Till 16th October, 2019, Foreign Investment was governed, by RBI in consultation with Central Government, by Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017, called as TISPRO. Pursuant to amendment made in FEMA through Finance Act 2015, Central Government is empowered to make rules for Capital Account Transactions. On 17th October, 2019, Department of Economic Affairs, Ministry of Finance, notified Rules called Foreign Exchange Management (Non-debt Instruments) Rules 2019, (referred to as NDI Rules) which supersedes TISPRO. NDI Rules consists of provisions on Foreign Investment in Non-debt Instrument and also Purchase and Transfer of Immovable Property in India. Mode of payment and reporting of Non-debt Instrument are regulated by RBI through Foreign Exchange Management (Mode of Payment and reporting of Non-debt Instruments) Regulations 2019. 

Foreign Investment 

Foreign investment means any investment made by a person resident outside India (PROI), on a repatriation basis, in the equity instruments of an Indian company or to the capital of LLP.

If a declaration is made by a person under the Companies Act 2013, about the beneficial interest being held by a PROI, then even though investment is held by a person resident in India (PRI), it would be treated as Foreign Investment. 

Foreign Investment

Equity Instrument

Equity instruments (EI) means following instruments issued by an Indian Company

  • Equity shares,
  • Fully compulsorily and mandatorily convertible debentures,
  • Fully compulsorily and mandatorily convertible preference shares,
  • Share warrants issued in accordance with regulations by SEBI.

EI can contain an optionality clause subject to a minimum lock-in period of 1 year or as prescribed for the specific sector, whichever is higher. Equity Instrument should not contain an option or right to exit at an assured price.

Repatriation and Non-Repatriation

Repatriation means remitting money back to the host country.

Non-Repatriation means that remittance of sale proceeds (Original Investment plus Capital Gains) is not permitted. Such money can-not be remitted outside India without prior approval of RBI. It’s interesting to note that even in case of investment on non-repatriation basis, interest, dividend or any returns on such investment is repatriable but principal amount and capital appreciation thereon is not repatriable.

Under Schedule IV of NDI Rules, special dispensation has been given to NRI/OCI/Companies, Trust, Firm owned and controlled by NRI/OCI to make Investment on non-repatriation. Investment on non-repatriation basis is treated at par with domestic investment and hence it is not considered as “Foreign Investment”. There are no reporting requirements or limits for accepting such investments.

Foreign Direct Investment (FDI) vs Foreign Portfolio Investment (FPI) 

Not all the foreign investment is categorized as FDI. An investment, on repatriation basis, in equity instrument of unlisted Indian company irrespective of amount would be categorized as FDI. Similarly, investment, on non-repatriation basis, by a PROI in equity instrument of a listed Indian company would be categorized as FDI only if it is 10% or more of post issue paid up capital on fully diluted basis. Fully diluted basis means total number of shares that would be outstanding if all possible sources of conversion are exercised.

An Investment once categorized as FDI would always remain as FDI even though the investment comes down below 10%.

Below 10% Investment in Equity Instrument of Listed Indian Company by a PROI, on repatriation basis, would be treated as FPI. It’s important to note that Foreign Portfolio Investment is different from Foreign Portfolio Investor, to which Schedule II of NDI rules are applicable. Foreign Portfolio Investor has to be registered with SEBI (Foreign Portfolio Investors) Regulations 2014.

Investment in LLP towards capital would be a Foreign Investment and not FDI.

Sectoral Cap 

Sectoral Cap consists of limits up-to which total Foreign Investment can be accepted by an Indian Company in Equity Instrument or in Capital of LLP, operating in that sector. Total Foreign Investment means Foreign Investment plus Indirect Foreign Investment. This is composite limit of Indian Investee Entity. Indirect Foreign Investment has been explained later in this article.

Sectoral cap, for the sectors specified in the table of Schedule I of NDI Rules, is the limit indicated against each sector in the table. For instance, in Terrestrial Broadcasting FM (FM Radio) up-to 49% Foreign Investment, in uploading/steaming of News and Current Affairs through Digital media up-to 26% Foreign Investment is permissible.

