Common Mistakes while doing Overseas Direct Investment (ODI) & judicial proceedings

With the aim of diversifying the business abroad, Overseas direct investments (ODI) are undertaken as significant means for developing economies and emerging markets where companies need funding and expertise to expand their international sales. The importance of ODI can be accurately measured by the innumerable benefits like better economic co-operation, economic integration, growth of capital etc.

ODI means investment outside India by way of contribution of capital or subscription to the Memorandum of a foreign entity or through purchase of existing shares of a foreign entity signifying a long-term interest in the foreign entity {Joint Venture (JV) or Wholly-Owned Subsidiary (WOS)}.

The transactions on account of ODI are governed by clause (a) of section 6 (3) of the Foreign Exchange Management Act, 1999 read with Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations notified vide Notification No. FEMA.120/RB-2004 dated July 7, 2004.

ODI Form is divided into three parts-

  • Form ODI Part I– This form is submitted when investments is made in the JV/WOS.
  • Form ODI Part II– Annual Performance Report (APR) – This form is required to be submitted every year by Dec 31st as long as the JV / WOS is in existence. This is required to be certified by Statutory Auditors of the Indian party and shall be filled through the designated AD Category– I bank.
  • Form ODI Part III– This form is required to be submitted on disinvestment by way of closure/voluntary liquidation, winding up of the JV/WOS abroad/sale/transfer of the shares of the overseas JV/WOS to another eligible resident or non-resident/ buy back of shares by the overseas JV/WOS of the IP/RI.

Any person making ODI has to furnish the details in Form ODI within 30 days of making the remittance. Any post investment changes are also required to be reported within 30 days of such change. Form ODI is available as an Annex to the Master Direction titled ‘Master Direction on Reporting under Foreign Exchange Management Act’(herein referred to as “the Act”)

If any person contravenes any provision of this Act, then he will be required to apply for compounding. The penalty is computed in accordance with section 13 of the Act, which is

  • thrice the sum involved in such contravention where such amount is quantifiable, or
  • up to two lakh rupees where the amount is not quantifiable, and
  • where such contravention is a continuing one, further penalty which may extend to five thousand rupees for every day after the first day during which the contravention continues.

The compounding fee is calculated in compliance with the Guidance Matrix provided in the Master Direction on Compounding of Contraventions under FEMA, 1999.

In this article we have tried to cover the common mistakes with regard to ODI

Compounding orders issued by RBI can be viewed at- https://www.rbi.org.in/scripts/Compoundingorders.aspx

1. Delay in submission of Form ODI-Part 1 beyond the stipulated time period

Application for making ODI and reporting of Remittances/ Transactions is required to be submitted by the applicant to the RBI in Form ODI-Part-1. Form ODI has to be submitted within 30 days of making the investment.

In the case of Solutions Infini Technologies (India) Private Limited (C.A. No.4483/2017, dated 12th December 2017), the applicant had made remittances in 9 parts towards pre-incorporation expenses in Solutions Infini FZE, UAE, a WOS and thereafter capitalized these pre-incorporation expenses on 31st May, 2015. The applicant submitted Form ODI-Part 1 on 8th July, 2016 to the AD Bank for transaction involving capitalization of pre-incorporation expenses.

The applicant had capitalized pre-incorporation expenses and was required to submit duly completed Form ODI-Part 1. Since the form was submitted with a delay, this was a contravention of Regulation 6(2)(vi).

2. Funding for ODI through sources not permitted

Indian Parties may invest out of India through one or more of the following sources –

i. Out of balance held in the Exchange Earners Foreign Currency (EEFC) account of the Indian Party maintained with the Authorized Dealer. Provided that the ceiling of 100% of net worth shall not apply where the investment is made out of balances held in its EEFC account, maintained in accordance with the aforesaid regulations.

ii. Drawl of foreign exchange from an authorized dealer in India which shall not exceed 100% of the net worth of the Indian Party as on the date of last audited balance sheet.

2.1. Remittance made in Cash      

In the case of ZIM Laboratories Limited (C.A. No. 4328/2017, dated 13th July 2017), the applicant company decided to set up a subsidiary in UAE to expand its operations. For this purpose one of the directors used a part of his travel allowance which was in USD currency notes for making a payment of UAE Dirhams for incorporating ZIM Laboratories FZE. The currency notes were purchased by the Indian company. The payment was made directly in cash instead of routing it through an AD for setting up and acquiring equity ownership in the overseas WOS.

