This article is written by Danie Joseph, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.

Introduction

With the economic liberalisation of the Indian economy in 1991, it has contributed in a positive manner as the Indian economy is considered as one of the largest growing economies with respect to size and growth prospects. Foreign Direct Investment (FDI) is defined as a cross-border investment made by a company/individual in a foreign country into another company/entity residing in another country. Therefore India’s economy has been considered as one of the most profitable and prospective destinations for foreign investors and businesses. Furthermore, it has vice-versa benefitted the Indian economy, as foreign investment is one of its major monetary sources and also provides various job opportunities for a large number of its citizens. In order to facilitate the ease of inflow of global funds into the economy, the government has taken steps to ensure a favourable policy regime to attract foreign investors and MNCs by adopting favourable measures and policies. So with respect to the dynamic business conditions and competitive nature of the Indian economy, it is essential to understand the legal system and regulatory framework revolving around foreign direct investments in order to establish a solid foundation for international businesses intending to initiate their operations in the Indian market. 

Regulatory compliances

Before a foreign company sets foot in India, it is advisable to take into account the various socio-economic and political factors, ability to carry out its operations in India, the location of its customers, the efficiency of its workforce from the perspective of the investment. Once the prior condition has been fulfilled, incorporating operations in India or any kind of cross-border investment will require compliance with the regulation that governs FDI, India’s foreign exchange regulations. There are several legislations and regulations enacted to govern the various aspects of foreign transactions. 

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Who can invest in India? 

  • Any non-resident individual (NRI)/Entity can invest subject to FDI policy except for the prohibited sectors. NRI residents and Citizens of Nepal & Bhutan are permitted to invest on a repatriation basis
  • Foreign Institutional Investors (FII) and Foreign Portfolio Investors (FPI)
  • Registered FIIs/ FPIs/ NRIs as per Schedules 2, 2A and 3 respectively of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 can invest or trade through a broker of Indian Companies registered on the stock exchange. 
  • Compny, trust or partnership firm that incorporated outside India and also which owned and controlled by NRIs
  • SEBI registered Foreign Venture Capital Investor (FVCI) in any activity mentioned in Schedule 6 of Notification No. FEMA 20/2000.

Modes/routes for foreign direct investment  

1. Automatic route 

Provided that the sector does not fall within the prohibited sectors, 100% foreign direct investment is permitted subject to the applicable laws/regulations. FDI made through the automatic route does not require any prior approval either by the Central Government or RBI subject to the extent of foreign investment that is permitted in the concerned sector as specified in Regulation 16 of FEMA 20 (R) Another consideration is the Press Note 3 (2020 series) dated April 17, 2020 and notification dated April 22, 2020, by the Government had implemented certain changes to its policy in light of the COVID-19 pandemic with the intent to prevent opportunistic takeovers/acquisitions of Indian companies. It stated that regardless of the sector/activity in which such foreign investment is directed to is situated in or is a citizen of Bangladesh, China, Pakistan, Nepal, Myanmar, Bhutan or Afghanistan would mandatorily require the prior approval of the Government 

2. Government route 

As per the FDI policy, foreign investment in certain sectors is permitted to a certain percentage however any investment beyond the permitted threshold would require the approval of the Government. The sectors which allow FDI under partial automatic route and partial government approval route are defence, retail trading, private banking services etc. 

Sectoral caps and compliances 

With respect to the shareholding of non-residents in Indian companies, there are certain FDI limits that are divided between prohibited and permitted sectors.

I. Sectors where FDI is prohibited 

Sectors which include activities such as Atomic Energy, Railway operations, Gambling and betting including casinos/ Lottery business including government/lottery, online lotteries etc. Chit funds, Nidhi company, Real estate business or construction of farmhouses,  Trading in Transferable Development Rights, (TDRs), Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes are sectors in which any kind of foreign investment are not permitted. 

II. Sectors where FDI is Permitted 

Below are certain illustrations of sectors that permit FDI through either automatic route and government approval.

Defence sector – In the defence sector (subject to the industrial license under Industries (Development and Regulation) Act, 1951) and manufacturing of small arms and ammunition under Arms Act, 1959 has permitted 100% FDI where up to 49% is under the automatic route. Any investment above the 49% threshold requires the approval of the government where it is likely to result in access to modern technology or for other reasons to be recorded.  

Civil aviation – With respect to greenfield and existing projects for “Airports” and Non-Scheduled Air Transport Service, FDI of 100% is permitted. In the case of “Air Transport Services” being Scheduled Air Transport Service/Domestic Scheduled Passenger Airline and Regional Air Transport it partially permits up to 49% FDI in automatic route and beyond that percentage would require government approval. Also, 100% FDI is permitted for Helicopter services/ seaplane services under the automatic route subject to the approval of DGCA. 

Banking services – With respect to the private sector, Foreign investment of up to 49% is permitted under the automatic route and beyond 49% and up to 74% under the government route. Foreign investment of up to 74% is permitted in banks in the private sector. Furthermore, individual NRI’s cannot hold more than 5% of the total paid-up capital and aggregate NRI holdings cannot exceed 10% of the total paid-up capital. In the case of public sector banks, foreign direct investment is capped at 20%. 

