A German company's presence in India: liaison, branch or project office under the Reserve Bank's Master Direction

A German company that wants a presence in India without a subsidiary can seek a liaison office (LO), a branch office (BO) or a project office (PO), approved by an Authorised Dealer Category-I (AD Category-I) bank under the Reserve Bank of India's Master Direction of 1 January 2016, updated to 18 May 2021, which implements the Foreign Exchange Management (Establishment in India of a Branch Office or a Liaison Office or a Project Office or any other Place of Business) Regulations, 2016. A branch office needs five years of profit and a net worth of USD 100,000, a liaison office three years and USD 50,000. Whether an office is a permanent establishment turns on Article 5 of the India-Germany Double Taxation Avoidance Agreement (DTAA) and the facts, and the Department of Economic Affairs (DEA) lists the India-Germany investment treaty as terminated on 23 March 2017.

Which instrument governs the choice, and who decides?

Establishing a branch, liaison or project office in India is regulated under section 6(6) of the Foreign Exchange Management Act, 1999 (FEMA), read with Notification No. FEMA 22(R)/2016-RB of 31 March 2016, which replaced Notification No. FEMA 22/2000-RB of 3 May 2000. The Master Direction (FED Master Direction No. 10/2015-16) consolidates the Reserve Bank's instructions to AD Category-I banks. Its rbi.org.in page shows 18 May 2021 as the latest update.

The applicant files Form FNC with a designated AD Category-I bank, which does the due diligence and grants the approval, but first sends the proposal to the Reserve Bank for a Unique Identification Number. A circular of 12 May 2016 (A.P. (DIR Series) Circular No. 69) adds that the bank may decide under delegated powers where the principal business lies in a sector open to 100 per cent foreign direct investment.

Prior approval of the Reserve Bank itself is needed for applicants from Pakistan, for some from neighbouring countries seeking offices in sensitive regions, for a principal business in defence, telecom, private security or information and broadcasting (unless the Ministry or regulator has already approved), and for non-profit and foreign government bodies. A German manufacturer outside those sectors falls under none of them on the text.

What are the eligibility thresholds for each office?

Paragraph 1(iii) of the Master Direction fixes the thresholds:

• a branch office: a profit-making track record during the immediately preceding five financial years in the home country, and a net worth of not less than USD 100,000 or its equivalent;
• a liaison office: a profit-making track record during the immediately preceding three financial years in the home country, and a net worth of not less than USD 50,000 or its equivalent. Net worth is paid-up capital plus free reserves, less intangible assets, per the latest audited balance sheet certified by a Certified Public Accountant or registered accounts practitioner. An applicant that is not financially sound but is a subsidiary may offer a Letter of Comfort from a parent or group company that meets the criteria; in the prescribed format the parent undertakes to meet any liability the Indian office cannot.

A project office has no net worth or profit test. It has a general permission where the non-resident has a contract from an Indian company for a project that has its regulatory clearances and is funded by inward remittance, by an international financing agency, or by an Indian term loan from a public financial institution or bank.

What may each office do?

Annex C lists the permitted activities. A branch office should normally engage in the activity of the parent, and may export or import goods, give professional or consultancy services (other than legal practice), do research, promote collaborations, act as buying or selling agent, render software services and give technical support to the parent's products. A liaison office may only represent the parent or group in India, promote exports and imports, promote technical or financial collaborations, and act as a communication channel between the parent and Indian companies.

The bank-account rules show the same line. A liaison office may hold one account, credited only with head office funds, refunds of deposits and taxes, and sale proceeds of its assets, and debited only for local expenses. A branch office account may also take legitimate receivables, and a branch may remit its profit net of applicable Indian taxes against audited accounts and a Chartered Accountant's certificate that the profit came from permitted activities.

How long does an office last, and what must it file?

A liaison office is generally approved for three years (two for a non-banking finance company or a construction and development entity, other than infrastructure development companies); a project office lasts for the tenure of the project. The bank may extend a liaison office by three years at a time, on a request made before expiry, if the annual certificates are filed and the account has been run as approved. For the two-year categories no extension is considered, and on expiry the office must close or convert into a joint venture or wholly owned subsidiary in conformity with the foreign direct investment policy.

An approval lapses if the office is not opened within six months of the approval letter; the bank may grant six months more, and anything beyond needs the Reserve Bank.

Each office files an Annual Activity Certificate (AAC) as at 31 March. A liaison or branch office sends it to its bank and to the Director General of Income Tax (International Taxation), New Delhi; a project office sends it to the bank only. More than four offices, one in each of the East, West, North and South zones, needs the Reserve Bank's prior approval.

How does this compare with a wholly owned subsidiary?

The Master Direction speaks to the subsidiary only at its edges. Three points come from the Master Direction alone.

First, the offices are the German company itself in India: the application rests on its own accounts and profit history, and the Letter of Comfort makes the parent answerable. Second, the liaison office account takes only head office funds, so the office cannot trade. Third, the Reserve Bank treats conversion into a joint venture or wholly owned subsidiary as the exit for an office that has run its course. Assets move to the subsidiary only on closure, at not more than book value, with intangibles and leasehold improvements excluded and taxes paid.

Is there an investment treaty to fall back on?

The DEA's list of bilateral investment treaties gives, for Germany, a date of agreement of 10.12.1995, enforcement on 13.07.1998 and termination on 23.03.2017. The text is dated 10 July 1995 at Bonn.

Article 15 provides that the agreement stays in force for ten years and thereafter until twelve months after either party gives notice of termination, and that for "investments made while the Agreement is in force" it continues for fifteen years after termination. Counted from the listed date, that period ends on 23 March 2032, and it covers on the words only investments made before 23 March 2017. An office opened in 2026 or 2027 is outside it, and Article 1(b) defines investment as every kind of asset invested under the host country's laws, so whether an office's assets are an investment at all is a separate question.

What do the numbers look like?

An illustration. The company, figures and dates below are hypothetical, in United States dollars because the Master Direction states its thresholds that way.

A German company, latest audited accounts
  Paid-up capital                                      USD 400,000
  Free reserves                                        USD 180,000
  Intangible assets                                    USD 520,000
  Net worth (400,000 + 180,000 - 520,000)              USD 60,000
  Liaison office test (USD 50,000)                     met
  Branch office test (USD 100,000)                     not met

Profit record: profit in the last three years, loss in year four
  Liaison office (three years)                         met
  Branch office (five years)                           not met

Approval letter dated 1 December 2026
  Office must open by                                  1 June 2027
  With one bank extension, by                          1 December 2027
  Liaison office, three years from the letter          30 November 2029

On these figures the company meets the liaison office tests and not the branch office tests. The last date assumes the three years run from the letter, which the Master Direction does not say. A Letter of Comfort is open only to an applicant that is itself a subsidiary whose parent meets the criteria.

What remains unsettled?

Three points.

Whether any office of a German company is a permanent establishment. That turns on Article 5 of the DTAA and on the facts.

How the bank treats a Letter of Comfort from a German parent. The Master Direction states the format and the tests without further guidance.

Whether any investment protection reaches a German business that sets up in India now. On the Article 15 wording it does not, but the termination notice has not been seen.