Opening for business in India: retailers' options.

• Author: Shabshelowitz, Eric

1. INTRODUCTION

   India's retail market is currently valued at over $250 billion, and reports indicate it is growing at a rate of ten percent each year. (1) This tremendous growth is encouraging even Mickey Mouse to enter India's retail market. (2) Because of recent policy changes encouraging foreign investment, Disney and many other retailers have leapt at the opportunity to enter the market. (3) However, foreign retailers are still limited in their ability to operate in India because Indian law strictly regulates foreign participation in its retail market. (4) As foreign retailers formulate their plans to expand into India, they must consider the allowable modes of operation and identify which of these options best suit their business needs. (5)

   This Note evaluates the various ways in which foreign retailers may operate retail stores and manufacturing facilities in India. (6) Part II of this Note introduces some of the reasons foreign retailers are so interested in India. (7) Part III discusses the legal obstacles foreign retailers face and recent developments in Indian law intended to open the country's doors to foreign businesses. (8) Part IV discusses the allowable modes of operation for foreign retailers. (9) Part V suggests the optimal choices for foreign retailers to operate retail stores and manufacturing facilities in India. (10)

2. INDIA'S ECONOMY--WHY FOREIGN RETAILERS ARE INTERESTED

   India has one of the largest economies in the world. (11) Its consumer market stands at an estimated three hundred million people and is growing at approximately eight percent per year. (12) Currently, organized retail sales comprise only three percent of India's $250 billion in total retail sales. (13) However, organized retail is rapidly growing, and some analysts predict it could account for as much as thirty percent of India's total retail market by 2010. (14) This has led some to speculate that "[b]eing in India today is like being in the [U. S.] in the wild days of the dotcom era." (15)

   Foreign retailers must initially consider two issues before expanding into India: (1) whether India presents a viable market for their products and (2) whether the opportunity in India exceeds that of other foreign markets. (16) First, cultural differences present one obstacle to the marketability of foreign products because Indian consumers wish to maintain the uniqueness of their culture and foreign brands may not suit their tastes. (17) However, foreign retailers who modify their products and services to cater to India's unique culture have enjoyed success. (18) Second, foreign retailers must consider whether another country would be more suitable for their expansion plans. (19) For instance, Chinese workers are more productive than their Indian counterparts and China has a much more developed infrastructure. (20) However, certain other factors such as lower minimum wages and lower levels of corruption, as well as India's potential for growth, lead some to anticipate that India will overtake China as the business leader in Asia. (21) Although observers can only speculate on whether India will enjoy the success some predict, many well-established, multinational companies already operate in India and continue to further expand their presence. (22)

3. BACKGROUND OF INDIAN LAW AFFECTING FOREIGN RETAILERS

   India gained independence from Great Britain in 1947 and immediately placed heavy restrictions on foreign trade in an attempt to improve its economy. (23) As a result, India's share of world trade shrank. (24) In July of 1991, the Indian government introduced a new policy to address the international community's lack of confidence in its economic viability and removed some of the obstacles blocking foreign investment. (25) However, the Indian government did not allow foreign retailers to operate stores in India until January 2006, and even then it left a number of restrictions in place. (26) This policy change allows foreign retailers to operate single-brand retail stores, but they may only hold a fifty-one percent or less ownership interest in such ventures. (27) Indian law still prohibits foreign ownership of multi-brand retail ventures. (28)

   When operating stores and manufacturing facilities, foreign retailers must also consider the impact of India's general laws; for instance, India's labor laws affect companies' abilities to terminate employees. (29) India has also changed its tax law to further encourage foreign investment. (30) In general, foreign companies are subject to Indian tax on business profits only if they have a permanent Indian establishment. (31) Foreign retailers' tax liability therefore differs based upon the chosen mode of operation. (32) Additionally, the Indian government offers tax incentives for foreign companies to establish themselves in certain geographic locations, such as through the creation of special economic zones (SEZs), which are designated duty-free zones for manufacturing, services, production, assembling, trading and other permitted activities. (33)

