Gift of Foreign Securities to Indian Individuals – A FEMA Refresher

Background

In August 2022, the regulation of overseas investments by persons resident in India underwent a change with the Foreign Exchange Management (Overseas Investment) Rules, 2022, the Foreign Exchange Management (Overseas Investment) Regulations, 2022, and the Foreign Exchange Management (Overseas Investment) Directions, 2022 (collectively, “ODI Regime”) replacing the erstwhile Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (“Erstwhile Regulations”). Whilst the Erstwhile Regulations provided general permission for persons resident in India to acquire equity capital of a foreign entity (for ease of reference, “foreign securities”), the ODI Regime specifies that acquisition of foreign securities by an Indian resident individual by way of gift from a person resident outside India must also be in accordance with the Foreign Contribution (Regulation) Act, 2010 (“FCRA”) and the Foreign Contribution (Regulation) Rules, 2011 (“FCRR”).

Whilst the FCRA regulates acceptance and utilization of “foreign contribution” by certain Indian individuals and entities and imposes specific guidelines in relation thereto, it remains ambiguous in relation to acquisition of foreign securities by resident individuals. The key regulatory considerations below aim to bridge the gap between the ODI Regime and the FCRA in relation to legal compliances for receipt of foreign contribution in the form of foreign securities by way of gift from a person resident outside India.

Acquisition of Foreign Securities by Indian Individuals

A. ODI Regime Considerations

The following key legal considerations apply to overseas investment by an Indian resident individual:

1. ODI vs. OPI: Acquisition of foreign securities that are either unlisted or constitutes 10% or more of the paid-up equity capital of a listed foreign entity or otherwise constitutes control through the right to appoint majority of directors or control over management or policy decisions of such listed foreign entity, is reckoned as “overseas direct investment” (ODI). On the other hand, any acquisition of foreign securities which is not an ODI investment, is reckoned as “overseas portfolio investment” (OPI).
2. Bona fide Business Activity: Overseas investment can only be made in a foreign entity engaged in a bona fide business activity (i.e., any business activity permissible under any law in force in India and the host country/ jurisdiction) either directly or through a step-down subsidiary. Further, ODI investment cannot be made in a foreign entity engaged in real estate activity, gambling in any form, or dealing with financial products that are linked to the Indian Rupee without specific approval of the Reserve Bank of India (RBI).
3. Financial Services Sector: An Indian resident individual must also make ODI investment only in an operating foreign entity, which is not engaged in financial services activities and which does not have a subsidiary or a step-down subsidiary where such individual has control. “Financial services activities” has been defined to mean activities, which if carried out by an entity in India, require registration with, or will be regulated by, a financial sector regulator in India.
4. Liberalised Remittance Scheme Limit: Under the Master Direction on Liberalised Remittance Scheme (“LRS”) dated January 1, 2016 (as amended) issued by the RBI, Indian resident individuals are allowed to remit up to USD 250,000 (or equivalent) per financial year (i.e., from April to March) for making overseas investment – however, this limit does not apply to remittances for OPI investment via acquisition of foreign securities as sweat equity or under an employee stock option/ benefits plan/ scheme. In any case, the LRS limit would not be applicable in the case of gift received by an Indian resident individual.
5. Round Tripping: An Indian resident individual may make financial commitment (which includes ODI investment, debt, and non-fund based commitments) in a foreign entity that has, directly or indirectly, invested or invests into an Indian entity (either at the time of investment or in the future), only if the resulting investment structure is limited to 2 layers of subsidiaries of the foreign (investee) entity (including the Indian entity). A “subsidiary” under the ODI Regime is reckoned through “control” by the foreign entity (i.e., where the foreign entity has 10% or more stake or otherwise exercises control in another entity through the right to appoint majority of directors or control over management or policy decisions).

B. FCRA Considerations

If the manner of overseas investment is by way of gift received by a resident individual from a person resident outside India, compliances under the FCRA additionally apply and such gift of foreign securities constitutes a “foreign contribution” under Section 2 of the FCRA.

1. Restricted Individuals: Under Section 3, receipt of such foreign contribution by a resident individual is prohibited if such individual is any of the following: (a) candidate for election; (b) correspondent, columnist, cartoonist, editor, owner, printer or publisher of a registered newspaper; (c) public servant, judge, government servant or employee of any corporation or any other body controlled or owned by the Indian government; (d) member of any legislature in India; (e) office-bearer of any political party in India; or (f) correspondent or columnist, cartoonist, editor, owner of an association or company engaged in the production or broadcast of audio news or audio visual news or current affairs programmes through any electronic mode, or any other electronic form or any other mode of mass communication.
2. Further, a resident individual must also not receive the foreign contribution on behalf of any of the persons mentioned above, or on behalf of any political party in India or an organization of a political nature, or on behalf of an association or company engaged in the production or broadcast of audio news or audio visual news or current affairs programmes through any electronic mode, or any other electronic form or any other mode of mass communication.
3. Exempted Transactions: Section 4, however, provides an exemption to certain transactions from the restrictions imposed by Section 3, which includes: (i) a gift received as a member of any Indian delegation in accordance with the Foreign Contribution (Acceptance or Retention of Gifts or Presentations) Rules, 2012; and (ii) receipt of foreign contribution from a “relative.” The term “relative” has the same meaning as under the Companies Act, 2013 (i.e., members of a Hindu Undivided Family, spouses, parents (including step-parents), children and their spouse, and siblings (including step-siblings)).

