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The Reserve Bank of India (“RBI”) in consultation with the Government of India (“GoI”), has recently revamped the regulatory framework governing the overseas direct investment (“ODI”) made by residents in India. The GoI has brought in Foreign Exchange Management (Overseas Investment) Rules, 2022 and the RBI has issued Foreign Exchange Management (Overseas Investment) Directions, 2022, and Foreign Exchange Management (Overseas Investment) Regulations, 2022 (collectively referred to as “New ODI Framework”) which will subsume the existing regulations namely, Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015 (collectively referred to as “Former ODI Norms”). The New ODI Framework will come into effect on August 22, 2022.
The New ODI Framework is more transparent and simplified for overseas investments with minimum compliances. While approval requirements have been done away with in some cases at the same time, more accountability and consequences of delayed reporting have been introduced. This overhaul has been made to improve the ease of doing cross-border transactions.
Let us dive into the key changes brought under the New ODI Framework:
Changes in Definition
Some of the key terms that have been defined/ revised under the New ODI Framework are as follows:
It includes a company incorporated under the Companies Act, 2013 (“Act”); a body corporate incorporated under any law; or Limited Liability Partnership, or a registered partnership’.
It is similar to the definition of ‘Indian Party’ provided under the Former ODI Norms with a key change that each investor entity shall be separately considered as an Indian entity instead of all the investors from India in a foreign entity being together considered as Indian Party.
It is similar to the definition of ‘Control’ under the Act. Control means the right to appoint a majority of directors or to control management or policy decisions either individually or collectively whether directly or indirectly arising by virtue of their shareholding or any agreement. The key distinction from the Act is the linkage to 10% of the voting rights. As per the definition of Control under the New ODI Framework having entitlement of 10% voting rights in an entity may lead to establish control for the purposes of overseas investment.
Foreign entity (erstwhile overseas JV/ WOS)
The concept of joint venture/ wholly owned subsidiary has been substituted with the concept of ‘foreign entity’ which means a foreign entity having liability including in the International Financial Services Centre (“IFSC”).
It also clarifies that in the event a foreign entity is an investment fund/ vehicle regulated by the regulator of the financial sector in the host jurisdiction and set up as a trust outside India, the liability of the person resident in India should not exceed the interest or the contribution in the fund and trustee of that trust should be a non-resident.
It is important to note that for the first-time entities formed or registered in IFSC has been recognized as a ‘foreign entity’ under the ODI regime.
Subsidiary or step-down subsidiary (“SDS”) of the foreign entity
The definition of SDS now includes an element of control. SDS means an entity in which a foreign entity holds ‘control’, and such entity shall have limited liability, and whose core activity is not in the strategic sector as defined under the New ODI Framework. If the foreign entity does not have control over such entity, then it shall not be treated as SDS and hence, no reporting is required.
ODI and Overseas Portfolio Investment (“OPI”)
The term ‘ODI’ has been defined to mean investment: (i) by way of acquisition of any unlisted equity capital or subscription as a part of the memorandum of association of a foreign entity; (ii) an investment in 10% or more of the paid-up equity capital of a listed foreign entity; or (iii) investment with control where investment is less than 10% of the paid-up equity capital of a listed foreign entity.
OPI primarily means overseas investments other than ODI in foreign securities (except in unlisted debt securities or securities issued by Indian residents (except IFCSs)).
It is pertinent to note that once the investment is classified as an ODI/ OPI, it will continue to be treated as an ODI/ OPI even if does not satisfy the ‘10%’ or ‘control’ or listing criteria at any later point in time.
It means OPI and Financial Commitment made by a person resident in India.
It has been redefined to mean the aggregate amount of investment by way of ODI, debt other than OPI and non-fund-based facilities extended by an Indian entity to all foreign entities.
