This article is written by Aditi Singh of Symbiosis Law School, Pune. The article discusses the key highlights of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations, 2018.

ABSTRACT

Foreign Direct Investment is advantageous for the economy of a country to develop but if it becomes limitless it can be equally disadvantageous. The Indian Government has been reluctant to remove restrictions for boosting the foreign direct investment in the country, but the Central Government in 2018 has liberalized the important sectors of the Indian economy to attract the foreign investors to invest in India by enacting the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations, 2018 which aims towards enhancement of foreign direct investment, by relaxing the stringent and complex procedure under Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017.

The paper interrogates the determinants of FDI in civil aviation sector, the Real Estate Sector, Single Brand Product Retail Trading, Power Exchange Sector, purchase and sale of capital instruments and other sectors by comparing the Principal Regulations of 2017 with the Amendment Regulations of 2018. The author has critically analyzed the intention of the Central government behind liberalizing the important sectors of the Indian economy and aims to understand the complexities involved in relaxing the procedures. The study has referred secondary sources of data collected mostly through the notifications of Reserve Bank of India.

Introduction

Central Government has been implementing favorable policies to enhance the Foreign Direct Investment in India. Passing of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations, 2018 (hereinafter referred as Amendment Regulations 2018) is one such step. The Reserve Bank of India (“RBI”) under its ‘power to make regulations’[1] has brought the amendment regulations to the Foreign Exchange Management (Transfer or issue of Security by a Person Resident outside India) Regulations, 2017 (hereinafter referred to as the Principal Regulations) to liberalize the important sectors of the Indian Economy. The RBI on March 26, 2018 notified the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulation, 2018. The significant changes brought by the Amendment Regulations 2018 with respect to sector-specific policy for Total Foreign Investment are as follows:

1. Foreign Investment In Non-Banking Financial Company

The first amendment that has been brought by the Amendment Regulations 2018, deletes the word “Indian Company” from sub-regulation 5 under Regulation 16.B of the Principal Regulations, and states that foreign investment in investing companies which are Non Banking Financial Companies, and are not registered with the Reserve Bank[2] engaged in the capital investment in other Indian entities will require prior approval of the government in addition to compliance with the regulatory framework under the Reserve Bank of India Act, 1934 and Regulations framed thereunder while Non- Banking Financial Companies which are registered with Reserve Bank will be under 100% automatic route unlike in the Principal Regulations 2017.

• Provisions with respect to the core investment companies still remains same.

Analysis of the Amendment Regulation

Non-banking financial companies are financial institutions that are engaged in the business of providing banking services without obtaining banking license. NBFCs are registered under the companies Act 2013, engaged in providing loan and purchase of bonds/stocks/shares/securities issued by Government, hire purchase, leasing, chit business.[3] NBFCs have been playing major role in the development of the Indian economy by providing almost similar services as banks. The procedure followed by the banks is more stringent and time taking in comparison to NBFCs and therefore, the Regulation has been amended to enhance the foreign Direct Investment by relaxing the procedure in the principal regulation. Investment through Automatic Route allows a foreign entity to invest in Indian entity without obtaining prior approval of the government or complying with the regulatory framework under the Reserve Bank of India Act [4]

Allowing Investment in Non-Banking Financial Company (registered with RBI) through automatic route up to 100% has removed the complexity of obtaining permission of the government which has relaxed the procedure and will attract the foreign entities to invest in the NBFCs (registered) in India. On one hand Investing Companies will feel secured because the NBFCs are registered with the RBI and on the other hand it will reduce the time taken in receiving approval by the government and complying with the frameworks under the RBI Act.

2. Joint Audit of The Indian Investee Company

The Amendment Regulations 2018 have inserted sub-regulation 8 to the regulation 16.B of the Principal Regulation, which now states that the auditioning of an investee company in India needs to be carried out as joint audit. The auditioning needs to be carried out by the auditor/auditing firm specified by the person who has invested in the investee company of India and by an independent auditor who is not associated with the audit/auditor firm specified by the person.

Analysis of the Amendment Regulation

Joint audit is where the auditioning of an entity is carried by two or more auditors. The principal Regulation is unclear about the appointment of auditors by the Indian Entity. The amendment ensures that the auditioning is just not carried by the auditors specified by the foreign investors but also by an auditor which is not a part of the international network making it a joint audit of the Indian Investee Company. The essence of the amendment lies in the fact that it will give an opportunity to the small and medium size audit firms in India. The Foreign Investors have always preferred the auditioning by the top international audit firms but the amendment will surely promote the role of domestic firms in case of joint auditioning. The amendment will further result in the interaction of domestic audit firms with the firms having international network.

