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Insights FAQ: Company incorporation in India

FAQ: Company incorporation in India

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last updated on 23 September 2022 | reading time approx. 6 minutes

Author: Ursula Hoffmann-Mukherjee 

   

India is an excellent investment location for various industries. In recent years, Indian companies have developed market leadership qualities, particularly in the automotive, automation, high-tech, software and service sectors. 

 

Its continuously growing market plays a big factor in this, which has been lately pushed by introducing new economic and tax reforms. Foreign Direct Investments were recently eased to 100% in almost all sectors, which gave a fresh boost to the Indian economy. The Prime Minister Narendra Modi is inter alia planning to introduce further tax reforms, with a keen focus on the "Ease of Doing Business“ to leapfrog the Indian economy from currently being the fifth to the third largest in the world by 2030. In order to keep his election promises, new reforms are expected to be introduced in the coming years to stabilize the domestic market and attract further foreign investment.

Index:

1. What are the forms of setting up a business entity in India available for Foreign Investors? Which one is the most popular?

Foreign investors can operate in India through separate legal entities such as Private Limited Company (Pvt. Ltd.), Public Limited Company (Ltd.) and Limited Liability Partnership (LLP) or through dependent representative offices such as the Liaison Office (LO), Project Office (PO) and Branch Office (BO). The Private Limited Company is the most frequently chosen form to set-up a business in India, as it is particularly convincing due to its relatively uncomplicated incorporation process and high flexibility when it comes to business models. There are other investment vehicles like partnerships etc., but they are not available for foreign investors.

 

2. What is a Private Limited Company?

A Private Limited Company is a separate legal entity, which offers limited liability to its shareholder. The liability of the shareholders can be either limited by shares or limited by guarantee. A Private Limited Company is comparable to a German GmbH or a French SARL. A Private Limited Company generally consists of shareholders and Board of Directors. The Memorandum of Association (MoA) and the Articles of Association (AoA) constitute the statutes of the Private Limited Company.
   

3. Is there a minimum number of shareholders required for an Indian Private Limited Company?

Yes, minimum of two shareholders are required to form a Private Limited Company in India. It is sufficient if one of the two shareholders hold only one share and the other holds all of the remaining shares. Shareholders can be either individuals or legal entities, as long as they are legally recognized.
    

4. What are the duties and rights of shareholders of an Indian Private Limited Company?

The essential duty of every shareholder is to pay his capital contribution. In return, the shareholder receives dividends. However, the declaration whether to and to what extent dividends may be distributed is made solely by the Board of Directors. The shareholders only have an approval right in the General Meeting.
The shareholder acts more as a silent investor or promoter. The shareholders can carry out their rights exclusively through General Meetings. Shareholders have a right, among others, to vote on matters concerning the substrate of the company. Such matters include, but are not limited to, liquidity, the sale of assets, the MoA/AoA, inspect statutory registers and minutes books and appointment and removal of Directors. The shareholders are obliged to participate in the General Meetings and exercise their voting rights.
There are two different kinds of General Meetings, the Annual General Meeting (AGM) and the Extraordinary General Meeting (EGM). The AGM confirms the auditor, Directors and finances. EGMs can be called upon by the shareholders or the Board of Directors to discuss urgent matters that cannot wait until the next AGM, such as the appointment or resignation of a Director. Unlike the EGM, the AGM must take place at the company's registered office in India.
Our Tip: The shareholders of the Private Limited Company need to be physically present for certain steps in India, for example for the AGM. Therefore, it may be easier to have two legal entities as shareholders, since an individual shareholder may not be able to give power of authorisation to someone else and thus would have to continue to be physically present in India for the attending the meeting.
  

5. Who is responsible for managing a Private Limited Company?

The responsibility to manage the company is on the Board of Directors, as a collective management body. It carries out a double function: On one hand, it is the collective management body but on the other hand, it is also carrying out the controlling functions and is therefore comparable to a supervisory or advisory board.
 
The Board of Directors consists at least two members of which at least one has to be Resident of India (Resident Director). Resident of India is a person who stayed, means who has been physically present, in India for 182 days or more within the last Financial Year. The purpose of his stay in India does not matter. 
  
Our Tip: In order to ensure that the Board of Directors can operate anytime, it is advisable to appoint at least two Directors from the same country and one from another country, if required. However, it is advisable to appoint two Directors from India in order to ensure that the management of the business is carried out to a sufficient extent in India and therefore no risk of constituting a permanent establishment is arising.
  

