With a view to liberalise and simplify the regulatory framework on overseas investments and to promote ease of doing business, the Central Government has issued the Foreign Exchange Management (Overseas Investment) Rules, 2022 (‘ODI Rules’). The Reserve Bank of India (‘RBI’) has simultaneously issued the Foreign Exchange Management (Overseas Investment) Regulations, 2022 (‘ODI Regulations’) and the Foreign Exchange Management (Overseas Investment) Directions, 2022 (‘ODI Directions’, which together with the ODI Rules and the ODI Regulations, are referred as (‘ODI Guidelines’). Set out below are a few key changes brought about under the ODI Guidelines:
Concept of JV/WOS Substituted by ‘Foreign Entity’
The erstwhile Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (‘FEMA 120’) permitted Indian parties to extend loan or guarantee to or on behalf of the Joint Venture (‘JV’)/Wholly Owned Subsidiary (‘WOS’) abroad. Under the ODI Guidelines, the concept of a JV/WOS has been substituted with the concept of a ‘foreign entity’, which is an entity formed, registered or incorporated outside India, including in the International Financial Service Centre (‘IFSC’) in India that has limited liability. The requirement of limited liability for the foreign entity does not apply to a foreign entity with core activity in a strategic sector (i.e., sectors including energy and natural resources sectors such as oil, gas, coal, mineral ores, submarine cable system and start-ups and any other sector as deemed necessary by the Central Government). Subject to other compliances, overseas direct investment (‘ODI’) in strategic sectors can, therefore, also be made in unincorporated entities.
Eligibility for ODI Other Than Through Equity Capital
Interestingly under the new ODI Guidelines, an Indian entity may also lend or invest in any debt instrument issued by a foreign entity or extend non-fund based commitment to or on behalf of a foreign entity (including its overseas step down subsidiaries) where it: (i) is eligible to make ODI; (ii) has made ODI in the foreign entity; and (iii) has acquired ‘control’ in such foreign entity. The investment in debt instruments issued by the foreign entity will require a loan agreement and rate of interest on an arm’s length basis.
What Constitutes ‘Control’?
In addition to the right to appoint majority of the directors/ to control management/ policy decisions where the shareholding is less than 10% (ten percent), under the ODI Guidelines, the definition of “control” has been expanded to include even a mere 10% (ten percent) shareholding in an entity.
Pricing Guidelines Now Applicable
Under the erstwhile ODI regime, valuation of shares was required to be obtained for transfer of shares, partial/ full acquisition of a foreign entity, and swap of shares. However, unlike in the case of FDI, pricing guidelines did not specifically apply to ODI. This position has changed under the ODI Guidelines where for any issue or transfer of equity capital of a foreign entity: (i) from a person resident outside India or a person resident in India to a person resident in India who is eligible to make such investment; or (ii) from a person resident in India to a person resident outside India, the price should be on an arm’s length basis after taking into consideration the valuation as per any internationally accepted pricing methodology.
NOC from Lender Bank/Regulatory Body/Investigative Agency for ODI
Earlier there was a blanket prohibition on Indian party making any investments and financial commitment under ODI if such Indian party appeared on the RBI’s Exporters’ caution list / list of defaulters to the banking system circulated by the RBI / or any credit information company or the entity under investigation by any investigation / enforcement agency or financial service regulatory body. The blanket ban has now been replaced with a requirement for a No-objection Certificate (‘NOC’). Now, any person resident in India: (i) having an account appearing as a Non-performing Asset; (ii) being classified as wilful defaulter; or (iii) who is under investigation by a financial service regulator/ investigative agency, is required to obtain an NOC from the lender bank, financial service regulatory body or investigative agency concerned, before making any financial commitment or undertaking any disinvestment. Interestingly, the concept of presumption of no -objection / deemed approval has been introduced where the lender bank, financial service regulatory body or investigative agency concerned fails to furnish the NOC within 60 days of the application. In the case of an ODI made in an IFSC, if any approval by the financial services regulator is required, it will be decided within 45 days from the date of the application, failing which it will be deemed to be approved.
