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Jul 15, 2013

Government clarifies stand on Indirect Foreign Investment

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Guidelines for calculation of total Foreign Investment
Department of Industrial Policy and Promotion (DIPP) had on 13th February, 2009 issued two press notes i.e. Press Note 2 & 3 (2009) stating Guidelines for calculation of total foreign investment in Indian companies, transfer of ownership and control of Indian companies and downstream investment by Indian companies. The same has been incorporated in FEMA regulations for FDI vide Notification No.FEMA.278/2013-RB dated June 07, 2013.
Now the Reserve Bank of India (RBI) has vide A.P. (DIR SERIES) CIRCULAR NO. 01 DATED JULY 04, 2013 provided for the one time reporting mechanism in respect of the calculation of the total foreign investment (Direct and Indirect) in respect of the press notes issued by DIPP and incorporated n the FDI Policy. The reporting with respect to the foreign investments made between 13th February, 2009 and 7th June, 2013 (inclusive of both dates) which are not in compliance with the regulatory framework prescribed by RBI pursuant to the aforesaid circular, is mandatory and must be done through the authorized dealer within 90 days of the date of the circular i.e. by 2nd October, 2013.
Reserve Bank shall consider treating such cases as compliant with these guidelines within a period of 6 months or such extended time as considered appropriate by RBI in consultation with Government of India.
The guidelines which have been incorporated by RBI in its regulations basically provide for:

  1. Definitions for Control and Ownership of the company either by an Indian resident or foreign resident, downstream investment and indirect foreign investment
  2. When investment would be counted as direct investment or indirect investment
  3. Calculation of the percentage of foreign investment into an Indian company
  4. Guidelines for establishment of Indian companies and transfer of ownership or control of Indian companies, from resident Indian citizens and Indian companies to non-resident entities, in sectors with caps;
  5. Downstream investment by an Indian company which is not owned and/or controlled by resident entity/ies.

    6. The aforesaid guidelines have been explained below for better understanding:

1. Definitions:
  •  Ownership
  Where in the Indian company, more than 50% of the capital, is beneficially owned by resident Indian citizens and/or Indian companies, which are ultimately owned and controlled by resident Indian citizens, that Indian company would be considered as Owned by Indian Company and if in the Indian company, more than 50% of the capital is held by non-resident(s) [citizen and /or entity which are ultimately owned and controlled by non-resident citizen or entity(ies)], such Indian company would be considered as Owned by Non-resident(s).
  •  Control
  A company shall be considered Controlled by resident Indian citizens if the resident Indian citizens and/or Indian companies, which are owned and controlled by resident Indian citizens, have the power to appoint the majority of its directors and shall be considered as Controlled by non-residents where non-residents have power to appoint a majority of its directors in that company.
  •  Downstream Investment
  It means indiect foreign investment by one Indian company into another Indian company by way of subscription or acquisition.
  •  Indirect Foreign Invetsment.
  It means investment by an Indian company which is owned and/or controlled by non-residents, into another Indian company.
2. Calculation of Direct and Indirect foreign investment in Indian companies – How the company would be called as owned and/ or controlled by Non-residents and how to calculate the direct and indirect foreign investment is explained herein below with the help of different illustrations:
 
(i) Company A (foreign company) making foreign investment in the capital of company B (Indian company) is counted as Foreign Direct Investment (FDI) and further investment by company B (Indian company) making investment into company C (Indian company) is counted as downstream investment and indirect foreign investment by company A.
In the above example, if a company A (foreign company) holds more than 50% into company B (Indian company), the company B would be called as owned by company A (foreign company).
And, if company A (foreign company) has power to appoint majority of directors in company B (Indian company), then company B (Indian company) would be called as controlled by company A (foreign company).
Now, company B can either be a purely Investing Company or an Investing cum Operating Company.
Calculation of percentage of Indirect foreign investment into the company C is based on the percentage of direct investment by company A into company B:
  • General Rule of calculation of Indirect foreign investment – Where if company A (foreign company) owns and/or controls Company B (Indian company), then entire Foreign Investment by company B (Investing or Investing cum operating) in company C (another Indian company) would be calculated as Indirect foreign investment. The same is diagrammatically represented as follows:
 
  In both the situations company B (Indian company) is owned by company A (Foreign Company) and the total investment by company B in company C is considered as indirect foreign investment by company A in company C i.e. 30%, and 80% in situation1 and situation 2 respectively.
 
  In both the situations company B (Indian company) is wholly owned by company A (foreign company) and the total investment by company B in company C is considered as indirect foreign investment by company A in company C i.e. 30% and 80% in situation1 and situation 2 respectively.
 
  In both the situations company B (Indian company) is not owned by company A (foreign company) and the total investment by company B in company C is purely Indian investment (assuming that company B is also not controlled by company A). However, in the event company A holds less than 50% shareholding in company B but has the power to appoint majority of the directors on board of company A, any investment by company B into company C would be considered as indirect foreign investment.
 
  • Exception to the General Rule – Where if company A owns and/or controls company B and company B holds 100% in company C then only that percentage would be counted as Indirect foreign investment in company C up to which percentage company A holds in company B. The same is diagrammatically represented as follows:
 
  In Situation 1, percentage of downstream investment in company C by company B is 51%;
  In Situation 2, percentage of downstream investment in company C by company B is 100%; and
  In situation 3, since company B is not owned by company A (assuming no direct or indirect control) then no percentage is counted as Indirect or downstream investment in company C. However, if company B was controlled by company A, in such a situation, percentage of downstream investment in company C by company B would stand at 49%.
  This exception has been made since the downstream investment should be a mirror image of the ultimate holding company.

