This article is written by Aabir Shoaib pursuing a Diploma in General Corporate Practice: Transactions, Governance and Disputes from Lawsikho. 

This article has been written by Aabir Shoaib and has been published by Sneha Mahawar.​​

The Indian Government recently notified the New Overseas Direct Investment rules that have liberalised overseas investments by Indians. This article sheds light on the same along with the challenges and way forward. 

Introduction 

India is currently the world’s fifth-largest economy, with financial experts estimating it to grow to a $3.54 trillion economy by the end of 2022. This size of the economy is derived not only from domestic consumption or exports but also from investments made by Indian companies in foreign markets outside of India.

Today, Indian companies own global brands such as Hamleys UK, Jaguar Land Rover UK, and others. In addition, India’s outbound deal value has risen to USD 7.6 billion in 2022, the highest level since 2018. The trend shows Indian companies expanding into new markets in search of growth.

The Finance Ministry has issued recently, consolidated regulations for overseas investment by Indian businesses in an effort to boost the ease of doing business. The Foreign Exchange Management (Overseas Investment) Rules, 2022 (Overseas Investment Rules 2022) will replace the existing Overseas Investment Regulations and the Acquisition and Transfer of Immovable Property Outside India Regulations, 2015. The Finance Minister also opined ““In view of the evolving needs of businesses in India, in an increasingly integrated global market, there is a need for Indian corporates to be part of the global value chain. The revised regulatory framework for overseas investment provides for simplification of the existing framework for overseas investment and has been aligned with the current business and economic dynamics“, in a statement. 

Last year, the Indian Government, in collaboration with the Reserve Bank of India (RBI), started a comprehensive initiative to streamline these regulations. The proposed Overseas Investment Rules 2022 and the draft of Foreign Exchange Management (Overseas Investment) Regulations were also made available for public notice.

The proposal was formerly part of the Finance Act of 2015, which included a split/distribution of powers between the RBI and the government in terms of capital account transactions. A similar shift in Foreign Direct Investment (FDI) was discovered in 2019 via Notification, which gave birth to the Foreign Exchange Management (non-debt instruments), 2019 (NDI Rules). In addition to the modification, new Overseas Direct Investment Rules (ODI Rules) were announced. The recent revision to the new ODI standards sparked a debate among investors, attorneys, and clients over how investments would now be made in light of the new ODI and Overseas Portfolio Rules (OPI Rules).

The new regime

In the spirit of liberalisation and to promote ease of doing business, the Central Government and RBI have announced a new overseas regime superseding the earlier regime, which is given hereunder:-

  1. The Central Government has issued Foreign Exchange Management (Overseas Investment) Rules, 2022 (dealing with non-debt instruments).
  2. RBI has issued Foreign Exchange Management (Overseas Investment) Regulations 2022 (dealing with debt instruments) under Central Government Notification no: G.S.R. 646(E).
  3. RBI has issued Foreign Exchange Management (Overseas Investment) Directions 2022 (dealing with directions to be followed by authorised dealer-banks) under RBI (Notification no: FEMA 400/2022-RB).

The new regime simplifies the existing framework for overseas investment by a person resident in India to cover wider economic activity and reduces the need for seeking specific approvals. The new regime will also reduce the compliance burden and associated compliance costs.

Overseas investment guidelines under the new regime

The new regulations bring forward a set of path-breaking and important changes and present a full package for the Indian corporate entities to push the pedal on growth and development and expand ambitiously. Moreover, as per the new regulations and guidelines, a lot of changes have also been introduced to the way overseas transactions operate through India and foreign countries with respect to investments made by and from Indian individuals and entities as well as Non-Resident Indians (NRI). 

However, this article shall be discussing only the prominent ones. They are as follows: 

Changes to round-tripping structures and other investments outside of India

For Indian entities (other than resident individuals)

Prior to the change in laws, an Indian-resident other than an individual who wanted to invest in a foreign firm that already had certain investments in India needed special permission from the RBI.

