Technology Law Analysis
July 22, 2022
Make in India: Demystifying the Applicability of Procurement Orders to Software Products
The Make in India (“MII”)policy was initiated to encourage Indian and global companies to increase the development, production, manufacturing, and assembly of products made in India, “to transform India into a global design and manufacturing export hub”1. The larger objective of the policy is to create a conducive framework to promote foreign investments into the manufacturing sector and develop a robust infrastructure to support such foreign capital entering newly opened sectors, and to enhance income and employment within India.2
In furtherance of this policy objective, the Department of Industrial Policy and Promotion (“DPIIT”) of the Ministry of Commerce and Industry, issued the Public Procurement (Preference to Make in India), Order 20173 [modified by revision orders dated June 04, 20204, and September 16, 20205] (General Order)].6
The DPIIT noted that the government procurement through tenders (through its various ministries and departments) could significantly contribute towards the objectives of the MII program; if preference is given to local goods or services (in India). Therefore, the General Order, introduced a purchase preference for goods and services having a higher extent of Local Content,7.
Given that value addition chains applicable to various products and services may vary depending on the Government’s procurement requirements, the DPIIT’s General Order enables Nodal Ministries to specify methods of determining local content through separate MII procurement preference orders (“MII-PP Orders”)
Due to rapid strides in digitalisation and technology adoption across the public and private sector, India is a massive market engaged in both, (i) the research, development, and manufacturing of software products; as well as (ii) the sale of software products.8 Resultantly, the Government’s own procurement requirements for software products has increased significantly over the past decade.
However, for both Indian and foreign Multi-national companies (“MNCs”) significant uncertainty remains over the applicability of the MII requirements under the General Order of the DPIIT and orders of the other Nodal Ministries. This is primarily due to the unique nature of software development activities, which do not render themselves to any one method of determining local value addition. Since the DPIIT’s General Order, does not specify any particular factors for determining local content in software products, several MNCs continue to face issues with determining and self-certifying the percentage of local content in their software products.
Notably, while the Ministry of Electronics and Information Technology (“MeitY”), the Nodal Ministry for the purposes of prescribing methods of determining local content in information technology and software products, has issued separate MII-PP Orders applicable to cyber security products and hardware products – it has yet to specify mechanisms for determining local content in software products.
Similarly, other MII-PP Orders, such as the MII-PP Order for the procurement of telecom goods, services or works issued by the Department of Telecommunications (“DoT”), cover software products (e.g. encryption). But they refer to the stipulations contained in the General Order for the purposes of determining local content.
In this paper, we analyse the relevant MII-PP Orders issued by the DPIIT, DoT and MeitY, in order to identify methods of determining local content in software products. Further, we identify how these methods would be applicable to various business models for selling software products in India, and discuss the implications for each business model in terms of qualifying as a “local supplier” for the purposes of the MII-PP Orders, and other implications from a taxation perspective.
Applicability and Operability of the MII-PP Orders
The applicability of the General Order and other MII-PP Orders is dependent on the terms and conditions of each specific tender. Therefore, based on the scope of products sought to be procured by the Government and the specific conditions of the tender, the bidder entity will need to identify applicable order.
Both the General Order and other MII-PP Orders set out two classes of Local Suppliers, based on the percentage of the Local Content in their products, i.e., Class I and Class II suppliers. The manner in which the General Order, and existing MII-PP Orders issued by the MeitY define “local suppliers”, and regulate purchase preferences, has been set forth below:
Methods of Local Content Determination under the General Order: An Emerging Consensus and Potential Issues
Due to their global presence, MNCs typically hold IP in offshore entities, while the research and development may happen in India. The offshore entity, in turn, enters into agreements with their Indian subsidiaries (at arm’s length pricing, following transfer pricing rules) under which the Indian subsidiary either gets license to the IP subsisting in software product or distribution rights in relation to the software product. Therefore, it will be important to understand whether locally incurred costs (such as costs of employment and R&D in India) will be relevant to determining local content.
A plain reading of the terms of the General Order, does not clarify whether the local content determination needs to be made on the basis of: (a) locally incurred costs by the Indian subsidiary for development of the software product, as a percentage of the costs of developing a software product; (b) locally retained sales proceeds by the Indian subsidiary as a percentage of the selling price of the software product to the government; or some other metric.
There also lack of clarity around the applicability of the General Order to the procurement of cloud services. Prior to the issuance of the General Order, cloud procurement by the Government was guided by the GI Cloud (MeghRaj) Guidelines, which continues to be in effect, and requires empanelled cloud providers to locally incorporate, localize data centre facilities, and adhere to data residency requirements for storage and processing of data.13 Subsequent to the issuance of the General Order, procurement of cloud services entails an additional requirement to determine local content. The GI-Cloud (MeghRaj) Guidelines already require cloud service providers to localize both data centres and data processing activities – therefore it is unclear if this would be sufficient for the purposes of meeting the local content requirement under the General Order – or whether cloud service providers would need to demonstrate certain other cost/price-based factors in order to qualify as Local Suppliers.
While the DPIIT has not issued any formal/written clarifications in this regard, based on bids that have been already been validated by the Government, the emerging consensus amongst the industry on the issue of determining local content in software products is based on the selling price of each unit of the software product.
