Introduction
- Overseas investments by Indian entities have been recognised as important avenues for promoting global business by Indian entrepreneurs. Overseas investments are perceived as a medium of economic and business co-operation between India and other countries. Overseas investments are also important drivers of foreign trade through increased exports from India and also a source of foreign exchange earnings.
- In keeping with the spirit of liberalisation and to promote ease of doing business, the Central Government and the Reserve Bank of India (RBI) have been progressively simplifying the procedures and rationalising the rules and regulations under the Foreign Exchange Management Act, 1999 (FEMA). In this direction, a significant step has been taken with operationalisation of a new Overseas Investment regime. Foreign Exchange Management (Overseas Investment) Rules, 2022 (‘OI Rules’) have been notified by the Central Government vide Notification No. G.S.R. 646(E) dated 22 August 2022 and Foreign Exchange Management (Overseas Investment) Regulations, 2022 (‘new OI Regulations’) have been notified by the Reserve Bank of India (RBI) vide Notification No. FEMA 400/2022-RB dated 22 August 2022 in supersession of the Notification No. FEMA 120/2004-RB dated 7 July 2004 [Foreign Exchange Management (Transfer or Issue of any Foreign Security) (Amendment) Regulations, 2004](‘erstwhile OI Regulations’) and Notification No. FEMA 7 (R)/2015-RB dated 21 January 2016 [Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015]. Further, Foreign Exchange Management (Overseas Investment) Directions, 2022 (‘new OI Directions’) have been issued on 22 August 2022 [vide A.P. (DIR Series) Circular No.12], which need to be read with OI Rules and new OI Regulations.
We, at BDO in India, have summarised these regulations and provided our comments hereunder. OI Rules, new OI Regulations and new OI Directions are collectively referred to as ‘new OI regime’ in the alert.
- Some of the significant changes brought about through the new OI regime are listed below:
- enhanced clarity with respect to various definitions and introduction of the concept of “strategic sector”
- dispensing with the requirement of approval for:
- deferred payment of consideration
- investment/disinvestment by persons resident in India under investigation by specified investigative agency/regulatory body
- issuance of corporate guarantees to or on behalf of second or subsequent level step down subsidiary
- write-off on account of disinvestment
- introduction of Late Submission Fee for reporting delays
Key regulations and changes are discussed hereunder
- ‘Overseas Investment’ means any investment by a person resident in India in a foreign entity, either directly, through Step Down Subsidiary (SDS) or through a Special Purpose Vehicle (SPV). The foreign entity must be engaged in a bona fide business activity.
- ‘Bona fide Business Activity’ means any business activity permissible under Indian laws and those of the foreign host country. The new OI regime also prescribes the manner and detailed conditions for making ODI depending on the category of the persons making investments including overseas investment by Indian entities and resident individuals, overseas investment by registered trusts, societies, mutual funds or Alternative Investment Funds (AIFs) and investment in an International Financial Services Centre (IFSC) by a person resident in India.
- ODI is prohibited in a foreign entity engaged in:
- real estate activity
- gambling in any form
- dealing with financial products linked to the Indian rupee without specific approval of the RBI.
- New OI regime shall not apply to:
- any investment made outside India by a financial institution in an IFSC.
- acquisition or transfer of any investment outside India made
- out of Resident Foreign Currency Account or
- out of foreign currency resources held outside India by a person who is employed in India for a specific duration irrespective of length thereof or for a specific job or assignment, duration of which does not exceed 3 years or
- in accordance with section 6(4) of FEMA i.e. holding, owning, transferring or investing in foreign currency/foreign security/any immovable property outside India if such currency/security/property was acquired, held or owned by such person when he was resident outside India or inherited from a person who was resident outside India.
Definitions
- Foreign Entity
The concept of Joint Venture (JV) and Wholly Owned Subsidiary (WOS) in the erstwhile OI Regulations is substituted under the OI Rules with the concept of foreign entity, which means an entity formed or registered or incorporated outside India, including in IFSC in India, that has limited liability.