Assume A Company is an Indian business interested in acquiring F Company, say in the UK, which already has a subsidiary in India. Because F Company already has investments in India, acquiring F Company’s shares by A Company would have required prior RBI approval under the previous regime. It has also been noticed in the past that the RBI directs Indian corporations to unwind structures in foreign companies if such foreign companies have an investment (even if existing) in India. This created difficulties (time spent on prior clearances, for instance) for an Indian corporation looking to buy worldwide brands/companies with a presence in India.

According to the new Rules, an Indian entity (company/LLP/ firm) shall not make financial commitments to a foreign entity (with or without control) that has invested or invests in India, either at the time of making such financial investments or at any time thereafter, resulting in more than two layers of subsidiaries, directly or indirectly. As a result, it appears that round-tripping structures, up to two layers of a subsidiary, may not require RBI monitoring for an Indian firm. But, it is still to be ensured and evaluated that the structure of the company exists for a bona fide business structure, for any overseas investment of debt funding. From the standpoint of expansion or acquisition, this is a good move for Indian companies.

The new legislation also greatly enhances the capacity of Indian Entities to acquire properties abroad. Firstly, by allowing deferred consideration, the new regulations clearly empower Indian corporations to use deferred payments in international investments. Previously, non-resident Indians could acquire Indian assets and defer the consideration, but when Indian companies had to make outward remittances, there was a lack of flexibility for deferred consideration, which has now been addressed expressly because there is no cap on the amount and time period of deferred consideration under the current regulations.

Secondly, the new regulations authorise swaps via the automatic method, which will offer the deal structuring process energy and flexibility. Under the previous regulations, there was a lack of clarification as to whether swaps were permissible or not, which resulted in differing opinions from lawyers, accountants, and advisors alike. Furthermore, there was a lack of clarification on which types of swaps were permitted (primary or secondary swaps), which would encourage differing opinions from the legal and financial communities.

According to current legislation, an ODI may be made or held through a share swap. Both types of swaps are permitted through the automatic method, as understood by attorneys and financial advisors.

Thirdly, it also gave a push to the ‘ease of doing business’. In the erstwhile regime, prior RBI approval was required by an unlisted entity for restructuring foreign holdings and writing off overseas investments as losses, and this was usually met with strict regulatory scrutiny and often posed a hurdle for Indian corporations when investing overseas. With the new regulations, the government has been showing a lot of trust and confidence in Indian corporations to invest overseas and diversify their business aspects, with the current regulations allowing Indian corporations to write off overseas investments as losses in case there are losses and allow for the restructuring of the balance sheet of the overseas entity involving right off of up to 25% of the investment if the foreign entity has been incurring losses for 2 years as evidenced by the audited balance sheet of those 2 years. In case the amount of investment is more than $10 million or the company experiences a diminution (reduction in share capital) of more than 20%, a certificate of diminution of value prepared on an arm’s length basis by a registered valuer shall also be required.

For Indian resident individuals

Previously, Indian residents were not permitted to participate in a foreign firm that had a step-down subsidiary. The new rules have caused an amendment to the same.

According to the new guidelines, an Indian person may invest in a foreign entity (without control) that has a subsidiary or step-down subsidiary. Unlike other Indian residents, resident people are not permitted to participate in foreign entities (with control) through an investment/subsidiary. This does not apply to a foreign entity’s gift, inheritance, or ESOP.

When it comes to individual investors, such as startup founders HNWIs and others can invest in listed companies abroad. Individual investors can invest through OPI in unlisted companies, but only in the case of ESOPs (where employees get stock options), sweat equity, or some sort of management shares.

It is a positive step to have parity between persons and corporate entities for round trip structures, as Indian entrepreneurs establish foreign holding companies to obtain private equity capital, which would ultimately fuel major economic growth in India.

Automatic route for foreign investments

Previously, Indian residents needed RBI clearance to make different investments; however, new laws have eased the process for seeking approval, allowing such transactions to be done automatically.

The following are the primary sectors where automatic investments are now permitted under the revised rules:

Power of the President of India to make foreign investments

The new rules offer that a person resident in India may, directly or through a vehicle or step-down subsidiary, make a direct investment or financial commitment abroad through an automatic route in a foreign entity engaged in a bona fide business activity.

