An Introduction to the Foreign Direct Investment Policy

Foreign Direct Investment (FDI) means investment by non-resident entity/person outside India in the capital of an Indian company under Schedule 1 of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000. Foreign (Direct) investment was introduced under Foreign Exchange Management Act (FEMA) 1991. The Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce & Industry, Government of India makes policy pronouncements on FDI.  As of now FDI is allowed in almost all the major sectors of India economy.

The Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce and Industry, Government of India (GOI) recently released the consolidated foreign direct investment (FDI) policy circular of 2017 (New FDI Policy). The New FDI Policy is effective immediately from the date of its publication, i.e., 28 August 2017. The New FDI Policy supersedes the consolidated FDI policy of 2016 issued by the DIPP on 7 June 2016 (Erstwhile FDI Policy) and consolidates all the press notes issued by the DIPP post 7 June 2016 until 27 August 2017.

The policy of Foreign Direct Investment (FDI) provides a mechanism of investment in an enterprise in one nation by another enterprise in another nation. FDI acts as the bridge to fill in the lacuna between saving and investment of resources and thus, plays one of the most essential roles in the growth of both developed countries as well as developing countries. It aims to increase the efficiency of the rate of input as well as output (which includes existing capacity of production along with the new capacity of production that will be generated). In a way, it also helps in saving the domestic constraint and brings in the superior or ideal technology required for the venture from foreign.

The consolidated FDI policy which has been in effect from 28th of August 2017 directs towards liberalization norms and has brought in some key changes which include:

• FDI in LLPs
• Downstream investment intimation
• Cash and carry wholesale form of trading
• FDI in one single brand retailing
• FDI in e-commerce
• Fresh approval for additional FDI
• FDI linked with the performance conditions
• Foreign Investment Promotion Board (FIPB) abolishment
• FDI in start-ups
• Pension sector
• FDI in other financial services
• FDI in infrastructure companies in the securities market
• Liberalization in: -Defense -Pharmaceuticals -Broadcasting
• Deferred consideration
• Remittance against pre-incorporation expenses.

FDI can be made through two ways:

• Automatic Route where FDI is allowed without prior approval either of the Government or the Reserve Bank of India in all activities/sectors as specified in the consolidated FDI Policy, issued by the Government of India from time to time.
• Government Route where FDI in activities not covered under the automatic route requires prior approval of the Government which is considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, and Ministry of Finance.

FDI policy 2017 has specifically prohibited investment in some of the sectors. They are:

• Lottery Business including Government/private lottery, online lotteries, etc.
• Gambling and Betting including casinos etc.
• Chit funds
• Nidhi company
• Trading in Transferable Development Rights (TDRs)
• Real Estate Business[1] or Construction of Farm Houses. ‘Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes
• Activities/sectors not open to private sector investment e.g. (I) Atomic Energy and (II) Railway operations (other than permitted activities).

