Contents of the Article

  1. What is an overseas JV?
  2. What is meant by wholly-owned subsidiary, first level subsidiary and second level subsidiary?
  3. How can direct investments (DI)/ financial commitments (FC) in overseas wholly owned subsidiaries (“WOS”)/JVs be made?
  4. What are the conditions to be followed to invest or give FC in overseas JVs and WOS?
  5. What is the overall exposure limits?
  6. What are the provisions with regard to Guarantee given to or on behalf of direct subsidiary/first level step down/second or subsequent step down
  7. Can contingent liability be created by Indian companies or their AD Category – I banks for borrowings by their overseas holding/ associate/ subsidiary/ group companies? What are the penal consequences for contravention?

1. What is an overseas JV?

The term “Overseas Joint Venture” has not been specifically defined, though, regulation 2(m) of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004 (the “Regulation ”) defines Joint Venture (“JV”) in the context of overseas investment as-

Joint Venture (JV)” means a foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country[1] in which the Indian party makes a direct investment;”

Now we must understand what constitutes an “Indian party” and what is meant by “direct investment”. Regulation 2 (k) of the Regulation defines an Indian party as-

“Indian party” means a company incorporated in India or a body created under an Act of

Parliament or a partnership firm registered under the Indian Partnership Act, 1932 making investment in a Joint Venture or Wholly Owned Subsidiary abroad, and includes any other entity in India as may be notified by the Reserve Bank: –

Provided that when more than one such company, body or entity make an investment in the foreign entity, all such companies or bodies or entities shall together constitute the “Indian party”

Since investments made abroad are of relevance here, we can refer to regulation 2 (e) of the Act which defines direct investment outside India as-

“Direct investment outside India” means investment by way of contribution to the capital or subscription to the Memorandum of Association of a foreign entity or by way of purchase of existing shares of a foreign entity either by market purchase or private placement or through stock exchange, but does not include portfolio investment.”

It is to be noted that the quantum or percentage of investments have not been specified. Hence, irrespective of the amount involved or number of shares invested in, any investment by way of contribution to the capital or subscription to the Memorandum of Association of a foreign entity shall cause that entity to be termed as a JV of the Indian party. Therefore, an investment less than 100% of the paid up capital of the foreign entity, by the Indian party, makes such an entity a JV of the Indian party.

2. What is meant by wholly-owned subsidiary, first level subsidiary and second level subsidiary?

In the context of overseas investments, regulation 2 (q) of the Act defines a wholly-owned subsidiary (“WOS”) as-

“Wholly Owned Subsidiary (WOS)” means a foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country, whose entire capital is held by the Indian party;”

The concept of first level subsidiary/second level subsidiary may be understood through this diagramwith regard to overseas WOS

overseas WOS

In the diagram above,

  1. “Y” Ltd. Is the direct subsidiary of “X”Ltd
  2. “Y” Ltd. Is the holding company of “YY” Ltd., making “YY”Ltd and the First-level step-down of “X”Ltd. Also, X is the ultimate holding company
  3. “YY” Ltd. Is the holding company of “YYY” Ltd., making “YYY”Ltd the second-level step-down of “X”Ltd. Also, X is the ultimate holding company

3. How can direct investments (DI)/ financial commitments (FC)[2] in overseas wholly owned subsidiaries (“WOS”)/JVs be made?

Investments / FC can be made in overseas JVs and WOS through the following modes[3]

TypeModes
Direct investment· Contribution to the capital or

· Subscription to the Memorandum of Association of a foreign entity or

· By way of purchase of existing shares of a foreign entity either by market purchase or private placement or through stock exchange

· But does not include portfolio investment;

Financial Commitment(FC)· Direct investment by way of contribution to equity/ Compulsorily Convertible Preference Shares (CCPS),

· 100% of the amount of other preference shares

· Direct investment by way of loan and

· 100 per cent of the amount of guarantees and

· 50 per cent of the performance guarantees issued by an Indian Party,

to or on behalf of its overseas JV or WOS

Restriction has been specifically laid down prohibiting Indian party from making investment (or FC) in foreign entity engaged in real estate.