It is to be also noted that the amendment regulation states that “wherein one of the auditors is not part of the same network”[5] which can also result in the auditioning by two international network auditioning firm which can defeat the purpose of the Amendment Regulation. The step of the central government has been brought up to enhance transparency, accountability and the promotion of good governance in India. It will be interesting to observe the consequence of such an amendment in near future.

3. Foreign Investment – Civil Aviation Sector

The regulations 2018 have amended existing SL. No 9.3(a) of regulation 16.B of the Foreign Investment.

Air Transport Services	Principal Act	Amended Regulation
(a) (i) Scheduled Air Transport Service/ Domestic Scheduled Passenger Airline (ii) Regional Air Transport Service	·         Investment up to 49% through Automatic Route. ·         100% FDI for NRI and OCBs	·         Automatic up to 49% ·         Government route beyond 49% ·         Automatic up to 100% for NRIs and OCIs

Analysis of the Amendment Regulation

The Principal Regulations, 2017 allowed Foreign Investment in Air Transport Services up to 49% through automatic route. Anything beyond 49% was restricted under the regulations. The Amendment Regulations 2018, allowed 100% Foreign Investment in domestic airlines out of which, up to 49% through automatic route and beyond 49% through government route. After, relaxing the FDI norm 100% foreign investment is allowed in Domestic Scheduled Passenger Airlines, Non-Scheduled Air Transport Services, and helicopter and seaplane services.

However, it is to be noted foreign airlines are allowed to invest in the capital of Indian companies, operating scheduled and non-scheduled air transport, services up to the limit of 49 percent through government approval route.[6] The restriction ensures that the foreign airlines, which are in a position to fully own Indian airlines, do not control the management of Indian airlines. The amendment aims to boost foreign Investment to ease the process of doing business in India and also, ensures the involvement of the government to keep a check in case the investment is beyond 49%.

4. Foreign Investment In M/S Air India Ltd.

The Regulations, 2018 deletes Note 3 from SL.No 9.5 of regulation 16.B which stated that the policy mentioned at 9.5(c) above is not applicable to M/s Air India Limited.[7] The regulation 2018 permits the foreign investment in M/s Air India and inserted clause (d) in SL.No 9.5, after clause (c). The regulation lays down certain conditions with respect to investment in M/s Air India which are as follows-

• Foreign investment in M/s Air India Ltd., including that of foreign airline(s) shall not exceed 49% either directly or indirectly.
• Substantial ownership and effective control of M/s Air India Ltd. shall continue to be vested in Indian Nationals.[8]

Analysis of the Amendment Regulation

M/s Air India is the national Carrier of India which has always received preferential treatment. There have been various reasons like regulation of price, security standards, public interest which has always refrained government from privatizing Air India. It is to be noted that United Kingdom and Australia have been successful after privatizing their national carrier. The amendment seeks to privatize M/s Air India so that it can enable from the debts of crores of rupees. Since, Note 3 from SL. No. 9.5 has been removed; the added clause (d) is subject to the conditions laid down in clause (c) and allows the Indian Nationals to have substantial ownership of Air India so that the risk to lose the management of the National Carrier is avoided.

The use of the word “Directly and indirectly” ensures that the foreign investment does not exceed the limit of 49% either by investing directly in M/s Air India or by indirectly investing in an entity which invests in M/s Air India. Foreign investors and foreign Airlines are permitted to invest in Air India but the amendment ensures that the effective control still remains with Indian Nationals to avoid any kind of future conflict of interest and also its smooth functioning. The essence of the amendment is to attract foreign investment in Air India but foreign entities usually refrain from investing in a sector where the government has a role to play.

5. Foreign Investment – Real Estate Broking Services

The Principal Regulations through SL. No. 10.2 of regulation 16.B stated the “other conditions” with respect to foreign investment in Construction Development: Townships, Housing, Built-up infrastructure. The Amendment Regulations, 2018 inserts Note 7 in SL. No. 10.2. Foreign investment is not permitted in an entity which is engaged or proposes to engage in real estate business, construction of farm houses and trading in transferable development rights.[9] Real Estate Business has been defined under the Principal Regulation as

“dealing in land and immovable property with a view to earning profit therefrom and does not include development of townships, construction of residential/ commercial premises, roads or bridges, educational institutions, recreational facilities, city and regional level infrastructure, townships”[10]

Analysis of the Amendment Regulation

In India Foreign Investment is not permitted to invest in an entity investing in the Real Estate business. The restriction is imposed to avoid all such risks which can result in the control of Land of Indian Territory by an outsider. No country in the world can allow foreign entity to control its land. The amendment also, avoids the risk of prize escalation of land which can be one of the consequences of FDI in an entity investing in Real Estate Sector (Land). The regulation 2018 excludes Real Estate Broking services om the “Real Estate Sector” and permits Foreign Direct Investment up to 100% in the Real Estate Broking Sector through the Automatic route. Real Estate Broking Service is where a company or an individual is engaged in buying and selling of an immovably property.

