Accounting and Audit News

A WORD OF CAUTION – FOREIGN COMPANIES SETTING UP ENTITY IN INDIA

India being a global hub, with low costs, high quality output; more and more foreign players are setting up companies in India. Once the company is incorporated, the next step is to get statutory registrations and set-up the bank accounts so that the company is ready to do the business.

In a haste to start the business, many companies overlook basic things to do, which can lead to potential non-compliances; one of the issues pertains to pre-incorporation and post incorporation expenses.

Pre-incorporation expenses

Pre-incorporation expenses, also termed as preliminary expenses, are the costs incurred in the formation of a company, drafting legal documents, advertising, promotional activities, etc. There can be cases where the preliminary expenses are borne by the foreign parent company which are in turn recovered from the Indian subsidiary. In case it does not intend to recover the same, then the same needs to be noted in the first Board Meeting of directors to have clarity that no intercompany charge will be there towards these costs.

If the parent company decides to recover the said cost, Foreign Exchange Management Act (FEMA) provisions needs to be complied with. For instance, as per RBI Master Direction Foreign Investment in India, a wholly owned subsidiary set up in India by a non-resident entity operating in a sector where 100 per cent foreign investment is allowed under the automatic route and there are no FDI linked performance conditions, may issue equity instruments to the said non-resident entity against pre-incorporation/ pre-operative expenses incurred by the said non-resident entity up to a limit of five per cent of its authorized capital (as defined in the Companies Act, 2013) or USD 500,000 whichever is less, subject to the following conditions:

Form FC-GPR, as prescribed in the Master Direction on Reporting as amended from time to time, is filed by the Indian company within thirty days from the date of issue of equity instruments but not later than one year from the date of incorporation.
A certificate issued by the statutory auditor of the Indian company that the amount of pre-incorporation/ pre-operative expenses against which equity instruments have been issued has been utilized for the purpose for which it was received should be submitted with the Form FC-GPR.

Non-filing of Form FC-GPR can result in penal provisions. From Income tax perspective, it is pertinent note that u/s 35D of the Income Tax Act, 1961, the pre-incorporation expenses can be claimed as allowable expenses against business income, in 5 equal instalments i.e. in 5 subsequent financial year. The maximum deduction allowed is 5 per cent of the project cost/capital employed or actual pre-incorporation expenses whichever is lower.

Post-incorporation expenses

Expenses incurred after the company is incorporated can be termed as post incorporation expenses. Companies should prepare a systematic budget of at least for a period of 1 year and accordingly should determine the right Authorized and Paid-up Share Capital. Many companies in a hurry to set-up the company gets incorporated with a nominal share capital and kick starts the business. With the said nom-inal capital, further commitments arising on commencement of bits business such as hiring of employees, office space, procurement of assets etc. becomes an issue as funds are limited. Post incorporation

expenses of the Indian company are to be borne by the Indian company itself. In case the same are

incurred by the foreign parent company, it can lead to FEMA non-compliances in India.

Hence, foreign companies setting up entity in india should be careful while setting up the Indian subsidiary in order to avoid any FEMA non-compliances in India.