Shalini Singh & Aditi Utkarsha
The Department of Economic Affairs under Finance Ministry has released the new The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024[1] which marks a significant step to alter the rules which governs the foreign investments landscape in India. This amendment aligns with the broader plan of the Ministry of Finance to boost the India’s economic growth by simplifying and accelerating the flow of FDIs and OI. This modification alters the previous 2019 rules aiming to make the process of FDIs more simplified and favourable for India.
AMENDMENT IN DEFINITION
The first significant modification is regarding the definition of “control”. The new rules have equated the meaning of control for companies with the established definition under the Companies Act of 2013, but retained specific provisions for LLPs.[2] Control, for Limited Liability Partnerships (LLP), is still defined as the power to select the majority of designated partners who exercise sole control & authority over the policies of the partnership. This modification, which relocates the definition from Rule 23(7)(d) of 2019[3] to Rule 2 of the Non-debt Instruments Rules, 2024 is a strategic move towards regulatory simplification rather than a fundamental change in the rules. Its mainly function is to standardize definitions across various legal frameworks, making compliance and interpretation more straightforward for both enterprises and investors.
The definition of a startup company has also been aligned with the DPIIT guidelines of 2019[4] in the foreign investment regulation of India. As per the new definition, a private company that was incorporated under the Companies Act, 2013[5] and meets the DPIIT’s recognition requirement shall be considered a startup company or firm. The updated regulation have expanded the ambit of startup recognition by extending the eligibility term to ten years from the date of incorporation instead of five years. Additionally, the threshold for turnover for any fiscal year has also been enhanced from INR 250 million to INR 1 billion since the inception of the company.
ADDITION OF RULE 9A
A new rule 9A[6] relating to “Swap of equity instruments and equity capital” has been added to the original rules of 2019. This newly added rule 9A of the original act, significantly alters how swapping equity instruments within cross-border transactions will take place. This amendment permits two types of swaps: first, between equity instruments of Indian companies or business, and second, between Indian company shares and foreign enterprises equity capital. Both residents and non-residents can participate in these swaps with a condition that they abide by the RBI regulations and overseas investment rules.
An important point to note is the requirement of the government approval. The rule had previously required the need for such approval in only a certain area where it was by non-residents and in specific sectors. However, it is made clear now that wherever such a requirement is there under current legislation, government approval or clearance would mandatorily be required. In other words, wherever the transaction is between land bordering countries with India, as specified under Press Note 3 of 2020, without distinction of the sector, the approval is required.
Previously, share swaps were only covered under pricing guidelines, but Rule 9A now offers a dedicated framework for these transactions. It is anticipated to increase cross-border share swap transactions because it will provide a guideline and will bring the necessary regulatory procedures or checks into place. The definition of ‘equity capital’ in these transactions follows the Overseas Investment Rules, ensuring uniformity across regulations.
DOWNSTREAM INVESTMENT
In Downstream investment, an Indian entity receives Foreign Direct Investment (FDI) and then invests it in other Indian companies or Limited Liability Partnership (LLP). With the notification of this new rule, an amendment has been made in Rule 23(7)(i) explanation[7] where an investment is made by an Indian entity that is owned and controlled by an NRI or an OCI including a company, a trust, or a partnership, owned or controlled by an NRI or an OCI in compliance with the rules given in Schedule IV of this rule on a non-repatriation basis, will not be taken into account while calculating or determining indirect foreign investment. Here, non-repatriation means that the funds that have been invested in a country cannot be transferred back to the investor’s home country. Earlier, the explanation only referred to investments made by Indian entities owned and controlled by an NRI.[8]
The revision in this rule reflects a more inclusive approach and aligns with the broader endeavour by the Ministry of Finance to simplify the regulations pertaining to foreign investments. Additionally, this amendment will also have a favourable impact on Alternative Investment Fund (AIF) managed by NRIs or OCIs. Earlier such funds were categorized as FDI and faced regulatory restrictions however, now after the amendment if an AIF is owned or controlled by NRI or OCI, such investment will be treated as a part of domestic funds.
