RBI aligns FEMA regulations with Consolidated FDI policy

Arundhuthi Bose

Preface

With an attempt to streamline the regulations on transfer or issue of securities by a person resident outside India with the consolidated FDI Policy[1], the Reserve Bank of India (RBI), on the 15^th of February, 2016, amended Foreign Exchange Management (Transfer or issue of Security by a Person Resident outside India) Regulations, 2000 (hereinafter referred to as the “Principal Regulations”) vide the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Second Amendment) Regulations, 2016[2](hereinafter referred to as the “amendment notification”).

The amended notification shall come into force from the 15^th of February, 2016.

This update is intended to focus on the amendments and insertions brought vide the amended notification. The changes made in the amended notification had been covered in the press note 12 of 2015[3] on review of the FDI Policy.

Definition of term “manufacture”

Annexure B of Schedule I of the Principal Regulations specifies the permitted limit of foreign investment in various sectors and other conditions. In certain sectors, reference has been made to manufacturing activity; however, there is no specific definition of the term ‘manufacture’. The amendment notification inserts definition ‘manufacture’ in the manner reproduced hereunder, in line with the insertion made vide DIPP press note no. 12 of 2015 in the consolidated FDI policy:

“(vii AA) “Manufacture”, with its grammatical variations, means a change in a non-living physical object or article or thing-

(a) resulting in transformation of the object or article or thing into a new and distinct object or article or thing having a different name, character and use; or

(b) bringing into existence of a new and distinct object or article or thing with a different chemical composition or integral structure.”

Moreover, the amended regulation, like the press note 12 of 2015 on FDI policy review, also facilitates a manufacturer to sell its products manufactured in India through wholesale or retail mode, including e-commerce without Government approval. This will help in reaching to a wider consumer base and helping growth of the nation as a whole.

Also, 100% foreign investment has been allowed under automatic route for the entities operating in the manufacturing sector vide press note 12 of 2015, on reviewed FDI policy. The amended regulation incorporates this move to align the Principal Regulations with the FDI policy. The amended regulation states that-

“Subject to the provisions of the FDI policy, foreign investment in `manufacturing’ sector is under automatic route. Further, a manufacturer is permitted to sell its products manufactured in India through wholesale and/or retail, including through e-commerce without Government approval.”

Amendment in the definition of “ownership and control”-

Regulation 14 of the Principal Regulation deals with the guidelines for calculation of total foreign investment in Indian companies, transfer of ownership and control of Indian companies and downstream investment by Indian companies.

The Principal Regulation defined “ownership and control” in terms of companies by defining terms viz. Company ‘owned by resident Indian citizens’, Company ‘Owned by non-residents’ and accordingly defined control to include right to appoint a majority of directors or to control the management or policy decisions. However, corresponding definition in case of LLPs were not provided.

Accordingly, aligning the Principal Regulation with the press note 12, the amendment notification substitutes the definitions with the following:

 “(a) a company shall be considered as owned by resident Indian citizens if more than 50% of the capital in it is beneficially owned by resident Indian citizens and/or Indian companies, which are ultimately owned and controlled by resident Indian citizens. A Limited Liability Partnership will be considered as owned by resident Indian citizens if more than 50% of the investment in such an LLP is contributed by resident Indian citizens and/ or entities which are ultimately ‘owned and controlled by resident Indian citizens’ and such resident Indian citizens and entities have majority of the profit share;

(b) A company owned by non-residents shall mean an Indian company that is not owned by resident Indian citizens.”

“Control” has also been defined in the amended policy, as in the FDI policy.The term “control” shall mean-

(ia) ‘Control’ shall include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements.

Explanation: For the purpose of Limited Liability Partnership, ‘control’ shall mean right to appoint majority of the designated partners, where such designated partners, with specific exclusions to others, have control over all the policies of Limited Liability Partnership.”

Additional requirements to the guidelines for calculation of total foreign investment in case of Information & Broadcasting (I&B) sector

The additional requirements were formerly provided in case of I& B and defence sector. However, pursuant to press note 12 of 2015, foreign investment in defence sector has been permitted upto 49% under automatic route; and beyond 49% under government route on case to case basis. The amendment notification now refers to only I&B sector in the light of amendment in defence sector vide the aforesaid press note. Other amendments relate to referring to corresponding provisions of Companies Act, 2013 instead of Companies Act, 1956. The entire paragraph has been aligned in line with the amended paragraph of consolidated FDI policy, 2015.

Guidelines for establishment of Indian companies/ transfer of ownership or control aligned with FDI Policy

Regulation 14 (5) has been amended to align the amendments made vide DIPP press note no. 12 of 2015. Foreign investments in sectors under government approval route will be subject to approval of government in case where the Indian company being established/ ownership of an existing Indian company subsequent to fresh issue and/or transfer of shares are not owned and controlled by a resident entity.

