Rationalizing of Overseas Investment – A summary!

Abstract:

The article provides a brief insight into the recently introduced regulation and rules governing Overseas Direct Investment by Indian entities and Companies in foreign jurisdictions. The Draft Regulations and Rules purport to regulate overseas investment by way of equity capital and other debt and non-debt instruments, and also provides guidelines for acquisition or transfer of immovable property outside India by Indian residents. While public comments have been invited into the same, the release of such regulations and rules by RBI has created a spur in the market.

On 9th August 2021, the Reserve Bank of India (“RBI”) vide Press Release 2021-2022/661 placed two drafts on its website, namely Foreign Exchange Management (Non-debt Instruments-Overseas Investment) Rules, 2021 (“Draft Rules”) and Foreign Exchange Management (Overseas Investment) Regulations, 2021 (“Draft Regulations”). By virtue of such a move, the RBI aims to ease and simplify the process of overseas investment and purports at boosting economic situations vis-à-vis foreign relations.

It is important to note that these regulations will also aim to promote and prosper ease of doing business and bring into a picture a much-needed rigid and liberalized structure for making Overseas Direct Investment (“ODI”). This is necessary because ever since 2005, India’s share in the total developing economy in ODI has been increasing rapidly and western countries have a growing appetite for assets and acquisitions. Therefore, by easing the process of investment in foreign markets and creating more investment opportunities, it will help in diversifying investment portfolios vis-à-vis strengthening debt trust and industrial relations internationally.

As per the recent data published by the Department of Economic Affairs on 09.08.2021, the Actual ODI outflow in 2021-22 was 5758.70 (US$ mn) as compared to 13,143.34 (US$ mn) in 2019-20.

Moreover, in the last few years (2019-2021), Singapore was the main target of actual ODI outflow i.e., having 28.42 % share in total ODI outflow and the USA having a 16.28% share. Other countries like UK, Netherlands, Mauritius, etc. hold a minimal share of the total outflow of ODI. These trends further the fact that there is a growing impetus to promulgate and encourage more overseas investment not only to facilitate economic growth for the recipient country but also to broaden market horizons for Indian companies and residents.

A summary of the key provisions of the draft rules and regulations are provided hereinbelow:

1. Foreign Exchange Management (Overseas Investment) Regulations, 2021

1. Conditions for undertaking Financial Commitments

While the draft regulation does not per se provide for undertaking financial commitment by equity capital for Indian residents, such encumbrance does not apply to Indian entities who have already made an investment in a foreign entity by way of equity capital and acquired control, on or before the date of making financial commitments by any other mode. Under the Draft Regulations, financial commitments can be made via the following routes, excluding equity capital:

• Debt Instruments issued by Foreign Entity, subject to a duly backed loan agreement and rate of interest charged at an arm’s length basis.
• Guarantees issued to or on behalf of a foreign entity, or its step-down subsidiary (“SDS”) in which the Indian entity has acquired control. These include corporate and/or performance guarantee by the Indian entity or its group company (holding 51% stake in the Indian entity) or its subsidiary company (having 51% stake by the Indian entity) or promoter group company. The draft regulations also allow ODI by way of personal guarantee issued by resident individual promoters, subject to forming part of ‘promoter group’ under Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000. However, any such guarantee issued under these directions cannot be open-ended.
• An Indian entity may also have the option of pledging equity capital of foreign entity or creating a charge by way of mortgage, pledge or hypothecation on its assets in India or outside India, subject to the conditions mentioned therein, provided it had already made ODI by way of equity capital in such foreign entity.

Acquisition/Transfer by way of Deferred payment

The provision pertains to such Indian residents, who by way of purchase or issuance from a foreign resident, or vice-versa, acquires equity capital in a foreign entity, reckoned to be ODI is allowed to defer such payment subject to the conditions mentioned therein.

