FDI IN REAL ESTATE BY MRS.SHOBHA JAGTIANI, Advocate
Partner of M/s D.M.HARISH & CO.

FDI is not exactly a new concept in India. The year 1608 would ring a bell. That was when the East India Company made its first investment and foray into India and in return acquired the Indian Empire for the British Imperial Masters.

It is perhaps because of this psychological fear of being conquered by foreigners that in the first five decades since independence, India has been so resistant to globalisation and liberalisation. But suddenly now there is an acceptance that Change is the only constant. Every day there is progressive liberalization - new circulars/press notes are being issued which are the mantras of change. India is come of age and ready to be introduced as the most alluring debutante, being wooed by all manner of wealthy suitors from across the nations. What are the vital statistics. An impressive figure population- one billion plus. Average Internal Rate of Return (IRR) of over 30% Demand and hunger for housing fuelled by availability of housing loans at reasonable rates. Mall Mania running into million of sq.ft. of space being snapped up on announcement of projects yielding returns as high as Rs.200 to Rs.300 per sq.ft. in Gurgaon and Delhi. Forget our Mumbai becoming like
Shanghai one would be happy, if Vashi and Nariman Point were to become like Gurgaon. From our point of view over population is a critical malady but from the investors point of view it is a huge opportunity. The rationale being that no other market is going to see such growth. Small nations simply cannot add population. Israel gives extra benefits for every additional child but the population does not go beyond six million. Sam Tell the largest US landlord who pioneered the Homex Model is enthusiastic and says there is no better market in the world for low cost housing. Real Estate from being a No No for FDI until 2001-02 has swung to the other extreme and there is almost an unrestricted open door for FDI in real estate development as brought about by the Industrial Policy Press Note 02/2005 dated 3rd March 2005 which supercedes in Toto the earlier circular Press Note No.3 (2002 SERIES) and Para (IV) of Press Note No.4 (2001 Series).

In 2001 the FDI upto 100% was permitted for development of integrated townships of 100 acres which included commercial premises. It envisaged providing of allied infrastructure. This was permissible with Government approval.

The Circular of 2002 laid down the guidelines. It is important to look back and see the guidelines and to contrast it with the new Circular to see what are the requirements now. If you contrast the two you would see that Yesterday was a Nightmare. Today is a dream.


Another key change has been the removal of real estate from the negative list for investments by Venture Capital Funds (VCFs) and Foreign Venture Capital Investors (FVCIs) - which enables VCFs and FVI's registered with SEBI to invest in the real estate segment;

It is now acknowledged that there is a rush of investors and industry players bother foreign and domestic. But how did this change come about. Apparently there were demands by international players and particularly trading partners like Singapore to reduce the acerage requirement. Singapore as part of the negotiations for the Comprehensive Economic Co-operative Agreement had exerted its clout. So now the stage is set for a union between Foreign & Indian investors because the Govt. has removed some of the restrictive conditions of prior approval and has removed conditions of investors giving dowry such as free parks, playgrounds etc.

But how long will the honeymoon last if the path is strewn with landmines - CRZ ULC, Environment, Forests, Agriculture Land, Reservation -


A construction project still requires various permissions, sanctions, ULC clearances, CRZ restrictions


A Hotel project still requires about 65 clearances.


There is also the challenge posed by ever vigilant environment groups.


In UAE there is a genuine single window clearance.


This is the experience of Indian builders - Hiranandanis, who got all permissions within 23 days.

To top that there is no tax.

No tax :

So once we have invited the foreign investor and inducted them into the family, it is an opportune time that the Govt authorities should simplify the local law and reduce the complexities.

Let us examine some of the implications of investing in India :

There is an interesting Circular issued by the Urban Development Department of 21st August 2004 which talks about Development Control Regulations exclusively for Special Townships for Maharashtra.

Special concessions granted are as follows:

· If scheme is notified lands acquired even if agricultural land will be deemed to be converted into non-agricultural land - No ceiling limit for holding agricultural land for Special Township Project.

· Stamp Duty rates applicable in township area shall be 50% of prevailing rates of Mumbai Stamp Act.

· Condition that only agriculturist will be eligible to buy agriculture land will not be applicable in township area.

· Circular stipulates general norms for different land uses.