Fund and non-fund-based commitment 

Financial transfers to the foreign entity for loans and/or the issuing of bank guarantees to/on behalf of the foreign entity are authorised when the Indian entity has made ODI and has control over the foreign entity. Furthermore, interest should be charged on an arm’s length basis.

Restructuring the balance sheet

Indian residents with ODI in a foreign corporation that has been incurring losses for the last two years have been allowed to reorganise their balance sheets without the consent of the RBI.

The new regulations allow Indian Corporates to write off overseas investments as losses in case there are losses and allow for the restructuring of the balance sheet of the overseas entity involving the right off of up to 25% of the investment if the foreign entity has been incurring losses for 2 years as evidenced by the audited balance sheet of those 2 years. In case the amount of investment is more than $10 million or the company experiences a diminution (reduction in share capital) of more than 20%, a certificate of diminution of value prepared on an arm’s length basis by a registered valuer shall also be required.

Gifting of securities 

A resident of India can now donate foreign securities to a relative who lives in India without the need for RBI approval, which was previously necessary. Furthermore, subject to specific restrictions, transfers of investment in equity share capital including write-offs are permissible via the automated route.

Deferred payment in overseas investment

The new rules have also permitted deferred payment options for acquiring and transferring foreign securities under automatic route. This dramatically increases the ability of Indian Entities to acquire properties abroad. First, by allowing deferred consideration, the new regulations clearly empower Indian corporations to use deferred payments in international investments. Previously, non-resident Indians could acquire Indian assets and defer the consideration, but when Indian companies had to make outward remittances, there was a lack of flexibility for deferred consideration, which has now been addressed expressly because there is no cap on the amount and time period of deferred consideration under the current regulations.

New avenues for overseas investment 

Revised ODI guidelines have broadened the scope of company investments to include new market sectors, permitting investments in the following:

Strategic sector

The rules established a new concept of the strategic sector, which includes energy, natural resources, and any others determined by the government, and in which ODI is now permitted.

Overseas start-ups 

Indian residents may invest in foreign start-ups using their own funds rather than borrowed funds.

International Financial Services Sector (IFSC)

An Indian entity that is not engaged in the financial services sector in India can now invest in a foreign entity that is directly or indirectly engaged in financial services operations, excluding banks and insurance.

Concept of control

The definition of control has been updated. The term includes the right to appoint a majority of directors or to govern management or policy choices as evidence of control. This right may be utilised by an individual or individuals acting alone or in concert. It could be either direct or indirect.

The form of exercising the right in the entity could be: 

i) through their shareholding,

ii) through management rights, 

iii) through shareholder agreements, 

iv) through voting agreements entitling them to 10% or more of voting rights, or 

v) through any other means. 

In addition to the right to appoint a majority of the directors/to control management/policy decisions where the shareholding is less than 10%, even a mere 10% shareholding will amount to control under the ODI Guidelines.

Introduction and differentiation of Overseas Portfolio Investment (OPI) vis a vis Overseas Direct Investment (ODI)

The new amendment also defines a new set of terms that were earlier not defined under the earlier regime, such as ODI and OPI.

OPI refers to non-ODIs investing in foreign securities and excludes investment in unlisted debt instruments or securities issued by an Indian resident who is not a member of an International Financial Services Centre (IFSCs). The classification is important because Schedules I and II of the ODI Rules specify how an Indian entity can make an ODI or OPI. The OPI and ODI limits are different. In the case of ODI by an Indian entity, the maximum for financial commitment in all foreign entities combined is 400% of the net worth as of the last audited balance sheet, but the limit for OPI is 50% of the net worth as of the last audited balance sheet.

Earlier, the investment was operated through FDI or a joint venture and was always qualified as an ODI, and there was always debate on what an OPI transaction was since portfolio and OPI were not defined clearly in the earlier regime. This used to stir up discussion amongst regulatory bodies, banks, and financial institutions, which have their own views about portfolio investment.

The erstwhile law spoke about Portfolio Investment in the context of listed companies when the investment was made around 50% of their net worth. This was debated as a big concern by the investors, who said that this should be extended to all other forms of investment as well because if an investor was a minority shareholder, continual reporting and providing information annually was a bit of a challenge.