Mode of payment

Under these regulations, the RBI has eased the process of making ODI, by stipulating for easier and faster modes of payments which are namely:

• Remittances made through banking channels
• Out of funds held in an account maintained in accordance with the FEM (Foreign Currency Accounts by a Person Resident in India) Regulations, 2015
• Swap of Securities
• Proceeds from American Depository Receipts / Global Depositary Receipt, and External Commercial Borrowings

Obligations

The RBI has also laid down certain obligations that are required to be complied by an Indian entity making ODI, in terms of ensuring that any foreign exchange is routed through due process and with the knowledge of the Authorized Dealer (“AD”). These include, inter alia, obtaining share certificate (s), Unique Identification Number from RBI, designated branch of AD for routing all transactions in such foreign entity. Further, the resident person is also required to realise and repatriate all dues receivable from such foreign entity, amount of consideration on account of transfer/disinvestment of such ODI and the net realizable value of assets concerned, within 90 days from the date when such receivable falls due.

Reporting and Delay in Reporting

Any person making ODI is required to report transactions through AD bank in Form FC (Making of financial commitment) and Form OPI (ODI/transfer of sale). In addition, the Indian entity is also required to submit an Annual Performance Report (APR), in case of multiple ODI transactions, and Annual Return on Foreign Liabilities and Assets (FLA). Further, the Indian entity is also required to report winding or setting up of subsidiary or alteration in shareholding, in case of ODI is by way of equity capital.

Delay in Reporting by any such person or entity will result in them being liable for payment of Late Submission Fee (LFS), in the rates and manner as provided by RBI.

Restriction

The only restriction under the Draft Regulations is that an Indian entity already having made a financial commitment under the Draft Regulations or rules, cannot make a further commitment until any delay in reporting is regularized.

Foreign Exchange Management (Non-Debt Instruments- Overseas Investment) Rules, 2021

As compared to the Draft Regulations, the Draft Rules provide a wider insight into ODI by Indian entities and the undertaking of financial commitments. The Draft Rules will be administered by RBI and any rules, directions, etc. made by thereof. The provisions are summarized hereinbelow, as follows:

1. General Restrictions

Any Indian Resident can only make ODI per the draft rules and regulations. Further, investment can only be made in any such foreign entity having bona fide business activities.

• Permissions

While there is no prior permission required in most cases, the Draft Rules provide for prior approval for making ODI in a foreign entity incorporated or formed in Pakistan. Further, it also provides RBI with the power to stipulate the total aggregate outflow of ODI in a financial year.

In addition, a No-Objection Certificate (“NOC”) would be required in specific situations for making ODI, where such an Indian entity has been categorized as a Non-performing Asset, Willful Defaulter, has a pending investigation, or falls within the categories mentioned therein. All other conditions for making ODI are categorically provided in Schedule I-IV of the Draft Rules.

• Pricing Guidelines

This is only applicable to ODI in the form of equity capital, whereby price, in the case of a listed company has to be valued in accordance with the concerned stock exchanges of the host country and in the case of an unlisted company, price is to be determined at 5% range of fair value arrived on arm’s length basis as per internationally accepted pricing methodology, subject to a valuation certificate.

• Restrictions

An alarming stipulation in the Draft rules is that ODI is not permitted for foreign entities engaged in real estate, gambling or offering of financial products linked to Indian Rupee. Further, ODI is also not permitted in countries located in a jurisdiction that is not Financial Action Task Force (FATF) or “International Organization of Securities Commission (IOSCO) compliant countries. Lastly, any foreign entity having invested in an Indian company, designed for tax evasion/avoidance also falls within the non-permissible options.

• Acquisition and Transfer of Immovable Property Outside India

Any acquisition/transfer of immovable property outside India, by an Indian resident, can only be made with the prior permission of RBI. This restriction is not applicable to Indian residents being a national of a foreign state, or such property is acquired before 8th July 1947 or acquired on a lease not exceeding 5 years.

Any acquisition by a person resident in India from a person resident in India, for immovable property can be done by:

• Inheritance
• Purchase out of foreign exchange held in Resident Foreign Currency
• Purchase out of remittances sent under the Liberalized Remittance Scheme
• Jointly with the relative resident outside India
• Out of income/sale proceeds of assets, other than ODI

Transfer of immovable property outside India, by Indian resident, can be down by way of:

• Gift to a foreign resident, eligible under Draft Rules and Regulations.
• Inheritance
• Sale
• Creation of charge on such property.

To conclude, while the Draft Rules and Regulation are yet to be seen in action, the RBI has invited public comments on the same, requiring market participants to provide consultation and feedback. Whilst the detailed structure of the Draft Rules and Regulations, promise a better output, there is a growing imperative to properly regulate ODI and boost economic growth worldwide.