This article highlights the provisions of Foreign Exchange Management Act, 1999 (FEMA), where IT companies have opted compounding of contraventions.
IT has been significant contributor to India’s growth in the services and has emerged as the biggest IT Hub in the modern world. This sector has to its credit creation of more than 15 million direct and indirect employment in India. It’s revenue for FY 20 is estimated at US$ 191 billion, growing at 7.7% y-o-y and expected to reach US$ 350 billion by 2025. More than three fourth of its revenues are from exports. Being a global player, this industry has witnessed significant Foreign Direct Investment (FDI), Overseas Direct Investment (ODI), hiring of expats in India or deputation of Indian citizens to Projects Overseas etc.
Provision on Foreign Investment/FDI
Pursuant to amendment made through Finance Act 2015, Central Government is empowered to legislate for Capital Account Transactions. Department of Economic Affairs under Ministry of Finance has issued Foreign Exchange Management (Non-debt Instrument) Rules, 2019 (herein after referred as NDI Rules) for acceptance of foreign investment/Foreign Direct Investment in India. NDI Rules supersedes Foreign Exchange Management (Transfer of Issue of Security by a Person Resident outside India) Regulations, 2017, called as TISPRO. Foreign Investment in India is subject to entry route, sectoral cap, pricing guidelines and attendant conditionalities as specified in Schedule 1 of NDI Rules.
Important Terms in NDI Rules
Foreign Investment means 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 a LLP.
Equity Instrument means following instruments issued by an Indian Company
FDI means following investment in equity instrument by PROI on repatriation 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%.
Entry Route: “Automatic Route” and “Government Route” are two entry routes through which foreign investment may be done in India. Automatic route” means the entry route through which investment by PROI does not require prior approval of RBI/Government. Government route means investment by a PROI requires prior government approval.
Sectoral Cap consists of limits up-to which total foreign investment (TFI) can be accepted by an Indian Company in equity instrument or in capital of LLP, operating in that sector. TFI means Foreign Investment plus Indirect Foreign Investment. This is composite limit of Indian investee entity. Sectoral cap, for the sectors specified in the table of Schedule I of NDI Rules, is the limit indicated against each sector. The sector (Other than Financial Services) which is neither specified in the table of Schedule 1 nor is a part of prohibited sector for FDI, 100% foreign investment is permissible under Automatic Route.
Foreign Investment for IT Sector as per NDI Rules
IT sector is not specified in the table of Schedule 1 of NDI Rules, hence 100% Foreign Investment is permitted under Automatic Route subject to applicable laws or regulations, security and other conditionalities. IT includes KPO which is subject to regulations / guidelines issued by Department of Telecommunication. Due care should be exercised in deciding the sector. Leaving besides the broader saga of Antrix- Devas case, Enforcement Directorate (ED) had imposed a penalty of INR 1,585 Cr on Dewas Multimedia Private Limited in violation of FDI Policy. It was alleged that Devas Multimedia Private Limited had sought the approval of Foreign Investment by claiming that it operates in IT sector while ED claimed that the company was operating in Telecom sector.
Though, investment by PROI, in the equity instrument of an Indian Company/ to the capital of LLP in IT sector, is under automatic route, but FDI from the below would be subject to government approval:
Thus, FDI from the companies incorporated/persons living in/citizens of Afghanistan, Pakistan, Bangladesh, Nepal, Bhutan, Myanmar, and China, would be subject to government approval (NDI amendment rules 2020).
NDI Rules consist of 10 schedules for foreign investment. Schedule 1 consist of FDI. Each schedule is different, and foreign investment would be subject to the limits, conditions/restrictions mentioned in respective schedules. Investment from NRI, on non-repatriation basis under schedule 4, is treated at par with domestic investment and hence not considered as foreign investment.
Equity Instruments to PROI: should be issued within 60 days from the date of receipt of consideration, failing which consideration should be remitted back, to PROI within 15 days from the date of completion of 60 days, through banking channels or by credit to his NRE/ FCNR (B) account.
Mode of payment for equity instrument and the reporting compliances are governed by Foreign Exchange Management (Mode of Payment and Reporting of Non-debt Instruments) Regulations 2019, issued by RBI.
