Reserve Bank of India (RBI) regulates overseas direct investment (ODI) made by Indian entities and resident individuals in joint ventures (JV) and wholly owned subsidiaries (WOS) outside India pursuant to Foreign Exchange Management (Transfer of Issue of any Foreign Security) Regulations, 2004 (Regulations).
While insertion in the FAQs cannot be the correct way of addressing a crucial issue as it can surely be the deal breaker in case of acquisitions of JV or WOS and also pose concerns for existing JV and WOS having investments in India.
RBI surreptitiously inserts a crucial clarification in ODI FAQs. One of the questions in the updated FAQs (Q. No. 64) that has been recently inserted, reflects the intent of RBI to prohibit round tripping of funds in India by Indian entities. The FAQ provides as under:
64.Q Can an Indian Party (IP) set up a step down subsidiary/joint venture in India through its foreign entity(WOS/JV) directly or indirectly through step down subsidiary of the foreign entity?
Ans: No, the provisions of
Notification No. FEMA 120/RB-2004 dated July 7, 2004, as amended from time to time, dealing with transfer and issue of any foreign security to Residents do not permit an IP to set up Indian subsidiary(ies) through its foreign WOS or JV nor do the provisions permit an IP to acquire a WOS or invest in JV that already has direct/indirect investment in India.
While referring queries by AD Bank in the Conference of the Authorised Dealers on FEMA, 1999 – 2015, 12 February 2016 (
https://www.rbi.org.in/scripts/feduser.aspx#odi), one of the query was raised by AD bank that whether it is permitted for an Indian company to acquire an overseas company and such overseas company also has an Indian subsidiary. RBI responded that it was not envisaged under the extant guidelines at the point of time.
The FAQ provides two restrictions:
a. IP cannot set up subsidiary through WOS or JV;
b. IP cannot acquire WOS or invest in such JV that already has direct/ indirect investment in India.
Contradicting provisions
While, the intent of RBI is very clear from aforesaid, there is no express provision in the Regulations prohibiting the investments. In fact, certain provisions of the Regulations provide otherwise.
Prohibitions under the Regulations
(a) Indian Parties are prohibited from making investment (or financial commitment) in foreign entity engaged in real estate (meaning buying and selling of real estate or trading in Transferable Development Rights (TDRs) but does not include development of townships, construction of residential/commercial premises, roads or bridges) or banking business, without the prior approval of RBI.
(b) An overseas entity, having direct or indirect equity participation by an Indian Party, shall not offer financial products linked to Indian Rupee (e.g. non-deliverable trades involving foreign currency, rupee exchange rates, stock indices linked to Indian market, etc.) without the specific approval of the Reserve Bank. Any incidence of such product facilitation would be treated as a contravention of the extant FEMA regulations and would consequently attract action under the relevant provisions of FEMA, 1999.
Permission to invest by way of swap of shares
In cases of investment by way of swap of shares, irrespective of the amount, valuation of the shares will have to be made by a Category I Merchant Banker registered with SEBI or an Investment Banker outside India registered with the appropriate regulatory authority in the host country. Approval of the Foreign Investment Promotion Board (FIPB) 1will also be a prerequisite for investment by swap of shares, if required in terms of
Notification No. FEMA 20/2000-RB dated May 3, 2000.
The aforesaid provisions permit the Indian entity to invest in JV/WOS against swap of shares as per provisions for foreign direct investment. This provision is then contrary to what is stated by RBI in the FAQ. This will result in the JV/WOS to have investment in India.
Permission to invest in exchange for ADRs/ GDRs
As per the Regulations, investment (or financial commitment) in an overseas JV / WOS may be funded by exchange of ADRs/GDRs issued in accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993, and the guidelines issued thereunder from time to time by the Government of India.
ADR/ GDR have underlying shares of the Indian Entity. Accordingly, an Indian Entity can invest in JV/WOS in exchange of ADRs/GDRs which will result in the JV/WOS to have investment in India.
Position under Companies Act, 2013 in case of foreign companies:
Currently, there are two limbs of section 2(42) and section 379 of Act, 2013 read together:
(a) Section 2(42 defining criteria to be regarded as a foreign company and thereby required to comply with such provisions of Chapter XXII that are applicable to every foreign company;
(b) Section 379 specifying applicability criteria of the other prescribed provisions of the Act, 2013, in addition to Chapter XXII, on the basis of Indian shareholding in such foreign company.
Pre-requisite to qualify under Section 379 of Act, 2013
(a) Company should be a foreign company as per section 2(42) of Act, 2013; and
(b) Atleast half of the total paid up capital in such company should be held by Indian citizens or Indian companies/ body corporate.
This was inserted as sub-section (1) of Section 591 vide the Companies (Amendment) Act, 1974 as some of the foreign companies operating in India were foreign only in name i.e., only by virtue of incorporation in a foreign country, but the main business or trade or manufacture was being conducted wholly or almost wholly in India.
While the intent behind the insertion in the FAQ is to curb round tripping of funds, RBI should insert the same appropriately in the Regulations to ensure better enforceability. Further, the restriction that the Indian party cannot acquire WOS or invest in such JV if it has direct and indirect investment in India, lacks clarity. Will the JV and WOS even holding one share in an Indian entity result in any violation?
Insertion in the FAQs cannot be the correct way of addressing such crucial issue as this can surely be the deal breaker in case of acquisitions of JV/WOS and also pose concerns for existing JV/WOS having investments in India.
(CS Vinita Nair is Partner at Vinod Kothari & Co)
