The 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and Transfer of Immovable Property Outside India) Regulations, both of which were previously in effect, have been replaced by the Overseas Investments Rules and Regulations (‘OI Guidelines’) dated 22 August 2022.
The RBI also issued Foreign Exchange Management (Overseas Investment) Directions, 2022 (the “OI Directions”) on August 22, 2022, to give effect to the aforementioned and replace the previous Master Directions on Direct Investment by Residents in Joint Venture and Wholly Owned Subsidiary (the “WOS”) abroad.
Indian corporations must participate in the global value chain due to the changing demands of Indian firms in a world market that is becoming more interconnected. The updated regulatory framework for foreign investment offers simplicity of the previous framework and is in line with the current business and economic trends.
The definitions of overseas direct investment and overseas portfolio investment have been clarified, and several overseas investment-related activities that previously required clearance are now handled automatically, greatly improving the “Ease of Doing Business.” The rules establish a flexible framework for self-regulation that is in accordance with the existing economic and business dynamics while also taking into account the changing demands of businesses operating in a more globally linked market.
History and Background
Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004, and Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015, collectively referred to as the “Erstwhile Regime,” were the laws and regulations that governed and controlled foreign direct investment in India prior to the notification of the OI Framework.
The OI Rules allows for the mandatory registration of foreign investments made under the Erstwhile Regime by treating any investment or financial commitment made outside of India in accordance with the Foreign Exchange Management Act, 1999 (“FEMA”) or the rules or regulations made thereunder as having been made in accordance with the OI Rules and Regulations.
Since then, the industry has been anticipating the OI Rules and Regulations. Important to note is that the OI Rules, as opposed to the OI Regulations, were published by the Ministry of Finance of the Central Government, giving current government, the authority to regulate, which was previously exercised by the RBI.
The new regime represents the government’s effort to improve ease of doing business by streamlining and liberalising the regulatory framework governing overseas investments by Indian residents.
Several modifications have been made in light of the changing company demands and the more connected global market. Additionally, the many investment-related transaction types that were formerly then under approval route during the previous regime have been moved under the automated route to ensure convenience of doing business.
The OI Rules now allow resident Indians to invest abroad in the International Financial Services Centre (“IFSC”), subject to a few restrictions, which is one of the most desired reforms. This regulatory clarification is a positive addition for the sector, which previously troubled by concerns about round-tripping. However, OPI by people has only been possible through a few select channels, such as reinvestments.
OVERSEAS INVESTMENT
Automatic Route – The overall guideline for foreign investments made via the automated method is outlined in Rule 9. It stipulates that any overseas investment by a person residing in India must be made in a foreign entity engaged in legitimate commercial activity, either directly or through a step-down subsidiary or a special-purpose vehicle, according to the established restrictions and requirements.
In relation to a foreign entity, a step-down subsidiary is an organisation over which the foreign entity holds control. The step-down subsidiary must also adhere to the structural criteria of a foreign business, i.e., it must have limited liability, in order for investments made through it to qualify as overseas investments and be permitted under these OI Rules.
Previously, only an entity engaged in legitimate commercial activity either directly or indirectly through one layer of SPV, could receive overseas direct investments (ODI). In this regard, the new Rule appears to be broad in as much as it permits foreign investment in a bona fide corporate company, including through a number of step-down subsidiaries or special purpose vehicles.
In other words, as long as the primary foreign subsidiary is involved in a legitimate commercial activity, it may now be allowed to participate in a foreign holding company (SPV) that has one or more layers of foreign subsidiaries.
Any commercial activity that is permitted by any legislation in effect in India and the host nation is described as a “bona-fide business activity. “As a result, for a commercial operation to be considered “bona-fide,” it must be allowed by both Indian and the host country’s legal systems.
The word “bona-fide business activity” being defined is a positive development since it adds some degree of clarity. Despite this, there is still ambiguity on what is meant by “permitted under Indian law”. There may be some state-regulated activities, like gambling, that are legal in some states but illegal in others. In addition, because of the way the term has been written, it is still unclear whether a pure holding company will count as a legitimate commercial activity.
Further, considering that ODI refers to the purchase of unlisted equity capital, subscription to a foreign entity’s MoA, investment in 10% or more of listed securities, or investment in less than 10% of listed securities with control, and that control is defined as the right to appoint a majority of the directors or control the management or policy decisions, it may be possible to argue that control is possible without infusion of capital.
In light of this, a transaction should qualify as an ODI when a foreign corporation is established without any outbound transmission of cash for instance, in Delaware, where a business can be created without a capital investment. Similar to the last example, a resident may have transformed ODI into a foreign entity if a non-resident gifts them to another resident.
Approval Route- Additionally, Rule 9 states that investments made outside through the automatic method are not permitted in companies with legal status in Pakistan or any other nation that the Central Government may, at any time, determine to be appropriate.
1. Application to Central Government for Approval- The Central Government must be contacted through the RBI in order to submit an application for approval of any overseas investments (including financial commitments) in Pakistan or other countries where the Central Government may from time to time impose restrictions, or in strategic industries or regions outside of the established limits. In light of this, the applications must be sent by the AD banks to the RBI for submission to the Central Government.
2. Approval from Reserve Bank: According to the Erstwhile Regime, the OI Rules also stipulate that even when an Indian entity’s full investment commitment is within the allowable limit, any financial commitment exceeding USD 1 billion (or its equivalent) in a fiscal year requires prior approval from the RBI.
In brief, the Rule stipulates that the Central Government must approve investments in specified geographies or sectors, whereas the RBI must approve investments that exceed a certain amount of money.
First article in the series on the subject by Nayan Behal