- Indian Entity
The concept of an ‘Indian Party’ as defined under the erstwhile OI Regulations has been substituted with the concept of an ‘Indian entity’. Under the erstwhile regulations, all investors from India in a foreign entity were together considered as an ‘Indian Party’, but now each investor entity will be separately considered as an Indian entity.
- Strategic sector
The term ‘Strategic sector’ shall include energy and natural resources sectors such as Oil, Gas, Coal, Mineral Ores, submarine cable system and start-ups and any other sector or sub-sector as deemed fit by the Central Government.
The restriction of limited liability structure of foreign entity shall not be mandatory for entities with core activity in any strategic sector. Accordingly, Overseas Direct Investment can be made in such sectors in unincorporated entities as well.
An Indian entity is also permitted to participate in a consortium with other international operators to construct and maintain submarine cable systems on co-ownership basis.
Authorized Dealer (‘AD’) banks may allow remittances for ODI in strategic sector after ensuring that Indian entity has obtained necessary permission from the competent authority, wherever applicable.
- Control
The term ‘control’ means the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders’ agreements or voting agreements that entitle them to 10% or more of voting rights or in any other manner in the entity.
- Subsidiary/ Step Down Subsidiary (SDS)
Subsidiary or SDS of a foreign entity means an entity in which the foreign entity has control and the structure of such subsidiary/SDS shall comply with the structural requirements of a foreign entity, i.e., such subsidiary/SDS shall also have limited liability where the foreign entity’s core activity is not in strategic sector. The investee entities of the foreign entity where such foreign entity does not have control (as defined above) shall not be treated as SDSs.
- Overseas Direct Investment (ODI) and Overseas Portfolio Investment (OPI)
ODI means
- acquisition of any unlisted equity capital or subscription as a part of the Memorandum of Association of a foreign entity or
- investment in 10% or more of the paid-up equity capital of a listed foreign entity, or
- investment with control where investment is less than 10% of the paid-up equity capital of a listed foreign entity.
Once an investment in a foreign entity is classified as ODI, the investment shall continue to be treated as ODI even if such investment falls below 10% of the paid-up equity capital or the investor loses control in the foreign entity.
OPI means investment, other than ODI, in foreign securities subject to the specified conditions and exceptions.
- Financial commitment
Financial Commitment by a person resident in India means the aggregate amount of investment by way of ODI, debt other than OPI and non-fund-based facility or facilities extended by it to all foreign entities. An Indian entity may lend or invest in any debt instruments issued by a foreign entity or extend non-fund based commitment to or on behalf of a foreign entity, including overseas SDSs of such Indian entity, subject to the following conditions:
- the Indian entity is eligible to make ODI.
- the Indian entity has made ODI in the foreign entity.
- the Indian entity has acquired control in the foreign entity on or before the date of making such financial commitment.
The total financial commitment made by an Indian entity in all the foreign entities taken together at the time of undertaking such commitment shall not exceed 400%.
The new OI regime freely provides for issue of guarantees on behalf of any foreign entity or SDS, regardless of their level, provided such entity is controlled by the Indian entity. However, as provided under the erstwhile ODI Regulations, prior approval of the RBI would still be required in cases where the financial commitment by an Indian entity, exceeds USD 1 billion (or its equivalent) in a Financial Year (‘FY’) even when the total financial commitment of the Indian Entity is within the eligible limit under the automatic route (i.e. 400% of net worth of the Indian entity).
- Equity capital
“Equity capital” means equity shares or perpetual capital or instruments that are irredeemable or contribution to non-debt capital of a foreign entity in the nature of fully and compulsorily convertible instruments.
- Net worth
“Net worth” shall have the same meaning as assigned to it in clause (57) of section 2 of the Companies Act, 2013.
Specific provisions
- Financial commitment by way of guarantee and debt
The types of guarantees that can be issued and the conditions are similar to those provided in the erstwhile OI Regulations.
An Indian entity can lend or invest in any debt instruments issued by a foreign entity provided such loans are duly backed by a loan agreement and the rate of interest meets arm’s length standard.
