The Overseas Investment framework before 22 Aug 2022 was not clear on some aspects and left room for multiple interpretations. With an aim to revamp the Overseas Investment framework, in attempt to simplify and liberalize the regulatory framework, the Government of India and RBI notified the Overseas Investment Rules and Regulations respectively. In this article, we shall restrict ourselves in examining the key changes brought by the Government of India vide its notification No. G.S.R 646(E), dated August 22, 2022 which deals with the Overseas Investment Rules. The Rules governing the investment in non-debt instrument (equity) are notified by the Ministry of Finance, Government of India while the Regulations for debt instruments are notified by the RBI.
Some of the key changes notified vide the new Rules on Overseas Investment are discussed in succeeding paragraphs.
The new Regulation broadens the definition of “Foreign Entity,” and incorporation” of a Foreign Entity is not required. This is relevant for LLPs that are registered but not incorporated (in some countries).
The term “Indian Entity” now includes companies, LLPs and Partnership Firms.
Further, the definition of equity capital under the new rules has been broadened to include perpetual capital, irredeemable instruments and contribution to non-debt instruments.
With the change in definition of Indian Entity, Foreign Entity and Equity capital, now the LLPs and Partnership Firms are also eligible for making overseas investments. This investment can be made even in LLPs (referred to as LLCs in some countries) as the definition of equity capital has been broadened.
Earlier, an Indian Entity was permitted to utilize the net worth of its holding / subsidiary company to the extent not utilized by the holding / subsidiary company for the purpose of reckoning financial commitment for ODI. The new Overseas Investment Rules discontinues such concept of utilization of net worth of holding / subsidiary company.
Now Indian Entities which are not engaged in Financial Services activity, have been permitted to make overseas investment in a foreign entity which is directly or indirectly engaged in financial services activity (barring banking and insurance). For this, a condition has been provided that the investing entity shall have posted net profits during the preceding three financial years.
Further, regulatory approval is currently not applicable to an Indian entity that proposes to undertake financial services activity in host country, and is not engaged in the same in India. Earlier, for undertaking financial services activity in the host country, an Indian entity had to obtain approval from both the Indian regulator and the regulator of the host country. Now, regulatory approval will be required only if required under the Indian law or the laws of the host country (approval from the authority where it is required).
This may open the opportunities to invest in overseas financial services through Core Investment Companies and NBFCs
The previous ODI rules / regulations did not explicitly prohibit the setting up of Indian subsidiary through its foreign JV created or acquired through ODI (ODI-FDI structure). However, the FAQ issued by RBI prohibited creation of such structure under automatic route. This prohibition by way of FAQ might have been enacted to check any evasion of taxes. It seems that the Government of India has acknowledged the fact that not all step-down subsidiaries are formed for evasion of taxes, but to structure the operations of the holding company in a more efficient way. To form layer of subsidiaries is a commercial decision which sometimes becomes inevitable and hence the industry feels that the Government should have no role in regulating the layers of subsidiaries.
Rule 2 (1) (b) of Overseas Investment Rules has defined the following investments as ODI:
Explanation: where an investment by a person resident in India in the equity capital of a foreign entity is classified as ODI, such investment shall continue to be treated as ODI even if the investment falls to a level below ten per cent. of the paid-up equity capital or such person loses control in the foreign entity.
This 10% test has been introduced in the new Rules to determine the control in the entity in which investment is made. The term “Control” has been defined in Rule 2 (1) (c) where it is stipulated that “control” means the right to appoint majority of the directors or to control management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders’ agreements or voting agreements that entitle them to 10 per cent. or more of voting rights or in any other manner in the entity. This 10 percent voting rights requirement for determining control is inconsistent with the Companies Act 2013 (Sec 2 (27) and Sec 2(87)). As per section 2 (87) of the Companies Act 2013, “subsidiary company” or “subsidiary”, in relation to any other company, means a company in which the holding company—
Thus, the foreign entity may be identified as a subsidiary even if it does not fall under the term subsidiary as defined by Companies Act, 2013. This clause for defining control through 10 percent voting right has been introduced to determine whether the Foreign Entity is subsidiary or step-down subsidiary.
Further, Overseas Portfolio has been defined as investment, other than ODI, in foreign securities, but does not include:
OPI by an Indian resident in the equity capital of a listed entity shall continue to be treated as OPI even after delisting, until any further investment is made in the entity.
