New regulation on foreign investment in India
12 January 2018
The Reserve Bank of India (RBI) has notified a new regulation for governing foreign investment in India vide a notification dated 07 November 2017, i.e., Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (New Regulation).
The New Regulation has replaced Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (notification no. FEMA 20/2000-RB dated 03 May 2000) and Foreign Exchange Management (Investment in Firm of Proprietary Concern in India) Regulations, 2000 (notification no. FEMA 24 /2000-RB dated 03 May 2000) (Old Regulations).
The New Regulation has introduced the following definitions:
Capital instruments: The definition of the term capital instrument has been inserted in the New Regulation replacing the term capital. The term capital instruments has been defined to include equity shares (including partly paid-up shares), debentures, preference shares and share warrants. The following additional clarifications have also been inserted in the definition of capital instrument:
(a) Issue of warrants: In terms of the Old Regulations, the definition of the term warrant included share warrants issued by an Indian company in accordance with the provisions of the Companies Act, 2013 (Act). However, the New Regulation provides that share warrants are those issued by an Indian company in accordance with the regulations issued by the Securities and Exchange Board of India. It appears that the implication of this may be that under the new regime, only listed Indian companies might be able to issue share warrants to persons resident outside India.
(b) Consideration for share warrants: The New Regulation has made a provision clarifying the manner in which the consideration for issue of share warrants may be received. It provides that 25% of the consideration is required to be received upfront and the balance amount within a period of 18 months of issuance of share warrants.
(c) Issue of partly paid shares: The New Regulation has also provided a clarification with respect to the issue of partly paid shares. It requires 25% of the total consideration amount to be received upfront and the remaining consideration to be fully called up within a period of 12 months of issuance.
Foreign direct investment (FDI): The term has been defined to mean investment through capital instruments made by a person resident outside India in an unlisted Indian company or in 10% or more of a listed Indian company.
Foreign investment: The term foreign investment has been defined to mean any investment made by a person resident outside India on a repatriable basis. Under the New Regulation, non-repatriable investments are treated at par with domestic investments.
Sectoral cap: The New Regulation defines the term sectoral cap as the maximum investment including both foreign investment on a repatriation basis and indirect foreign investment.
Change in provisions of foreign portfolio investment (FPI)
The New Regulation provides a clarity in relation to FDI and FPI in case of a listed Indian company. Any investment made by a person resident outside India in a listed Indian company that is less than 10% of the post issue paid-up share capital (on a fully diluted basis) or less than 10% of the paid-up value of each series of capital instruments of a listed company will be regarded as FPI. However, if the investment increases to 10% or more, it will be reclassified as FDI.
Changes in sectoral cap
(a) Private security agencies: The sectoral cap for private security agencies was increased to 74% (automatic up to 49% and government route beyond 49%) vide the Consolidated Foreign Direct Investment Policy, 2017. The New Regulation has reduced the sectoral cap from 74% to 49% under the approval route. The amendment has been made to align the regulation with the requirement mentioned under the Private Security Agencies (Regulation) Act, 2005.
(b) Commodities spot exchanges: A sectoral cap of 49% under the automatic route has been specified for investments in commodities spot exchanges. Guidelines for investments will be prescribed by the Government in due course.
Payment of dividend on preference shares
The Old Regulations provided that the rate of dividend on preference shares or convertible preference shares must not exceed a limit of 300 basis points over the prime lending rate of State Bank of India. This cap on payment of dividend on preference shares has been removed under the New Regulation.
Issue of capital instruments
The timeline for the issue of capital instruments has been changed from 180 days to 60 days from the date of receipt of consideration. This change has aligned the New Regulation with the requirements of the Act. The New Regulation further provides that in case of non-issuance of capital instruments within a period of 60 days of receipt of consideration, it shall be refunded by outward remittance to the persons concerned.
Changes in reporting requirements
Under the old regime, the onus of submitting Form FC-TRS in case of a transfer was on the transferor/transferee, resident in India. In terms of the New Regulation, in addition to the transferor/transferee resident in India, the onus of reporting the transfer of capital instruments is also on the person resident outside India holding capital instruments on a non-repatriable basis.
The New Regulation has also introduced a late fee payment in case of delayed reporting/filings with the RBI. The RBI, in consultation with the Central Government, is permitted to determine the amount of fee to be levied on the person responsible for filing the forms.
Transfer of capital instruments
The Old Regulations allowed a non-resident Indian (NRI) or an overseas corporate body (OCB) to transfer the capital instruments held by them to only another NRI or OCB. The New Regulation has, however, permitted transfers by an NRI or OCB to any person resident outside India subject to the prescribed conditions.
The New Regulation expressly permits transfer of capital instruments of an Indian company pursuant to liquidation, merger, demerger, amalgamation of entities incorporated or registered outside India.
The New Regulation has amended the definition of downstream investment to include investment by a limited liability partnership (LLP) or any other form of investment vehicle in a downstream Indian company or LLP. Accordingly, the definition of downstream investment now includes investment received by an Indian company or LLP from another Indian company or LLP or any investment vehicle made in accordance with the New Regulation.
(a) The New Regulation clarifies that the total foreign investment shall be calculated on a fully diluted basis. The term fully diluted basis has been defined to mean the total number of shares that would be outstanding if all possible sources of conversion are exercised.
(b) The valuation of capital instruments required to be done as per internationally accepted pricing methodology on an arms length basis of an unlisted Indian company can now also be done by a practicing Cost Accountant.
(c) In case of a merger, amalgamation, demerger or any other similar arrangement, the Old Regulations provided that the transferee company may issue shares to the shareholders of a transferor company resident outside India, subject to the prescribed conditions. Indian companies are now permitted to issue any capital instruments to the existing holders of the transferor company resident outside India.
• The New Regulation consolidates all the amendments that were made to the Old Regulations and also incorporates certain new concepts with respect to the issue or transfer of securities of an Indian company by a person resident outside India.
• The New Regulation provides clarity on various matters such as foreign investment to be calculated on a fully diluted basis and the difference between FDI and FPI. This would help in providing an approachable regulatory framework for foreign entities to make investment in India.
• The introduction of a penalty on delayed reporting would help an investor to regularize the contravention by payment and is a time-efficient method as the person concerned can avoid going in for compounding.
• Various matters have also been aligned with the requirements mentioned under the Companies Act, 2013, which would help bring in greater clarity.