In this blogpost, Aditya Manubarwal, Student,  Pravin Gandhi College of Law, Mumbai University, writes about what is a foreign direct investment, foreign direct investment in India and the ideal structure for a business to attract FDI.

What is Foreign Direct Investment?

Foreign Direct Investment hereafter referred to as FDI, may be defined as ‘Investment from one country into another (normally by companies rather than governments) that involves establishing operations or acquiring tangible assets, including stakes in other businesses’.[1] FDI generally involves the transfer of factors such as technology, management, organizational skills, etc.[2] The most common methods of making FDI in a country include participation in joint ventures, merger and acquisition of existing businesses in the host country, re-investment of profits in the host country and the creation of a new subsidiary or manufacturing base in the host country.[3]

Foreign Direct Investment in India

In 2015, India overtook China and the United States of America and became the top global destination for FDI.[4] In India, 100% FDI is allowed in several sectors excluding a few such as Petroleum Refining by PSU (49%), Teleports (setting up of up-linking HUBs/Teleports), Direct to Home (DTH), Cable Networks (Multi-system operators (MSOs) operating at national, state or district level and undertaking upgradation of networks towards digitalisation and addressability), Mobile TV and Headend-in-the-Sky Broadcasting Service (HITS) – (74%), Cable Networks (49%), Broadcasting content services- FM Radio (26%), uplinking of news and current affairs TV channels (26%), Print Media dealing with news and current affairs (26%), Air transport services- scheduled air transport (49%), non-scheduled air transport (74%)Ground handling services – Civil Aviation (74%), Private security agencies (49%), Satellites- establishment and operation (74%), Public Sector Banking (20%), Private Sector Banking- Except branches or wholly owned subsidiaries (74%), Commodity exchanges (49%), Credit information companies (74%), Infrastructure companies in securities market (49%), Insurance and sub-activities (49%), Power exchanges (49%) and Defence (49% above 49% to CCS) and Pension Sector (49%) where FDI is allowed but with a cap. Moreover, FDI is completely prohibited in Lottery Business including Government /private lottery, online lotteries, etc., Gambling and Betting including casinos etc., Chit funds, Nidhi company, Trading in Transferable Development Rights (TDRs), Real Estate Business (other than construction development) or Construction of Farm Houses, manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes, activities / sectors not open to private sector investment and services like legal, bookkeeping, accounting & auditing.[5]

Ideal Structure of a Business for Attracting FDI

In order to identify the ideal structure for attracting FDI, it is necessary to examine ease and permissibility of FDI in various structures:

FDI in Trusts:

According to the FDI Policy of India, FDI is not allowed in Trusts with the exception of Venture Capital Funds.[6]

FDI in Venture Capital Funds (VCFs):

In the case of VCFs, which have been set up as trusts, a non-resident entity or individual can invest in such a VCF with the approval of the Foreign Investment Promotion Board (FIPB). However, with regard to VCFs, which have been set up as incorporated companies under the Companies Act, non-resident entities or individuals can invest through the automatic route of the FDI scheme subject to regular guidelines and restrictions.[7]

FDI in Limited Liability Partnerships (LLPs):

FDI is allowed in LLPs but is subject to the following conditions:

• FDI is allowed, albeit only through the approval route, for LLPs, which are operating in sectors where 100%, FDI is allowed through the automatic route and where there are no performance-related conditions.[8]
• Moreover, LLPs with FDI are not allowed to operate in agricultural, media and real estate sectors.[9]
• Indian Companies, which have FDI, can make downstream investments in LLPs with FDI only if both are operational in sectors where 100% FDI is allowed and where there are no performance-linked conditions.[10]
• LLPs with FDI are not eligible to make any downstream investments.[11]
• Foreign Capital participation in LLPs is allowed only by way of cash consideration, received by inward remittance, through normal banking channels or by debit to NRE/FCNR account of the person concerned, maintained with an authorized dealer/authorized bank.[12]
• Investment in LLPs by Foreign Portfolio Investors (FPIs) and Foreign Venture Capital Investors (FVCIs) is not permitted. LLPs are also not permitted to avail External Commercial Borrowings (ECBs).[13]
• When an LLP with FDI has a body corporate that is a designated partner or nominates an individual to act as a designated partner in accordance with the provisions of Section 7 of the LLP Act, 2008, such a body corporate should only be a company registered in India under the Companies Act, as applicable and not any other body, such as an LLP or a trust.[14] For such LLPs, the designated partner “resident in India”, as defined in the ‘Explanation’ to Section 7(1) of the LLP Act, 2008, would also have to satisfy the definition of “person resident in India”, as prescribed under Section 2(v)(i) of the Foreign Exchange Management Act, 1999.[15] The designated partners are responsible for compliance with all the aforementioned conditions and are also liable for all penalties imposed on the LLP for their contravention if any.[16]
• Conversion of a company with FDI, into an LLP, is allowed only if the aforementioned stipulations are met and with the prior approval of FIPB/Government. [17]

FDI in Incorporated Companies

According to FDI Policy, Incorporated Companies can directly issue capital against FDI.[18]

Conclusion

In light of the aforementioned structures and the FDI policy relating to each of them, an Indian entrepreneur who wishes to attract and receive FDI should ideally incorporate a Company as it is the most direct and easy route, which is fraught with the least number of restrictions and regulations. He can receive FDI through the direct route in sectors where 100% FDI is allowed. Moreover, he can receive FDI even in sectors where 100% FDI is not allowed. Thus, an incorporated company is the most expedient and convenient option for such an entrepreneur.

[1] Lexicon.ft.com, Foreign Direct Investment Definition from Financial Times Lexicon (2016), http://lexicon.ft.com/Term?term=foreign-direct-investment (last visited Jan 29, 2016).

[2] Id

[3] Srijanee Bhattacharyya & Slaughter and May, Legal Regimes Governing Foreign Direct Investment (FDI) in Host Countries 3 (1 ed. 2012), http://www.a4id.org/sites/default/files/user/documents/FDI%20Legal%20Guide.pdf (last visited Jan 29, 2016).

[4] Santosh Tiwari, India is world No. 1 in FDI, PM Narendra Modi gets big booster shot, Financial Express, 2015.

[5] Makeinindia.com, FOREIGN DIRECT INVESTMENT – Make In India (2016), http://www.makeinindia.com/policy/foreign-direct-investment (last visited Jan 29, 2016).

[6] Para 3.2.4, Consolidated FDI Policy, 2015, Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India

[7] Id, Para 3.2.3

[8] Id, Para 3.2.5 (a)

[9] Id, Para 3.25 (b)

[10] Id, Para 3.2.5 (c)

[11] Id, Para 3.2.5 (d)

[12] Id, Para 3.2.6 (e)

[13] Id, Para 3.2.5 (f)

[14] Id, Para 3.2.5 (g)

[15] Id, Para 3.2.5 (h)

[16] Id, Para 3.2.5 (i)

[17] Id, Para 3.2.5 (j)

[18] Id, Para 3.2.1