Foreign investment shall include all types of foreign investments i.e. FDI, investment by FIIs, FPIs, QFIs, NRIs, ADRs, GDRs, Foreign Currency Convertible Bonds (FCCB) and fully, mandatorily & compulsorily convertible preference shares/debentures, regardless of whether the said investments have been made under Schedule 1, 2, 2A, 3, 6, 8, 9 and 10. This was incorporated in the FDI policy vide DIPP press note no. 8 of 2015.

Investment by NRIs and a company, trust and partnership firm incorporated outside India and owned and controlled by non-resident Indians made under Schedule 4 will be deemed to be investment at par with domestic investment. RBI vide Notification FEMA.361/2016-RB[4] on 15^th February, 2016 amended corresponding provisions relating to investments by NRI in the principal regulations.

Downstream investments by Indian companies/LLPs-

Earlier, only an Indian Company with FDI was allowed to make downstream investment. LLPs with FDI were not permitted to make downstream investment. With an aim to provide flexibility to foreign investors in setting up operations in India under the LLP structure, downstream investments by LLPs have been made permissible vide press note 12 of 2015 subject to certain conditions.

The principal regulation covered only the downstream investment by Indian companies and not by LLPs. Hence, to align the same with the FDI policy, downstream investment by LLPs has been allowed. The conditions for making the downstream investment has been streamlined with the press note 12 of 2015. For the purpose of making downstream investment, the Indian companies/LLPs have to bring funds from abroad and not leverage funds from the domestic markets. Further, such a company/LLP is to notify SIA, DIPP and FIPB of its downstream investment in the form available at http://www.fipbindia.com within 30 days of such investment, even if capital instruments have not been allotted, along with the modality of investment in new/existing ventures (with/without expansion programme).

Other conditions with respect to downstream investment applicable to Indian companies are same as before.

Swap of shares under automatic route

An Indian company, otherwise eligible to issue shares under Schedule I may issue equity/preference shares, subject to pricing guidelines as given in paragraph 5 of the said Schedule, to a person resident outside India by way of swap of shares subject to following conditions:

i. The investee company is in a sector under the automatic route.

ii. Irrespective of the amount, valuation of the shares is to be done by a Merchant Banker registered with SEBI/Investment Banker outside India registered with appropriate regulatory authority in the host country.

iii. If the investee company is in a sector under the approval route, issuance of shares to non-residents through swap of shares will occur only with approval of the government.

Previously, swap of shares in lieu of consideration to be paid for shares acquired in the overseas company required prior approval of FIPB of Government of India. The amendment notification deletes the aforesaid provision..

Amendment in Annexure B to Schedule I

Annexure B, which provides for the foreign investments caps and entry route in various sectors has been amended according to the amendments made in the FDI policy vide DIPP press note no. 12 of 2015. The amendments made vide the said press note may be read here.

Amendment in Schedule 9

DIPP press note 12 of 2015 permitted LLPs to obtain FDI under automatic route. The recipient LLP should be operating in sectors/activities where 100% FDI is allowed through the automatic route and there are no FDI linked performance conditions. Similarly, LLPs were permitted to make downstream investments in another company or LLP engaged in sectors in which 100% FDI is allowed under the automatic route and there are no FDI-linked performance conditions. However, corresponding amendments were not made in Schedule 9 to the principal regulations that provides for scheme for acquisition/transfer by a person resident outside India of capital contribution or profit share of LLPs.

Amendment in Schedule-11

Schedule 11 deals with Investment by a person resident outside India in an Investment Vehicle.

“Ownership and control” has been amended in terms of LLP vide the amendment notification in line with DIPP press note. Accordingly, the provision that since ownership and control could not be determined for the purpose of LLPs, LLPs shall refrain from acting as sponsor or manager/investment manager, stands deleted.

Conclusion

Foreign investment in India is governed by RBI by way of the principal regulation and by DIPP by way of FDI policy. The GoI is trying its level best to bring India to better ranks in terms of “Ease of Doing Business”. Host of amendments are being made and regulations are being framed to boost the motive of increasing commerce and trade in India. This also requires aligning various inter-related laws and regulations so as to remove the creases of disparity. The amended notification aligns the principal regulation in line with the Consolidated FDI policy. The law-makers and regulators have to ensure that the laws and regulations are framed/ amended in such a way that the abiding of laws become a simpler and easier process, rather than being looked upon as hurdles in the path of development.

[1] https://taxguru.in/rbi/consolidated-fdi-policy-effective-12-2015.html

[2] https://taxguru.in/rbi/foreign-exchange-management-transfer-or-issue-of-security-by-a-person-resident-outside-india-second-amendment-regulations-2016.html

[3] https://taxguru.in/corporate-law/review-foreign-direct-investment-fdi-policy-sectors.html

[4]  https://taxguru.in/rbi/foreign-exchange-management-transfer-issue-security-person-resident-india-amendment-regulations-2016.html

(Author is Associated with Vinod Kothari and Company)