My Thoughts & Views

Things you need to know for Starting a Software Company in India

Posted on: July 9, 2007

Below are listed steps, laws, rules and specifications about Companies act 1956 which one must consider when setting up a company in India.

The below is divided in 2 sections. Foreign investors willing to start a company in India, and Indian citizens willing to start a company in India.

Disclaimer: The author, or ad4business.com cannot be held responsible for the accuracy of the content below, This is for informational purposes only. Please consultant a lawyer in your local area for changes brought to laws, information about and new bills passed.

For Foreign investors:

1. Incorporating a Company.
2. Registering with the Software Technology Parks of India (STPI).
3. Gaining Approval from the Department of Telecommunications (DoT) for Call Centers.
4. Exit Options.

Incorporating a Company

There are mainly two types of companies in India: public and private companies. Overseas organizations will find it easier to set up a private company rather than a public one as private companies have more flexibility and are easier to operate. It takes around 20 – 30 days to incorporate a company in India.
See below for information on how to register a company in India (Overseas companies, methods, options and procedure).

Registering with the STPI

The STPI grants approval to establish a unit and specifies the amount of capital goods that can be imported, the minimum export performance
and the net foreign exchange earnings as a percentage of exports. The units in the STPI are also granted certain indirect tax benefits, such as exemption
from the payment of custom duties.

Gaining Approval from the Department of Telecommunications (DoT):

The DoT has to give its approval for the setting up of a call center in India. The DoT guidelines on call centers classify them within the ambit of other service providers.

Exit Options

Exit options take the following forms:

1. Shareholders of Indian BPO companies can exit the company either through a transfer of shares or other routes.

2. Under Indian exchange control laws, the transfer of shares from a resident to a non-resident will require the prior approval of the Foreign Investment
Promotion Board (FIPB) and the Reserve Bank of India (RBI)

3. The transfer of shares from a non-resident to a resident requires the prior approval of the RBI. The RBI ensures that the price of the transfer is not above a maximum price, which is based on the NAV (net asset value) of a private company and the price on the stock exchange for a listed company.

4. Under the provisions of the IT Act, gains realized on sale/transfer of shares on the Indian company by the foreign company would attract capital gains tax in India.

5. Long term capital gains realized on sale of shares of Indian companies not listed on a recognized stock exchange in India will be taxed at the rate of
20 percent and a surcharge of five percent.

6. Long term capital gains realized on sale of shares of Indian companies listed on a recognized stock exchange in India will be taxed at the rate of 20%.

7. Short term capital gains realized by a domestic company will be subject to tax at the rate of 36.75 percent.

It may be possible to reduce the capital gains tax to zero, if the investments are routed through Mauritius and the operations are structured so as to avoid a PE in India.

The shareholders of the BPO company can exit at an IPO. However, if the shareholders are treated as promoters of the company, there are certain lock in requirements on the shares held by such promoters. The shareholders can exit from the BPO company through a merger of the BPO company with another company or after a winding up of the Indian company.

Drawing up the BPO agreement

The BPO agreement, which defines the relationship between the concerned parties and the nature of the
transaction can take myriad forms including the following:

1. A third party agreement, where the customer and the vendor are not related.

2. A captive agreement, where the customer and vendor are related parties.

3. Build-Operate-Transfer agreements where the vendor builds and develops the BPO operation for the customer and at a future date transfers it to the customer.

Also note: To hire independent consultants, you do not need to go through the STPI. This will be a simple client (you) – vendor (consultant) relationship
where you pay them as an Independent contractor. You will need to be sure of data security, intellectual property rights etc. while dealing with
Independent Consultants.

For Indian Citizen, (Information Technology software and services operations):

One can form any one of the following types of companies:

1. As an Individual / Proprietor.
2. As a Partnership / Firm / Trust.
3. As a Company registered under the Companies Act, 1956.

Fortunately, to start an IT software unit, no prior permission is required from government of India. As a matter of fact, to encourage development in IT industry, the government of India has announced following schemes:

* Domestic Tariff Area: When the primary focus is to sell in the domestic market in India. This unit can be set anywhere in India. All normal laws apply.
No concession is available on import duties. Exports are permitted. A special Export Promotion Capital Goods (EPCG) scheme of Ministry of Commerce can
be availed. This scheme allows zero duty import of capital goods against export obligations.

* Special Economic Zones (SEZs): SEZ is a new scheme announced by the Government of India. SEZs are areas where export production can take place free from plethora of rules and regulations governing imports and exports. Units operating in these zones have full flexibility of operations and can 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.