· However, it grants FSI on the entire gross area included in the township area that utilised for parkas, gardens and open spaces (except forests, water bodies.) There will be no limit of FSI for the development of individual plots.

Structuring Foreign Participation:

There are number of factors which would be required to be taken into consideration for determining the entry strategy of a non-resident investor in the real estate sector, some of which are as follows:

1. Nature of the entity, for example whether it is an equity fund, a private trust, VCF, FVCI, and industry player, an individual qualifying as an NRI; a foreign entity in India in JV or WOS.

2. Objectives of the entity;

3. Financial appetite or capacity;

4. Extent of control over that the entity wishes to exercise over its investment (whether in a certain segment of the real estate business or a specific target Company);

While structuring both entry and exit strategies it is important to take into consideration the provisions of the Indian Income-tax Act and the Double Taxation Avoidance Agreement that India has with other countries, with specific reference to capital gains.

Impact on economy:

The surging demand for real estate is driving large financial firms and private equity funds to launch exclusive funds targeted at the real estate sector, while at the same time, inducing big-ticket institutional investors to loosen their purse strings.

HDFC and ICICI Venture, which announced plans for real estate funds last year, are likely to collect between themselves at least Rs.2,000 crore from domestic and foreign investors, officials said.

While HDFCs Real Estate Fund is likely to raise about Rs.1,000 crore, ICICI Venture's India Advantage Fund-3 is expected to mop up at least $225 million. An ICICI official said the fund will have its first closing some time this month with about $100 million.

Construction was nearly 12% of India's FY 04 GDP and has accounted for 40%-50% of domestic fixed capital formation over the last decade.
FDI in the construction industry is negligible and hence the potential for growth

Construction activity had an unsavory association with underworld and black-market in the seventies. This has undergone a complete makeover with the corporate houses such as Tatas, Bombay Dyeing, Godrej, Mahindra, Hiranandani, Rahejas, DFL, Unitech adding the hallmark of quality and credibility.


Procedures:

Foreign Direct Investment:

Foreign Direct Investment (FDI) has been recognized as one of the important drivers of the economic growth of our country. Government has, therefore, taken this initiative to invite and facilitate FDI and investment from Non-Residents whether foreigners or Indians.


Policy for Automatic Route:

(a) New Ventures -

All items/activities for FDI/NRI investment upto 100% fall under the Automatic route:
For inward remittance and issue of shares to NRI/Foreign entities upto 100 per cent equity also, prior permission of RBI is not required. These companies have to file the required documents with the concerned Regional offices of RBI within 30 days after the issue of shares to NRI.

(b) Existing Companies -

Besides new companies, automatic route for FDI/NRI investment is also available to the existing companies proposing to induct foreign equity. For existing companies with an expansion programme the additional requirements are that:

1. the increase in equity level must result from the expansion of the equity base of the existing Company without the acquisition of existing shares by NRI/foreign investors.

2. the money to be remitted should be in foreign currency and

3. proposed expansion programme should be in the sector(s) under automatic route. Otherwise, the proposal would need Government approval through the FIPB. For this the proposal must be supported by a Board Resolution of the existing Indian Company.


For existing companies without an expansion programme, the additional requirements for eligibility for automatic approval are:

1. that they are engage in the industries under automatic route

2. the increase in equity level must be from expansion of the equity base and

3. the foreign equity must be in foreign currency.


Procedure of Automatic Approval for New & Existing Companies:

The proposals for approval under the automatic route are to be made to the Reserve Bank of India in the FC (RBI) form. In a major drive to simplify procedures for foreign direct investment under the "automatic route", the RBI has given permission to Indian Companies to accept investment under the route without obtaining prior approval from Reserve Bank of India. However, investors are required to notify the concerned Regional offices of RBI of receipt of inward remittances within 30 days of such receipt and will have to file the required documents with the concerned Regional office of he RBI within 30 days after issue of shares to foreign investors. This facility is available to NRI investment also.


Preference shares:

Foreign investment through preference shares is treated as foreign direct investment. Proposals are processed either through the automatic route of FIPB as the case may be. The following guidelines apply to issue of such shares:

(i) Foreign investment in preference share are considered as part of share capital and fall outside the External Commercial Borrowing (ECB) guidelines/cap.

