Updated: Apr 2
[Pranav Sethi is a Third-Year Law Student of NMIMS School of Law, Navi Mumbai]
The Reserve Bank of India ("RBI") invited stakeholder opinions on the Draft Foreign Exchange Management (Overseas Investment) Regulations, 2022 in August 2022. The regulations regulating overseas direct investment from India has been completely revised by the RBI in consultation with the Central Government.
A significant alteration changed the definition of "control," so that an Indian entity would be considered to have control of a foreign entity if it obtained 10% or more of that entity's voting rights. This is a broader definition of control than the law currently in effect, which defines it as the power to choose the majority of the directors on a company's board or to command operational or policy decisions for a company. This new concept of control has been connected to the term of a foreign subsidiary or a foreign step-down company. Therefore, a foreign entity or its step-down subsidiary will therefore be considered a subsidiary of the acquired Indian firm if it holds 10% or more of the company. Up until this moment, a subsidiary was defined as a company in which another company owned a majority stake (defined as more than 50% or the right to elect a majority of the company's directors).
The Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004, and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015 have been replaced by these new ODI Norms.
There are mainly three divisions under which the new regime can be classified that are Overseas investment, Joint Venture and debt considering residential individuals.
Regulatory key changes that have come under highlight
The Explanation of the term foreign entity has now been changed and by the definition of "foreign entity," which is "an entity created, registered, or incorporated outside India, including International Financial Services Center (IFSC), that has limited liability”, has replaced the concepts of "joint venture" and "wholly owned subsidiary" under the Old OI Norms [Rule 2(h) , FEMR (Overseas Investment), 2022]. An organisation having its primary business in a strategic industry is exempt from the limited liability constraint.
The Separation drawn in the meaning of “Indian Party” and “Indian Entity” definition is again to be noted. Earlier the term “Indian Party” was used to refer under the previous ODI framework but now it has been replaced and called as an “Indian Entity”. The major difference to be noted is that in the erstwhile ODI framework in the term “Indian Party” it would comprise of several investors from India invested in a foreign entity as a whole party have come up with investments but in counterpart to this presently, now each investor will be treated separately as an “Indian Entity”.
Defining on the qualitative as well as quantitative test of the term “Control”. Control is the ability to select a majority of the directors from the management and to make policy decisions in the form of acting alone or with others through direct or indirect participation including through ownership or strategic planning rights, shareholders' agreements or voting agreements that grant them 10% or more of the voting rights, or through any other means in the entity. Below the ten percent barrier for Overseas Direct Investment (ODI) in international entities and Step-Down-Subsidaries (SDS) are also permitted although these investments are not eligible for certain types of financial obligations from their Indian entities.
Introduction of the Pricing guidelines mechanism wherein in the New ODI Framework as per this concept the transfer of equity capital of a foreign entity from a person resident in India or a person resident outside India to a person resident in India or Vice Versa shall now be able to arrive on a price on arm's length basis. Considering prior to facilitation of a transaction by the AD (Authorised Dealer) Bank will now be ensuring compliance by keeping up into consideration that in case where there is any International pricing methodology for Valuation the value of any entity will be determined according to that method.
Redefinition of the term financial Commitment which means that the total amount of Investment through ODI combining debt (excluding the unlisted debt) and funds excluded facilities extended by an Indian entity to all foreign entities. A clarification for the same had been elaborated on that made clear that Indian entities may invest or even lend in debt instruments issued by a foreign entity or including non-fund based commitment outside step-down-subsidiary of such Indian entity. Adding more to this certain pre-requisites are mandatorily required to be ensured that include firstly, Indian entity to make Overseas direct investment. Secondly, the Indian entity should have made investment as well as acquired control in the foreign entity on or before the date of making such financial obligation.
With the largest difference becoming an automatic authorization to issue guarantees on place of any foreign entity or SDS, irrespective of its level,given that such organization is managed by the Indian entity, the Modified ODI Framework vastly simplified and liberalises the current framework. Separately, similar to the demands under the previous ODI regime, prior RBI approval would still be necessary to be obtained in cases where a financial commitment by an Indian entity exceeds USD 1 (or its equivalent) billion in a financial year, even if the total financial commitment of the Indian Entity is within the range of eligible commitments under the automatic route (i.e. 400% of the Indian Entity's net worth in all foreign entities at the time of undeclared commitment).
The new investment framework has even taken initiative to provide certain relations by introducing Deferred Payment Consideration while acquiring or transferring foreign securities. The sale of any equity capital between a person whether resident or non-resident in India will still have to follow certain compliance that will become applicable through pricing guidelines. The consideration will also need to be agreed upfront by the seller to the buyer from the date of such agreement. Another choice given to sellers in such a type of arrangement is that they can offer indemnity coverage to protect the interests of buyers as well.
Clarification on Round tripping investments that the new overseas investment framework provides for Indian entities is still somewhat unclear. However, the clarification given by RBI means that any financial commitment by a foreign entity that makes investments in India either through direct or indirect routes then in that case it doesn't require RBI Approval as far as more than 2 layers of subsidiaries doesn't get added on into the structure. It is to be noted as what RBI quoted, “no further layer of subsidiary or subsidiaries shall be added to any structure existing with two or more layers of subsidiaries post notification of the OI Rules/Regulations”. The above clarification lead to arise many questions as to whether the restrictions on multi layered structures will be keeping only investments in India through round tripping or even those investments which happen outside India.
Implications and Concluding thoughts
The new overseas Investment framework actually seeks to reduce RBI Approvals and encourages more overseas investments from entities in India and from HNIs (High networth individuals) as well. It takes into account a perfect blend of rules and regulation which will help in enhancing the new corporate landscape of India. This will further provide a boost to ease of doing business. This revised framework has made things more simplified considering the regulatory requirements for credit enhancing within different layers of investments. Adding more to this by leverage of onshore and offshore assets; Indian Companies will now be able to access vastly some foreign lenders and not only banks which hold large amounts of capital.