Rule 19 (3) of ibid rules state 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.” Thus, by notification of the new rules, the Government of India has permitted setting up of Indian subsidiaries (ODI-FDI) as long as the number of step-down subsidiaries is restricted up to two layers. For determining the control over subsidiaries, the test of 10% voting rights as mandated by Rule 2 (1) (c) [as discussed in detail in preceding paragraphs] may be applied.
The previous ODI regulations did not provide clear procedures for acquisition of shares by Resident Individuals through LRS, gifts, ESOPs, etc. Earlier, it was mandated that investment by resident individual should be made in an operating entity and no step-down subsidiary was allowed to be acquired by the Joint Venture or Wholly owned Subsidiary. Further the LRS also permitted capital account transactions by way of investment into units of venture capital funds and unlisted shares of foreign companies.
The New Overseas Investment Rules allow resident individuals to make ODI through capitalisation of amounts owed to foreign entities, swap of securities as a result of a merger, demerger, amalgamation, or liquidation, acquisition of equity capital through a rights issue or the allotment of bonus shares and acquisition of sweat equity shares. Further, resident individual is permitted to acquire shares in companies irrespective of their status as subsidiary or step-down subsidiary and whether they are engaged in financial services activity or not, if the shares are acquired by:
If the resident individual has acquired the shares through above routes and holds less than 10 percent of equity of the foreign entity (listed / unlisted) will be considered as OPI.
Though the gifting of foreign securities was under general permission under the previous rules, it was silent on the compliance procedures to be followed in the event of transfer of securities from a non-resident to resident (not a relative). The new Overseas Investment rules make it clear that in such transactions, compliances under Foreign Contribution (Regulation) Act, 2010 have to be met. This will be classified as receipt of foreign contribution in terms of FCRA and the resident individual receiving such gifts of shares shall be required to obtain FCRA registration.
Further, if gift of shares is being received by the resident individual from his / her relative but the value of securities is less than INR 10 Lakh, such gift can be accepted without complying with the provision of FCRA (approval of Ministry of Home Affairs shall not be required in this case). If the value of gifted securities exceeds INR 10 Lakh, then the provisions of FCRA shall apply; irrespective of the relation between the recipient and the person gifting such securities.
Rule 9 of ibid rules stipulates that the term “Bonafide” shall mean any business activity permissible under any law in force in India and the host country or host jurisdiction.
Overseas Investment or transfer of such investment including swap of securities in a foreign entity formed, registered or incorporated in Pakistan or in any other jurisdiction as may be advised by the Central Government from time to time shall require prior approval of the Central Government.
Further, ODI is not permitted in the following:
NOC requirement has been introduced for persons:
What if the agencies fail to provide NOC?
If the agencies do not provide NOC within 60 days of the application, the AD bank shall treat it is deemed approval.
Rule 16 of the Overseas Investment Rules mandates that the AD bank, before facilitating any transaction related to issue or transfer of equity capital of a foreign entity from a person resident outside India or a person resident in India to a person resident in India who is eligible to make such investment, or from a person resident in India to a person resident outside India shall ensure compliance with arm’s length pricing taking into consideration the valuation as per any internationally accepted pricing methodology for valuation. Such valuation report can be issued from any recognized valuer.
The reporting norms have been reformed and the concept of Late Submission Fee (LSF) for delayed reporting has been introduced for delayed reporting of overseas investments. Earlier, for lapse or delay in reporting was dealt with adjudication process and the defaulting party had to apply for compounding. Now, with the introduction of LSF, such lapses or delayed reporting can be regularized within 3 years from the due date of reporting. The rates and calculation methodology of LSF can be accessed at our blog on RBI amendments to LSF.
The RBI’s latest Overseas Investment Rules have reduced the need for approvals, disclosures and compliances, and automated several actions. It has also eased the ODI-FDI structure which earlier restricted Indian investors and companies from setting business outside India and structuring a subsidiary back in India. It will also help Indian startups expand overseas, build businesses in partnerships with foreign startups and allow investors to expand their business operations. Most importantly, it has reduced the compliance burden by way of introduction of LSF for regularization of defaults in reporting within 3 years from the due date of reporting.
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