Introduction

Hitherto, foreign direct investment into India from Pakistan and Bangladesh was given differential treatment and made subject to government approval. However, as a direct fallout of weakening economy and freefalling stock markets, and with a view ‘to curb opportunistic takeovers or acquisitions of Indian companies on account of the outbreak of COVID-19’, the Department of Commerce and Industry has vide Press Note 3 of 2020 dated April 17, 2020 (“Press Note”) amended the extant Foreign Direct Investment Policy, 2017 (“FDI Policy”).

The amendments to the FDI Policy vide the Press Note (“Amendments”) follow actions on similar lines taken by other countries such as Italy, Spain, France and Australia[1] and primarily aims to prevent distress sales and opportunistic takeovers of Indian companies facing stress in an economy weakened by the COVID-19 pandemic, by Chinese entities. The move also coincides with the securities market regulator, SEBI, asking custodian banks to disclose details of `ultimate beneficial owners’ of foreign portfolio investors based in China, Hong Kong and 11 (eleven) other Asian countries.[2]

The Press Note was made effective from 22nd April 2020 – the date on which the Government amended the Foreign Exchange Management (Non-Debt) Rules, 2019 (“FEMA Amendment”). The Amendments fail to address quite a few issues (discussed below), which the industry had expected, would be addressed/clarified in the ensuing FEMA Amendment. Unfortunately, FEMA Amendment is a just a formal amendment to the non-debt rules and does not attempt to clarify or address issues arising from the Amendments (set out in the Press Note). FEMA Amendment merely reflects the text of the Press Note.

Amendments

The Amendments provide that any non-resident entity incorporated in, or any citizen of, a country that shares its land border with India i.e. China, Nepal, Pakistan, Bhutan, Bangladesh, Myanmar and Afghanistan (“Restricted Persons”), can make investments in India under the FDI route, only after obtaining the prior approval of the government. The Amendments further restrict investments into India, where the beneficial owner of such investment is a Restricted Person, without the approval of the government. The approval will be mandatory for all sectors (including sectors presently under the automatic route) regardless of the quantum of investment. The restriction against the entities incorporated in Pakistan and its citizens with respect to foreign investment into India remains unamended.

The Amendments restrict any transfer of existing or future foreign direct investment in an Indian entity, if such transfer would directly or indirectly result in the beneficial ownership of such foreign investment being held by a Restricted Person.

Analysis

  • The Amendments are all encompassing and do not make any exceptions for minority acquisitions or passive investments, where the ownership and control of the Indian company continues to be with Indian citizens or Indian entities. Similarly, the Amendments apply to investments across all sectors and are not restricted to sensitive, or vulnerable sectors. The uncertainty around these approvals, including the timelines for obtaining such approvals, could severely impact investment decisions, and the plans of the proposed investee.
  • The Amendments do not draw a distinction between the different types of investments and investors. The blanket application of the restriction would severely impact genuine private equity investments into India. For instance, the restriction also applies to all future greenfield investments, even when there is no risk of a hostile take-over in such investments.
  • The Amendments do not provide any exceptions for / concessions to, existing investments made by investors from China, where subsequent rounds of funding may not result in any change in the shareholding percentage of the Chinese investors. This may impact the ability of Indian companies to raise bridge funding/subsequent rounds of funding from the existing bona fide Chinese investors.
  • The Amendments fail to differentiate the following scenarios:
  • Where the monies may have already been invested and held under an escrow arrangement or held as application monies in India, pending transfer / allotment;
  • Transactions involving multiple tranches of investments; and
  • Transactions with holdback and earnout elements

The Amendments do not provide any grandfathering to contractual arrangements that have been executed and are pending closure.

  • The Amendments do not provide for any exclusion for Hong Kong based entities[3]. India has a separate tax treaty with Hong Kong, independent of China. Historically, Hong Kong has been treated as a separate jurisdiction. However, since the Amendments are widely worded, and cover within their ambit all investments made by entities of countries that share a land border with India, it is unclear if the investments from Hong Kong, which is a part of China (or investments whose beneficial ownership originates in Hong Kong), would be exempted from the applicability of the Amendments.
  • The Amendments also do not provide any concession to investments made by structured vehicles set-up in Hong Kong, where the ultimate beneficial ownership lies with entities or individuals which are not Restricted Persons. Such investments should ideally be kept outside the purview of the Amendments. However, till such time that the Government issues a clarification in this regard, this will continue to remain a grey area.
  • The term ‘beneficial ownership’ is not defined in the Press Note or the FDI Policy. Whilst, the term ‘significant beneficial ownership’ has been defined in the Companies (Significant Beneficial Owners) Rules, 2018, for determining the significant beneficial ownership in entities incorporated in India, it is debatable if one can use the same definition for determining the beneficial ownership for the purpose of the Amendments. It remains to be seen how the Government defines ‘beneficial ownership’ for the purpose of compliance of the Amendments, especially considering that FDI investments in India are often multi-layered and multi-jurisdictional.
  • Whilst the Amendments restrict FDI, similar amendments have not been made for investments by Foreign Portfolio Investors (FPIs), which continue to be entitled to make investments on the stock markets in India under the FPI route. If the intent is to completely restrict Chinese participation in the country, the Government may also consider amendments to the FPI regulations.

Whilst the intent of the Amendments seems to be to prevent Chinese domination of a fragile economy, it will also dampen the investment sentiment of bona fide investors looking to invest, or continue to invest in Indian entities. The Amendments have also left several existing PE investors struggling to find answers to the unintended consequences of the Press Note and its impact on their investments, and the Government would do well to provide more clarity on the scope and applicability of these changes, while achieving the intent behind the Amendments.

This Article has been authored by Ms. Saloni Mody (Associate Partner) and assisted by Ms. Preeti Kumari (Senior Associate) and Ms. Harini Sutaria (Associate) of DSK Legal. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views and opinions of DSK Legal.

[1] Per Newspaper reports

[2] Per Newspaper reports

[3] Hong Kong is a special administrative region of the People’s Republic of China and enjoys a measure of autonomy under a ‘one country, two systems’ policy. It is treated as a separate jurisdiction for transaction and tax purposes.

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