Additionally, the new ODI regime provides that if the guarantee is extended by a group company, it will be counted towards the utilisation of that group company’s financial commitment limit independently, but where the guarantee is extended by a resident Indian promoter, it will be counted towards the financial commitment limit of the Indian entity.
- Financial commitment by way of pledge/charge
The new ODI regime has relaxed the conditions for leveraging offshore securities and offshore as well as onshore assets of Indian entity, by permitting creation of security in favour of an overseas lender. The provisions regarding financial commitment by way of pledge/charge are summarized below:
|
Security by Indian entity |
In whose favour |
Facility availed |
Amount reckoned towards financial commitment |
|---|---|---|---|
|
A. Pledge the equity capital of the foreign entity /its SDS outside India |
AD bank or a Public Financial Institution in India (‘PFI’) or an overseas lender. |
Fund/non-fund based facilities for Indian entity |
Nil |
|
Fund/non-fund based facilities for any foreign entity/its SDSs outside India |
The value of the pledge or the amount of the facility, whichever is less |
||
|
SEBI registered Indian debenture trustee |
Fund based facilities for Indian entity. |
Nil |
|
|
B. Create charge on its assets (other than A above) in India [including the assets of its group company or associate company, promoter and / or director].
|
AD bank / PFI / overseas lender
|
Fund/non-fund based facility for any foreign entity/its SDS outside India |
The value of charge or the amount of the facility, whichever is less |
|
Overseas or Indian lender |
Fund/non-fund based facilities for Indian entity. |
Nil |
|
|
C. Create charge on the assets outside India of the foreign entity/ its SDS outside India |
AD bank /PFI
|
Fund/non-fund based facility for any foreign entity/its SDS outside India. |
The value of the charge or the amount of the facility, whichever is less |
|
Fund/non-fund based facilities for Indian entity. |
Nil |
||
|
SEBI registered Indian debenture trustee |
Fund based facilities for Indian entity. |
Nil |
- Investment in financial services sectors
The new OI regime has now permitted Indian entities to invest by way an ODI in a foreign entity which is directly or indirectly engaged in financial services activity. The provisions pertaining to ODI in financial services activity are summarised below:
|
Indian entity |
ODI in foreign entity |
Conditions |
|---|---|---|
|
A. Engaged in Financial Services activity |
Engaged in Financial Services activity |
|
|
Not engaged in Financial Services activity |
Subject to the guidelines issued by the respective regulator |
|
|
B. Not engaged in Financial Services activity
|
Engaged in Financial Services activity except banking or insurance |
Indian entity has posted net profits during the preceding 3 FYs. However, an Indian entity not meeting 3-year profitability condition may make such ODI in a foreign entity in IFSC in India |
|
Engaged in general and health insurance
|
Apart from the 3 years profitability criteria, such insurance business is supporting the core activity undertaken overseas by such Indian entity such as health insurance to support medical/hospital business, vehicle insurance to support the manufacturing/export of motor vehicles, etc. |
|
|
C. ODI in any sector by banks and NBFCs regulated by the RBI shall be subject to such other conditions stipulated by the RBI. |
||
|
D. A foreign entity will be considered to be engaged in the business of financial services activity if it undertakes an activity, which if carried out by an entity in India, requires registration with or is regulated by a financial sector regulator in India. |
||
- ODI in start-ups
Any ODI in start-ups recognised under the laws of the host country or host jurisdiction as the case may be, shall be made by an Indian entity only from the internal accruals whether from the Indian entity or group or associate companies in India and in case of resident individuals, from own funds of such an individual. The AD bank shall obtain necessary certificate in this regard from the statutory auditors/chartered accountant of the Indian entity/investor.
- Round tripping
Save for certain specified sectors, new OI regime specifically prohibits any financial commitment by a person resident in India in a foreign entity that has directly or indirectly invested or invests into India at the time of making such financial commitment or at any time thereafter, resulting in a structure with more than 2 layers of subsidiaries. The old OI regulations were silent on this issue and by way of an FAQ, clarification was issued that the RBI will consider such structures on merits under the approval route.
