Indian Businesses with ODI await clarifications – Are regulators listening?

Indian Businesses with Overseas Direct Investment (ODI) await clarifications – Are the regulators listening?

Indian entrepreneurs found the outlet to tap into the foreign markets and mark their presence in foreign lands, thanks to liberalization brought in by Foreign Exchange Management Act 1999 (FEMA), allowing much-needed relaxation. Necessary changes have been made in regulations under FEMA from time to time, to smooth out the encumbrances and provide succour to the Indian Entrepreneurs. Few more changes are required, that have been discussed and highlighted on different forums, time and again, to no effect. Presently when Central Government is charged up to promote “Make in India” the growth mantra a big success, which certainly is a welcome directive, it is also imperative to bring about the necessary changes or required clarification, as detailed below, in regulations relating to ODI by Indian Entrepreneurs thereby enabling them to expand their wings to foreign land without fear.

Investment in Overseas JV/Wholly Owned Subsidiary (WOS) can be done only for bona-fide business activity as per Regulation 6(2)(ii) of Foreign Exchange Management (Transfer and Issue of Foreign Security) Regulations 2000, as amended time to time.

What exactly qualifies for the “Bona-fide Business Activity or what not

Bona-fide business activity has not been defined under FEMA, 1999, or Regulations made thereunder. Organizations struggle to comprehend whether a particular activity falls under bona-fide business activity or not. Basis the Compounding Order by the RBI in the past, it’s apparent that Overseas JV/WOS formed for the purpose of buying flat/land overseas or formed for the purpose of just funneling the borrowed money from overseas to India would not be categorized as bona-fide business activity. However Central Government or RBI, till the date of omission of Section 6(3) is notified, should provide long awaited clarification as to what either would constitute a bona-fide business activity or what would not constitute a bona-fide business activity.

As per Regulation 6(4)(i), an Indian Party may extend a loan or a guarantee to or on behalf of Overseas JV/WOS under Automatic Route, within the permissible financial commitment (400% of Net Worth), provided that Indian Party has made investment by way of contribution to the equity capital of JV, else RBI approval is required. In other words, under Automatic Route, Equity Participation is required before extending any loan or guarantee by Indian Party

Whether Equity Participation without remittance of Equity would be treated as Equity Participation under Regulation?

Some countries like Dubai, Cyprus, etc. have laws permitting incorporation of companies by issue shares without receipt of money. Indian regulation is silent on whether owning of such shares in oversea JV companies pending remittance by Indian Party will be treated as Equity Participation or not.  However, FAQs on ODI, by RBI updated on 19^th September 2019 states that existing Regulation does not permit acquisition of foreign shares without payment or on deferred payment basis.

Let’s take the case of Krishiraj Trading Co (Welspun Group) where Enforcement Directorate has imposed a penalty of more than Rs. 55 cr on the company for extending Corporate Guarantee to overseas JV company in which it was holding the shares but the remittance of less than Euro 10K towards issue of shares was pending.. Such an exorbitant penalty certainly discourages, new entrepreneurs or startups to expand their ventures out of India. When existing regulations, except a cap of financial commitment of 400% of Net Worth, does not put a restriction on quantum of Guarantee or Loan w.r.t Investment in Equity Shares/Compulsorily Convertible Preference Share, logic of having such a clause is also not understandable.

Equity Participation means that the person should be a holder of shares and his name should be in Shareholders/Members’ Register, but since Indian Company Law have no such provisions, RBI do not accept owning of such shares as Equity Participation. Technically speaking, this is a faulty proposition. Once the shares are issued, equity participation becomes intrinsic. Government should make the necessary changes in regulation to be in parity with laws of host country, thus freeing Indian entrepreneurs to spread their wings in foreign lands.

Is ODI possible by Indian Party in Overseas JV/WOS with existing FDI?

Direct Investment by an Indian Party in Overseas JV/WOS which already has Foreign Direct Investment in India is not permissible under Automatic Route. Though Regulation does not contain such restriction, but question no. 64 of FAQ on ODI released by RBI suggests that such investment cannot be done under Automatic Route. Putting restrictions by way of FAQ, RBI has started taking actions for contravention, creating roadblocks for investors. RBI has directed the companies to unwind either FDI or ODI leg of the structure leading to hardships to existing companies.

High Level Advisory Group (HLAG) in its report released on 12^th September 2019 has recommended that an Indian party should be allowed to undertake ODI in a structure which already has an existing FDI structure in India provided the following conditions are met:

1. Total value of existing FDI does not exceed 25% of the consolidated net worth of the foreign entity in which ODI is being made; and

2. Any additional FDI should be allowed provided such funds are not directly or indirectly from India.

It is high time the Government should make necessary changes in Regulations to remove bottlenecks for free flow of investments in India as FDI and also Investments outside India as ODI.

Lastly, Section 6(3) of FEMA, 1999, conferring powers on RBI to prohibit, restrict or regulate the Capital Account Transactions, was omitted by Finance Budget 2015, and the date is yet to be notified. The premise of such omission was that Capital Account Control is policy rather than Regulatory and hence such controls would be exercised by Central Government rather than RBI.  The necessary changes were done in section 6(2) and Section 6(2A) of FEMA, 1999 to give effect of shifting the powers of controlling these transactions from RBI to Central Government but the date is still to be notified to give effect to the changes. Its time the government rose from slumber and give shape to the such amendments.

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About Author:

Vikas Maheshwari, Chartered Accountant, 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 senior position including CFO, Global Treasury Head, etc. in MNCs.