The Ministry of Finance via the Department of Economic Affairs notified the Foreign Exchange Management (Overseas Investment) Rules 2022 on 22 August 2022 (‘Investment Rules’).
This update highlights the key changes brought about by the Investment Rules.
The Investment Rules supersede the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015.
The Investment Rules prescribe the manner in which overseas investments may be made by resident individuals, Indian entities (that is an Indian company, body corporate, a limited liability partnership or a partnership firm) and other organizations (such as a registered trust or a society, mutual funds, venture capital funds or alternative investment funds).
In terms of the Investment Rules, any investment by a person resident in India may be made in a foreign entity engaged in a business activity permissible under any law in force in India and the host country/ jurisdiction (that is, a bona fide business activity), directly or through a step down subsidiary or a special-purpose vehicle.
The Investment Rules have replaced the extant concept of a joint venture and wholly owned subsidiary with the concept of a ‘foreign entity’, which means an entity formed or registered or incorporated outside India, including International Financial Services Centre (IFSC) that has limited liability.
Overseas Direct Investment or ODI
The Investment Rules have introduced a more comprehensive definition of overseas direct investment. ODI means:
- investment by way of acquisition of unlisted equity capital of a foreign entity; or
- subscription as a part of the memorandum of association of a foreign entity; or
- investment in 10% (ten percent) or more of the paid-up equity capital of a listed foreign entity; or
- investment with control where investment is less than 10% (ten percent) of the paid-up equity capital of a listed foreign entity.
Overseas Portfolio Investment or OPI
The Investment Rules have also recognized Overseas Portfolio Investment, as a means of investment in foreign securities (other than ODI), but not in any unlisted debt instruments or any security issued by a person resident in India who is not in an IFSC.
Focus on ‘control’
The Investment Rules have introduced the definition of control. Control means the right to appoint majority of the directors or to control management or policy decisions exercisable by a person (s) (acting individually or in concert) directly or indirectly, including by virtue of their (i) shareholding; (ii) management rights; (iii) shareholders’ agreements (iv) voting agreements that entitle them to 10 (ten) percent or more of voting rights; or (v) in any other manner in the entity. Accordingly, a ‘subsidiary’ or ‘step down subsidiary’ of a foreign entity means an entity in which the foreign entity has control.
Permissibility of investment in foreign entity engaged in financial services
The extant regime only allowed investment in a foreign entity engaged in financial services by an Indian entity also engaged in financial services activity. The Investment Rules have now permitted an Indian entity not engaged in financial services activity also to make ODI in a foreign entity engaged in financial services activities provided such Indian entity has posted net profits during the preceding 3 (three) financial years.
Investment in health and insurance sector
Similarly, an Indian entity which is not engaged in the insurance sector in India is also now permitted to make ODI in general and health insurance sector outside India where such insurance business supports the core activity undertaken overseas by such an Indian entity.
Gift of securities
The Investment Rules clarify that a resident individual may acquire foreign securities by way of gift:
- without any limit, from a person resident in India who is a relative and holding such securities in accordance with FEMA.
- from a person resident outside India in accordance with the provisions of the Foreign Contribution (Regulation) Act, 2010.
Limitation of investment by trusts and societies in ‘foreign entities’
The Investment Rules have now limited investment by a registered trust/ society to only those which are engaged in the educational sector or which has set up hospitals in India, provided such investment is made in a foreign entity engaged in the same sector. Accordingly, the permissibility for investment by registered trusts and societies engaged in manufacturing, as allowed in the extant regime, has now been dispensed with.
Investment in startups through internal accruals
The Investment Rules have imposed additional conditions in respect of ODI in start-ups recognised under the laws of the host country/ jurisdiction. It is provided that investment in a start-up outside India can be made by:
- an Indian entity only from the internal accruals whether from itself, group or associate companies in India; and
- in case of resident individuals, from own funds of such an individual.
Permissibility of deferred payment for investment
The Investment Rules have now recognized the concept of deferred payment as a mode of payment of consideration for any investment outside India.
Permissibility of round tripping structures
A person resident in India is now permitted to invest in a foreign entity that has invested or invests into India, directly or indirectly without obtaining approval from RBI, provided that such investment does not result in the Indian entity having more than 2 (two) layers of subsidiaries.
Pricing on arm’s length basis
Pricing guidelines have been introduced for ODI transactions as well. In terms of the Investment Rules, the pricing for issue or transfer of equity capital of a foreign entity from a person resident outside India or in India to a person resident in India is required to be undertaken on an arm’s length basis. The AD bank is responsible to ensure compliance with arm’s length pricing taking into consideration the valuation as per any internationally accepted pricing methodology for valuation.
Acquisition of immovable property
The Investment Rules have now allowed a person resident in India to acquire property on a lease not exceeding 5 (five) years, with the approval of RBI. This is in addition to the existing permitted avenues of acquisition of immovable property such as those by way of inheritance or out of funds in RFC account.
Restrictions on investment in certain sectors
In addition to the existing restrictions on real estate activity, the Investment Rules now also restrict ODI in a foreign entity engaged in–
- gambling in any form; and
- dealing with financial products linked to the Indian rupee without specific approval of RBI.
Write-off owing to of disinvestment
In terms of the Investment Rules, the approval of RBI is no longer required for write-off on account of disinvestment.
Grandfathering of transactions under old regime
The Investment Rules recognize investments or financial commitment made outside India under the old regime. Accordingly, investment made and held as on the date of publication of the Investment Rules is deemed to have been made under the new regime.
The Investment Rules, with a view to promote ease of doing business, have opened new avenues of investment. The Investment Rules bring clarity on the manner and mode of investment outside India.
The Foreign Exchange Management (Overseas Investment) Regulations, 2022 and the Foreign Exchange Management Overseas Investment) Directions issued by the RBI, in consonance with the Investment Rules, also detail out the regulatory aspect governing overseas investments.
Devyani Chugh, Associate from Lumiere Law Partners also contributed to the article.