It has been permitted that Indian entities may lend or invest in any debt instruments issued by a foreign entity or extend the non-fund-based commitment to or on behalf of a foreign entity, including overseas SDSs of such Indian entity, subject to the following conditions:
- the Indian entity is eligible to make ODI;
- the Indian entity has made ODI in the foreign entity; and
- the Indian entity has acquired control in the foreign entity on or before the date of making a such financial commitment.
Some of the key changes brought in under the New ODI Framework are as follows:
Recognition of ODI FDI Structure with a Rider
More clarity on ODI-FDI has come with the New ODI Framework allowing a person resident in India to set up an SDS in India with a condition that it does not result in a structure with more than two (02) layers of subsidiaries at any point in time.
However, the layers restriction shall not apply to banking companies, non-banking finance companies (NBFC), insurance companies and a Government company, and such other classes of companies mentioned in Rule 2(2) of the Companies (Restriction on Number of Layers) Rules, 2017.
Earlier resident individuals were prohibited from investing in a foreign company if such foreign entity, whether directly or indirectly had an investment in any Indian Company regardless of the percentage of holding.
This is a welcome move that will allow Indian entities to invest in overseas companies which have presence in India.
Pricing Norms- Arm Length basis
Under the New ODI Framework, now all ODI transactions, issuance/transfer of equity capital of foreign entity, shall be on an arm’s length basis except transfer resulting from a merger/ demerger/ amalgamation/liquidation where the price is approved by a competent court/ tribunal. The price has to be determined based on the valuation report as per internationally accepted pricing methodology for valuation and the authorized dealer facilitating the transaction has to ensure compliance with the said requirement.
However, in a case of restructuring of the balance sheet of a foreign entity, if diminution is more than USD 10 million of the corresponding original investment or exceeds 20% of the total value of the outstanding dues towards the Indian entity or investor, diminution in value must be determined by a registered valuer.
Under the Former ODI Norms, the valuation was only required to be done (i) at the time of acquisition of an existing foreign entity involving an investment of more than USD 5 Million; (ii) in case of swap of shares irrespective of the amount; and (iii) transfer of share on an unlisted foreign entity.
No Objection Certificate from the Lender/ Regulatory Body/ Investigative Agency
A person resident in India having an account classified as non-performing asset (“NPA”) or who is a wilful defaulter or under investigation can now make a financial investment or disinvest an undertaking subject to the condition that he/she/it obtain, a no-objection certificate (“NoC”) from the lender/ regulatory body/ investigative agency. It also clarifies that any guarantee given prior to the commencement of investigation/ or classification of the account as NPA will not require NoC.
It is a complete departure from the earlier position as such persons were not allowed to make overseas investments in the Former ODI Norms.
Financial commitment by way of pledge/charge
The New ODI Framework permits pledge over the equity capital of, a foreign entity in which the Indian Entity has made ODI or its SDS outside India, such pledge can now be also in favour of a debenture trustee registered with SEBI for availing fund-based facilities for such an Indian Entity.
In addition, a charge over assets of, the foreign entity in which ODI has been made (or its SDS outside India) is now allowed in favour of a public financial institutions for availing fund or non-fund-based facilities. Similar change is also allowed in favour of a debenture trustee registered with SEBI for availing fund-based facilities for such an Indian entity, or the foreign entity in which it has made ODI or its offshore SDS which was not available under the Former ODI Norms.
Investment Allowed in the financial sector
Unlike the earlier Former ODI Norms, the New ODI Framework now allows Indian entities not engaged in financial services sector in India (directly or indirectly) to make an ODI in a foreign entity engaged in financial services activity (other than banking and insurance) subject to terms and conditions stated therein. Similarly, an Indian entity not engaged in the insurance sector has now been permitted to undertake ODI in general and health insurance subject to compliance with specified conditions. Resident individuals are not permitted to make ODI in a foreign entity engaged in financial services activities.
