Overseas Investment Rules: Do They Open Floodgates to Money Laundering, Asks EAS Sarma
Moneylife Digital Team 24 September 2022
Expressing concerns over the overseas investment rules issued by the Union ministry of finance, India's former revenue secretary EAS Sarma has urged the ministry to revisit the overseas direct investment (ODI) regime and make sure that it does not open the floodgates to unhealthy money laundering that hurts the economy. 
In a letter to Ajay Seth, Union secretary in the department of economic affairs, Mr Sarma, a highly regarded former secretary of finance and power, says, "I am somewhat perplexed about the timing of the 2022 ODI rules, at a time when India's external debt, especially short-term external borrowings are mounting, when foreign exchange remittances are plateauing, when the import bill on several important commodities like oil, gas, fertilisers, coal and so on is increasing, with the rupee has come under pressure in the exchange market and when the foreign exchange reserves are depleting."
As reported by Moneylife, even as the Indian rupee is in trouble, the Reserve Bank of India (RBI), on 22 August 2022, issued a circular ostensibly to permit overseas investment by persons resident in India, to "enhance the scale and scope of business operations of Indian entrepreneurs by providing global opportunities for growth."
In a nutshell, RBI has permitted capital convertibility with an overall limit of US$1bn (billion) when the government is trying to raise non-resident Indian (NRI) deposits because the rupee is under pressure.
Shorn of jargon, RBI's new outbound investment regulations seem to allow any Indian entity that is not engaged in financial services and has a three-year profit track record to invest anywhere in the world for financial services without any permission from the central banker. (Read: EXCLUSIVE: Has RBI Allowed Backdoor Convertibility with a Limit?
These rules were notified based on a draft notification placed in the public domain by the ministry about a year ago, calling for feedback. "I am not sure whether the ministry had received any objections on the draft and whether the same was carefully examined before notifying the rules one year later," Mr Sarma says.
According to the former secretary, one crucial change that has got incorporated in the notified rules, compared to the earlier draft, whatever be the provocation for it, is that the last year's draft clearly stipulated that the proposed relaxations would be prohibited if there was any indication whatsoever that the investment in question was being made to avoid taxation and not by way of a genuine business transaction. 
In contrast, he says, the latest notified rule 19(3) has dropped that stipulation altogether and substituted it with the condition that "no person resident in India shall make financial commitment in a foreign entity that has invested or invests into India, at the time of making such financial commitment or at any time thereafter, either directly or indirectly, resulting in a structure with more than two layers of subsidiaries." 
"In other words, an overseas investment would still be permissible now, if the foreign entity in question invests into India, either directly or indirectly, either through a subsidiary registered in the main overseas location or in a third country, irrespective of whether the investment implies tax avoidance or outright evasion. Often, some companies do create such layers of subsidiaries spread over more than one country, primarily to evade domestic taxation," Mr Sarma says.
"It is surprising that such a paradigm change should be introduced within one year of the publication of the draft last year," he says, adding, "By introducing such a change, has the ministry of finance indirectly done something that will legalise tax evasion through money laundering?" 
This, according to Mr Sarma, is further compounded by the absence of any stipulation regarding the nature of the country where the overseas investee company is located. "In the absence of such a stipulation, it is possible that a domestic company invests in an overseas company located in a country where there are not enough safeguards to prevent money laundering."
The former secretary shares the example of a notification issued by market regulator the Securities and Exchange Board of India (SEBI). 
SEBI guidelines, issued on 17 August 2022 for overseas investment by alternative investment funds (AIFs)/ venture capital funds (VCFs), have stipulated that, 
"(iv) AIFs/VCFs shall not invest in an overseas investee company, which is incorporated in a country identified in the public statement of Financial Action Task Force (FATF) as: 
(a) a jurisdiction having a strategic Anti-Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply; or 
(b) a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with FATF to address the deficiencies..."
Mr Sarma says, "I am surprised that the 2022 ODI notification fails to qualify the destination country in a similar manner. In the absence of such a stipulation, it is possible that some domestic companies make ODI in countries where there are no safeguards against money laundering and therefore create opportunities for outright tax evasion. I am sure that it is not the intention of the ministry of finance to create such opportunities."
According to the former secretary, there is another component of the 2022 ODI rules that raises concerns. 
Rule 3(1) states that  
"the total financial commitment made by an Indian entity in all the foreign entities taken together at the time of undertaking such commitment shall not exceed 400% of its net worth as on the date of the last audited balance sheet or as directed by the Reserve Bank of India (RBI), in consultation with central government from time to time."
Mr Sarma says, "The upper limit of 400% could cause the domestic economy's exposure to undue risk, especially when more than one domestic company takes advantage of this relaxation, which needs to be carefully analysed."
He also highlights other equally essential lacunae in the ODI rules. The high-level advisory group (HLA) set up in 2019 by the ministry of commerce considered, among others, the restrictions required for ensuring that overseas investment opportunities may not be misused for laundering money and evading taxes. 
"That group had recommended a stipulation to the effect that an Indian party should be allowed to undertake ODI in a structure which already has an existing FDI structure in India only if the total value of existing FDI does not exceed 25% of the consolidated net worth of the foreign entity in which ODI is being made; and, any additional FDI should be allowed only if such funds are not directly or indirectly from India."
"The latest ODI rules are totally silent on this aspect. Apparently, the ministry of finance has not cared to consider the HLA group's recommendations," the former secretary says. 
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4 months ago
Many companies are maintaining establishments in UK, USA which are manned by son/daughter etc or acts as a 2nd home of the promoter and funded by the tax deductible expense from India
4 months ago
May be window has been opened for short duration may close full or half shortly
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