company has been duly registered and incorporated as an Indian company, it is subject to Indian laws and regulations as applicable to other domestic Indian companies. Companies in India can be incorporated as a private company or a public company.

In comparison with branch and liaison offices (discussed subsequently), a subsidiary company provides maximum flexibility for conducting business in India. However, the exit procedure norms of such companies are relatively more cumbersome.

An Unincorporated Entity could be Liaison Office/Representative Office or Project Office or Branch Office. Such offices can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office of other place of business) Regulations, 2000. They are also governed by the Companies Act 1956, which contains special provisions for regulating such entities.

3.3.2.1 Liaison Office/Representative Office

The role of a liaison office is primarily to:

• Collect information about the market

• Disseminate information about the company and its products to prospective Indian customers

• Promote exports/imports from/to India

• Facilitate technical collaboration between parent company and companies in India

A liaison office cannot undertake any commercial activity directly or indirectly and cannot, therefore, earn any income in India. Approval for establishing a liaison office in India is granted by the RBI.

3.3.2.2 Project Office

Foreign Companies planning to execute specific projects in India can set up temporary project/site offices in India. RBI has granted general permission to foreign entities to establish Project Offices subject to specified conditions. Such offices cannot undertake or carry on any activity other than the activity relating and incidental to execution of the project. Project Offices may remit outside India the surplus of the project on its completion, general permission for which has been granted by the RBI.

Since a Project Office is an extension of the foreign incorporation in India, it is taxed at the rate applicable to foreign corporations.

3.3.2.3 Branch Office

Foreign companies engaged in manufacturing and trading activities abroad are allowed to set up Branch Offices in India for the following purposes :

• Export/Import of goods

• Rendering professional or consultancy services

• Carrying out research work, in which the parent company is engaged.

• Promoting technical or financial collaborations between Indian companies and parent or overseas group company

• Representing the parent company in India and acting as buying/ selling agents in India

• Rendering services in Information Technology and development of software in India

• Rendering technical support to the products supplied by the parent/ group companies

• Foreign airline/shipping company

Branch Offices established with the approval of RBI, are allowed to remit outside India profit of the branch – net of applicable taxes (which are at rates applicable to foreign companies) – however, subject to RBI guidelines. Permission for setting up branch offices is granted by the RBI.

Branch Offices could also be on stand alone basis in SEZ. Such Branch Offices would be isolated and restricted to the SEZ alone and no business activity/transaction would be allowed outside the SEZs in India, which include branches/subsidiaries of its parent office in India. No approval shall be necessary from RBI for a company to establish a branch/unit in SEZs to undertake manufacturing and service activities, subject to the conditions that:

• they function in sectors in which 100% FDI is permitted

• they comply with part XI of the Company’s Act (Section 592 to 602)

• function on a stand alone basis

• in the event of winding up of business and for remittance of winding-up proceeds, the branch should approach an authorized dealer in foreign exchange in the with documents required as per FEMA.

A Branch Office provides the advantage of ease in operations and an uncomplicated closure. However, since the operations are strictly regulated by exchange control guidelines, a Branch may not provide a foreign corporation with most optimum structure for its expansion/diversification plans.

3.3.3 Financing Options for Corporates

Companies registered in India can raise finances through Share Capital or Debentures and Borrowings.

3.3.3.1 Share Capital

The Companies Act, 1956 allows for two kinds of share capital, viz., Preference share capital (preferred stock) and Equity share capital (with/without voting rights). Apart from this, private companies which are not subsidiaries of public company have the option of raising funds through Venture Capital.

The issue of shares to the public is governed by the guidelines issued by the Securities & Exchange Board of India (SEBI) – the body that regulates and oversees the functioning of Indian Stock markets and the RBI.

A company issuing shares or debentures has to comply with SEBI disclosure requirements with regards to its prospectus. The prospectus has to be approved by the stock exchange and scrutinized by SEBI and then filed with the Registrar of Companies.

Indian companies having foreign investment approval through FIPB route do not require any further clearance from RBI for receiving inward remittance and issue of shares to the foreign investors. The companies are required to notify the concerned Regional office of the RBI of receipt of inward remittances within 30 days of such receipt and within 30 days of issue of shares to the foreign investors or NRIs.

Equity participation by international financial institutions such as ADB, IFC, CDC, DEG, etc., in domestic companies is permitted through automatic route, subject to SEBI/RBI regulations and sector specific cap on FDI.

In all other cases a company may issue shares as per the RBI regulations. Other relevant guidelines of SEBI and RBI, including the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, wherever applicable, would need to be followed.

The Companies Act does not specify the nominal value of shares. According to RBI/SEBI Guidelines, in case of listed companies, the issue price shall be either at the ave