Another key aspect is the differentiation of ODI and OPI on the basis of control. The new amendment outlines the definition of OPI with a monetary threshold, which is an investment of 10% in the company. This means that if a person holds 10% or more in an overseas entity, it becomes an OPI. However, if a person holds 10% and control in the company or even without holding 10% if the investor is holding certain voting rights in the overseas entity, it becomes an ODI.

Even with such definitions and clarifications, there’s still some way to go. This resonates a lot with the aspirations of Indian corporations to expand their operations. With a lot of Indian corporations eyeing to become multinational entities, this does seem to be a benefit, especially with the rapid growth and development of the Indian market where corporations can take advantage of the investments through the ODI and OPI routes.

Concept of foreign entity

The new ODI Rules replace the terms joint venture (JV) and wholly owned subsidiary (WOS) with foreign entities, which include companies with limited liability created, registered, or incorporated outside India or in an IFSC, as well as unincorporated entities with core activity in a strategic area. The new ODI directions go on to say that the fundamental criteria are that the liability of Persons Resident in India be clear and limited. Energy and natural resource sectors such as oil, gas, coal, mineral ore, submarine cable system, and start-ups have been identified as strategic sectors.

While the ODI Rules and Regulations are silent in the case of a trust-based investment vehicle, the ODI Directions require that the PRI’s obligation be clear and limited to the amount of interest or contribution in the fund and that the trustee should be a person resident outside India.

Components of overseas investment

The former ODI regulations, which were in existence until August 21, 2022, included a notion of direct investment outside India in JV and WOS, which excluded portfolio investment and foreign commitment (FC). ODI Rules combine the two to define FC and define OPI separately. ODI is the sum of FC and OPI. The designation as an ODI is determined by the nature of the instruments used in the investment, the type of entity used in the investment, and whether or not control has been obtained.

ODI in financial services activity

The ODI Rules allow an Indian entity that is not engaged in financial services activity in India to make an ODI with a foreign entity that is directly or indirectly engaged in financial services activity other than banking or insurance, provided that such an Indian entity has posted net profits in the previous three fiscal years.

In terms of insurance, an IE not engaged in the insurance sector can make ODI in general and health insurance where such insurance business supports the IE’s core operations carried out overseas. According to the new ODI regulations, a foreign entity is regarded as being involved in the business of financial services activity if it engages in an activity that, if carried out by an entity in India, would require registration with or regulation by an Indian financial sector regulator.

NOC from lender bank/regulatory body/investigative agency for ODI

Earlier, there was a blanket prohibition on Indian parties making any investments or financial commitments under the ODI if such an Indian party appeared on the Reserve Bank’s Exporters’ Caution list/list of defaulters to the banking system circulated by the RBI/or on any credit information company or entity under investigation by any investigation/enforcement agency or regulatory body. The blanket ban has now been replaced with a requirement for a NOC. 

Now, any person resident in India who-

(i) having an account appearing as a Non-Performing Asset (NPA),

(ii) being classified as a wilful defaulter, or 

(iii) who is under investigation by a financial sector regulator/investigative agency is required to obtain a NOC from the lender bank/regulatory body/investigative agency concerned, before making any financial commitment or undertaking any disinvestment.

A company under investigation or whose accounts have been deemed NPAs does not require a NOC from the bank or the investigative agency to make an ODI investment. If the company applies for a NOC to either the bank or the investigative agency and does not get a reply within 60 days, it is deemed to be approved. There has also been a lot of flexibility and clarification given to IFSC and debt investments, which were in a bit of a grey area in the erstwhile regime.

Newly implemented pricing guidelines:

Under the previous ODI regime, the valuation of shares was necessary for share transfers, the partial/complete acquisition of a foreign business, and share swaps. However, unlike FDI, the pricing guidelines did not apply particularly to ODI. The new ODI Guidelines have revised this position, and pricing guidelines have been implemented. 

The issue or transfer of equity capital of a foreign entity must now be made at a price determined on an arm’s length basis after taking into account the valuation as per any internationally recognised pricing methodology for valuation, whether it is- 

(i) from a person resident outside India or a person resident in India to a person resident in India who is entitled to make such an investment, or 

(ii) from a person resident in India to a person resident outside India.