Direct payment in cash is not a permissible mode of remittance for making ODI under Regulation 6(3) of FEMA Notification 120.

2.2. Remittance through traveler’s cheque

In the case of Dynemic Products Limited (C.A. No.4587/2017, dated May 18, 2018), The applicant company (DPL) had set up a wholly owned subsidiary (WOS) viz. Dynemic USA Inc., USA and the remittances were made by way of purchase of foreign currency (Traveler’s Cheques) from a full-fledged money changer (FFMC), to be handed over to an employee recruited and based in the US. The use of traveler’s cheques is not a permitted method for the purpose of ODI. Hence it is a contravention of Regulation 6(3) of FEMA 120/2004.

2.3. Payment made to vendors on behalf of overseas JV and recorded as loan

In case of Indus Biotech Private Limited (C.A. No.4286/2017, dated 22nd December 2016), the applicant incorporated its JV in USA. The applicant had remitted several amounts to its overseas JV. It made payment of Rs. 46,53,138 to vendors on behalf of JV and such payment was recorded as a loan in the books of JV. Such transaction is not recognized as a permitted source of funding overseas investment. Paying to vendors and then capitalizing the same in the books would require prior RBI approval as it is not a permitted mode of funding as per Regulation 6(3) of FEMA Notification 120.

2.4 Utilization of funds of parent company for direct investment in SDS and extending loan to step down subsidiary (SDS) through overseas branch office

In the case of Patel Realty (India) Limited (C.A. No.4083/2016, dated December 22, 2016), The applicant remitted USD 3,25,000 directly from the branch office of its parent company, Patel Engineering Limited (PEL), USA to the account of its SDS, Les Salines Development Limited (LSDL) in Mauritius. LSDL is the subsidiary of Waterfront Developers Limited (WDL), Mauritius, a WOS of the applicant. The utilization of funds of overseas branch office of the parent company for direct investment in the SDS is not a permissible method of investment and is a violation of Regulation 6(3) of Notification No. FEMA 120/2004-RB dated July 7, 2004.

Further, the applicant extended loan to the SDS through its branch office in Mauritius, which is not a permissible method of funding. An Indian Party may extend a loan or a guarantee to or on behalf of the JV / WOS abroad, provided that the Indian Party has made investment by way of contribution to the equity capital of the JV whereas the above loan was extended by the applicant to the SDS through its branch office in Mauritius which is not a permissible method of funding.

3. Non-Reporting of Step-Down Subsidiary (SDS) to RBI

In terms of Regulation 13 of Notification No. FEMA.120/2004-RB A JV/WOS set up by the Indian party may diversify its activities/ set-up step-down subsidiaries/alter the shareholding pattern of the overseas entity. The Indian Party has to report to the Reserve Bank, the details of such decisions taken by the JV/WOS within 30 days of the approval of those decisions and, include the same in the Annual Performance Report required to be forwarded annually to the Reserve Bank in terms of Regulation 15.

In the case of The Malayala Manorama Company Limited (C.A. No. 3892 / 2016, dated July 12,2016), A WOS of the applicant company, namely, Malayala Manorama FZ LLC. Further, a step-down subsidiary, namely, Malayala Manorama Fujairah FZ LLC was set up in 2013-14. The Form ODI for the above investments was filed with delay and setting up of step-down subsidiary was not reported within the stipulated time.

4. Non receipt of Share certificate and non-submission of Annual Performance Reports (APR)

Regulation 15 (i) of Notification No. FEMA.120/2004-RB dated July 07, 2004 states that “An Indian Party which has acquired foreign security in terms of the Regulation in Part I shall receive share certificates or any other document as an evidence of investment in the foreign entity to the satisfaction of the Reserve Bank within six months”

Further, in terms of Regulation 15 (iii) of Notification No. FEMA.120/2004-RB dated July 07, 2004, “An Indian Party which has acquired foreign security in terms of the Regulation in Part I shall submit to the Reserve Bank, through the designated Authorized Dealer, every year on or before a specified date, an Annual performance Report (APR) in Part III of Form ODI in respect of each JV or WOS outside India”.

In the case of Dada Sons Private Limited (C.A. No. 4112 / 2016, dated December 22, 2016), A WOS of the applicant company, namely, Dada Sons Singapore Pte. Ltd., was incorporated in Singapore. Further, a step-down subsidiary (SDS), namely, Transrev RSA Pty. Ltd. was set up in South Africa. The applicant made investments in its WOS and SDS. The investments were reported with a delay beyond the stipulated time period, thus contravening Regulation 13 of Notification No. FEMA 120/2004-RB.

