Foreign investments in equity instruments by a person resident outside India (PROI) is governed by Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules) and the Consolidated FDI Policy as amended from time to time. Foreign investments can be made on a repatriation basis or non-repatriation basis.

Recently, on March 19, 2021, Department of Promotion of Industry and Internal Trade (DPIIT) issued a press note clarifying on downstream investment in case of companies with investment from Non-Resident Indians (NRIs) on non-repatriation basis. The press note will become effective from the date of FEMA notification amending NDI Rules, that is pending as on date.

1. What is downstream investment?

Foreign Investment in to India comprises of both direct foreign investment from non-residents and indirect investments through resident Indian entities having such direct foreign investment. Indirect Foreign Investment is often referred to as “Downstream Investment (DI)” under FEMA.

2. What is indirect foreign investment (IFI)?

IFI has been defined in Regulation 14(1)(v) of FEMA Notification No. 20 as under:

“‘Indirect foreign investment’ means entire investment in other Indian companies by an Indian company (IC), having foreign investment in it provided (a) IC is not ‘owned and controlled’ by resident Indian citizens and/or Indian Companies which are owned and controlled by resident Indian citizens or (b) where the IC is owned or controlled by non-residents.

However, as an exception, the indirect foreign investment in the 100% owned subsidiaries of operating-cum-investing/investing companies will be limited to the foreign investment in the operating-cum-investing/ investing company.”

3. What is the basic principle behind Downstream Investment (DI)?

The main principle behind DI is – “What can be done directly can be done indirectly. What cannot be done directly cannot be done indirectly.”

4. What are the implications of Indirect Foreign Investment?

All IFI have to comply with all FEMA rules – sectoral caps, conditions or restrictions of FDI policy. This includes capitalisation norms, valuation rules, optionality clauses, etc. Where approvals are required, the same have to be obtained. Thus, even though the transactions may be between Indian entities, if one of them is Indirect foreign investor, FEMA applies.

5. Who is responsible for compliance of IFI?

The responsibility for compliance of IFI rules is on the investee company at all levels. Thus, even small start-up companies which receive investment from a Venture fund, will need to consider whether the VCF is domestic investment or foreign investor.

6. Can IFI be undertaken by Indian Individual?

No, IFI can be undertaken by an Indian company (IC), Limited Liability Partnership or an Investment Vehicle (VCF / AIF).

7. Can Indian Company (IC) give loans or issue debentures?

No, Investment includes equity shares and fully convertible instruments.

8. Is there any proportionality in the investment made by IC?

No, If Indian entity is considered as indirect foreign investor, the entire investment will be considered as IFI. There is no proportionality. Thus, if there is foreign investment of 60% in Indian company, investment by Indian company in downstream company will be entirely considered as IFI. IFI will not be restricted to 60%. This method has to be considered for every downstream company at every level.

9. Can Indian Company invest in prohibited sectors?

No, it should however be noted that there are some sectors which are totally prohibited for foreign investment like agriculture, atomic energy, etc. Even if the Indian company is owned and controlled by Indian resident citizens, but has slightest foreign investment, it cannot invest in these sectors.

10. How can we determine the extent of foreign investment in Indian Entity?

To determine the extent of foreign investment in Indian entity (whether it is 50% or more), all categories of foreign investments have to be considered – FDI, FII, NRI repatriable, FVCI, etc. In fact now for considering the sectoral cap in the first level company also, all categories of foreign investment have to be considered. Thus, if FDI is 20%, but together with other foreign investments, total foreign investment crosses 50%, the company will be considered as foreign investor for downstream investment.

NRI Investment on Non-Repatriation basis (Schedule 4) is not counted as foreign investment for these purposes. Share issued as Sweat equity or under employee stock option plans are also not to be considered.

11. Can Indian Company borrow funds from India for investment?

Indian entity however cannot borrow and invest. They can raise debt for their business, but not for further downstream investment.

Indian companies/LLPs have to bring in requisite funds from abroad for making downstream investment. Downstream investments can also be made through internal accruals also. Internal accruals mean profits transferred to reserve account after payment of taxes.

12. Which are the relevant laws for IFI?

The relevant law for IFI is as under:

  • Press notes 2, 3 and 4 of 2009 (while these are now subsumed within the Consolidated FDI Policy), these form the basis. (Issued by DIPP.)
  •  FEMA Notification No. 20 on Foreign Investment – especially Regulation 14. (Issued by RBI.)
  • Specific Notification nos. 278, 354, 355, 362 (including the corrigendum), and 363 which have amended FEMA Notification No. 20. (Issued by RBI.)

(Generally, these are referred to as “rule/s” in this article.)

13. Key issues to be checked for IFI?

Key issues to be checked for IFI are:

– Whether the Indian investor entity is Indian owned and controlled and therefore domestic investor; or it is foreign owned or foreign controlled and therefore foreign investor.

– What kind of foreign investment in IC is considered for determining whether Indian investor entity is considered as Indirect foreign investor.

– The guidelines for Indian investor company to invest in downstream companies.

14. Will IFI rules apply, if IC wants to invest abroad?

If the IC has to invest abroad, IFI rules do not apply. It is not considered as “Reverse Round Tripping”.

15. What is repatriation Basis?

Investment on repatriation basis means an investment, sale or maturity proceeds of which are net of taxes, eligible to be repatriated out of India. For an investment to be regarded as foreign investment, it should be made on a repatriation basis in the equity instruments of a company.

16. What is non-repatriation basis?

Where the investments are made on non-repatriation basis, the same is regarded as domestic investment and are considered on par with investments made by residents.


Author: CS Lucky Bansal, Bansal & Co., Practising Company Secretary

Disclaimer: – The entire contents of this document have been prepared on the basis of relevant provisions and rules and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, I assume no responsibility therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws. The user of the information agrees that the information is not a professional advice and is subject to change without notice. I assume no responsibility for the consequences of use of such information.

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Qualification: CS
Company: Bansal & Co.
Location: Mumbai, Maharashtra, India
Member Since: 24 May 2021 | Total Posts: 1

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June 2021