  • The methodology for calculation of total foreign investment would apply at every stage of investment in Indian companies and thus in each and every Indian company.
  • Additional Requirements for calculation of indirect investment:
    • At the time of seeking approval of Government of India, full details of the foreign investment including ownership and control details of Indian company will be required to be furnished.
    • Any inter-se agreements between/amongst shareholders which have the effect on the appointment of the board members or on the exercise of voting rights or of creation of disproportionate voting rights, such agreements will have to be informed to the approving authority at the time of making investment in any sector/activity where government approval is required.
    • The sectors having sectoral caps, the balance equity i.e. beyond the sectoral cap set for foreign investment, is specifically required to be owned by Indian resident(s) and/or Indian entities owned and controlled by resident Indian citizens(s).
    • In the I&B and Defence sectors where the sectoral cap is less than 49%, the company would need to be “owned and controlled” by resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens.
      1. For this purpose, it is mandatory that at least 51% of the total equity is held by the largest Indian shareholder excluding the equity held by Public Sector Banks and Public Financial Institutions, as defined in Section 4A of the Companies Act, 1956 (the “Act”).The largest Indian shareholders means:
        1. In case of Individual – Individual shareholder, his/her relative within the meaning of Section 6 of Companies Act, 1956 or/and company or group of companies in which the individual shareholder or HUF to which he belongs has management and controlling interest.
        2. In case of Indian Company – The Indian company and /or group of Indian companies under the same management and ownership control.
      2. Further Indian company for the purposes of this section has been defined a company in which an HUF or an individual shareholder (as defined earlier) holds, either singly or in combination (legally binding agreement to act as a single unit in managing the matters of the company is a pre-requirement for any such combination), at least 51% of the shareholding.
    • Where in pursuance of section 187C of the Companies Act, 1956 declaration is made by persons about a beneficial interest being held by a non resident entity, then even though the investment may be made by a resident Indian citizen, the same shall be counted as foreign investment.
  Guidelines for establishment of Indian companies/ transfer of ownership or control of Indian companies from resident individuals/entities to non-resident entities in sectors with caps:
  In sectors with caps, Government approval would be required in all cases where:

  • An Indian company is being established with foreign investment and is not owned and controlled by a resident entity, or
  • Where the ownership and/or control of an existing Indian company owned and controlled by resident Indian citizen(s) or entities owned and controlled by Indian citizen(s), is being transferred to a non-resident entity either by virtue of transfer of shares, fresh issue of shares or by merger or amalgamation etc.
  • These guidelines are not applicable for companies into the sectors under 100% automatic route.
  Various sectors having sectoral caps and requiring FIPB approval are defense, air transport, ground handling, asset reconstruction, private sector banking, broadcasting, credit information companies, insurance, print media, telecommunications and satellites.
  However, for the computation of Indirect Foreign Investment, all types of direct foreign investments in Indian company making downstream investment shall be considered. Further, any portfolio investments made on 31st March of the previous year either by FIIs, NRIs or QFIs shall be taken into account. Besides investment in the form of FDI, Foreign Venture Capital investment, investments in ADRs/GDRs, Foreign Currency Convertible Bonds (FCCB) will also be taken into account.
  If any investment is made by a Banking Company under Corporate Debt Restructuring (CDR), or other loan restructuring mechanism, or in trading books or for acquisition of shares due to defaults in loans, such investment shall not count towards indirect foreign investment. However, if any strategic downstream investment is made by such company, it will be counted as indirect foreign investment. The term strategic downstream investments mean investment by banking companies in their subsidiaries, joint ventures and associates.1
  For making downstream investment, Indian companies, owned or controlled by non-resident entities must raise funds from abroad and not through funds raised from domestic market.
Indian Investing companies are, however, allowed to make downstream investment from funds raised by internal accruals. For making downstream investment through internal accruals, investing company must have complied with the following:
 
(i) Indian companies engaged only in investing activity must require FIPB approval irrespective of amount and extant of investment.
(ii) For infusion of foreign investment into an Indian company which does not have any operations and also does not have any downstream investments, Government/FIPB approval would be required, regardless of the amount or extent of foreign investment.
 

1Press Note 2(2012 series) dated July 31, 2012
 
(iii) Further, as and when such a company commences business(s) or makes downstream investment, it will have to comply with the relevant sectoral conditions on entry route, conditionalities and caps.
  Downstream Compliances:
  The FDI recipient Indian company is primarily responsible for ensuring compliance with downstream investment guidelines. The FDI recipient company shall also obtain certificate on annual basis from statutory auditor ensuring that the company has complied with regard to prohibited sectors, entry route and sectoral caps. The fact that company is in compliance of instructions of downstream investment and FEMA provisions shall be included in the Board report of the company, and in case of negative remark(s) in the auditors report, the same shall be immediately reported to RBI.
  Indian company who has made downstream investments has to notify secretariat for Industrial Assistance, DIPP and FIPB within 30 days of such investment, even if the investment have not been allotted. The documents to be supported with such investments are:

  • Resolution of board of directors
  • Shareholders agreement
  • Valuation of shares
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