6. What are the duties and rights of Directors of a Private Limited Company?

The Board of Directors is responsible for implementation of shareholder resolutions and is therefore the sole executive body responsible to the shareholders. 
  
Therefore, all Directors are obligated to Fiduciary Duties and to the Duty of Care, Skill and Diligence. Fiduciary duties ensure that Directors always put interests of the company and its shareholders first and above their own. Fiduciary duties arise from the general authorization granted to the Board of Directors, according to which Directors have to act in good faith and their best knowledge. In addition, their position is comparable to that of a trustee due to their power to dispose of the company's assets, which means that the Directors are also subject to similar fiduciary obligations of a trustee. Further, Directors have the fiduciary duty to act in accordance with the AoA of the Company. All Directors must exercise their powers with due skill and care and act honestly without being negligent. An objective standard is applicable, while assessing this. In principle, the Directors fulfil their obligation as a collective body.
  
The Directors are entitled to both individual and collective rights. Individual rights include, for example, the right to inspect the books and various voting rights. The collective rights of the Board of Directors include, in particular, the right to propose dividends, to appoint a Chairman and a Managing Director. A Managing Director is, who is appointed by virtue of the articles of the company or agreement with the company or resolution passed in its general meeting or by its board of Directors, entrusted with substantial powers of management. The Managing Director usually manages the day-to-day business of the company. He has a double role, as he is both a Director and also an employee of the company. It is not compulsory to appoint a Managing Director for a Private Limited Company.
  

7. How do the Directors pass a resolution?

Resolutions of Directors are taken in Board Meetings. There must be at least four Board Meetings in a year, with a maximum gap between two meetings of not more than 120 days. In order to pass a resolution, at least two Directors or one third of the Directors must attend the Board Meeting either in person or via video conference. Earlier, at least once a year a Board Meeting must have been held in person, i.e. physically, in order to legitimately confirm the company's finances. However, nowadays the Board Meeting to confirm the company’s finances can be held also via video conference. In addition, every director is required to attend at least one Board Meeting in a year. Board Meetings can also be held outside of India.
 

8. What is the liability of a Director?

Liability of Directors may result from willful acts, gross negligence or slight negligence. 
  
Directors are personally liable to the company for all unlawful acts and for transactions for which they were not authorized and are inadmissible for being Ultra Vires. This liability also includes damage compensation. 
  
Directors are in general not liable for gross negligence or slight negligence, if the Directors have acted truly in the interest of the company and within the scope of their powers of disposal and with such due diligence, as it is appropriate for their level of knowledge and experience. 
  
In addition, there are several liabilities of the Directors for violations against the Companies Act, 2013. 
  
For example, Directors are liable under the Companies Act, 2013 if the required compliances under the Act are not carried out. In such scenario, the Directors are jointly and severally liable. A personal individual liability of a Director under the Companies Act, 2013 can only be possible in special individual cases and is based on Supreme Court jurisprudence ("lifting up the corporate veil").
  
A liability may also result from Indian Income Tax Law. In principle, Directors are not liable for outstanding tax debts of the company. However, an exception is Sec. 179 of Income Tax Act, 1961, which provides for joint and several liability of Directors for the payment of outstanding taxes for those financial years in which they have acted as Directors and if the due tax payment cannot be recovered by the company. 
  
Furthermore, various liability cases may arise from Labour and Social Security Law. For example, as per the Factories Act, 1948, the Manager or the Occupier, who is usually also appointed as Director, shall be punished with a fine or imprisonment for noncompliance regarding safety, health and welfare. 
  

9. Is it required to have a statute? 

Yes, every Indian Private Limited Company has to have a statute which is the Memorandum of Association (MoA) and the Articles of Association (AoA). The MoA defines the name, objectives, registered office address and the capital of the company. Therefore, it explains the relationship of a company with the outside world. The AoA regulates the internal rules and regulations and the internal relationship with the outside world. Both documents can be seen as public documents at the Registrar of Companies (ROC).
 

10. Is there a requirement for minimum share capital in India?

There is no minimum share capital required for incorporating a Private Limited Company. However, the amount of capital required depends on the requirements of the proposed business model of the company. Therefore, the company should have at least enough capital in order to secure business activities for a few months after incorporation. 
Our tip: Depending on the business model, the company should have a minimum capital for running its business activities for three to six months. If you are planning a manufacturing company in India, please reach out to us.
     