The share certificates for the investments were submitted with a delay beyond the stipulated time period, thus contravening Regulation 15(i) of Notification No. FEMA 120/2004-RB.

The Annual Performance Reports (APRs) for the year 2014-15 was submitted with a delay beyond the stipulated time period, thus contravening Regulation 15 (iii) of Notification No. FEMA 120/2004-RB.

5. Delayed reporting of corporate guarantee

In terms of Regulation 6(2)(vi) of FEMA 120/2004, an Indian Party making direct investment in a JV/WOS outside India has to submit duly completed Part I of Form ODI, as prescribed by Reserve Bank from time to time, to the designated branch of an Authorized Dealer.

In the case of Uma Polymers Limited (C.A. No. 4234/2016, Dated May 26, 2017), the applicant was engaged in the business of manufacturing flexible packaging materials. set up a WOS namely, Umax Packaging LLC which was reported to RBI on October 27, 2011.

UPL had also extended three corporate guarantees aggregating USD 31.50 lacs (Rs.1568.70 lacs) to its WOS which was reported to RBI on January 07, 2013. The company did not report the above guarantees within the prescribed time period of 30 days in contravention of Regulation 6(2)(vi) of Notification No. FEMA 120/2004-RB dated July 7, 2004.

6. Making ODI via automatic route while the same is permitted under approval route

ODI can be made through approval or automatic route. Under the Automatic Route, an Indian Party does not require any prior approval from the Reserve Bank for making ODI in a JV/WOS abroad. The Indian Party should approach an Authorized Dealer Category – I bank with an application in Form ODI and the prescribed enclosures / documents for effecting the remittances towards such investments. Transactions which require prior approval are provided in Regulation 5 and Regulation 6 of Notification No. FEMA120/RB-2004.

One such condition of regulation 6 is that an Indian party can route the transactions through automatic route if it is not on the Reserve Bank’s Exporters caution list /list of defaulters to the banking system circulated by the Reserve Bank or under investigation by any investigation /enforcement agency or regulatory body.

In the case of PC Jeweller Limited (C.A. No. 4619/2018, Date: July 12, 2018), The applicant set up a WOS namely, P. C. Jeweller Global DMCC in UAE and made remittances to the overseas WOS, under the automatic route. The company had to remit USD 500 to compensate for the shortfall in the first remittance on account of deduction of the bank charges.

The applicant was under investigation by Directorate of Revenue Intelligence (DRI) which was concluded in July 2014 and a show cause notice (SCN) was issued to the applicant. The applicant filed an appeal against the SCN to Commissioner (customs) Imports in January 2015 which was pending. The applicant was not eligible to undertake ODI, under the automatic route pending disposal of the appeal and prior approval of RBI should have been obtained. The applicant thus contravened regulation 6(2)(iii) of Notification No. FEMA 120/2004-RB.

7. Equity Contribution made in the form of Capitalization of Software export receivable and Form ODI and Form Softex not filled

Regulation 12(1) of Notification No FEMA 120-RB 2004 requires An Indian Party exporting goods / software / plant and machinery from India towards equity contribution in a JV or WOS outside India shall declare it on SOFTEX and also quoting Identification Number, if already allotted by Reserve Bank.

In the case of Greytip Software Private Limited (C.A. No. 4359/2017, dated July 31, 2017), The applicant incorporated a WOS Viz., Greytip Software, FTZ in UAE. Equity contribution was made in the form of capitalization of software export receivables. The same was done without submitting Form ODI-part I and Form Softex, thereby contravening the provision of Regulation 6(2)(vi) and regulation 12 of Notification No FEMA 120-RB 2004.

8. Shares issued to directors in the name of company:

In the case of All-ways Logistics Private Ltd (C.A. No. 3914/2016, dated 5th August 2016), the company incorporated a WOS in Hong Kong. Equity Shares were allotted in the name of the directors of the company instead of in the name of the company. Upon identification of the mistake the aforesaid equity shares were transferred to the company without any consideration in cash/kind. Also foreign currency meant for travelling expenses were used to open a new bank account in Hong Kong and same was treated as transfer of initial share capital instead of advance. The applicant did not submit Form ODI for the above transaction. The applicant contravened Regulation 6(3) of FEMA Notification 120 which deals with funding of overseas investment through other than permitted modes.