The sector (Other than Financial Services) which is not specified in Table and such sector does not form part of prohibited list of sectors for FDI, then 100% Foreign Investment is permissible for these sectors under Automatic Route. If the company operates in Financial Service Sector, and the same is not specified in the table of Schedule 1, then Foreign Investment is such company is permissible under Government approval. Onus of compliance with sectoral caps on foreign investment and attendant conditions, if any, is on the company receiving foreign investment.

Entry Route

“Automatic Route” and “Government Route” are two Entry Routes through which Foreign Investment may be accepted. Automatic Route means Foreign Investment can be accepted by company without any approval, though post receipts reporting obligations are prescribed. Government Route means that Foreign Investment requires prior approval of the government i.e. concerned Ministry/Department. Sector wise Entry Routes are mentioned in Table given in Schedule 1. For instance, 100% FDI is permissible in Pharmaceuticals but for Brownfield projects in Pharmaceutical, 74% Foreign investment is permissible under Automatic Route and beyond that with Government Route. As mentioned earlier as well, if sector (other than financial services) are not mentioned in Table, then, 100% Foreign Investment is permissible under Automatic Route.

Prohibited Sectors for FDI:

  • Lottery including online lotteries,
  • Gambling/ Betting/ Casino
  • Foreign Technology Collaboration in Lottery/ Gambling,
  • Real Estate Business/Construction of Farm-House/ Trading of TDR.
  • Prohibited sectors for private investment viz (i) Atomic energy and (ii) Railway operations
  • Chit funds (except investment by NRIs/ OCIs on non-repatriation basis), Nidhi company.
  • Manufacturing of tobacco products/ substitutes.

Aggregate Foreign Investment by FPI up-to 24% permissible in abovementioned prohibited sectors. Citizen of Pakistan/ its entity may invest, under Government route, only in sectors other than Defence/ Space/ Atomic Energy/ Prohibited sectors for FDI as per above.

Indirect Foreign Investment (IFI)

Sectoral cap specifies the limit up-to which total foreign investment is permissible for the company in specified sector.  Total Foreign Investment means Foreign Investment plus Indirect Foreign Investment.

Investment made by an Indian Entity into the Equity Instrument of another Indian Entity is called as Down Stream Investment (DSI). A DSI would be categorised as Indirect Foreign Investment if

Indirect Foreign Investment

DSI would be categorized as IFI only if it satisfies both 1st and 2nd part of above. For example, if Investor Indian Entity does not have any foreign investment in its equity instrument, then DSI by such entity would not be categorized as IFI. Similarly if Investor Indian Entity has foreign investment in its equity instrument but it is owned and controlled by Resident Indian Citizen, then also DSI made by such company would not be categorized as IFI.

Further, Investment made by Investment Vehicle would also be called as IFI if sponsor, manager or investment manager is either not Owned & not Controlled by Resident Indian Citizen or is Owned or Controlled by PROI. It may be noted that Foreign Investment is not criterion for deciding IFI in case of Investment by Investment Vehicle.

Entire amount of DSI is being categorized as Indirect Foreign Investment and not the proportionate amount. For instance if USA X Co has made investment of 80% in Equity of  an Indian “A Co” and   A Co has made 60% investment in Indian “B Co”, then entire Investment by A Co into B Co i.e. 60% would be categorized as Indirect Foreign Investment and not the proportionate foreign investment (80%*60%= 48%).

There is an exception to the above rule. IFI received by a wholly owned subsidiary company shall be limited to the total Foreign Investment received by the Company making the downstream investment. In above instance, if A Co invests 100% in B Co then IFI for B Co would be 80% and not 100%.

Since the investment in Indian Entity is being done by Indian Entity, many companies/ LLP, contravene on the provisions of Indirect Foreign Investment. Indus Towers Limited ( JV of Bharti, Vodafone, and Idea) engaged in the business of building, owning, operating and maintaining passive infrastructure in different telecommunication circles across India and providing infrastructure services to telecommunications service providers and others in such circles. Under FDI Policy of August 2017, 49% of foreign investment was permissible under automatic route. Indus Tower had foreign investment of 47% approx till 2017, but in February 2018, Idea group allotted equity shares to its promoters (including non-resident entities) and consequently Idea became a foreign owned company. This led to increase in indirect foreign investment in Indus Tower by 11.15%, and, therefore, the aggregate foreign investment (direct and indirect) in Indus Tower increased to 58% (beyond 49%). The company missed on prior approval of foreign investment and has regularized this contravention by way of compounding (CA NDL 299-2018).