* Export Processing Zones (EPZ): These zones are located at various places including Cochin, Falta (Near Calcutta), Kandla, Chennai, Noida, Santacruz (Mumbai), Vishakhapatnam and Surat. A unit can be set up in these zones subject to availability of space. “Zero import duty” and a “special 10 years income tax rebate”, (Previously 3 years),
are some of the incentives provided. Also, there is no restriction on quantity of domestic sales.
* 100% Export Oriented Unit (EOU): This is similar to EPZ scheme. But in this scheme, there is no need to be physically located at EPZ. All other
incentives are same as provided to EPZ units.
* Software Technology Park (STP): This is a very special scheme under the Ministry of Information Technology. 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”, availability of infrastructure facilities like high-speed data communication links, etc.

For overseas companies:
(This information is both for foreign companies, and individuals willing to set up a business entity in India.)
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 Companies Act, 1956

* As a foreign company through a Liaison Office / Representative Office, Project Office or a Branch Office.
* As an Indian company through a Joint Venture or a Wholly Owned Subsidiary.

Liaison Office / Representative Office

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

The Foreign Exchange Regulation Act (FERA) regulates the opening and operation of such offices. Also, approval of Reserve Bank of India (RBI) is required to open such offices. These offices have to ensure the following:

1. Expenses of such offices are met entirely through inward remittances of foreign exchange from Head Office abroad.
2. These offices do not undertake any trading or commercial activities. Commercial activities should be limited to collecting and transmitting information between overseas Head Office and potential Indian customers.
3. Liaison offices should not charge any commission or receive other income from Indian customers for provisioning of liaison services.
4. Permission for such offices is initially granted for a period of three years and may be extended from time to time.

Project Office

Foreign companies planning to execute specific projects in India can set up temporary project, or site offices in India with the approval of RBI. Such approval is generally accorded in respect of Government approved projects.

Branch Office

Foreign companies engaged in manufacturing and trading activities abroad may set up Branch offices in India, with the permission of RBI, for the following
purposes:

1. To represent the parent company / other foreign companies in various matters in India e.g. acting as a buying / selling agents in India
2. To conduct research work in the area in which the parent company is engaged provided the results of the research work are made available to Indian companies
3. To undertake export and import trading activities
4. To promote possible technical and financial collaborations between the Indian companies and overseas companies. A branch office is not permitted to carry out manufacturing activities on its own but is permitted to sub-contract these to Indian manufacturers

As an Indian Company

A foreign company can commence operations in India through incorporation of a company under the provisions of Indian Companies Act 1956. Foreign equity
in such Indian companies can be up to 100 percent depending upon the business plan of the foreign investor, prevailing investment policies of the Government and on 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.
* Available 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:

1. Automatic Route: Approvals for foreign equity up to 50 percent, 51 percent and 74 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.
2. Government Approval: Approval in all other cases where the proposed foreign equity exceeds 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).

Wholly Owned Subsidiary

The foreign investor has the option of setting up a wholly owned subsidiary, wherein the foreign company owns 100 percent share of the Indian company. All such cases are subject to prior approval from the FIPB. Some of the criteria for setting up wholly owned subsidiary include:

* Only “holding” operation is involved and all subsequent / downstream investments to be carried out need prior approval of the Government.
* Where proprietary technology is sought to be protected or sophisticated technology is proposed to be brought in.
* At least 50 percent of the production is to be exported.
* Proposals for consultancy.
* Proposals for infrastructure like roads, industrial model towns, industrial parks or estates.

Corporate Documents involved & Registration of a Company

An application for registration should be submitted to the registrar of companies with the following documents:

1. Memorandum of Association,

2. Articles of Association,

3. A declaration signed by a person named in the articles of the proposed company as a director, manager, or secretary of the company, or by an advocate of the Supreme Court or High Court, or by an attorney entitled to appear before the High Court, or by a chartered accountant practicing in India stating that all the requirements of the Companies Act 1956 and the applicable rules with respect to the registration and other matters have been complied with,

4. A list of persons who have consented to act as directors of the company,

5. If the proposed company is a public company, consent of very person prepared to act as a director must be submitted in a prescribed form,

6. Information about directors, managing directors and managers and secretary must be submitted in a prescribed form,

7. Information about the registered office in a prescribed form,

8. Power of Attorney in favor of one of the promoters or any other person, authorizing him/her to make corrections in the documents submitted to the registrar of the companies, if it becomes necessary,

9. Applicable registration fee payable to the registrar of the companies.

Also note that public companies and private companies have different limitations for the number of share holders.

Links to Useful Resources

1. Ministry of Company Affairs

2. Bangalore IT

3. Department of Information Technology

4. Department of Telecommunication

5. Ministry of Communications & Information Technology

DIT Organisations

Attached Offices of DIT
Section 25 Companies
Autonomous Societies of DIT
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