TAX NEWS - January 2010

India: RBI introduces new guidelines for branch and liaison offices

The Reserve Bank of India (RBI) issued two circulars on 30 December 2009 (Circulars No. 23 and 24) that contain policies aimed at achieving transparency of the eligibility criteria and procedural guidelines for setting up branch and liaison offices in India, as well as rules for the delegation of powers to bankers in relation to branch and liaison offices.

The rules relating to eligibility criteria and procedural guidelines are effective as from 30 December 2009 and those governing the delegation of powers to bankers will become effective on 1 February 2010. The policies, which initially were published in draft form on the RBI website on 6 May 2008, affect all foreign entities conducting business in India or proposing to set up an office in India, except for entities in the banking and insurance sectors.

According to RBI regulations, foreigners need to obtain RBI approval to set up a branch or liaison office in India. Currently, the RBI is responsible for receiving, processing and approving applications. A liaison office is not permitted to engage in any business activities in India – its role is limited to representing a foreign company in India, collecting information on the Indian market and providing information about the company to prospective clients. A branch office, on the other hand, may engage in specified activities, which include the import and export of goods, professional or consulting services, research, IT services, etc.


Eligibility criteria and procedural guidelines

Circular No. 23 is intended to make the process more transparent by making public the eligibility criteria and procedural guidelines for the establishment of branch and liaison offices in India. Some of the criteria/procedural guidelines in the final version of the circulars and that also appeared in the draft circular are as follows:

- The RBI considers applications from foreign entities for establishing a branch/liaison office in India under two routes: (1) the RBI route, under which the principal business of the foreign entity falls in sectors where 100% foreign direct investment is permitted and the investment does not require prior approval of the government; and (2) the government route, under which applications are considered by the RBI in consultation with the government.

- The foreign entity must have a successful profit-making track record for five years before setting up a branch office (three years for a liaison office).

- The net worth of the foreign entity (i.e. paid-up capital plus free reserves minus intangible assets) as per the latest audited financial statements must be at least USD 100,000 for opening a branch office and USD 50,000 for a liaison office.

- No extension of the period of validity will be granted for a liaison office where the foreign entity is a non-banking financial company or is engaged in the construction and development sectors; in these cases, the liaison office must be closed when its period of validity expires or be converted into a subsidiary or joint venture in accordance with the foreign direct investment guidelines. (For sectors other than construction and development and nonbanking financial companies, the validity period of a liaison office may be extended beyond the initial period of three years provided certain requirements are met.)


The following modifications have been made to the draft circular:

- A firm, other association or an individual is also eligible to set up an office in India; this clarification is welcome because both the draft circular and the annual master circular issued by the RBI appeared to indicate that only corporate entities were eligible to set up a branch or liaison office.

- The RBI in consultation with the government will consider applications from nongovernment or nonprofit organizations and government bodies and departments.

- In addition to exercising due diligence in respect of the applicant's background, the nature and location of the applicant's activities, sources of funds, etc., and compliance with the "know your customer" norms, a banker must provide comments and/or recommendations at the time it forwards an application to the RBI.

- Branch and liaison offices must obtain a Permanent Account Number (i.e. an income tax identification number) when setting up an office in India and report this number in its Annual Activity Certificate.

- Branch offices should normally be engaged in the same activities as their head office.


Delegation of powers

By virtue of Circular No. 24, the RBI delegates the following powers to bankers, with effect from 1 February 2010:

- Authority to receive the Annual Activity Certificate;
- Authority to extend the period a liaison office is in existence; and
- Authority to permit the closure of a branch/liaison office.

The RBI retains authority to approve the initial set up of a branch or liaison office of a foreign company in India. The delegated banker will forward an application, along with relevant documents and its comments to the RBI. The following changes have been made to the draft circular:

- Branch and liaison offices are currently required to submit an Annual Activity Certificate from their auditors to the RBI certifying that the branch/liaison office has carried out only activities that have been approved by the RBI. As from 1 February 2010, the Annual Activity Certificate as at the end of March must be submitted to the delegated bank, with a copy to the Director General of Income-tax (International Taxation) in New Delhi on or before 30 April. Although the circular does not specifically state that the accounts must be prepared as of 31 March, it appears that all Indian offices of foreign companies may have to prepare their accounts for the period 1 April to 31 March.

- The non-eligibility of a liaison office in the construction and development sectors to obtain an extension of its period of validity does not apply to infrastructure development companies.


Conclusion

Based on an analysis of the two circulars, it is clear that the RBI is delegating a substantial portion of its administrative responsibilities to bankers, although the RBI will monitor activities as reported by bankers. From the perspective of foreign companies, there is greater transparency in the eligibility criteria for opening offices in India, but there generally has been no relaxation in the requirements for the establishment or maintenance of branch and liaison offices.