Eligible investors 

• A non-resident entity can invest in India, subject to the FDI Policy except in those sectors/activities which are prohibited. However, a citizen of Bangladesh/ Pakistan or an entity incorporated in Bangladesh/ Pakistan can invest only under the Government route.
• NRIs resident in Nepal and Bhutan as well as citizens of Nepal and Bhutan are permitted to invest in the capital of Indian companies on repatriation basis, subject to the condition that the amount of consideration for such investment shall be paid only by way of inward remittance in free foreign exchange through normal banking channels.
• OCBs have been derecognized as a class of investors in India with effect from September 16, 2003. Erstwhile OCBs which are incorporated outside India and are not under the adverse notice of RBI can make fresh investments under FDI Policy as incorporated non-resident entities, with the prior approval of Government of India if the investment is through Government route; and with the prior approval of RBI if the investment is through Automatic route.
• A company, trust and partnership firm incorporated outside India and owned and controlled by NRIs can invest in India with the special dispensation as available to NRIs under the FDI Policy.
• Foreign Institutional Investor (FII) and Foreign Portfolio Investors (FPI) may invest in the capital of an Indian company under the Portfolio Investment Scheme which limits the individual holding of an FII/FPI below 10% of the capital of the company and the aggregate limit for FII/FPI investment to 24% of the capital of the company. This aggregate limit of 24% can be increased to the sectoral cap/statutory ceiling, as applicable, by the Indian company concerned through a resolution by its Board of Directors followed by a special resolution to that effect by its General Body and subject to prior intimation to RBI. The aggregate FII/FPI investment, individually or in conjunction with other kinds of foreign investment, will not exceed sectoral/statutory cap.
• An Indian company which has issued shares to FIIs/FPIs under the FDI Policy for which the payment has been received directly into company’s account should report these figures.
• Only registered FIIs/FPIs and NRIs can invest/trade through a registered broker in the capital of Indian Companies on recognised Indian Stock Exchanges.
• A SEBI registered Foreign Venture Capital Investor (FVCI) may contribute up to 100% of the capital of an Indian company engaged in any activity mentioned in Schedule 6 of Notification No. FEMA 20/2000, including startups irrespective of the sector in which it is engaged, under the automatic route. A SEBI registered FVCI can invest in a domestic venture capital fund registered under the SEBI (Venture Capital Fund) Regulations, 1996 or a Category- I Alternative Investment Fund registered under the SEBI (Alternative Investment Fund) Regulations, 2012.Such investments shall also be subject to the extant FEMA regulations and extant FDI policy including sectoral caps, etc. The investment can be made in equities or equity linked instruments or debt instruments issued by the company (including start-ups and if a startup is organised as a partnership firm or an LLP, the investment can be made in the capital or through any profit-sharing arrangement) or units issued by a VCF or by a Category-I AIF either through purchase by private arrangement either from the issuer of the security or from any other person holding the security or on a recognised stock exchange.It may also set up a domestic asset management company to manage its investments. SEBI registered FVCIs are also allowed to invest under the FDI Scheme, as non-resident entities, in other companies, subject to FDI Policy and FEMA regulations.
• A Non- Resident Indian may subscribe to National Pension System governed and administered by Pension Fund Regulatory and Development Authority (PFRDA), provided such subscriptions are made through normal banking channels and the person is eligible to invest as per the provisions of the PFRDA Act. The annuity/ accumulated saving will be repatriable.

Eligible investee entities

♠ Indian Company-  Indian companies can issue capital against FDI.

♠  Partnership Firm/Proprietary Concern

(i) A Non-Resident Indian (NRI) or a Person of Indian Origin (PIO) resident outside India can invest in the capital of a firm or a proprietary concern in India on nonrepatriation basis provided;

(a) Amount is invested by inward remittance or out of NRE/FCNR(B)/NRO account maintained with Authorized Dealers/Authorized banks.

(b) The firm or proprietary concern is not engaged in any agricultural/plantation or real estate business or print media sector.

(c) Amount invested shall not be eligible for repatriation outside India.

(ii) Investments with repatriation option: NRIs/PIO may seek prior permission of Reserve Bank for investment in sole proprietorship concerns/partnership firms with repatriation option. The application will be decided in consultation with the Government of India.

(iii) Investment by non-residents other than NRIs/PIO:A person resident outside India other than NRIs/PIO may make an application and seek prior approval of Reserve Bank for making investment in the capital of a firm or a proprietorship concern or any association of persons in India. The application will be decided in consultation with the Government of India.

♠  Trusts FDI is not permitted in Trusts other than in ‘VCF’ registered and regulated by SEBI and ‘Investment vehicle’.

♠  Limited Liability Partnerships (LLPs) FDI in LLPs is permitted subject to the following conditions:

(i) FDI is permitted under the automatic route in Limited Liability Partnership (LLPs) operating in sectors/activities where 100% FDI is allowed through the automatic route and there are no FDI-linked performance conditions.

(ii) An Indian company or an LLP, having foreign investment, is also permitted to make downstream investment in another company or LLP in sectors in which 100% FDI is allowed under the automatic route and there are no FDI-linked performance conditions.

(iii) Conversion of an LLP having foreign investment and operating in sectors/activities where 100% FDI is allowed through the automatic route and there are no FDIlinked performance conditions, into a company is permitted under automatic route. Similarly, conversion of a company having foreign investment and operating in sectors/activities where 100% FDI is allowed through the automatic route and there are no FDI-linked performance conditions, into an LLP is permitted under automatic route.

(iv) FDI in LLP is subject to the compliance of the conditions of LLP Act, 2008.