Introduction of Deferred Consideration
The concept of deferred payment of consideration has been introduced for the first time in the ODI Guidelines. Payment of consideration may be deferred for a definite period from the date of agreement for acquisition of equity capital of foreign entity under ODI. However, in a structure where payment of consideration is deferred: (i) the foreign securities equivalent to the total consideration must be issued/transferred upfront; and (ii) full consideration must be paid in accordance with pricing guidelines. The deferred part of the consideration payable by a person resident in India will be treated as non-fund based commitment by such person and will be reported accordingly.
Introduction of Overseas Portfolio Investment
The ODI Guidelines define Overseas Portfolio Investment (‘OPI’) as investment other than ODI, in foreign securities. However, OPI cannot be made in: (i) any unlisted debt instrument; (ii) any securities issued by a person resident in India who is not in an IFSC; (iii) any derivative unless otherwise permitted by RBI; or (iv) commodities including Bullion Depository Receipts. While the financial commitment of an Indian entity under ODI is capped at 400% of such Indian entity’s net worth as on the date of the last audited balance sheet, investment as OPI by an Indian entity cannot exceed 50% of its net worth as on the date of its last audited balance sheet. The liberalised position, therefore, is that any operating Indian company can make investment through OPI and this is an avenue that may be used in the near future. It is pertinent to note that unlike in the case of listed Indian companies, OPI by an unlisted Indian entity may be undertaken only in limited scenarios such as: (i) acquisition of equity capital by way of rights issue or allotment of bonus share; (ii) capitalisation as permitted under Foreign Exchange Management Act, 1999 (‘FEMA’); (iii) swap of securities; and (iv) merger, demerger, amalgamation or any scheme of arrangement.
Clarification on Structural Round Tripping
Under the erstwhile FEMA 120, the RBI did not permit an Indian party: (i) to set up Indian subsidiary(ies) through its foreign WOS or JV; or (ii) to invest in a foreign WOS or JV that had any direct/indirect investment in India. The earlier blanket restriction has now been liberalised and under the ODI Rules, a person resident in India may make financial commitment in a foreign entity that has invested or invests into India, provided that such structure does not result in more than two layers of subsidiaries. The abovementioned layer restriction does not apply to: (i) banks; (ii) systemically important non-banking financial companies (NBFCs); (iii) insurance companies; and (iv) Government companies.
Swap of Securities
While FEMA 120 only permitted ODI through swap of shares, the ODI Guidelines now also permits a swap of ‘securities’ by an Indian entity and a swap of securities on account of a merger, demerger, amalgamation or liquidation by a resident individual.
Liberalisation of ODI in Financial Services
While earlier only an Indian entity engaged in financial services could make ODI in a foreign entity directly or indirectly engaged in financial services activity, now even an Indian entity not engaged in the financial services sector may invest in such an offshore entity (other than those engaged in banking or insurance activities) without the requirement of RBI approval, provided that the Indian entity has posted net profits during the preceding three financial years. As a COVID relief measure, the net profit requirement over the last two years (i.e., 2020-21 to 2021-22) may be excluded where the Indian entity is unable to meet the profitability requirement due to COVID impact.
Overseas Investment by Resident Individuals
Under the earlier regime, ODI in a foreign entity with a stepdown subsidiary was not permitted by a resident individual. However, under the ODI Guidelines, ODI is permitted in a foreign entity with stepdown subsidiary, provided that the resident individual does not exercise control over the foreign entity. Additionally, any acquisition of foreign securities by resident individuals by way of inheritance is permitted without any Liberalised Remittance Scheme (‘LRS’) limits, while acquisition by way of employee stock options will be reckoned towards the LRS limit of the person concerned. Lastly, any acquisition of foreign securities by resident individuals by way of gift is permitted from another resident individual, without any LRS limits, provided such resident individual is a relative and is holding securities in compliance with FEMA.
The slew of changes brought in by the ODI Guidelines will encourage Indian entities and resident Indians to expand their business in other countries. Some of these changes, especially in relation to OPI by Indian entities, have been long awaited and are being welcomed by market participants.