9. Remittance in further/ subsequent remittance without obtaining UIN

In the case of Ducom Instruments Pvt Ltd (C.A. No. 4168 / 2016, Date: January 11, 2017), The applicant made their first remittance of EUR 35,000 towards equity to their WOS in Netherlands and subsequently made two more remittances of EUR 16,104 and EUR 20,000 towards loan without submission of Form ODI within the prescribed period and without obtaining UIN after making the first remittance. This is in contravention of the provisions of Regulation 6(2)(vi) Notification No. FEMA120/RB-2004. UIN has to be obtained when the remittance is made for the first time and the same UIN has to be used for subsequent remittances.

10. Disinvestment without submission of APR

In the case of Tata Steel Ltd (TSL) (C.A. No 4669/2018, dated September 12, 2018), TSL remitted Bangladesh Taka 999,800 as a part of incorporation expenses of Bangla Steel and Mining Company Limited in Bangladesh under automatic route. The investment was then written off by TSL but this disinvestment was effected without the submission of APR, which is not in compliance with Regulation 16(1)(v) of Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 notified vide Notification No. FEMA 120/2004-RB dated July 7, 2004 as amended from time to time.

Summary of Compounding orders detailed above is as follows- 

S.No. Contravention Case Citation
1 Delay in submission of Form ODI-Part 1 beyond the stipulated time period

 

Solutions  Infini Technologies (India) Private Limited C.A. No.4483/2017, Date:  12th December 2017
2 Funding for ODI through sources not permitted-
2.1 Remittance made in Cash

 

ZIM Laboratories Limited C.A. No. 4328/2017, Date:  13th July 2017
2.2 Remittance through traveler’s cheque

 

Dynemic Products Limited C.A. 4587/2017, Date:  May 18, 2018
2.3 Payment made to vendors on behalf of overseas JV and recorded as loan

 

Indus Biotech Private Limited C.A. No. 4587/2017, Date:  May 18, 2018
2.4 Utilization of funds of parent company for direct investment in SDS and extending loan to step-down subsidiary (SDS) through overseas branch office

 

Patel Realty (India) Limited C.A. No. 4083/2016, Date:  December 22, 2016
3 Non-Reporting of Step-Down Subsidiary (SDS) to RBI

 

The Malayala Manorama Company Limited C.A. No. 3892 / 2016, Date:  July 12,2016
4 Non receipt of Share certificate and non-submission of Annual Performance Reports (APR) Dada Sons Private Limited C.A. No. 4112 / 2016, Date:  December 22, 2016
5 Delayed reporting of corporate guarantee

 

 

Uma Polymers Limited C.A. No.4234/2016, Date:  May 26, 2017
6 Making ODI via automatic route while the same is permitted under approval route

 

PC JewellerLimited C.A. No. 4619/2018, Date: July 12, 2018
7 Equity Contribution made in the form of Capitalization of Software export receivable and Form ODI and Form Softex not filled

 

Greytip Software Private Limited C.A. No. 4359/2017, Date:  July 31, 2017
8 Shares issued to directors in the name of company:

 

All-ways Logistics Private Ltd C.A. No. 3914/2016, Date:  5th August 2016
9 Remittance in further/ subsequent remittance without obtaining UIN

 

Ducom Instruments Pvt Ltd C.A. No. 4168 / 2016, Date:  January 11, 2017
10 Disinvestment without submission of APR

 

Tata Steel Ltd (TSL) C.A. No. 4669/2018, Date:  September 12, 2018

As seen from the above plethora of compounding orders, these are some common mistakes that have been committed while ODI transactions. These are the collection of past legal decisions taken by Reserve Bank of India in which the law was analyzed, to resolve ambiguities for deciding current cases. Therefore special consideration needs to be taken while doing Overseas Direct Investment transactions to avoid such mistakes.

“Let us all be aware and vigilant today to avoid any future hurdles.”

Disclaimer 

This article has been prepared on the basis of information available in the public domain and is intended for guidance purposes only. We have taken reasonable care to ensure that the information in this article is accurate. We, however, accept no legal responsibility for any consequential incidents that may arise from errors or omissions contained in this article.

CA.Harshita Dhariwal and Swati Jain

Author Bio

Qualification: CA in Practice
Company: Jain Shrimal & Co.
Location: Jaipur, Rajasthan, India
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