Form Foreign Currency-Gross Provisional Return (FC-GPR): An Indian company issuing equity instruments to PROI, under FDI should report such issue in Form FC-GPR, within 30 days from the date of issue of equity instruments.
Annual Return on Foreign Liabilities and Assets (FLA): An Indian Company, which has received FDI or an LLP which has received foreign investment, shall submit form FLA to RBI by 15th July of each year.
Foreign Currency-Transfer of Shares (FC-TRS): To be filed for transfer of equity instruments in accordance with NDI rules, between: PROI
Onus of reporting is on resident transferor/transferee or PROI holding equity instruments on a non-repatriable basis. Transfer of Equity Instrument of an Indian Company by/to PROI are governed by Rule 9 &13 of NDI Rules.
Form LLP (I): LLP receiving amount towards capital contribution/acquisition of profit shares from PROI, should file Form LLP (I), within 30 days from the receipt of consideration.
Form LLP (II): On disinvestment / transfer of capital contribution/profit share between PRI and PROI (or vice versa) Form LLP(II) should be filed within 60 days from the receipt of funds. Onus of reporting is on the resident transferor / transferee.
Common Contraventions on FI/FDI as observed from the compounding orders, are allotment of shares prior to receipt of inward remittance, delay in refund of money, allotment of shares after permissible period, delay in submission of Annual Return FLA, delay in submission of Form FC-GPR, non-adherence to pricing guidelines etc.
Keypoint Technologies India Private Limited, opted for compounding of contravention on delay in submission of Form FC-GPR, allotment of shares after permissible period, delays in filing FLA. The contravention were compounded on payment of Rs. 28 lacs (CA HYD 352). Similar contraventions were compounded by Sapient Consulting Private Limited (CA 738-2018).
M/s. Congruent Info-Tech Pvt Limited, an Indian Company, had issued 10,000 equity shares to PROI at face value of Rs. 10 each instead of fair valuation of Rs. 92.50 each. Further, one PRI shareholder of the company had gifted 20,000 shares of the company to PROI without prior approval of RBI and the company had taken the same on record without getting RBI approval letter from the donor. Both the contraventions were regularized through compounding (CA 954-2019).
M/s. Baton-Ubixi Systems India Private Limited, had allotted MoA shares to PROI in 2018 and received foreign inward remittances towards the same in 2019. Issue of shares prior to receipt of money led to contravention under FEMA regulation (CA 919-2019).
IBM India Private Limited had contravened on compliances of Down Stream Investment. The contravention was regularized through compounding on the payment of Rs. 1.7 Cr (CA 4287-2017). It is therefore important to understand Down Stream Investment (DSI) as if DSI is categorized as Indirect Foreign Investment, prescribed compliances must be adhered to.
Investment made by an Indian Entity into equity instrument of another Indian Entity is called Down Stream Investment (DSI). A DSI is categorised as Indirect Foreign Investment if
|a. Investor Indian Entity has Total Foreign Investment in it, AND (1st Part)
b. Investor Indian Entity is owned or controlled by PROI; OR
c. Investor Indian Entity is not owned & not controlled by Resident Indian Citizens
(Indian Entity means Indian Company or a LLP)
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.
Though the definition of ownership is clear but when it comes to control, there is ambiguity with reference to veto rights, which is commonly placed in JV agreements. How to factor the controls being exercised through veto rights? NDI rules are silent on this.
Entire amount of DSI is being categorized as IFI and not the proportionate amount. For instance, if ‘’X Co’’ of USA has made an investment of 80% in the equity shares of an Indian company “A Co” and ‘’A Co’’ has further made 60% investment in Indian company “B Co”, then entire Investment by ‘’A Co’’ into ‘’B Co’’ i.e. 60% would be categorized as IFI and not the proportionate (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 of the investor company, i.e. the company making DSI. In above instance, if ‘’A Co’’ invests 100% in ‘’B Co’’ then IFI for ‘’B Co’’ would be 80% and not 100%.