4. What are the conditions to be followed to invest or give FC in overseas JVs and WOS?

The investment or FC in overseas JV or WOS is subject to the following conditions as per Regulation 6 of the Regulations-

i. The total FC of the Indian Party in Joint Ventures / Wholly Owned Subsidiaries shall not exceed 400%[4], or as decided by the Reserve Bank from time to time, of the net worth of the Indian Party as on the date of the last audited balance sheet.

Provided that in the case of FC, exceeding USD 1 (one) billion (or its equivalent) in a financial year would require prior approval of the Reserve Bank even when the total FC of the Indian Party is within the eligible limit of under the automatic route.

ii. The Indian Party / entity may extend loan / guarantee only to an overseas JV / WOS in which it has equity participation.

Proposals from the Indian Party for undertaking financial commitment without equity contribution in JV / WOS may be considered by the Reserve Bank under the approval route.

iii. The Indian Party should not be on the Reserve Bank’s Exporters’ caution list / list of defaulters to the banking system circulated by the Reserve Bank / Credit Information Bureau (India) Ltd. (CIBIL) / or any other credit information company as approved by the Reserve Bank or under investigation by any investigation / enforcement agency or regulatory body.

iv. All transactions relating to a JV / WOS should be routed through one branch of an Authorised Dealer bank to be designated by the Indian Party.

v. In case of partial / full acquisition of an existing foreign company, where the investment is more than USD 5 million, valuation of the shares of the company shall be made by a Category I Merchant Banker registered with SEBI or an Investment Banker / Merchant Banker outside India registered with the appropriate regulatory authority in the host country; and, in all other cases by a Chartered Accountant or a Certified Public Accountant.

vi. 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) will also be a pre-requisite for investment by swap of shares.

vii. In case of investment by a registered Partnership firm, where the entire funding for such investment is done by the firm, it will be in order for individual partners to hold shares for and on behalf of the firm in the overseas JV / WOS if the host country regulations or operational requirements warrant such holdings.

viii. Investments / financial commitments in Nepal are permitted only in Indian Rupees. Investments / financial commitments in Bhutan are permitted in Indian Rupees as well as in freely convertible currencies.

All dues receivable on investments or FC made in freely convertible currencies, as well as their sale / winding up proceeds are required to be repatriated to India in freely convertible currencies only.

Investments / financial commitments in Pakistan by Indian Parties are permissible under the approval route.

ix. An Indian Party may acquire shares of a foreign company engaged in a bonafide business activity

x. Investments (or financial commitment) in JV/WOS abroad by Indian Parties through the medium of a Special Purpose Vehicle (SPV) are also permitted under the Automatic Route.

5. What is the overall exposure limits?

The total FC or investment by an Indian Party in its JV / WOS outside India should not exceed 400% of net worth of the Indian Party under automatic route. The ‘net worth’ should be as per the last audited balance sheet of the Indian Party. Moreover any FC exceeding USD 1 (one) billion (or its equivalent) in a financial year would require prior approval of the Reserve Bank even when the total FC of the Indian Party is within the eligible limit of under the automatic route.

6. What are the provisions with regard to Guarantee given to or on behalf of direct subsidiary/first level step down/second or subsequent step down

Indian Parties are permitted to issue corporate guarantees on behalf of their first level step down operating JV /WOS set up by their JV / WOS operating as either an operating unit or as a Special Purpose Vehicle (SPV) under the Automatic Route.

This is subject to the condition that the financial commitment of the Indian Party is within the extant limit. The reporting requirement is that such guarantees will have to be reported to the Reserve Bank in Form ODI, as hitherto, through the designated AD Category – I bank concerned.

Further, the issuance of corporate guarantee on behalf of second generation or subsequent level step down operating subsidiaries will be considered under the Approval Route, provided the Indian Party indirectly holds 51 per cent or more stake in the overseas subsidiary for which such guarantee is intended to be issued.

Type of subsidiaryParticulars

 

Direct JV / WOSConditions-

1. Indian Party must have equity participation to come under automatic route.

2. Proposals from the Indian Party for undertaking financial commitment without equity contribution in JV / WOS may be considered by the Reserve Bank under the approval route.

3. No guarantee should be ‘open ended’

4. In the case of performance guarantee, time specified for the completion of the contract shall be the validity period of the related performance guarantee.