Non-banking financial companies –  FDI of up to 100% is permitted under the automatic route in other financial services and activities regulated financial sector regulators viz. IRDA, SEBI, RBI, Pension Fund Regulatory and Development Authority, National Housing Bank or any other financial sector regulator as may be notified by the Government of India, subject to conditionalities specified by the concerned Regulator/Government agency.

Insurance sector – The insurance sector, as per the Press Note No.2 dated 14th June issued by DPIIT, has amended the sectoral cap on insurance companies and is permitted a maximum FDI cap of up to 74% under the automatic route which is also subject to approval/verification by Insurance Regulatory and Development Authority of India (“IRDAI”). Whereas in the case of Insurance intermediaries (insurance brokers, reinsurance brokers, insurance consultants), it has been allowed 100% FDI under the automatic route 

Multi-brand retail trading – A maximum percentage of 51% FDI is allowed under the government approval route. This investment simultaneously should be in compliance with the conditions (i) minimum capitalization of USD 100 million. (ii) 50% of the total FDI in the first tranche of USD 100 million to be invested in the backend infrastructure within 3 years. (iii) states which have agreed or agree in the future to allow FDI in multi-brand retail trade, retail sales outlets may be set up in such States (iv) 30% mandatory sourcing requirement from Indian micro, small, medium industries which have a total investment in plant and machinery not exceeding USD 2 million etc. 

Single Brand Product Retail Trading – FDI of up to 100%is allowed under the automatic route. SBRT can receive foreign investment on the fulfilment of conditions such as (i) products that are sold under a ‘single brand’ and products that should be sold under the same brand internationally. (ii) products should be branded under manufacture and to be covered within ‘single brand’ product retail trading. (iii) non-resident entities/entities, either owner of the brand or otherwise, shall be allowed to enter into a legally tenable agreement with the brand owner for the purpose of undertaking single brand product retail trading. (iv) if the FDI is above 51%, the sourcing of 30% of the value of goods purchased should be sourced from India itself, from Indian micro, small and medium enterprises. (v) SBRT entity operating through brick and mortar stores, is permitted to undertake retail trading through e-commerce which is also subject to certain conditions. (vi) SBRT entity may set off the mandatory sourcing requirements against its incremental sourcing of goods from India for global operations during the initial 5 years of starting its operations in India. The incremental sourcing for the purpose of set-off shall be equal to the annual increase in the value of goods sourced from India for global operations either director or through its group companies. However post the 5 year period, the SBRT entity is required to fulfil the 30% sourcing norms towards India’s operation on an annual basis. 

Print Media – With respect to Print Media, mainly concerned with publishing/ printing of periodicals, speciality journals, technical and scientific journals (subject to compliance with the applicable legal framework and the guidelines issued by Ministry of Information and Broadcasting periodically in this regard) and publication of a similar edition of foreign newspapers is allowed to have 100% foreign investment under the government approval route. On the contrary with respect to the Print Media specifically publishing of newspapers and periodicals which deal with the current affair and news and also publishing Indian content in foreign magazines dealing with news and current affairs is allowed FDI of only up to 26% with the prior approval of the government. 

Digital media – Digital Media which mainly consists of uploading News and Current Affairs through the medium of Digital Media is permitted 26% FDI. 

Railways – As per the FDI policy, the list of prohibited sectors have been revised to substitute ‘railway transport’ with ‘railway operations’, in effect allowing foreign investment in ‘railway transport. Railway infrastructure is allowed 100% FDI under the automatic route, however, in the case of particularly sensitive areas any FDI above 49% will require consideration from the Ministry of Railways from a security point of view. The Ministry of Railways has set up sectoral guidelines which include conditions and approvals required for domestic or foreign participation in the retail sector. 

B2B E-commerce – In the case of companies that are primarily involved in the activity of buying and selling through the medium of the e-commerce platform particularly in the Business to Business segment is permitted 100% FDI. 

B2C E-ommerce – As per the marketplace model of e-commerce where an e-commerce entity provides an information technology platform on a digital & electronic network and acts as the middle-person to the buyer and seller, 100 FDI is permitted under the automatic route. However, as per the inventory-based model of e-commerce which involves maintaining inventory of goods and services by the e-commerce entity and is sold to the consumers directly, FDI is not permitted. 

Pharmaceuticals – In the case of greenfield projects in the pharmaceutical sector, 100% FDI is permitted as per regulation 16 of FEMA 20R. Whereas in the case of Brownfield projects in the pharmaceutical sector up to 74% FDI is permitted under automatic route and above this threshold would necessitate the government approval route. 

Petroleum – Activities such as exploration, research and development, marketing, deriving petrol-based products are allowed by private companies in the petroleum sector. If the concerned activities are conducted privately then 100% FDI is permitted under the automatic route. However if the government undertaking conducts these activities, then 49% of FDI is allowed under automatic route and any investment over this limit would require the approval of the government. 

Conclusion 

In the event of ensuring the fulfilment of the regulatory compliances, the foreign entity/company can undergo the incorporation process of setting up its operations in India and also issue securities for the purpose of foreign investment. The FDI policy has prescribed the mandatory procedure to regulate the inflow of foreign funds and investments into the Indian economy. Hence it will be vital to adopt favourable policies and impose limited restrictions which would help facilitate the smoother inflow of capital investment within the economy and thus would usher wealth creation and growth in the economy and also enable the development of entrepreneurship in India. Therefore with the FDI policy actively scrutinising the investments routes, it will ensure a greater scope of foreign investment. 

References

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