(ii) Preference shares to be treated as foreign direct equity for purpose of sectoral caps on foreign equity, where such caps are prescribed, provided they carry a conversion option. If the preference shares are structured without such conversion option, they would fall outside the foreign direct equity cap.

(iii) Duration for conversion shall be as per the maximum limit prescribed under the Companies Act or what has been agreed to in the shareholders agreement whichever is less.


(iv) The dividend rate would not exceed the limit prescribed by the Ministry of Finance.


(v) Issue of preference shares should conform to guidelines prescribed by the
SEBI and RBI and other statutory requirements.



Incorporation of Company under Companies Act

How to form a Company - Legal Procedures - a summary


1st Step: Applying to the Registrar - for the name search:
Make an application mentioning three names to the registrar of Company - they take two to three working days to revert back.


2nd step : Drafting of documents:
Draft Memorandum of Association (MoA), Article of Association (AoA) and Statutory Declaration.
Time frame for this is three to four days.


3rd Step: Approval and Registration of documents from the Registrar:
Submitting all these documents to be registrar for approval and registration.
Registrar will give a Certificate of Incorporation. This may take about (maximum) two to three weeks.
Once you have this certificate, you can start the business.
The whole procedure takes about one month.


4th step: Open a Bank account:
In the name of the Company after receipt of Certificate of Incorporation.


5th Step:
Remit monies into the account for paying stamp duty registration fees for the Memorandum of Articles. This stamp duty registration is on the basis of quantum of the Authorized Share Capital.
50 crores Authorised Capital - Stamp duty Rs.10 lakhs, Registration Rs.26.6 lakhs
25 crores Authorised Capital - Stamp duty Rs.5 lakhs, Registration Rs.13.56 lakhs


Taxation :
If the J.V.Co. or the Indian Company is doing a Housing Project for low/middle income group then if the conditions of 80IA (10) are satisfied then there is no taxation.


The conditions are that the project should be an exclusive housing project with only 2000 sq.ft. of Commercial Space Unit size in metros 1000 sq.ft. built up. In other smaller towns 1500 sq.ft. built-up. Municipal Corporation approvals to be obtained latest by 2007. Project to be completed by 2011. There will be no tax for such housing projects.

Ironically if it is an Integrated Township with schools, dispensaries etc. it is possible that the I.T. Authorities will attempt to deny exemption to the housing project on the ground that the commercial area exceeds 2,000 sq.ft. This aspect needs urgent clarification. This anomaly has been repeatedly pointed out to the Finance Ministry.

If the returns are received by the investor as dividends withholding tax is 14s.02%. Dividends not to be taxed in the hands of the shareholders. Sale of shares after five years may be to the J.V. Partners under a Shareholding Agreement. Capital Gains tax is 22.4%

There is a recent ruling of the Authority for Advance Ruling in the case of Fidelity Advisor Services reported in 142 Taxman page 111 - This throws up the question whether these shares are capital assets or business assets. It was held that:

Under the particular connection of the US India DTAA business income which arose on sale of shares was not taxable as it was business income and the applicant not having a permanent establishment under Article 7.

If the project is a commercial/development of general plot project, there is tax applicable to Indian Companies which is 35% basic rate plus 10% surcharge plus 2% education cess = about 40%.

Foreign Construction Companies and Architects and Engineering Companies and Contractors can also do business. With the Real Estate sector and Foreign Companies can also enter into works and service contract with the lending or without lending.

It is important to see the clauses of a particular Double Taxation Avoidance Agreement to see whether the income earned by the foreign entity is taxable in India or not.

If one were to see the Indo Singapore Tax Treaty, then the permanent Establishment is constituted when the total contract period is more than 183 days.

If no PE is constituted then there is no tax on the foreign entity.
Indian entities can enter into works and service contracts to persons resident outside India.

So may I end with saying that we are prepared for FDI. Our construction companies will surely withstand foreign competitions and also contribute a grant deal to Joint Ventures.

We need to unlock economic growth and generate employment and land is the most valuable asset in this ancient country which has layers of civilization embedded within its folds. The danger is the overheating of the real estate market. That can never benefit the common man. There should not be another crash of 1995.