5. All guarantees are required to be reported to the Reserve Bank in Form ODI-Part II

6. Guarantees issued by banks in India in favour of WOS / JV outside India would be subject to prudential norms issued by the Reserve Bank of India (Department of Banking Regulation)

First level step down operating JV /WOSIssuing corporate guarantee to or on behalf of first level step down operating JV /WOS is permitted under Automatic Route.
Conditions-1. FC should be within extant limit2. The first level step down subsidiary must be an operating JV/WOS3. Such guarantee will have to be reported to the Reserve Bank in Form ODI, as hitherto, through the designated AD Category – I bank concerned.
Second generation or subsequent level step down operating subsidiaries– The issuance of corporate guarantee on behalf of second generation or subsequent level step down operating subsidiaries is permitted under the Approval Route.

– Indian Party must indirectly hold 51 per cent or more stake in the overseas subsidiary for which such guarantee is intended to be issue

7. Can contingent liability be created by Indian companies or their AD Category – I banks for borrowings by their overseas holding/ associate/ subsidiary/ group companies? What are the penal consequences for contravention?

Reg. 6 of the said Regulation, specifically provides for the way of the FC, through which an Indian Party can make investment in its overseas JV/WOS. Thus, creation of any contingent liability if it falls within the permitted mode of FC would qualify under the said Regulation.

Contingent liability can be in the form of letter of comfort, re-capitalisation obligation (obligation to contribute in the capital), guarantees in respect of trade payables of subsidiary, counter guarantee to an Indian AD for guarantee for an overseas subsidiary, etc.

Any contravention or departure from the aforesaid regulation would attract penal provision under the FEMA Act, 1999.

Prima facie no, an Indian company cannot create contingent liability for borrowings by their overseas holding/ associate/ subsidiary/ group companies apart from the explicitly permitted purposes.[5]

a. Indian companies or their AD Category – I banks are not allowed to create any contingent liability in any form for such borrowings by their overseas holding/ associate/ subsidiary/ group companies except for the purposes explicitly permitted in the relevant Regulations.

b. Further, funds raised abroad by overseas holding/ associate/ subsidiary/ group companies of Indian companies with support of the Indian companies or their AD Category – I banks as mentioned at (i)* above cannot be used in India unless it conforms to the general or specific permission granted under the relevant Regulations.

Note: The reference ought to be as “(a)” and not “(i)” since the point above is numbered as “(a)”.

c. Indian companies or their AD Category – I banks using or establishing structures which contravene the above shall render themselves liable for penal action as prescribed under FEMA, 1999.

An Indian company or their AD category –I banks cannot issue guarantee or create contingent liability or offer security against the borrowings by its WOS/JV unless otherwise specifically provided by regulation. Also the funds raised by the overseas JV/WOS cannot be used in India unless otherwise provided.

In case an Indian co. or its AD Category -1 banks has created any contingent liability on behalf of its JV/WOS in any manner referred in point(a), or if the funds raised by the way in point (a) are used in India unless otherwise specifically provided, such contravention shall attract penal action under FEMA, 1999.

[1]“Host country” means the country in which the foreign entity receiving the direct investment from an Indian Party is registered or incorporated;

[2]“Financial Commitment” means the amount of direct investment by way of contribution to equity, loan and 100 per cent of the amount of guarantees and 50 per cent of the performance guarantees issued by an Indian Party to or on behalf of its overseas Joint Venture Company or Wholly Owned Subsidiary

[3] http://taxguru.in/rbi/rbi-master-direction-direct-investment-residents-joint-venture-jv-wholly-owned-subsidiary-wos.html

[4] http://taxguru.in/rbi/financial-commitment-indian-party-odi-restoration-limit.html

[5] http://taxguru.in/rbi/rbi-master-direction-miscellaneous.html [Ref to Para 5 of the relevant Master Directions]

Author Details- Article is Authored  Arundhuthi Bose of M/s Vinod Kothari & Company and can be reached  via email at arundhuthi@vinodkothari.com)

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  • maheshspeak

    Very good and informative article.

  • Sameer

    Hi Can an LLP invest in Shares of a Foreign Company under this policy/ regulations?