♠  Investment Vehicle An entity being ‘investment vehicle’ is permitted to receive foreign investment from a person resident outside India (other than an individual who is citizen of or any other entity which is registered / incorporated in Pakistan or Bangladesh), including an Registered Foreign Portfolio Investor (RFPI) or a non-resident Indian (NRI).

♠  Startup Companies Start-ups can issue equity or equity linked instruments or debt instruments to FVCI against receipt of foreign remittance, as per the FEMA Regulation. In addition, startups can issue convertible notes to person resident outside India subject to the following conditions:

(i) A person resident outside India (other than an individual who is citizen of Pakistan or Bangladesh or an entity which is registered / incorporated in Pakistan or Bangladesh), may purchase convertible notes issued by an Indian startup company for an amount of twenty five lakh rupees or more in a single tranche.

Explanation: For the purpose of this Regulation, a ‘startup company’ means a private company incorporated under the Companies Act, 2013 or Companies Act, 1956 and recognised as such in accordance with notification number G.S.R. 180(E) dated February 17, 2016 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, and as amended from time to time.

(ii) A startup company engaged in a sector where foreign investment requires Government approval may issue convertible notes to a non-resident only with approval of the Government. Explanation: For the purpose of this regulation, the issue of shares against such convertible notes shall have to be in accordance with the Schedule 1 of the Notification No.FEMA.20/2000-RB dated 3rd May 2000.

(iii) A startup company issuing convertible notes to a person resident outside India shall receive the amount of consideration by inward remittance through banking channels or by debit to the NRE / FCNR (B) / Escrow account maintained by the person concerned in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016, as amended from time to time. Provided that an escrow account for the above purpose shall be closed immediately after the requirements are completed or within a period of six months, whichever is earlier. However, in no case continuance of such escrow account shall be permitted beyond a period of six months.

(iv) NRIs may acquire convertible notes on non-repatriation basis in accordance with Schedule 4 of the Notification No.FEMA.20/2000-RB dated 3rd May 2000.

(v) A person resident outside India may acquire or transfer, by way of sale, convertible notes, from or to, a person resident in or outside India, provided the transfer takes place in accordance with the pricing guidelines as prescribed by RBI. Prior approval 15 from the Government shall be obtained for such transfers in case the startup company is engaged in a sector which requires Government approval.

(vi) The startup company issuing convertible notes shall be required to furnish reports as prescribed by Reserve Bank of India.

♠  Other Entities – FDI in resident entities other than those mentioned above is not permitted.

Sector where 100% FDI is allowed through automatic route are:

• Agriculture & Animal Husbandry including Floriculture, Horticulture, Apiculture and Cultivation of Vegetables & Mushrooms under controlled conditions[2], Development and Production of seeds and planting material, Animal Husbandry(including breeding of dogs), Pisciculture, Aquaculture and Services related to agro and allied sectors
• Plantation Sector including Tea sector including tea plantations, Coffee plantations, Rubber plantations, Cardamom plantations, Palm oil tree plantations and Olive oil tree plantations.
• Mining and Exploration of metal and non-metal ores, Mining of Coal & Lignite and Mining and mineral separation of titanium bearing minerals and ores, its value addition and integrated activities.
• Exploration of Petroleum and Natural Gas.
• Defence Manufacturing
• Broadcasting
• Civil Aviation both for airports and air transport services
• Construction Development: Townships, Housing, Built-up Infrastructures
• Industrial Parks (new & existing)
• Satellites– establishment and operation, subject to the sectoral guidelines of Department of Space/ISRO
• Single Brand Retail Trading[3]

Major sectors where FDI is permitted but caps are put on these sectors:

Detail analysis of some noteworthy amendments:

1. Abolishment of FIPB; New SOP for processing of FDI applications.

FDI proposals in sectors like mining, broadcasting, print media, civil aviation, satellites, telecommunications, banking, pharmaceuticals, would be approved by the relevant sector specific ministries/departments. Additionally, certain applications involving investments from Countries of Concern (like Pakistan and Bangladesh) or applications seeking investment in defence, telecommunications, broadcasting, satellite etc. would need security clearance from the Ministry of Home Affairs. DIPP has been notified as the Competent Authority to approve FDI proposals in the trading sector. In cases of sectors where there is a doubt about the Competent Authority, DIPP will identify the Competent Authority for processing of the application. The earlier requirement of proposals for FDI above Rs. 5,000 crore requiring consideration of the Cabinet Committee on Economic Affairs, however, continues to apply.

