2008 Update To Guide To Establishing A Subsidiary In India

Article by Fred M. Greguras, S.R. Gopalan, Steven S. Levine And Tahir J. Naim

Although the current dollar-rupee exchange rate is causing more consideration of other locations, many businesses in the U.S. continue to move a portion of their development, support and other operations offshore to India, primarily for cost-saving reasons. Venture capital investors may require such outsourcing in order to reduce a company's burn rate. While a U.S. company may initially contract for services with a third party in India, many companies establish their operations in India through incorporation of a subsidiary, a private limited company under the India Companies Act of 1956, as amended (the "Companies Act"). This memorandum summarizes certain of the legal and administrative issues that a U.S. company (the "U.S. company") should consider in establishing an Indian subsidiary.

Where to Locate the Subsidiary

A key factor for determining the subsidiary's location is the availability of a reliable employee pool with required skill sets for the services. Many U.S. software companies have established a subsidiary in Bangalore in the State of Karnataka because of its skilled work force and welldeveloped telecommunications infrastructure. Life sciences companies, by contrast, have favored Hyderabad as the center of their investment. India's technical workforce is becoming increasingly mobile within India so that it may be possible to recruit the necessary employees to other locations.

Bangalore's infrastructure, apart from telecommunications, is going through significant growing pains which makes it increasingly difficult to do business there. As a result, many U.S. companies are increasingly establishing operations in locations such as Pune and Chennai, that have lower costs, less competition for employees and a less mobile workforce. Employee benefits and other indirect and direct expenses are likely to be higher in Bangalore and Hyderabad than other places in India. Bangalore still has a pool of junior employees available but senior employees are at a premium.

Another important factor is where the potential local managing director lives in India. As discussed below, a preexisting relationship with a potential managing director for the India subsidiary is an important practical consideration. The place of residence of this person may drive the decision of where to locate the subsidiary.

Hiring of Local Service Provider to Establish Subsidiary

The U.S. company will often hire an accountant, lawyer or other service provider in India to establish the subsidiary and complete the necessary administrative and legal requirements, such as applying for name availability, preparing the memorandum and articles of association, and tax and labor registrations. The most effective service provider tends to be in the same city where the subsidiary will be located. Some of these service providers also offer payroll, benefits and human resources support similar to what TriNet or Administaff provides in the U.S. These service providers vary significantly in terms of pricing and services and it is useful to compare cost, quality and scope of services. References should also be checked. In most cases, the U.S. company will want a written agreement with the service provider. Depending on the individual circumstances and needs of the U.S. company, there are local Indian law firms that can assist with the incorporation process. Many U.S. companies, however, complete the incorporation process through an accountant or similar service provider, without obtaining local legal counsel.

The Incorporation Process and Approximate Cost

Exhibit A contains the list of actions and estimated time schedule involved in the incorporation process. Time frames for completion of tasks may vary slightly from state-to-state in India. In our experience, the cost for establishing an Indian subsidiary through a local service provider ranges from approximately US$7,500 to US$20,000, including incorporation, registration and service fees, but excluding any initial capitalization provided to the subsidiary by the U.S. company. The high end of the fees would apply when one of the major U.S. accounting firms or a high-end law firm is used. As discussed above, pricing and scope of services provided by the service providers vary significantly and references should be checked by the U.S. company.

Corporate Structure: Initial Directors and Shareholders

A private limited company must have at least two directors and two shareholders. While it is not legally required that such directors and shareholders be residents of India, many service providers will recommend that the subsidiary initially have at least one local director and two local shareholders in order to efficiently complete the incorporation process. This structure avoids administrative time-delays, such as requirements that non-India residents have incorporation documents notarized in an Indian consulate in the United States, and enables the U.S. company to quickly establish the subsidiary. Recent regulations require electronic filing and authentication of applications for name registration, incorporations and other corporate filings. Consequently, at least one of the proposed directors of the subsidiary will need to have a digital signature issued by a certifying authority approved by the Ministry of Company Affairs. All directors also must have a Director's Identification Number. The service provider can assist with acquiring these items.

If the U.S. company does not have any relationships with persons in India, the initial director and shareholders will often be the service provider or persons referred by the service provider. The practical necessity of having an initial director and two initial shareholders be residents of India presents corporate control issues for the U.S. company. The U.S. company will want to ensure that the local director and shareholders do not make expenditures or bind the subsidiary to any commitments that are inconsistent with the expectations of the U.S. company. The U.S. company should also purchase the shares of the nominal Indian shareholder(s) as soon as practicable. Any delay in purchasing the shares could result in the shares having to be acquired at a price higher than the price paid, since pricing guidelines under exchange control regulations would apply. The U.S. company would also have to comply with the formalities prescribed by the Reserve Bank of India ("RBI") for such sale of shares.

In order to maintain adequate corporate control over the subsidiary and ensure the service provider, the initial local director and the initial shareholders act in accordance with the interests of the U.S. company, the U.S. company should enter into a written agreement with such parties providing for the following structure:

Initial Board of Directors Structure

The subsidiary will often initially...