Indian entity receiving IFI should comply with the entry route, sectoral caps, pricing guidelines and other attendant conditions as applicable for Foreign Investment.

Indian entity should not use domestically borrowed funds for downstream investment. Downstream investment should have the approval of Board of Directors and Shareholders’ Agreement, if any.

1st level Indian company making downstream investment shall be responsible for ensuring compliance with the provisions of the rules for downstream investment made by it at 2nd level and so on and so forth. 1st level company shall obtain a certificate to this effect from its Statutory Auditor on an annual basis and such compliance of these rules shall be mentioned in Directors’ Report in the Annual Report of the Indian Company. In case of qualified report, the same shall immediately be brought to the notice of RBI.

Pricing Guidelines:

Unless otherwise mentioned, any Foreign Investment in Equity Instrument or to the capital of LLP would be subject to pricing guidelines. However, pricing guideline is not applicable in the following cases:

  • Investment made on Non-Repatriation basis.
  • Sales, of equity instruments, made in accordance with SEBI regulations, where pricing is specified by SEBI.
  • Subscription to Memorandum of Association. It can be done at face value.

Pricing guideline is as follows:

Issue by Listed Co Relevant SEBI guidelines
Issue by Unlisted Co Fair value as per Internationally Accepted Pricing Methodology for valuation on an arm’s length basis, duly Certified by CA/ SEBI Registered Merchant Banker/ Cost Accountant
SWAP of Equity Instrument Valuation by SEBI Registered Merchant Banker/ Investment Banker outside India registered with Regulatory Authority in host country.
Share Warrants Pricing and price or conversion formula should be decided Upfront.

Price at conversion >= Fair Value worked out, at the time of issuance.

Transfer from PRI to PROI or vice versa As Prescribed above for Listed/ Unlisted Co as the case may be.
Investment in LLP Fair price as per Internationally Accepted/ adopted market practice. Valuation Certificate by CA/ SEBI Registered Merchant Banker/ Cost Accountant/ Approved Valuer

 General Rule 

  • Transfer from PRI to PROI should not be less than Fair Value.
  • Transfer from PROI to PRI should not be higher than Fair Value.

General Rules on Foreign Investment

  • No PROI to make investment in India unless permitted by Act/ Rules/ Regulations.
  • No Indian entity/ Investment Vehicle/ VCF/ Firm/ AOP/ Proprietary to receive or record in books any Investment from PROI unless permitted under Act/ Rules/ Regulations
  • Investment by PROI would be subject to entry route, sectoral cap & attendant conditionalities laid down in these rules.

NDI Rules consists of different schedules under which Foreign Investment or Investment from NRI can be accepted. It also consists of rules on issue of Right/ Bonus Shares/ ESOPs/ Convertible Notes to PROI, transfer of shares to/ from PROI, gift of shares by NRI etc. With clarity on the above concepts one may directly read the relevant rules or schedules of NDI Rules.

About Author: 

Vikas Maheshwari, FCA, Founder of VM Consulting & Advisory, engaged in interpreting FEMA, PMLA and laws relating to Black Money and Benami Properties. He has more than 3 decades of professional experience and has served at various senior position including CFO, Global Treasury Head etc. in MNCs.

Author can be reached at below coordinates: Email: [email protected] Mobile: +91 98811 36320

Author Bio

Qualification: CA in Job / Business
Company: VM Consulting & Advisory
Location: Pune, Maharashtra, IN
Member Since: 22 Sep 2020 | Total Posts: 10
A Fellow Member of the Institute of Chartered Accountants of India (1991 batch) has close to 3 decades of rich & varied experience, in industries ranging from Energy & Power, Manufacturing, FMCG to Financial Services. Vikas Maheshwari specializes in the vast domain of Treasury Management an View Full Profile

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September 2021