11. What different types of capital exist? 

There are three different "types" of capital: Authorised Share Capital, Subscribed Share Capital and Paid-up Capital. Authorised Share Capital is the maximum amount of share capital, up to which a company can issue shares. The Subscribed Share Capital is a subgroup of Authorised Capital and it indicates the number of shares that the shareholders have to subscribe to. Each shareholder must subscribe for at least one share, but is not obliged to convert the shares he subscribed for into capital in full. The Paid-up Capital is the capital which is actually paid into the company's bank account by the shareholders in accordance with their Subscribed Share Capital. Upon receipt of the Subscribed Share Capital, the company must issue  shares to the shareholders in the form of Share Certificates. This process has to be documented and reported to the authorities.
       
The personal liability of the shareholders then only extends to unpaid capital on their shares. 
     

12. Is there a need to obtain additional permits or approvals for foreign entities investing in India?

No, Foreign Direct Investment in India has been greatly liberalized in recent years and is now almost 100% permitted in all sectors through the automatic route. However, foreign exchange regulations and procedures under the Foreign Exchange Management Act (FEMA) must be carried out in the case of cash payments from foreign shareholders. For example, payments have to be made via the international banking channel and via the Reserve Bank of India (RBI). After the payment has been made, it has to be reported that the shares were issued at a Fair Value. 
Only in some highly sensible sectors, such as Defence and Defence Industries, Foreign Direct Investment is only allowed via the Approval Route.  Further, it is to be mentioned that the Foreign Direct Investment in the e-commerce sector is subject to restrictions.
     

13. Can the capital of an Indian Private Limited Company be increased?

Yes, the Paid-up Capital can be increased as long it is not exceeding the Authorised Share Capital. 
The Authorised Share Capital can also be increased. However, increasing the Authorised Share capital is rather time-consuming, as the MoA has to be changed for this purpose. For changing the MoA, a Special Resolution has to be passed at an EGM. Any change in the MoA must be filed with the ROC. 
     
Our Tip: At the time of incorporation it may be wise to plan your Authorised Capital at 10-20% higher than your planned Paid-up Capital. This ensures a fast increase of Paid-up Capital at a later stage. Please note that the amount of registration fees charged by the ROC for incorporation is calculated on the amount of the Authorised Capital.
     

Special Case Share Premium

With the so-called “Share Premium” Equity Capital can be provided to the company without having to exhaust the limits of Authorised Share Capital at an early stage. This is done by leaving shares to a shareholder not at nominal value, but at a higher value. The amount exceeding the nominal value is then set in a special equity account (Share Premium Account) and forms a non-free reserve.
     

14. Can an Indian Private Limited Company take a loan?

Yes, an Indian Private Limited Company can either take a loan or overdraft facilities without any regulatory restrictions. The loan is usually provided by an Indian bank at local conditions.
     
Loans from a foreign shareholder are considered as External Commercial Borrowings (ECB). These ECBs are subject to strict regulations. For example, minimum term and maximum interest rate are prescribed. Further, restrictions also exist with regard to the borrower, the lender and the end use of the loan. However, in January 2019 these regulations were considerably relaxed. Now trading companies and service companies are also eligible borrowers. Further, the purchase of land is now considered a permissible end use for ECB loan.
Our tip: Consider whether you prefer equity / loan financing for your company at an early stage.
     

15. How do you incorporate a Private Limited Company in India? 

If the shareholders are legal entities, they must report their will for incorporating a new company in a Board Resolution. Some basic information of the newly incorporated company such as name of the company, Authorised Share Capital, Paid-up Capital, registered office, etc. has to be reflected in the Board Resolution. Regulations clarify when a company would be considered inadmissible. Among other things, this can be a case when the name of the planned company is identical with the name of an already existing company or the name is generally confusing or misleading. Further, after the name of the company the applicable appendix (Pvt. Ltd., Ltd., LLP or UC.) has to be added. 
     
At least two Directors have to be appointed, from which one of them has to be Resident Director. All Directors have to apply for a Director Identification Number (DIN) and a Digital Signature Certificate (DSC) during the incorporation process. In addition, the Directors would require an Indian tax identification number, the Permanent Account Number (PAN), once the company has financial transaction of more than INR 250,000 in a Financial Year. Further, every shareholder who has provided more than INR 100,000 paid-up capital has to apply for a PAN. 
     