While it appears that under the new OI regime, round tripping structures involving less than 2 levels of subsidiaries now do not require prior RBI approval, the same is not explicitly mentioned in the OI Rules.
- Transfer and divestment of overseas investment
The old OI regulations contained various conditions and restrictions regarding transfer and divestment of ODI by way of a write-off or where the divestment proceeds were less than the original investment amount. The new OI Guidelines have removed restrictions and conditions on write-off of investments provided that, such write-off is made in accordance with the fair market value for the foreign entity arrived as per internationally accepted valuation methodology.
- No Objection Certificate (NOC) from the lender bank/regulatory body/investigative agency
New OI regime provides for the requirement of a NOC in case the person resident in India who is seeking to invest outside India has a Non Performing Asset (NPA) or is classified as a wilful defaulter by any bank or is undergoing investigation by any investigation agency namely the Central Bureau of Investigation, Directorate of Enforcement and the Serious Frauds Investigation Office or a financial service regulator. The new OI regime places the onus on the investigating agency or lender bank to respond to such written applications for an NOC within 60 days, failing which it would be construed as a deemed no objection to the proposed transaction.
- Overseas investment by resident individuals
With effect from 5 August 2013, resident individuals (single or in association with another resident individual or with an Indian entity) were permitted to make ODI subject to the specified conditions. The new ODI regime additionally provides for the following:
- Where a resident individual has made ODI without control in a foreign entity that subsequently acquires or sets-up a subsidiary/SDS, such resident individual shall not acquire control in such foreign entity.
- Overseas investment by way of capitalisation, swap of securities, rights/bonus, gift and inheritance shall be categorised as ODI or OPI based on the nature of the investment. However, where the investment, whether listed or unlisted, by way of sweat equity shares, minimum qualification shares and shares/interest under Employee Stock Ownership Plan (ESOP)/Employee Benefits Scheme does not exceed 10% of the paid-up capital/stock of the foreign entity and does not lead to control, such Investment shall be categorised as OPI.
- In case of swap of securities, both the legs of the transaction shall comply with FEMA provisions, as applicable.
- Resident individuals are not permitted to transfer any overseas investment by way of gift to a person resident outside India.
- AD banks may allow remittances, towards acquisition of the shares/interest in an overseas entity under the ESOP/employee benefit scheme offered directly by the issuing entity or indirectly through a SPV/SDS.
- Foreign entities are permitted to repurchase the shares issued to residents in India under any ESOP Scheme provided (i) the shares were issued in accordance with the rules/regulations framed under FEMA (ii) the shares are being repurchased in terms of the initial offer document, and (iii) necessary reporting is done through the AD bank.
- Though there is no limit on the amount of remittance made towards acquisition of shares/interest under ESOP/Employee Benefits Scheme or acquisition of sweat equity shares, such remittances shall be reckoned towards the limit under the Liberalized Remittance Scheme (‘LRS’) of the person concerned.
- Overseas investment by a person resident in India, other than an Indian entity or a resident individual
A person resident in India, other than an Indian entity or a resident individual, may make overseas investment in accordance with Schedule IV of OI Rules. Additionally, OI Directions provide for the following:
- Mutual Funds (MFs) and Venture Capital Funds (VCFs)/Alternative Investment Funds (AIFs) registered with SEBI may, in accordance with paragraph 2 of Schedule IV of OI Rules, invest overseas in securities as stipulated by SEBI within an overall cap of USD 7 billion and USD 1.50 billion, respectively. Further, a limited number of qualified MFs are permitted to invest cumulatively up to USD 1 billion in overseas Exchange Traded Funds, as may be permitted by SEBI. Such investment shall be considered as OPI irrespective of whether the securities are listed or not.
- MFs/VCFs/AIFs desirous of availing this facility may approach SEBI for necessary permission. General permission is available to such investors for sale of securities so acquired.