Resultantly, for the purposes of determining non-local content for software products, bidders may take into account the ‘royalty’/other price-components paid per product by the bidding entity to any overseas entity, as a percentage of the selling price of the software product (i.e. the price charged of the Government buyer by the bidding entity).
For example, if the price of a single user license for a payroll management software is INR 1,00,000 – then in order to qualify as a Class-I Local Supplier the amount of royalties payable to the offshore entity on account of providing the user license to the procuring agency, should not be more than 50% of the price of the user license, i.e. INR 50,000 (because the localization requirement for a Class-I Local Supplier is above 50%).
Similarly, in order to qualify as a Class-II Local Supplier, the amount of royalty payable to the offshore entity should not be more than 80% of the price of the user license, i.e. INR 80,000 (because the localization requirement for a Class-II Local Supplier is between 20% to 50%).
Given that this “selling price” based approach has been accepted and validated by the Government, bidders looking to supply software products to the Government may consider adopting a similar approach.
Notably however, this approach presumably focusses on models where the license/authorization to sell the software product, involves the payment of royalty on a per-product basis, such that it can built into the marked up selling price for the software product.
This may not be the case where the IP is acquired on the basis of a one-time payment for acquiring the IP/ license to market the IP to customers. In such cases, such as those involving a territorial assignment of IP based on a one-time payment, the bidder can potentially demonstrate 100% localisation, since no royalties are paid out of the sale consideration. While the costs of for acquiring IP/territorial rights may be amortized over multiple products, in order to determine royalty payable per license, such an exercise is not explicitly mandated – neither is it feasible to amortize royalty payments over actual as well as potential future sales.
Further, the above approach doesn’t suit use-cases such as procurement of cloud services, since typical software licensing / assignment models are not applicable in the cloud services industry. Given that localisation of data centres, data processing, and ancillary services are already prescribed as requirements for empanelment under the GI-Cloud (MeghRaj) Guidelines, the MeitY may consider treating GI-Cloud empanelled cloud service providers as Class-I Local Suppliers for the purposes of determining local content under the General Order.
Applicability of General Order to Software Products sold through various Business Models
Presuming that the above interpretation of the General Order vis-à-vis software products, is acceptable to the Government, we try to analyse how various business models for supplying software products, may demonstrate compliance with local content thresholds.
Conclusion and Way Forward
In the absence of a clearly demarcated approach for calculating Local Content in software products, significant uncertainty is likely to persist around the issue. As demonstrated above, Local Content stipulations which mandate localization of IP in India (e.g. the Cyber Security Products MII-PP Order) can be met merely by putting in place appropriate territorial assignment of IP to the bidding entity, and structuring the transaction in a manner where despite limited investments towards employment or R&D activities in India, a company can qualify as a Class-I Local Supplier.
A similar situation arises when Local Content is viewed as the component of the selling price retained with the bidding entity in India, since the assignment of IP and consideration on that account, can be structured in a manner which limits the pay-out due to off-shore entities, to below 20% of the selling price.
Given the above, the stated objectives of the MII initiative can perhaps be served better through a Local Content criteria which takes into account investments in India towards the development and creation of a software product – by taking into account various cost metrics such as employees in India (as a percentage of global employee numbers), or cost of R&D incurred in India as a proportion of global R&D costs. The DPIIT and other Nodal Ministries such as the DoT and MeitY should consult the relevant supplier base in arriving at a clear, certain and uniformly applicable set of rules for determining Local Content in software products – such that MNCs, which make significant investments in India, aren’t unduly disadvantaged merely because of the manner in which their IP-holdings are structured.
Nonetheless, pending additional clarity from the Government, the emerging approach provides a helpful benchmark for companies looking to qualify as “local suppliers” of software products. Given that the General Order and other MII-PP Orders, leave the task of determining local content to the bidders, companies looking to qualify as “local suppliers” have some room to structure their businesses in a compliant manner, and take a call on appropriate business models for supplying software products to the Indian Government.
Companies looking to structure their business models along the lines of the emerging approach, would need to bear in mind: (a) applicable self-certification requirements, requiring a bidder to self-certify the extent of Local Content in its products, accompanied by a certificate from a statutory auditor or a cost auditor of the company, or from a practicing cost or chartered accountant; and (b) the impact of arms’ length pricing of IP acquisition costs (license/territorial assignment/purchase) on the eventual local content of the software product.
Given that the interpretation of local content requirements may differ across procuring agencies and Nodal Ministries, companies looking to qualify for Government tenders for software products would be well advised to request clarifications from the procuring agency ahead of self-certifying local content. This would ensure reducing the risk of disqualification on grounds of incorrect calculation and declaration of local content.
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7 Defined in the General Order to mean “amount of value added in India which shall unless otherwise prescribed by the Nodal Ministry, be the total value of the item procured (excluding net domestic indirect taxes) minus the value of imported content in the item (including all customs duties) as a proportion of the total value, in percent.”
9 Clause 2 of the General Order
13 See, MeitY, Master Services Agreement – Procurement of Cloud Services (Ver 1.0), Available at URL:
https://www.meity.gov.in/writereaddata/files/Guidelines_Contractual_Terms_Cloud_Procurement_V1.2.pdf; See also, Cloud Management Office, e-Governance Division, MeitY, “Stepwise Guide on Process for Empanelment of Cloud Service Providers”, Available at URL: https://www.meity.gov.in/writereaddata/files/Stepwise%20guide%20on%20empanelment%20process.pdf
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