FDI proposals are required to be filed online on the revamped FIPB Portal (now Foreign Investment Facilitation Portal), which will thereafter be e-transferred by DIPP to the Competent Authority for necessary action. Submission of a physical copy would not be required if the online proposal has been signed digitally. DIPP will also circulate the proposal online to RBI, and proposals requiring security clearance would be additionally referred to the Ministry of Home Affairs. All proposals would also be forwarded to the Ministry of External Affairs and the Department of Revenue for information and comments. The SOP, thereafter, goes into step by step timelines for submission of comments by the consulted ministries/departments/RBI and expects the entire approval process to take approximately 8 weeks from the date of filing of a complete application with the Competent Authority and about 10 weeks for applications requiring security clearance.

2. Issuance of Convertible Notes by Start-Ups.

Earlier this year, RBI by its notification dated January 10, 2017permitted start-ups to issue ‘convertible notes’ to foreign investors, which was defined as an instrument evidencing receipt of money initially as debt, which is (a) repayable at the option of the holder, or (b) convertible into such number of equity shares of such startup company, within a period not exceeding five years from the date of issue of the convertible note, upon occurrence of specified events as per the agreed terms and conditions. Issuance of such convertible notes is, however, subject to certain prescribed conditions, such as:

• The convertible notes should be for a minimum amount of Rs. 25 Lacs in a single tranche.
• If the startup is in a sector where FDI requires Government approval, issuance of convertible notes to a non-resident or any transfer of such convertible note would also require Government approval.
• Issue of shares against convertible notes is to be in accordance with the Schedule 1 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000, which inter alia prescribe certain pricing guidelines. Similarly, acquisition or transfer of convertible notes between residents and non-residents would also need to be in accordance with the pricing guidelines prescribed by RBI, thereby treating them at par with other FDI instruments.
• The remittance of consideration can also be received in an escrow account which can continue until the requirements are completed (i.e. remittance of consideration into the issuer’s account and issuance of convertible notes to the investor) or a period of 6 months, whichever is earlier.

3. Conversion of a Company into LLP and vice versa: The FDI Policy – 2017, permits conversion of an Limited Liability Partnership (“LLP”) with FDI into a company, and conversion of a company with FDI into an LLP, under the automatic route, as long as the said LLP or company, is operating in a sector where 100% FDI is allowed under automatic route and where there are no FDI-linked performance conditions. A definition of ‘FDI Linked Performance Conditions’ has also been added, to mean sector specific conditions for companies receiving foreign investment.

4. Limit on additional FDI within approved foreign equity percentage or wholly owned subsidiary: Under the erstwhile FDI policy for the government route sector, any additional foreign investment into the same entity (which has already received government approval) within an approved foreign equity percentage or into a wholly owned subsidiary did not require prior government approval i.e., such approved entities could have generally received foreign investment exceeding Rs. 5000 crore without additional approval as long as (i) the earlier investments in the entity were government approved and (ii) such additional investments are within the approved foreign equity percentage. However, the FDI Policy-2017, has modified this paragraph and stated that additional foreign investment up to cumulative amount of Rs 5000 crore within the approved foreign equity percentage/or into a wholly owned subsidiary, would not require prior government approval. Therefore, by implication, any additional foreign investment beyond the said limit of Rs. 5,000 crores would require a fresh government approval.

5. Single Brand Retail Trading: In case the proposed FDI in a single brand retail trading (“SBRT”) entity is beyond 51%, sourcing of 30% of the value of goods purchased has to be done from India. However, the Press Note 5 of 2016, dated June 24, 2016 allowed SBRT entities undertaking trading of products having ‘state-of-art’ and ‘cutting-edge’ technology and where local sourcing is not possible, to seek exemption from these sourcing norms for a period of 3 (three) years from opening of its first store. Thereafter, the sourcing norms would become applicable. The FDI Policy-2017, reflects this change and further provides that examination of claims of applicants (and recommendations of relaxations) on the issue of products being in the nature of ‘state-of-art’ and ‘cutting-edge’ technology, where local sourcing is not possible would be undertaken by a committee under the Chairmanship of Secretary, DIPP.