Many companies/ LLP, contravene on the provisions of Indirect Foreign Investment as the investment is being done by Indian Company into Indian Company/LLP.
Indus Towers Limited (JV of Bharti, erstwhile Vodafone & 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% 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).
Compliance by Indian Entity Making DSI
Compliance by Indian Entity Receiving IFI: Entry route, sectoral caps, pricing guidelines and other attendant conditions as applicable for Foreign Investment.
Overseas Direct Investments (ODI) Regulations under FEMA from IT Perspective
Investment in Overseas Joint Venture (JV)/Wholly Owned Subsidiary (WOS), by Indian Companies in the IT sector, is a common occurrence and quite pervasive. Here are some important provisions of ODI regulated under “Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004” (Notification 120/RB-2004), as amended time to time.
Financial commitment/investment by an Indian Party (Indian Company/Registered partnership firm/LLP), up-to 400% of its Net Worth (based upon last audited Balance Sheet) is permissible under automatic route, provided:
400% limit is on the total financial commitment by an Indian party in all of its overseas JV/WOS. However, this limit is relevant at time of making remittance only. Subsequently, if due to erosion of net worth, existing ODI crosses the prescribed limit of 400%, then it would not have any repercussion on existing ODI but subsequent investment may not be possible under automatic route.
It should, however, be noted that any financial commitment exceeding USD 1 billion/ its equivalent, in a financial year would require prior approval of RBI even when total financial commitment of Indian party is within the eligible limit under automatic route.
What if Eligible Limit is Fully Utilized
Remittance, for investment in overseas JV/WOS, out of EEFC or proceeds of ADR/GDR are not being considered in prescribed limit of 400% of net worth. Thus, remittance from EEFC or out of proceeds of ADR/GDR, may be used for making investment in overseas JV/WOS under automatic route, even if the limit of 400% of net worth is fully utilized. This is important from IT industry perspective as they get substantial revenue from export.
Financial commitment means
Indian software exporters are permitted to receive 25% of their exports value to an overseas software start-up company in the form of shares without entering into Joint Venture Agreements, with prior approval of RBI.
Swap of Shares have been prominent way of acquiring stakes in foreign companies by Indian IT companies. This transaction involves acquisition of shares of an overseas company by swap of shares of an Indian company. On acquisition of shares of overseas company, the shares are issued by acquirer Indian company rather than paying cash. FDI would be applicable with respect to the shares that are being issued by Indian Company. In cases of swap of equity instrument, irrespective of the amount, valuation involved in swap arrangement should be made by a Merchant Banker registered with SEBI or an Investment Banker outside India registered with the appropriate regulatory authority in the host country. Such issue is also subject to entry route, sectoral cap, pricing guidelines etc.
An Indian Company may also acquire the shares of a foreign company by way of exchange of ADR/GDR issued to the foreign company provided
Loan or Guarantee to Overseas JV/WOS
Indian Party may extend loan/guarantee only to an overseas JV/WOS in which it has equity participation. Undertaking financial commitment without equity contribution in overseas JV/WOS requires prior approval of RBI. Many countries like UAE, Middle East, European Countries have provisions permitting issue of shares under MOA pending receipt of funds but Indian regulation considers equity participation post remittance of funds only. Enforcement Directorate had imposed penalty of Rs. 55 cr on Krishiraj Trading Co for extending corporate guarantee to its overseas JV in which it was holding the shares but the remittance towards issue of shares was pending.
Indian Party is also permitted to issue corporate guarantees on behalf of their first level step down operating JV/WOS, set up by their overseas JV/WOS operating as either an operating unit or as Special Purpose Vehicle, under automatic route, provided financial commitment is within the prescribed limit.
Issuance of corporate guarantee on behalf of second or subsequent level step down operating subsidiaries is subject to RBI approval, provided Indian Party indirectly holds 51% or more stake in the overseas subsidiary for which such guarantee is intended to be issued.
Wipro Limited had issued corporate guarantee on behalf of its second and onwards step-down subsidiaries, without prior approval of RBI, which was contravention of Regulation 6(4) of Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004. Compounding for the contravention was done at Rs. 69 lacs (CA 4710-2018).