4. FOREIGN RETAILERS' OPTIONS FOR OPERATING IN INDIA

   A foreign retailer looking to expand its operations in India has several options. (34) If a foreign company does not want to incorporate an entity in India, it may set up a liaison office or branch office, or it may enter into franchise agreements with Indian partners. (35) If a foreign company instead decides to incorporate an entity under Indian law, the company may form a joint venture or a wholly-owned subsidiary. (36) However, a foreign retailer need not limit itself to one type of operating entity, but rather may simultaneously operate a number of different entities. (37) As retailers have a number of choices, deciding which type of entity to utilize requires consideration of each available option. (38)

   1. Liaison Offices

      Liaison offices are normally established by foreign companies to promote their presence in India by spreading awareness of their products and exploring the option of setting up a more permanent presence. (39) Essentially, a liaison office acts as a communication channel between foreign companies and Indian parties. (40) However, liaison offices are not allowed to conduct any trading or commercial activities in India other than collecting and transmitting information to the foreign company. (41) Wal-Mart and Carrefour of France, the world's largest and second largest retailers respectively, both operate liaison offices in India. (42)

      To set up a liaison office, foreign companies must receive approval from the Reserve Bank of India (RBI). (43) The foreign company must cover all liaison office expenses because liaison offices cannot engage in any commercial activities. (44) Accordingly, liaison offices do not earn any taxable income. (45) However, foreign companies may be liable for income taxes even if they operate their liaison offices in compliance with the activity restrictions set forth by the RBI. (46) In determining the taxability of a foreign company's operations, the Indian government considers whether the company has a "business connection" in India, whether there is a Double Taxation Avoidance Agreement (DTAA) between India and the company's home country, and if the DTAA is applicable, whether the company has a permanent establishment in India, and how much income is attributable to that permanent establishment. (47)

   2. Branch Offices

      Foreign companies engaged in manufacturing and trading activities abroad may set up branch offices in India for various limited purposes, including exporting or importing goods, rendering professional or consultancy services, acting as buying or selling agents for the parent, or rendering technical support to the products supplied by the parent or group companies. (48) A branch office may not carry out manufacturing activities on its own unless it is located in a special economic zone (SEZ), nor may it undertake retail trading activities. (49) However, it may subcontract manufacturing activities to Indian manufacturers. (50) Furthermore, unlike a liaison office, which cannot engage in any commercial activities, a branch office may acquire property that is necessary or incidental to carrying on its activities. (51)

      Foreign companies must receive approval from the RBI before establishing a branch office in India. (52) Companies may set up branch offices on a "stand alone basis," meaning they are established in a SEZ and may not engage in any business activities outside of the SEZs in India. (53) SEZs allow such benefits as duty-free import of capital goods and raw materials, duty-free procurement of capital goods from the domestic market, and exemption from payment of central sales tax on interstate purchases from the domestic market. (54) For tax purposes, branch offices are treated as an extension of the foreign company, and thus must pay taxes on income earned from operating in India. (55)

   3. Franchising

      A foreign company may enter franchising agreements with persons or entities in India. (56) No laws currently prevent foreign companies from entering such agreements with Indian franchisees. (57) However, the Indian Government imposes certain restrictions on the franchisor-franchisee relationship, such as the requirement of obtaining government approval. (58) Besides legal hurdles, international franchisors face the additional difficulty of maintaining control over their franchisees. (59) Notwithstanding these challenges, several well-known retailers have established franchises in India, such as Louis Vuitton, Nike, Nine West, and Adidas. (60) Additionally, Carrefour signed an exclusive agreement with an Indian company, and Wal-Mart recently entered a franchise agreement with an Indian company as part of a larger expansion plan. (61)

   4. Joint Ventures

      A foreign retailer may decide to enter a joint venture with an Indian partner. (62) Joint ventures allow foreign companies access to the Indian partner's established distribution...