The relaxation granted to the Real Estate Broking Sector is to boost the Real Estate sector. Broking services are different from Real Estate Business therefore the risk of controlling the Indian Territory by the outsiders remains out of the picture. It will further result in the registration of property brokers in India under RERA 2016.

6. Foreign Investment- Single Brand Product Retail Trading

(E-Commerce)

• As per the SL. No. 15.3 of the Principal Regulations 16.B, allows FDI up to 49% through automatic route and beyond 49% and up to 100% is permitted through government route. The Amendment Regulations 2018, amends the provision by substituting “Automatic up to 49%; Government route beyond 49%” with “Automatic”.

Analysis of the amendment Regulation

Single Brand Retail trading is to sell goods to the customers with the same brand name. Removal of investment through government route will also increase the competition among Indian entity and will attract the investment in production and marketing area. The amendment will provide more options to the customers in India. Participation of foreign players will boom the Real Estate Sector of India.

• L.No. 15.3.1 of 16.B of the Principal Regulation states other conditions with respect to Single Brand Product Retail Trading. Clause (d) of the SL. No. 15.3.1 has been amended and now, it excludes the requirement of license agreement between the investor company and the brand owner.

Analysis of the amendment Regulation

The amendment has relaxed the procedure by removing the requirement of “The investing entity shall provide evidence to this effect at the time of seeking approval, including a copy of the licensing/ franchise/ sub-licence agreement, specifically indicating compliance with the above condition. The requisite evidence should be filed with the RBI for the automatic route and the Government for cases involving approval.”[11] The removal of the specified requirement implies that now, there is no need to file evidences with RBI for the investment through Automatic Route; the foreign entities can directly invest through automatic route. This definitely has eased out the procedure of doing business.

• In SL. No. 15.3.1 clause (g) and clause (h) which dealt with the requirement of application seeking permission of the government for foreign investment exceeding 49% and the requirement to process the said application by the Department of Industrial Policy has been deleted and a new clause (i) has been inserted. The new clause states that for the initial five years, incremental sourcing by overseas companies, including their group companies for the specific brand will count towards the mandatory 30% local sourcing commitment.

Analysis of the amendment Regulation

The amendment has changed the scenario of local sourcing requirement. Incremental sourcing is outsourcing from the other country, in the beginning a small part is outsourced and with the time the outsourcing increments. The principal regulation mandated the requirement of 30% local outsourcing from India for the foreign brands to invest from the beginning. The amendment has relaxed the procedure and it states that for initial 5 years incremental sourcing will count towards the requirement of 30% local outsourcing from India. The removal of the stringent regulation has been demanded by the foreign entities from a long time. The removal of the requirement will surely boost the investment in single brand retail trading in India.

• The Amendment Regulations 2018 also deletes Note 2 and Note 3 from SL. No. 15.3.1 and added Note 5 in Principal Regulations. The deleted Note 2 stated that the Indian manufacturer is permitted to sell its own branded products and Note 3 which mandated that Indian manufacturer would be the investee company, which is the owner of the Indian brand and which manufactures in India, in terms of value, at least 70 percent of its products in house, and sources, at most 30 percentfrom Indian manufacturers.

Analysis of the amendment Regulation

Under the principal regulation to qualify as the Indian Manufacture an entity has to manufacture 70 percent of its products in house, and sources, at most 30 percent from Indian manufacturers.[12] The amended regulation has removed this requirement from the Principal Regulations 2017. The amendment will allow foreign investment in case the Indian Manufacture could not meet the requirement stated in Note 3 of Principal Regulation. Now, the Indian Manufacturer can obtain FDI and wholesale, retail, including through e-commerce platforms.

The Amendment Regulations 2018 through the addition of Note 5 requires a committee to relax the procedure where the local sourcing is not possible which will enhance the foreign investment by allowing foreign investment without meeting the criteria of local sourcing and will bring wide options for the customers in India. It is definitely a great step by the Indian government to boost the Retail Industry. Note 5 also state the composition of the committee to be formed under the Chairmanship of Secretary, DIPP, with representatives from NITI Aayog, concerned Administrative Ministry and independent technical expert(s).[13] The amendment ensures that foreign brands could easily incorporate wholly owned subsidiariesIndia to undertake SBRT, without tying up with any local Indian partner.

7. Significance of The Word ‘Disability’

The Regulation 2018 replaces the word ‘handicap’ with ‘disability’ in SL. No. 16.3 in Note 2, in clause (a) and in sub-clause (ab) of clause 16.B of the Principal Regulations. Disability represents diversity and is a politically correct and respectable word to be used by the Indian Legislature. Handicap is never considered a positive word while the use of the word disability gives importance to an individual who is disabled.