Investment by MFs, VCFs and AIFs

These SEBI-registered firms can invest in securities overseas in accordance with SEBI guidelines, up to a total ceiling of USD 7 billion for mutual funds (MFs) and USD 1.5 billion for venture capital funds (VCFs) or alternative investment funds (AIFs).

Any investment in foreign securities (listed or unlisted) by these organisations will be classified as an OPI.

Rollover of guarantees

Roll-over of guarantees is not considered a new financial commitment if the amount on account of the rollover does not exceed the amount of the initial guarantee.

This is a welcome change because, under FEMA 120, a rollover was not considered a new financial commitment unless-

(i) There was no change in the end use of the guarantee or any other terms and conditions except the validity period. 

(ii) The reporting of the rolled-over guarantee was completed in Form ODI – Part I. 

(iii) The notification to the investigation/enforcement agency or regulatory body where the Indian Party was under investigation.

Permitting Indian corporates not engaged in the financial sector to invest overseas in the financial sector

Indian entities not engaged in the insurance sector may make ODI in general or health insurance, which is big evidence of the flexibility provided to non-banking financial companies.

While previously only an Indian entity engaged in financial services could make an ODI in a foreign entity directly or indirectly engaged in financial services activity, an unregulated Indian entity, other than those engaged in banking or insurance activities may now invest in such an offshore entity without the need for RBI approval, provided the Indian entity has posted net profits in the previous three fiscal years. The net profit criterion for the previous two years may be excluded as a COVID relief measure if the firm cannot fulfill the profitability criteria owing to the COVID impact.

Way forward for Indian corporate entities and Indian market in light of the new regulations

The ODI Guidelines’ avalanche of modifications will undoubtedly encourage Indian firms and resident Indians to develop their operations in other nations. Some of these developments, particularly those pertaining to OPI by Indian corporations, have been long anticipated and are being welcomed by market participants.

The Indian corporate and legal sector was waiting for such regulations since the draft rules circulated by the RBI became public since it is a massive step for liberalisation in terms of ease of doing business as it indicates the eagerness and far-sightedness of the government to encourage the Indian corporates to grow overseas and compete with the best in the field.

The new regulations do bring forward a set of path-breaking and important changes and present a full package for Indian corporate entities to push the pedal on growth and development and expand ambitiously.

The two biggest and most significant changes that have been brought about and will eventually allow Indian corporate entities to grow internationally are- 

(a) liberalising the process of round-tripping, blessing it with support systems, and 

(b) permitting Indian corporates not engaged in the financial sector to invest overseas in the financial sector.

Previously, in the absence of these two benefits, the Indian corporates were significantly hamstrung and had to abort multiple deals that never saw the light of the day even when lawyers tried to structure the deals in different possible ways.

The new legislation also greatly increases the ability of Indian entities to acquire properties abroad. First, by allowing deferred consideration, the new regulations clearly empower Indian corporations to use deferred payments in international investments. Second, the new regulations authorise swaps via the automatic method, which will offer the deal structuring process energy and flexibility. Third, it has increased the ‘ease of doing business.’ Previously, an unlisted business needed prior RBI approval for restructuring foreign holdings and writing down overseas investments as losses, which was frequently greeted with severe regulatory scrutiny and often created a barrier for Indian corporations when investing overseas.

Conclusion

The new investment regulations will be a beneficial shift in general. The new regulations will allow residents to access new markets and enhance their portfolios by expanding globally and improving funding alternatives for overseas investments. This groundbreaking action is particularly significant for Indian residents who have established their own enterprises abroad and have been sponsored by a foreign private equity fund, which has then invested in Indian companies through the business.

Given the changing needs of Indian businesses in an increasingly connected global market, Indian corporations must participate in the global value chain. The updated regulatory framework for foreign direct investment simplifies the existing framework for foreign direct investment and is linked with contemporary business and economic trends. Clarity on ODIs and OPI has been introduced, and several overseas investment-related transactions that were previously subject to permission are now subject to automatic approval, considerably improving ‘ease of doing business.’

However, RBI FAQs/clarifications on key topics that are currently unclear are awaited.

References 

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