All guarantees (including performance guarantees and Bank Guarantees/SBLC) should be reported to RBI in Form ODI-Part I through their designated AD, at the time of issuance of such guarantees.
Obligations of Indian Party making ODI
Contraventions on ODI, as observed from compounding orders, by the companies in this sector, are delays in submission of APR, delays in submission of Form ODI, non-reporting of SDS by overseas JV/WOS, FDI under ODI structure, divestment of Overseas JV/WOS without approval of RBI etc. ODI, without RBI approval, is not permissible if the overseas entity has made FDI in an Indian Entity.
Aricent Technologies (Holding) Limited (Aricent Holding), an Indian Entity, acquired a stake in Aricent Mauritius Engineering Services PCC (Aricent Mauritius). Aricent Mauritius was already holding investment in Aricent Technologies Private Limited, India when ODI was made by Aricent Holding. The resultant structure amounted to making ODI in an entity with pre-existing FDI, which is not permitted without prior approval of RBI, leading to contravention of Regulation 5(1) read with 13 of Notification No. FEMA 120/2004-RB. The entire structure (FDI and ODI) was unwound. Aricent Holding had regularized the contravention through compounding on the payment of Rs. 3.7 Cr (CA 4803/2018).
Newgen Imaging Systems Private Limited (NISPL), an Indian subsidiary of Newgen Knowledge Works Private Limited (NKWPL), acquired 76% stake in Global Publishing Solutions Limited (GPSL) in United Kingdom, in 2007. Subsequently, in 2009, GPSL, UK acquired entire holding of GPSL India Private Limited from its Indian promoters. Around the same time, NISPL was merged with NKWPL, resulting in transfer of investments in GPSL, UK and GSPL, India by NISPL to NKWPL. NKWPL failed to report the acquisition of GPSL India through GPSL, UK. This also led to existence of FDI through ODI structure, which is not permissible without prior approval of RBI (CA 4889-2019).
Divestment/Sale of shares of Overseas JV/WOS is permissible without RBI approval subject to specified conditions in regulation. Zensar Technologies Limited, (Zensar India) had divested its WOS in Japan, named, Zensar Advanced Technologies. This divestment should have done with prior approval of RBI as Zensar India, at the time of divestment, had due receivable from WOS and was also under investigation by Enforcement Directorate. Divestment by Zensar India without approval of RBI was contravention of regulation and has regularized the contravention by compounding on payment of Rs. 23.7 lacs (CA 4764-2018).
Divestment, involving write off, by unlisted company where ODI investment in JV/WOS exceeds USD 10 million, requires prior approval of RBI. Take Business Cloud Private Limited (TBCPL), and Trigyn Technologies Limited Indian Entities, had divested their stake in overseas JV, involving write off, without approval of RBI leading to contravention of Regulation 16(3) of Notification No. FEMA. 120/2000-RB . The contravention, was regularized through compounding on payment of Rs. 1.5 Cr and Rs. 33 lacs respectively (CA 4686/2018, CA 4539-2017).
Regent Computronics Private Limited had made an ODI in January 2017 in an overseas JV in USA and due to adverse market condition, disinvested its stake in August 2017 without prior approval of RBI. Divestment/closure, of overseas JV/WOS before one year of operations, is subject to RBI approval. Hence divestment, without RBI approval, in the present case, was contravention which was regularized through compounding (CA 4922-2019).
FEMA Provision for Appointment of Foreign National Employee in India by a Company
Employing expatriates is a common practice in the IT Industry. Such Foreign Nationals can remit 100% of their net salary outside India as per Current Account Transactions (Amendment) Rules 2015.
Foreign Citizens (other than Pakistan) or Indian Citizens on deputation to Office/ Subsidiary/ JV of foreign company in India, may make remittance up to his net salary (net of taxes/ Provident Fund/ other deductions), if he is in India for
Above employees are categorized as resident but not ordinary resident (RNOR) and are allowed to remit 100% of their net salaries.
