Behnam Khatami, Hooman Sabeti and Amir Mirtaheri of Sabeti & Khatami discuss the opportunities and challenges of the Iranian market.
Iran is situated at the geographic nexus of the Middle East, Levant, Russia, Central Asia and the Indian subcontinent. It connects the Caspian Sea and the Persian Gulf, and lies on the ancient and modern route from the Mediterranean to the subcontinent and China. It shares land borders with Iraq, Turkey, Armenia, Azerbaijan, Turkmenistan, Afghanistan and Pakistan; and is a maritime neighbour of Russia, Kazakhstan, Oman, UAE, Qatar, Bahrain, Saudi Arabia and Kuwait. It is the only country connecting the two large energy fields of the Caspian Sea and Persian Gulf regions, and itself ranks among the top five countries globally in both oil and gas reserves.
Iran’s area is approximately the same as Western Europe. Ringed by mountains and waters, it has had stable and secure borders for centuries, and benefits from internal stability in a tumultuous region. Iran’s civilisation, culture and language have long been resonant throughout the region. Persian was the language of administration and culture for the Mongols and Arabs and in India; it is spoken in over 25 countries today, about the same as Chinese and Spanish.
Iran’s population of over 85 million people is slightly larger than Germany’s, with about two-thirds under the age of 30. A quarter of the population have university degrees and nearly 60% of university-age people are enrolled in university.
Iran is a middle-income country with a nominal 2018 GDP of about $450bn (IMF). It has an industrialised and relatively diversified economy. While oil, gas and petrochemicals are preponderant, there are notable manufacturing, mining, metals, agriculture, power and water sectors. In the past decade, Iran has witnessed rapid growth in the renewables, technology and e-commerce industries as well.
An otherwise attractive market, Iran’s business environment has been significantly affected by US-led economic sanctions unprecedented in their scope and harshness. The country experienced a relatively short respite from most sanctions and a modest increase in foreign investors’ participation following the 2015 Iran nuclear deal (otherwise known as the JCPOA) and prior to the US withdrawal from the JCPOA in May 2018. Current US sanctions targeting key sectors (such as oil, petrochemicals, metals, automobiles and aviation) and the Iranian banking system have constrained trade and diminished the access of almost all business sectors to capital and cross-border banking services.
Attractions and challenges of doing business in Iran
The key attractions of doing business in Iran are its large consumer market, educated workforce, diverse economy, infrastructure investment needs, potential as a regional hub and new paradigms of privatisation and foreign investment. On the other hand, US primary and secondary sanctions, risk perceptions of foreign financial institutions, an inadequate domestic financial system, a weak private sector, complex and unreceptive regulatory environment, out-dated labour and corporate laws and FX volatility constitute the key challenges of doing business in Iran.
Privatisation and the government’s role
Iran’s economy has been characterised by the wide presence of state and quasi-state entities. Against this background, the government embarked on an ambitious privatisation initiative in the early 2000s, resulting in the promulgation of a major privatisation law in 2008 and its implementation thereafter. Over a decade later, the expansion of direct government ownership is tightly controlled but containing indirect control of state and quasi-state entities over the economy remains an elusive objective. The private sector, struggling to simultaneously cope with sanctions and a cumbersome financial and regulatory environment, still plays a relatively small role in the national economy.
Iranian law now allows full foreign ownership in most economic sectors, while the Foreign Investment Promotion and Protection Act 2002 (FIPPA) offers a number of incentives and protections for those who obtain a licence under that Act. Examples include protection against nationalisation and expropriation, national treatment, guaranteed repatriation of investment proceeds and a simplified visa procedure. FIPPA allows foreign direct investment in the private sector as well as foreign investment in the public sector through contractual arrangements (such as buy-backs, BOOs and BOTs). In addition, Iran has entered into bilateral investment treaties with close to 60 countries.
In most cases, those interested in doing business in Iran enter the market by: (i) establishing or acquiring a subsidiary (including for the purpose of incorporated joint venture arrangements); (ii) opening a branch or representative office; (iii) establishing an unincorporated joint venture arrangement with local entities; or (iv) entering into a sale or distribution agreement with a local entity. Establishing or acquiring a subsidiary allows the parent company to engage in the full range of corporate activities. Acquisition of an existing local entity may be attractive particularly where the entity holds the necessary licences, land or other relevant assets or know-how. In recent years, there has been an increase in the number of M&A transactions in Iran, resulting in an increase in the number of opportunities for potential foreign investors. Foreign companies who wish to have a limited local presence may open a branch or representative office, which can engage in specified activities such as conducting market research or providing after-sale services. A branch is exempt from corporate tax as long as it does not conduct any commercial activity. Entering into joint venture arrangements with local counterparts (whether or not through a joint venture company) is also a common approach but requires careful structuring to avoid legal, tax and operational hurdles. Finally, sales and distribution agreements are another option that allows market presence through a local representative or agent while managing liabilities and risks.