Accordingly, under the FCRA, a person who is prohibited from receiving foreign contribution under Section 3 may nevertheless receive foreign contribution in the form of foreign securities gifted by a person resident outside India, provided that: (i) such person resident outside India is a relative of the resident individual; and (ii) other applicable provisions of FCRA are complied with and the transaction is not otherwise prohibited under the Unlawful Activities (Prevention) Act, 1967.

Reporting Obligations 

1. Foreign securities received by resident individual from a person resident outside India as a gift, which constitutes ODI, must be reported to the RBI through its authorized dealer bank in Form FC along with the requisite documents for obtaining a unique identification number. Further, where such foreign securities also constitute 10% or more of the paid-up equity capital of the foreign entity or otherwise constitutes control, the resident individual will also be required to file an annual performance report (Form APR) with respect to the foreign entity by December 31 every year.
2. On the other hand, if the acquisition through gift is reckoned as OPI investment, no filing is contemplated under the ODI Regime.
3. Separately, Rule 6 of the FCRR creates an intimation requirement for receipt of foreign contribution from a relative. Such foreign contribution, notwithstanding whether it is reckoned as ODI or OPI investment under the ODI Regime, must be reported in Form FC-1 if it is in excess of INR 1,000,000, within 3 months from the date of receipt of such contribution. However, Rule 17 of FCRR creates a blanket requirement for submitting Form FC-1 to report foreign contribution relating to foreign securities received by every person, without specifying any threshold for the value of the foreign securities. Such Form FC-1 must also be certified by a chartered accountant.

Accordingly, the person resident in India receiving foreign securities by way of gift from a person resident outside India shall report the same in Form FC under the ODI Regime (if the acquisition is an ODI investment) and Form FC-1 under the FCRA. A reporting in Form APR under the ODI Regime will not be required if such foreign securities amount to less than 10% of the paid up equity capital without control in the foreign entity, and there is no other financial commitment other than by way of equity capital.

Disposal of Foreign Contribution

The transfer of foreign securities held by the resident individual to a person resident outside India in compliance with the above guidelines should be undertaken taking into account the following key requirements under the ODI Regime. If the transfer is to another person resident in India, such transferee must be eligible to make the underlying overseas investment under the ODI Regime.

• Lock-in Requirement: If an Indian resident individual has acquired foreign securities under the ODI investment route, transfer is permitted after a lock-in period of one year.
• No Dues: If an Indian resident individual has acquired foreign securities under the ODI investment route, transfer is permitted when all dues outstanding to the transferor as an investor are satisfied by the foreign entity.
• Swap Permitted only through Merger: There can be no swap of the foreign securities held by the resident individual for foreign securities of any other entity, other than on account of a merger, demerger, amalgamation or liquidation, with the approval of the competent authority as per the applicable laws in the host jurisdiction.
• Price and Valuation Report: The price paid to the resident individual from an offshore buyer for the foreign securities must be the fair market value, determined on the basis of a valuation report prepared by a chartered accountant in accordance with an internationally accepted pricing methodology on an arm’s length basis. The authorized dealer bank of such resident individual proposing to transfer foreign securities, is required to ensure compliance with such arm’s length pricing prior to facilitating such transfer.

Each such bank is also required to have in place a board approved policy, inter alia covering requirements around documents required to facilitate the transfer (including the valuation report), circumstances where valuation may not be insisted on (e.g., in case of a merger, where price has been approved by a governmental authority or where the price is available on a stock exchange), etc. The relevant bank’s policy may have also set a tolerance or deviation limit in relation to transfer price qua the valuation of the foreign securities and the reasons for which such deviation may be permitted. Therefore, the parties to the transfer must consult with the resident individual’s bank prior to consummating the transfer.

• Payment of Consideration: The consideration for the foreign securities must be paid directly into the Indian bank account held by the resident individual, or, if paid outside of India, must be repatriated by them to India within 90 days.
• Deferred Consideration: Whilst the ODI Regime does not explicitly permit or prohibit payment through deferred consideration for transfer of foreign securities between two resident individuals, payment of consideration on a deferred basis by a person resident outside India for foreign securities held by a resident individual under the ODI investment route is permissible provided that: (i) such consideration is deferred for a definite period as set out under the purchase agreement; (ii) the foreign securities equivalent to the amount of total consideration must be transferred upfront; and (iii) the full consideration finally paid must be compliant with the pricing requirement set out at (D) above.
• Transfer by way of Gift: Resident individuals are not permitted to transfer their foreign securities to a person resident outside India by way of gift.
• Reporting under ODI Regime: While undertaking such transfer, the resident individual holding foreign securities under the ODI investment route would have to file Form FC under the ODI Regime to report their disposal of these foreign securities within 30 days of receipt of the inward remittance. In case of deferred consideration, a filing in Form FC is required to be made within 30 days of each tranche of inward remittance.
• Reporting under FCRA: Further, under Section 7 of the FCRA, no person who is registered and granted a certificate or has obtained prior permission for acceptance of foreign contribution, and receives any foreign contribution, is permitted to transfer such foreign contribution to any other person. However, FCRA remains silent on the transfer of foreign contribution by a person who is undertaking an exempted transaction under Section 4. Accordingly, whilst the FCRA does not provide for a specific filing in case of a transfer/ disposal of foreign securities held by a resident individual, Part B of Form FC-1 must be filed by the resident individual as it provides for a reporting on the disposal of such securities and related details thereto.