Several required documents must be signed and stamped by the shareholders. This documentation process is usually quiet time-consuming. In case of foreign entities, it could be the case that the foreign country has not recognized India as a signatory state under the  Hague Apostille Convention of 1961. This would mean that all documents, which are relevant for Indian authorities, have to be first notarized by a notary, then Regional Court and then legalized by the Indian Embassy.  Subsequently, all documents as well as the MoA and AoA must be submitted to the ROC and the registration fee has to be paid. Usually after submitting the documents, the ROC will raise further queries and/or questions. With an approval from ROC, the company will receive a Company Identification Number (CIN) and a Certificate of Incorporation (COI) will be issued. The company's Permanent Account number (PAN) is automatically created with incorporation.
     

16. How long does the incorporation process take? 

Usually the incorporation process for a Private Limited Company takes three to four months. However, this duration heavily depends on the participation of the shareholders and the procurement of necessary documents. Only after incorporation, can start the process of opening a bank account. Documents such as the COI, PAN along with Know Your Customer (KYC) documents of the Directors are mandatory to open a bank account in India. This process takes about one to three months and can differ from bank to bank.
 
Only after opening a bank account can the newly incorporated Private Limited Company be declared to be fully operational. This entire incorporation process can take anything between four to seven months. 
Our tip: With us, you can do it also faster! Read more under point 17.
        

17. What is a Fast Track Incorporation? 

It is possible to first incorporate a company with local shareholders. The incorporation process and the bank account opening process are significantly faster in such a scenario. After incorporation, this fully operational company can then be transferred to the foreign shareholders. Do you want to know more about this? Please contact us! 
     

18. How do I close my Indian Private Limited Company?

An Indian Private Limited Company can be closed in three ways: through voluntary liquidation, through Striking-off via Fast Track Exit (“FTE”) or through insolvency proceedings.
 
The voluntary liquidation procedure gives creditors and shareholders an opportunity to settle their affairs amongst themselves. The voluntary liquidation procedure is only possible in case of a solvent company. 
The striking off the company via the so-called Fast-Track Exit is only possible if it is an inactive company that has no assets nor liabilities and/or has not started any business or carried out any activities since its incorporation. 
 
The insolvency takes place via an official insolvency procedure according to the Insolvency & Bankruptcy Code, 2016, in which a court-appointed insolvency administrator carries out the liquidation. This Act has significantly simplified and shortened the insolvency process. Insolvency proceedings can now also be initiated by application of the creditors and should be concluded within 180 days. For newly incorporated companies and companies with assets of less INR 10 million, the procedure is to be completed within 90 days.
 

19. How will an Indian Private Limited Company be taxed?

An Indian private limited company is considered as a company resident in India and is subject to tax on its worldwide income, unless the income is specifically exempt.  Profits from carrying on business activities are taxable as business income after allowing a deduction for necessary business expenses on satisfaction of conditions specified under the domestic tax law.
  
Indian companies are subject to tax at a basic rate of 30% (25% for companies that had gross turnover not exceeding INR 4 billion in the financial year 2020-21). An Indian company can also opt for a concessional tax rate of 22% subject to fulfillment of specified conditions. An Indian company engaged in manufacturing activities can opt for a concessional tax rate of 15%, subject to fulfilment of specified conditions. Additionally, a surcharge of 7%, 10% or 12%, as maybe applicable, and a cess of 4% are imposed on the income tax of such companies. 
   
Minimum alternative tax (MAT) is payable by an Indian company, if the tax payable by the company on its total income, as computed under the Income Tax Act (normal provisions), is less than 15% of its book profit. It is levied at a rate of 15% of book profit, plus applicable surcharge and cess.  However, companies opting for concessional tax regime are not subject to MAT.  Refer table below for a quick synopsis.
 

 

Note 1:  The rates are subject to an additional levy consisting of a surcharge and a cess. They are increased by the following surcharges on such taxes:

  • No surcharge is payable if the net income does not exceed INR10 million except in the case of domestic companies opting for a reduced tax rate of 15% or 22%.
  • Domestic companies with net income exceeding INR10 million: 7%
  • Domestic companies with net income exceeding INR100 million: 12%
  • Domestic companies opting for a reduced income tax rate of 15% or 22% {refer point (d) and (e)}: 10%
  • The tax payable (inclusive of the surcharge, as applicable) is further increased by a cess levied at 4% of the tax payable

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