Common corporate vehicles used by foreign participants to establish an Iranian entity are private joint stock companies and limited liability companies. However, corporate registration and maintenance in Iran can be demanding due to a formalistic and sometimes inconsistent approach taken by the corporate registrar; it therefore requires time and involvement of senior management to avoid the onerous liabilities for a company and its directors that can follow from unintended lapses.
Iran has a complex, multi-layered, overlapping and at times ambiguous regulatory environment, and a significant number of new regulations are issued each year. In certain areas, such as import-export, foreign exchange or banking, regulation can change with dizzying speed. This constantly evolving regulatory landscape requires business owners and managers to keep abreast of new regulatory requirements and opportunities to manage their costs and risks.
Banking and capital markets
Iran’s banking system is, for the most part, government owned or controlled, although a number of private banks have successfully emerged in the past decade. Bank loans are the most important source of debt financing, although banks are undercapitalised and laden with large arrears from the government, credit is limited, financing instruments are rigid and regulations can be outdated. The government budget has limited development funding, and most project and infrastructure funding comes from the country’s sovereign wealth fund, the National Development Fund (NDF). A number of banks act as agents and intermediaries for NDF’s Iranian rial and foreign currency loans, which support projects that meet NDF’s mandate. While Iran has a legal framework allowing foreign banks to open a local branch or representative office, there is no longer a significant presence of international banks due to sanctions. The capital markets are regulated and supervised by the Securities and Exchange Organisation. The Tehran Stock Exchange, founded in the 1960s, is the oldest in the Middle East, and its market capitalisation in July 2019 was approximately $90bn (at prevailing market exchange rates). The debt capital market is much smaller, and is dominated by government debt. All onshore debt financing, whether through banking or capital market instruments, is Sharia-compliant.
Iran has long had a multiple-rate FX regime. Currently, there is a low, official rate exclusively allocated by the central bank for import of ‘essential goods’ (mostly food and medicine), a much higher open market rate, and an intermediate ‘NIMA’ rate for imports of non-essential goods. Exporters are under a general obligation to repatriate their export revenues, which are intended to support the currency needs of importers of non-essential goods via the NIMA platform, where the NIMA rate is determined on a managed supply-and-demand basis. The current FX regime, which was introduced in April 2018 following the significant devaluation of the Iranian rial, is still in flux and further transformation in the near future can be expected. Therefore, it is essential for businesses for whom foreign currency is material to closely monitor and respond to changes in the FX regulatory environment.
In recent years, concerns over anti-money laundering (AML) standards and recommendations of the Financial Action Task Force (FATF) have led the legislative and executive branches of the government to take major steps to pass several AML laws and regulations. A Financial Intelligence Unit has been established within the Ministry of Economic Affairs and Finance, and AML compliance and enforcement is gradually emerging as a significant area of concern for larger business owners, financial institutions and judicial authorities. Despite these developments, Iran’s AML regime is not yet functionally comparable with international standards and best practices.
The Labour Law 1990 covers many aspects of employment relations, most of which are mandatory. Failure to fulfil employee-related social security and tax obligations could in particular have significant adverse consequences for the company and its directors and principal shareholders.
The Iranian tax code generally imposes a flat 25% tax rate on corporate income, subject to numerous reliefs, exemptions and reduced rates based on, among other things, industry sector (eg, manufacturing, power generation or mining) or location (eg, special economic zones, free trade-industrial zones or designated ‘less developed’ areas) of the enterprise. In free trade-industrial zones, for instance, there is a 20-year exemption from property and income taxes, starting from the issue date of the taxpayer’s activity licence. Iran has also entered into double taxation avoidance treaties with over 50 countries.
Most business disputes in Iran go through the court system, which is under-resourced and lacks the necessary expertise to deal with sophisticated commercial disputes. As a result, in recent years there has been a growing interest in the use of ad hoc or institutional arbitration to resolve commercial, investment and other business disputes. The two local arbitration institutions are Tehran Regional Arbitration Centre (TRAC) and the Arbitration Centre of Iran Chamber of Commerce (ACIC), although the parties may choose arbitration by a foreign institution such as the International Chamber of Commerce or the London Court of Arbitration. Government entities must obtain the approval of the Council of Ministers, and in certain cases including where there is a foreign counterparty, the approval of the Parliament, before they can submit to arbitration. Iran is a party to the 1958 New York Convention on Recognition and Enforcement of Foreign Arbitral Awards.