Investment in companies outside India by Indian entrepreneurs and portfolio investors is an important avenue for promoting global business. Also, Indian companies invest outside India across the globe to take the benefits of lower cost of production.
Another rationale for investment outside India is the need for diversification of investments. Diversification is a well-accepted investment management strategy for mitigating the risks which can be achieved by investing in avenues that are independent of Indian economic factors too much extent. While usually, investors diversify their portfolios by investing across different asset classes like equity, debt, and gold, investing in international markets is another way to do so. Investment in developing countries is most favoured for investment since such countries have the highest prospects for growth and returns.
Broadly categorized, investment outside India can be made by Indian Corporate, Persons Resident in India (Individuals), Partnership firms in India, or Indian Trusts. Further, the ultimate purpose can either be a long-term strategic investment with the intention of getting control known as ‘Direct Investment’ over the entity or it can be with the intention to merely enjoy the income on these investments known as ‘Portfolio Investment’.
The purpose of this article is to provide a brief summary of who is eligible to make an investment in the companies outside India and the regulations governing the same.
The transaction of the Indian party outside India with respect to the purchase and sale of the securities outside India is the capital account transaction in terms of section 6 of the Foreign Exchange Management Act, 1999 (hereinafter referred to as ‘FEMA’). It is regulated and governed by the FEMA (Transfer or Issue of any Foreign Securities) Regulations 2004 vide Notification No. FEMA. 120/RB-2004 dated 7 July 2004 (hereinafter referred to as ‘ODI Regulations’)
The ODI Regulations seek to regulate the acquisition and transfer of foreign securities by the Indian entities in overseas Joint Ventures (‘JV’) and Wholly Owned Subsidiaries (‘WOS’) and as also investment by a person resident in India in shares and securities outside India.
The term JV/WOS has been defined under the FEMA ODI Regulation as:
“Joint Venture (JV)” means a foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country in which the Indian party makes a direct investment”;
“Wholly Owned Subsidiary (WOS)” means a foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country, whose entire capital is held by the Indian party”
The term direct investment is defined in Regulation 2(e) of the ODI Regulations, “Direct Investment outside India means”
Investment by way of contribution to the capital or subscription to the Memorandum of Association of a foreign entity or by way of purchase of existing shares of a foreign entity either by market purchase or private placement or through stock exchange, but does not include portfolio investment.
The whole crux of the investment outside India is in the definition of “Direct Investment outside India”. Hence, it is important to analyse the aforesaid definition.
The investment can be made by way of the contribution to the capital of the Company. If the investment-making entity is a partnership firm, the individual partner will hold the shares on behalf of the firm. However, the funds will be provided by the partnership firm. Another way is by subscribing to MOA and AOA of the Company outside India. Shares of the company outside India can be purchased through market purchase, private placement or through a stock exchange.
The definition of Direct investment outside India specifically excludes the portfolio investment. Now the immediate question arises as to what portfolio investment means. The term portfolio Investment is not defined under the ODI regulations. However, one can make a reference to the Foreign Direct Investment Regulations, which classify the investment as Foreign Portfolio Investment, if the investment is less that 10% in the listed companies. Hence investment equal to or above 10% in the listed companies outside India can be considered as ODI.
Moreover, on 9th August 2021, RBI came out with a set of new proposed framework governing Outbound Investments-ODI architecture in India. These regulations, although not yet notified till date, were drafted in a manner to imitate the structure of inbound investments in India. It is important to note that for investments in listed companies to count towards ODI, a numerical limit of 10% has been introduced. On the other hand, for unlisted companies, the threshold requirement for triggering the Draft Rules has been made stricter. A reading of the definition of ODI and OPI indicates that any and all amounts of investment in an unlisted foreign entity would fall under the regulatory ambit of the Draft Rules. Accordingly, it should be noted that even small investments made inter alia under RBI’s Liberalised Remittance Scheme (“LRS”) will trigger compliance with the Draft Rules.
From the above discussion, a conclusion can be drawn that under the current scenario until the draft rules are notified, Indian companies cannot invest below 10% in the companies listed outside India. Since the definition of Direct Investment outside India excludes Direct Investment outside India on that occasion we refer to the FDI Regulation to check the definition of the same which classifies the investment below 10% as Foreign Portfolio Investment.
For Direct Investment outside India by an Individual, it is important to refer to the Master direction on LRS which allows the resident individual to invest outside India in :
(i) acquisition and holding of both listed and unlisted entities;
(ii) debt instrument;
(iii) acquisition of qualification shares of an overseas company for holding the post of Director;
(iv) acquisition of shares of a foreign company towards professional services rendered or in lieu of Director’s remuneration;
(v) investment in units of Mutual Funds, Venture Capital Funds, unrated debt securities, and promissory notes;
The limit prescribed under the LRS is USD 2,50,000/-. Without any approval of the RBI. If the investment is a portfolio investment then the only requirement is to file out Form A2. Form A2 is an application cum declaration form for the drawal of foreign exchange and that the person has complied with all the requirements of FEMA.
Prohibition on Investments
There are no restrictions on the sectors in which investment can be made by the Person Resident in India or the Indian entities. However, investment in the following sector is prohibited by and cannot be made with the prior approval of the RBI are real estate business and banking business.
Further, Real estate is defined under the ODI Regulations as ) “Real estate business” means buying and selling of real estate or trading in Transferable Development Rights (TDRs) but does not include the development of townships, construction of residential/commercial premises, roads or bridges;
Concept of Round tripping
Round tripping is a practice where funds are transferred from one country to another and transferred back to the origin country for purposes like black money laundering or to get the benefit of tax concession/evasion/avoidance from countries like Mauritius which enjoy low taxes etc. Due to these reasons, RBI has always prohibited such transactions.
The RBI through the FAQ No. 64 of ODI in 2019 clarified its position on round tripping. It strictly prohibited such investments under the automatic route, but allowed them under the approval route i.e., with prior approval of the RBI on case-to-case basis.
However, it is pertinent to know that RBI has eased up this restriction by introducing the draft Foreign Exchange Management (Non-debt Instruments – Overseas Investment) Rules, 2021 dated August 9th 2021.
The RBI now seeks to liberalise this restriction to promote ease of doing business. It provides that, if such round tripping is for the purpose of tax evasion/ avoidance, then it shall be prohibited. So it may be safe to assume that, if the practice is not for tax evasion, it shall be permitted, thus liberalising the restriction.
Authors- CA Chintan Rachh & CA Priyanka Hotchandani.
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