Employee Stock Option Plan (ESOP) by IT Industry to its employee is regular phenomena. ESOP by Indian Company to PROI is notified under rule 8 of NDI Rules. An Indian IT company may issue ESOP to PROI employees/directors of its own/its holding company/JV/WOS, provided ESOP scheme is drawn under SEBI Act 1992 or Companies (Share Capital and Debentures) Rules, 2014 and should comply with entry route and sectoral cap. ESOPs to an employee/director who is a citizen of Bangladesh/Pakistan shall require prior approval of government.
Indian Companies, offering ESOP to any PROI, should submit Form ESOP within 30 days from the grant date and also at the time of exercise of right by employee.
VVDN Technologies Private Limited has granted ESOP to non-resident employee and directors but delayed the submission of Form ESOP, resulting into contravention which was regularized by compounding (CA 5016- 2019).
Mindtree Limited has delayed reporting of ESOP and issue of Bonus Shares to PROI and regularized this contravention by compounding (CA 4890-2019).
ESOP by Foreign Company to PRI
Person Resident in India (PRI), working either for Foreign Company or for an Indian Company having Overseas JV/WOS, are permitted to have ESOP of such Foreign Company/Overseas JV/WOS subject to below:
a) General permission of RBI is conferred to acquire shares under cashless ESOP provided it does not involve any remittance from India;
b) Authorized Dealer (AD) banks allow remittances for purchase of shares offered to PRI employee under ESOP by foreign company, provided
i. ESOP Scheme is offered globally on uniform basis by Issuing Company, and
ii. Indian Company has submitted Annual Return to RBI providing the details of remittances/ beneficiaries, etc.
c) PRI can exercise shares under ESOP by making remittance under LRS, subject to limit of USD 250,000 per financial year, provided sales proceeds of shares should be repatriated to India. In any other cases, RBI approval is required.
PRI must ensure repatriation, of sale proceeds in India, immediately on receipt of funds and in any case not later than 90 days from the date of sale of such securities.
Foreign companies are permitted to repurchase the shares issued to PRI under ESOP Scheme provided (i) the shares were issued in accordance with Rules & Regulations under FEMA (ii) shares are being repurchased as per terms of initial offer document, and (iii) Annual return is submitted to RBI giving details of remittances / beneficiaries, etc.
Employees of, July Systems & Technology, an Indian Subsidiary of Foreign Company, got ESOP from parent company. The company contravened on Annual Return reporting compliance and had regularized contravention by compounding (CA 4932/ 2019).
Import of Services: Remittances against imports should be completed within six months from the date of shipment, except where amounts are withheld towards guarantee of performance. AD banks are empowered to allow the remittance of import dues delayed due to disputes, financial difficulties etc, provided interest on delayed payment is payable only for a period up-to 3 years. It’s important to note that due extension must be sought from RBI on outstanding import payments.
Cisco Systems (India) Private Limited (Cisco India), was engaged in providing software development services to overseas Cisco affiliates. Its group company incurred the expenditure on behalf of Cisco India, the same was not paid by Cisco India within the time limit, and accordingly treated as ECB in contravention of Regulation 3 of Foreign Exchange Management (Borrowing and Lending) Regulations, 2018. The contravention was regularized through compounding at payment of Rs. 2.9 crores (CA 4253-2016).
Its important to be cautious on compliances of FEMA. Non-compliance leads of Penalty, u/s 13 of FEMA 1999, up-to 300% of the sum involved in the contravention, if the amount is quantifiable or upto Rs. 2 lacs if the amount is not quantifiable. In case of continuing contravention, further penalty up-to Rs. 5000 per day can be imposed.
In case of contravention by a company, the person, responsible for the business of the company, would be deemed guilty and liable to be proceeded against and penalized under section 42 of FEMA, 1999. Further, if proven that contravention had taken place with consent of or due to negligence on the part of director, manager, secretary or any authorized officer of the company, then they would also be deemed guilty and liable to be proceeded against and penalized accordingly.
Regulators are prompt in taking immediate action on contraventions against the company, directors, concerned officers. It is prudent to have periodical reviews of transactions under FEMA and seek timely advice on transactions involving foreign exchange.
Note: Extension of dates for current year, for reporting compliances, due to COVID pandemic have not been considered in the article.
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:
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