- An AD bank, including its overseas branch, may acquire or transfer foreign securities in terms of host country regulations/laws, as applicable, in the normal course of its banking business. The provisions contained in OI Rules/Regulations shall not apply to such acquisition or transfer of foreign securities by an AD bank.
- Indian bank may acquire the shares of Society for Worldwide Interbank Financial Telecommunication (SWIFT) as per the by-laws of SWIFT, provided the bank has been permitted by the Reserve Bank for admission to the ‘SWIFT User’s Group in India’ as a member.
- Any overseas investment by the sole proprietorship or unregistered partnership firms may be made by the proprietor concerned or the individual partners concerned within their limit available under the LRS. If the proposed investment is in strategic sector, any application for making overseas investment in excess of the LRS limit may be made under the government approval route.
- Overseas investment by registered trust/society may be made under the approval route.
- Overseas investment in an IFSC in India by a person resident in India
A person resident in India may make overseas investment in an IFSC in India in accordance with Schedule V of OI Rules. Additionally, OI Directions provide for the following:
- A person resident in India, being an Indian entity or a resident individual, may make investment (including sponsor contribution) in the units of an investment fund or vehicle set up in an IFSC as OPI.
- The restriction of making ODI only in an operating foreign entity or not making ODI in a foreign entity engaged in financial services activity by resident individuals, shall not apply to an investment made in IFSC. Such investment, however, shall not be made in any foreign entity engaged in banking or insurance. Such foreign entity in IFSC may have subsidiary/SDS in IFSC. It may also have subsidiary/SDS outside IFSC where the resident individual does not have control in the foreign entity. Resident individual who has made ODI without control shall not acquire control in a foreign entity that subsequently acquires or sets-up a subsidiary/SDS outside India.
- Acquisition or Transfer of Immovable Property outside India
Any acquisition or transfer of immovable property outside India shall be governed by the provisions contained in Rule 21 of OI Rules. Additionally, OI Directions provide for the following:
An AD bank may allow an Indian entity having an overseas office to acquire immovable property outside India for the business and residential purposes of its staff, provided total remittances do not exceed the following limits as laid down for initial and recurring expenses, respectively:
a. Limit for initial expenses
Higher of the following:
- 15% of the average annual sales/income or turnover of the Indian entity during the last 2 FYs or
- up to 25% of the net worth.
b. Recurring expenses
10% of the average annual sales/income or turnover during the last 2 FYs.
Delay in Reporting
In case a person resident in India has made a delay in filing/submitting the requisite form/return/document, such person may file/submit the requisite form/return/ document, etc. and pay the Late Submission Fee (LSF) through the designated AD bank The LSF for delay in reporting of overseas investment related transactions shall be calculated as follows:
|
Sr. no. |
Type of reporting delays |
LSF Amount (INR) |
|
|
Form ODI Part-II/ APR, FLA Returns, Form OPI, evidence of investment or any other return which does not capture flows or any other periodical reporting |
7,500 |
|
|
Form ODI-Part I, Form ODI-Part III, Form FC, or any other return which captures flows or returns which capture reporting of non-fund based transactions or any other transactional reporting |
[7500 + (0.025% × A × n)]
|
Notes:
i. “A” is the amount involved in the delayed reporting.
ii. “n” is the number of years of delay in submission rounded-upwards to the nearest month and expressed up to 2 decimal points.
iii. Maximum LSF amount will be limited to 100% of ‘A’ and will be rounded upwards to the nearest hundred.
iv. Restriction on further financial commitment or transfer – Unless any delay in reporting is regularised, any further financial commitment towards foreign entity or transfer of investment shall not be allowed.
BDO comments
The new OI regime simplifies the existing framework for overseas investment by persons resident in India to cover wider economic activity and significantly reduces the need for seeking specific approvals. This will reduce the compliance burden and associated compliance costs.
The intention of the Central Government appears to encourage overseas investment opportunities for Indian entities and individuals. New OI regime will go a long way to reinforce faith of Indian investors in the Government's commitment to promote and provide ease in making overseas investments.
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