In a departure from the Former ODI Norms, an Indian Entity not engaged in financial services activity in India can make ODI in a foreign entity, which is engaged in financial services activity (directly or indirectly), subject to the condition that such Indian Entity has a track record of net profits during the preceding 03 financial years, barring banking or insurance activities.
Financial commitment by way of debt and guarantees
An Indian entity can lend or invest in any debt instruments issued by a foreign entity subject to the requirement that such loans are duly supported by a loan agreement and the rate of interest is determined on arm’s length basis.
The guarantee can also be provided by an Indian entity or by a group company or resident Indian promoter. If the guarantee is extended by a group company, it will be counted towards the utilization of that group company’s financial commitment limit independently whereas if the guarantee is extended by a resident Indian promoter, it will be counted towards the financial commitment limit of the Indian entity. The form of guarantees that can be issued and the terms and conditions are similar to the Former ODI Norms.
Setting up of SDS by a resident individual
The New ODI Framework now permits a resident individual to make ODI in a foreign operating entity (not engaged in financial services activity), irrespective of whether such foreign operating entity has an SDS so long as the resident individual does not have control over the foreign operating entity.
Calculation of limits for financial commitment
Now the limits of financial commitment will be calculated as the lower of (i) the value of the pledge or charge, or (ii) the amount of the facility. Earlier it was permitted up to the loan amount granted to the foreign entity.
ODI in Start-ups
ODI can be made from internal accruals from the Indian entity or group or associate companies in India and in case of resident individuals, from the own funds of such an individual. In any case, it shall not be from borrowed funds, and a certificate from a statutory auditor/ chartered accountant to that effect shall be submitted to the authorized dealer.
Deferred Payment System
A deferred payment mechanism has been introduced for any person subscribing to equity capital or purchasing equity capital subject to compliance with pricing guidelines and issuance or transfer of equivalent foreign securities upfront. However, the period of deferment has to be decided upfront. Buyers are also permitted to obtain indemnity from the seller in such an arrangement. The part of the payment towards consideration deferred by the person resident in India shall be treated as a non-fund based financial commitment by such person and shall be reported accordingly.
Introduction of Late Submission Fee (LSF)
Like FDI reporting, the concept of LSF has been introduced in the ODI regime with an expiry of 03 (three) years from the due date of reporting. Any delay in reporting or filing form/document /return shall be chargeable to LSF through the designated AD Bank. In addition, new financial commitments whether fund-based or non-fund based cannot be made until the delay in reporting is regularized.
Acquisition by way of Gift or inheritance
A resident individual may acquire foreign securities either by way of inheritance or by way of gift from a person resident in India. Foreign securities received as gifts should be from a relative and will not attract the provision of the Foreign Contribution Regulation Act, 2010 (“FCRA”). The term ‘relative’ in each case shall be as defined under the Act.
On the other hand, gifts from non–relatives residing outside India will be subject to the provisions of the FCRA. This is a new restriction imposed upon gift of foreign securities to a resident individual. However, there is no clarity on the compliances under FCRA. FCRA in its current form appears to regulate the receipt of foreign contributions by certain classes of individuals such as candidates for election, journalists, public servants, judges, political parties, associations/companies engaged in the production/ broadcast of news/ current affairs, and not generally. It would be helpful to know if the receipt of foreign contributions in the form of a gift of foreign securities by an individual, other than the restricted category under FCRA requires any compliance. Clarity on this from RBI is desirable.
Contribution to a trust
All contributions to an overseas trust will be viewed as a non-debt instrument in terms of the ODI Rules.
Swap of Securities (not just of shares)
The New ODI Framework now allow swap of ‘securities’ by an Indian entity and a swap of securities on account of a merger, demerger, amalgamation or liquidation by a resident individual.
Considering the need of Indian corporates to join the global value chain in order to evolve the Indian business across the world, RBI has revamped the ODI Framework for Indian corporates so that Indian entities can become active business participants in an increasingly integrated global market. This overhaul should unleash a more favourable environment for overseas investment from India.