8. Foreign Investment – Pharmaceutical Sector

SL.No. 16.3 deletes the Note 3 which stated that the definition of “medical device” is subject to the Drugs and Cosmetic Act.The amendment has widened the definition of medical devices which will lead to the increase of investment in pharmaceutical department. The amendment implies that the definition stated in the Principal regulation is complete and making it subject to Drugs and Cosmetic Act will restrict the scope of the definition of medical device.

9. Foreign Investment- Power Exchange

The Amendment Regulations 2018 deleted clause (a) from F.6.1 of schedule 1, which stated that Foreign Portfolio Investor can only invest through Secondary Market Route which implies that FPI can also invest through Primary Market.

Analysis of the amendment Regulation

Foreign Portfolio investment is a short term investment without aiming to control the business by the non resident of India unlike the aim of the FDI which is to establish long interest in the economy. FPI aims investment in shares, government bonds, and corporate bonds. FPI were restricted, to invest only through secondary market but after the amendment the restriction has been relaxed.

Investment through primary market means to invest directly in the stocks, bonds, shares of a company while investment through secondary market is investing, after the company had sold out all its bonds, stocks and shares through primary market. Initially to avoid any circumstance of direct control by the foreign investors in the Indian entity government restricted FPI only through secondary but now, to ease mobilization of funds and welcome better technology, restriction from primary market has been relaxed.

10. Purchase/ Sale of Capital Instruments of an Indian Company by a Person Resident Outside India

• The Regulation 2018, deleted Para 1 (6) from schedule of the Principal Regulation and has amended Para 1 (4) which allows an Indian entity to issue a capital instrument as a consideration through automatic route and through government route. The entity is supposed to comply with the conditions prescribed by the government and /or RBI. In case of government route, its mandatory for the entity to receive permission of the government. The amendment allows an Indian entity to issue capital instruments against:

1. Swap of capital instruments; or
2. Import of capital goods/ machinery/ equipment (excluding second-hand machinery); or
3. Pre-operative/ pre-incorporation expenses (including payments of rent etc.).

Analysis of the amendment Regulation

Schedule 1 of the Principal Regulations dealt with the Purchase/ Sale of capital instruments of an Indian company by a person resident outside India. As peer principal regulation an Indian Entity could issue securities against swap of Capital Instrument engaged in an automatic route sector. While the issue of security by an entity engaged in government route required prior permission of the government and it could be issued against Swap of capital instruments, Import of capital goods/ machinery/ equipment (excluding second-hand machinery) or Pre-operative/ pre-incorporation expenses. The amendment aims to issue of security by the Indian entity against Swap of capital market which is the exchange of financial instruments or against import of goods/machinery/equipment from foreign suppliers or against Pre-operative/ pre-incorporation expenses which is the expense incurred by the company before its incorporation/ expense incurred before it became operative by an entity engaged wither in automatic route or government route provided that the entity engaged in the government route should obtain prior permission of government.

In the principal regulation Indian entity issuing capital instrument engaged in government route could have issued against swap of capital instrument and Import of capital goods/ machinery/ equipment (excluding second-hand machinery) or swap of capital instrument and Pre-operative/ pre-incorporation expensesbut in the amendment regulation it can be issued against Swap of capital instruments; or Import of capital goods/ machinery/ equipment (excluding second-hand machinery); or Pre-operative/ pre-incorporation expenses (including payments of rent etc.).

The amendment has relaxed the procedure for an Indian entity to issue capital instrument engaged in both automatic route and government route. Import of second hand – machinery has been excluded in order to promote the reuse of machinery in the country for being green and clean.

• All the amendments mentioned above have been included in the Principal Regulations brought up by the RBI on 6^th of April 2018 by the Notification No. FEMA 20(R)/2017-RB. It is yet to be seen, the impact of the amendments in the future but the step to liberalize the various sectors of the Indian Economy is a great step taken by the Indian Government. The essence of all these amendments lies in the fact that the control of Indian Nationals over the important sectors still remains intact.

References

[1] The Foreign Exchange Management Act 1999, s 47

[2] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations 2018, reg 2(i)

[3]‘Frequently Asked Questions; All you wanted to know about NBFCs’ (Reserve Bank India, 10 January 2017). https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92 accessed 13 June 2018

[4] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, reg 16 (A) (1)

[5]Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations 2018, reg (2) (iii)

[6] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, reg 16B, SL.No.9.5, cl (c)

[7]Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, reg 16B, SL.No.9.5, Note 3

[8]Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations 2018, reg (2) (xii)

[9] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, reg 16B, SL.No.10.2, Note 1

[10] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, reg 16B, SL No. 10.2, Note 6

[11] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, reg 16B, SL.No.15.3.1 cl (d)

[12] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, reg 16B, SL.No.15.3.1, Note 3

[13] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations 2018, reg (2) (xii)