Foreign equity investments in an Indian company are bound by the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (‘Rules’) and Foreign Direct Investment (‘FDI’) policy issued by the Ministry of Finance and Ministry of Commerce and Industry respectively (together referred as ‘Government’).

As per the said Rules, non-resident entities can invest in Indian company subject to FDI policy, except in certain prohibited sectors/activities along with some additional restrictions placed for citizens and corporate entities from countries like Bangladesh and Pakistan.

In pursuance to efforts taken by the Government of India to combat the negative effects of Covid-19 pandemic, particularly to curb opportunistic takeover of Indian entities, the Government amended the FDI policy and Rules imposing therein restrictions on investment by non-resident entities based in countries that share land border with India.

Amendments made in FDI policy and the Rules vide Press Note No. 03 (2020 Series)  Dated-7/04/2020 read with Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2020

  • Investment made by any non-resident entity of a country, which shares land border with India i.e. Pakistan, Bangladesh, China, Nepal, Myanmar, Bhutan and Afghanistan (‘Border States’) to be allowed only after obtaining Government approval.
  • Investment in India where beneficial owner of such investment is situated in or is a citizen of, any Border States to be permitted only under the Government approval route.
  • New restrictions to apply even in the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction.
  • Further, a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors / activities other than defence, space, atomic energy and sectors / activities prohibited for foreign investment.
  • The amendment is effective from 22 April 2020. Thus all previous investments are grandfathered.

Open Issues:

  • Beneficial owner of investment not defined:- 

Neither the press note issued for change in FDI policy nor the notification for change in Rules provide meaning of “beneficial owner of investment”. In absence of such important definition, question arises what should construe as beneficial owner.

While Foreign Exchange Management Act or its rules and regulations does not provide for this definition, Section 90 of the Companies Act, 2013 read with the Companies (Significant Beneficial Owners) Rules, 2018 mentions the term Significant Beneficial Owner (“SBO”) as against the beneficial owner.

It states that SBO is “an individual who acting alone or together, or through one or more persons or trust, possesses one or more of the following rights or entitlements in such reporting company, namely:-

  • holds indirectly, or together with any direct holdings, not less than ten per cent. of the shares
  • holds indirectly, or together with any direct holdings, not less than ten per cent. of the voting rights in the shares;
  • has right to receive or participate in not less than ten per cent. of the total distributable dividend, or any other distribution, in a financial year through indirect holdings alone, or together with any direct holdings;
  • has right to exercise, or actually exercises, significant influence or control, in any manner other than through direct-holdings alone..”

Further per provisions of the Prevention of Money Laundering Act, 2002, “Beneficial Owner” is defined “an individual who ultimately owns or controls a client of a reporting entity or the person on whose behalf a transaction is being conducted and includes a person who exercises ultimate effective control over a juridical person”

However, in absence of any specific direction by the Government, it may not be appropriate to simply use the above definitions provided in the other Acts. Immediate clarification in this aspect should be provided by the Government.

  • Foreign investment in AIFs/REITs/InVITs (‘Investment Vehicles’) covered?:-

Clause (a) of Rule 6 of the Rules states about investment by person resident outside India in Indian Company whereas clause (c) of the Rule 6 of the Rules states about investment by person resident outside India into Investment Vehicles.

It is pertinent to note that the amendment imposing restriction on Border States to invest in India is made in clause (a) of Rule 6 and not in clause (c). Thus, on mere reading of the amendment with Rule 6, it appears that said restriction is not applicable for investment in Investment vehicles in India. However, the intent of the amendment is to curb opportunistic takeover of Indian entities and such an interpretation may defeat the purpose for which amendment is made. Accordingly, Government should also clarify this aspect as this may affect many private equity funds in India.

  • Clarity on bonus issues, right issues, warrants on existing investments:-

It is unclear at present if government approval will also be required in case of issuance of right shares, bonus shares, warrants to their existing non-resident shareholder situated in Border States or to the entity whose beneficial owner is situated in the Border States. Government should also provide clarification is this aspect.

CA Grishma Mody – Email id – grish.mody@gmail.com

Disclaimer: This article is based on the relevant provisions of applicable laws as prevalent in India and as per the information existing at the time of the preparation. This is only a knowledge sharing initiative and views, thoughts, opinion expressed are of my own. In no event I should be held liable for any direct or indirect result from this article

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