Key changes in conditions related to single brand retail trading (SBRT) are as follows:

• For the initial five years, incremental sourcing by overseas companies, including their group companies for the specific brand will count towards the mandatory 30% local sourcing commitment.
• The requirement of license agreement between brand owner and investor has been removed.
• A Committee to be formed under the Chairmanship of Secretary, DIPP, with representatives from NITI Aayog concerned Administrative Ministry and independent technical expert(s) to examine the claim of applicants of the products being in the nature of “state-of-art” and “cutting-edge” technology, where local sourcing is not possible and give recommendations for such relaxation.

In the absence of clear definitions on what constitutes “state-of-art” and “cutting-edge” technology, constitution of this committee would allow applicants to approach the committee with their individual case and seek exemptions. However, to bring in further clarity, the Government should consider coming out with certain basic guidelines or qualifying parameters on the basis of which such applications would be examined and approved by the committee.

1. Wholesale Trading entity permitted to undertake both single brand and multi-brand retail trading: Earlier, a wholesale/cash & carry trader was not allowed to undertake retail trading in the same entity, which restriction was later relaxed and an entity undertaking wholesale trading was permitted to undertake single brand retail trading provided it maintained separate books of accounts for these two areas of business. The FDI Policy -2017 replaces the reference to “single brand retail trading” by “retail trading”, thereby allowing a wholesale/cash and carry trader to undertake both single brand and multi-brand retail trading in the same entity.

2. E-Commerce – Clarification on computation of 25% sales value cap: Last year saw detailed guidelines on FDI in the e-commerce sector being brought in by the Government, which inter alia restricted an e-commerce entity from permitting more than 25% of the sales affected through its marketplace from one vendor or their group companies. This restriction has been further clarified in the FDI Policy-2017 to be calculated as 25% of value of sales, on a financial year basis.

3. FDI in Construction Development: Townships, Housing, Built-up Infrastructure and Real Estate Broking – A new clause has been inserted, which states that real estate broking services do not amount to real estate business and 100% foreign investment is permitted under the automatic route.

4. Foreign investment in investing companies, NBFCs and CICs

• FDI in investing companies not registered as non-banking financial companies (NBFCs) with the RBI and
• FDI in Core investment companies (CICs), both engaged in the activity of investing in the capital of other Indian entities should require prior Government approval.
• FDI in investing companies registered as NBFCs with the RBI shall be under the 100% automatic route.

1. Joint Audit of Investee Companies – Where a person resident outside India (PROI) who has made foreign investment, specifies a particular auditor/audit firm with an international network, then the audit of the Indian investee company shall be undertaken by two or more auditors not forming part of the same network.

2. FDI in Air Transport Services- beyond 49% under the Government route, the notified regulations have amended the regulations to allow FDI beyond 49% under Government route.

• FDI in Air India Limited allowed under approval route, subject to the following conditions i.e., FDI not to exceed 49%, either directly or indirectly; and Substantial ownership and effective control shall continue to be vested in Indian Nationals.

1. FDI in Pharmaceuticals- The definition of medical devices amended in the regulations and its reference to Drugs and Cosmetics Act removed.

2. FDI in Power Exchanges- Foreign Institutional Investor/ Foreign Portfolio Investor permitted to invest even under the primary route (erstwhile only permitted under secondary route) within the overall cap of 49% in power exchanges registered under the Central Electricity Regulatory Commission (Power Market) Regulations, 2010.

Comment: Foreign investments have a deep impact on the economy of a fast growing country like India, and they have helped in achieving growth, developing the infrastructure, market and many other aspects of our country. FDI has an impact in many areas and is one of the key factors in the growth of the nation. A relation was established between FDI and GDP of our country as well as its effect on the ease of doing business ranking. The recent launch of the Make in India initiative has helped in attracting the FDI even more. The FDI has increased considerably due to this; as much as 23-25% in the year 2014 and 2015, right after the launch of Make in India. India is one of the emerging markets in the world, along with countries like China, Japan, and Brazil etc. However, in comparison to China; India is still far behind in attracting the investors. China has been the top priority of investors with approximately US$136 billion investments in the year 2015, while India only received an inflow of US$ 45 billion.