AMENDMENT IN SCHEDULE 1 PARAGRAPH 1(d)
Earlier, government approval was required only for an Indian Company which was operating in a sector under a government route to issue an equity instrument, against a swap of equity instrument, import of capital goods or machinery or equipment (excluding second-hand machinery), or preoperative or pre-incorporation expenses (including payment of rent, etc.) to a person resident outside India.[9] While issuing the equity instrument, the entities were subject to the conditions or guidelines prescribed by the central government and RBI.
After the latest amendment, now government approval is not only limited to a particular scenario, that is through the government route, but it covers all cases where government approval is required or necessary.[10] Application for such approval must be made in a manner prescribed by the Central government. Another significant shift is that Indian companies may issue equity instruments to a person resident outside India against a swap of equity capital of a foreign company in compliance with the rule prescribed by Foreign Exchange Management (Overseas Investment) Rules 2022.
FPI INVESTMENT LIMIT
In 2019 rules, in aggregate foreign portfolio investment up to 49% or sectoral cap whichever was lower, government approval or adherence to sectoral conditions was not necessary as long as such investment did not result in transfer of ownership or control. The new rule introduced significant changes to Paragraph 3(a)(iii) of Schedule I[11], where the limit to 49% has been removed and now FPIs up to the sectoral or statutory cap are exempted from any government approval if it does not cause a change in ownership or control.[12] However, investment made by a person resident outside India still have to adhere to the government approval and compliance with sectoral conditions. This change will allow a smoother capital inflow through FPI by easing the restriction.
FDI IN WHITE-LABEL ATM OPERATION
The amended rule includes the addition of a new entry in the table namely SL. No. F.11 & F.11.1. It allows 100% FDI via automatic route for the White label ATM Operations (WLAO).[13] The entity wishing to set up a WLAO should have a minimum net worth of one hundred crore rupees as per the latest financial year and it must be continuously maintained. If such a non-banking entity wishing to set up WLAO, is engaged in other financial services also, then it should also comply with the minimum capitalization requirements of the other financial services. Such FDIs have to follow the rules and regulations issued by RBI under the Payment and Settlement Systems Act, 2007.
REMOVAL OF RIGHTS
The rights that arises when two or more FPI’s including foreign governments & their related entities have control of more than 50%, have been eliminated by the newly amended rules which were explicitly mentioned in the previous rules.[14] Previously, this kind of control used to include the right to appoint the majority of the directors or to control the management or policy. Now, no such rights have been listed in Paragraph 1(a)(ii) of Schedule II.
CONCLUSION
The latest amendments to India’s foreign investment rules represent a significant update in cross-border transaction regulations. Removing the compulsion to obtain RBI approval for share swaps between an Indian party and a foreign party brings a measure of simplicity to the transactions across international boundaries. A uniformity of some of the important definitions, streamlining the investment regulations of an OCI with that of an NRI, and the addition of White Label ATMs to the list of new sectors available for foreign investment have been provided through this new amendment. These changes are intended to promote the business expansion across the globe and maintain regulatory stability to make India a more attractive destination for international investment while enabling Indian companies to compete more successfully at a global scale.
Notes:-
[1] The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024 (India).
[2] The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024, Rule 2 (India).
[3] The Foreign Exchange Management (Non-debt Instruments) Rules, 2019, Rule 23 (India).
[4] Department for Promotion of Industry and Internal Trade, Guidelines for Public Procurement (2019).
[5] The Companies Act, 2013, No. 18 of 2013, Acts of Parliament (India).
[6] The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024, Rule 9A (India).
[7] The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024, Rule 5 (India).
[8] The Foreign Exchange Management (Non-debt Instruments) Rules, 2019, Rule 23 (India).
[9] The Foreign Exchange Management (Non-debt Instruments) Rules, 2019, Schedule 1(India).
[10] The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024, Rule 6 (i) (India).
[11] The Foreign Exchange Management (Non-debt Instruments) Rules, 2019, Schedule 1 (India).
[12] The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024, Rule 6 (ii)(India).
[13] The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024, Rule 6 (iii) (India).
[14] The Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024, Rule 7 (India).
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