India: Much Ado About Half Measures! Reform Happens In Bit And Pieces

Last Updated: 4 March 2009
Article by Sakate Khaitan

In a bid to streamline, rationalise and liberalise the method of calculation of indirect foreign investment across sectors and make the foreign investment regime in India more transparent from the perspective of downstream investment, the Indian Government amended the existing guidelines recently through issue of Press Note 2 of 2009, Press Note 3 2009 and Press Note 4 of 2009 ("the Press Notes") or ("the Guidelines")1.

Though, the Press Notes assert to clarify the legal position on oft debated issues like cascading or downstream foreign investments in Indian companies through Indian investing companies and transfer of shares in companies that have sectoral caps, in essence these new Guidelines only partially address the real issues involved. The clarifications may be a non-starter as the policy makers seem to have failed to comprehensively achieve the intended objective and have created more confusion in the bargain.

In order to understand the attempted overhauling of the framework relating to downstream investments by Indian companies holding foreign investments, it is important to examine all the Press Notes contextually.

Before Press Note 2 of 2009 ("PN 2")

PN 2 essentially tries to homegenise the method of calculation of indirect foreign investment in Indian investee companies that secure investments from other Indian companies with foreign shareholding.

Prior to this, FDI was calculated in three different ways being – a) Proportionate method as stipulated under sectoral guidelines for telecom, print media, private sector banking etc b) Press Notes issued by DIPP on investing companies in services and infrastructure and c) Guidelines for calculation as provided in the regulations framed under statute as in the case of insurance sector. PN 2 stipulates a uniform method of calculation of indirect foreign investment for all sectors except insurance which is governed under separate regulations framed under statute.

PN 2

According to PN 2 , downstream investment by Indian companies which are 'owned and controlled' by resident Indian citizens2, irrespective of their foreign shareholding, would not be considered as indirect foreign investment.

Owned and Controlled

An Indian company is considered to be "owned" by resident Indian citizens if more than 50% of the equity in that company is held by resident Indian citizens, and it is considered to be "controlled" by resident Indian citizens if majority of the directors are nominated by resident Indian citizens. In order to avoid the classification of downstream investment in the investee company as indirect foreign investment, both the conditions of ownership and control as stated above must be satisfied. If the investing company is either owned or controlled by a non resident, then its entire investment in the Indian investee company is considered to be foreign investment.

Operating cum Holding Company a mirror image:

Downstream investments by Indian investing companies either owned or controlled by non-residents is deemed as indirect foreign investments in the investee companies. In such cases, the entire investment made by the Indian investing company in the downstream company will be treated as indirect foreign investment. (i.e. if the investment by the Indian company (owned or controlled by non-residents) in the downstream company is 60% then the indirect foreign investment in the downstream company will be considered to be 60%).

Thus foreign investment in an Indian company will include both direct investment and indirect foreign investment i.e. investment through another Indian investing company and such indirect foreign investment would be calculated in the manner stated above.

In Indian companies in sectors that attract FDI caps, the balance equity above the stipulated FDI caps must be beneficially held or owned by resident India citizens or Indian companies that are both owned and controlled by Indian resident citizens. Accordingly, companies in sectors with 49% FDI caps like broadcasting, credit information etc, will have to be owned and controlled by the resident Indian citizens or Indian companies owned and controlled by resident Indian citizens.

Press Note 3 of 2009 ("PN 3")

PN 3 deals with the procedures to be followed for the transfer of ownership or control of existing Indian companies from Indian residents to non-residents. It states that in sectors which have prescribed sectoral caps, prior approval of the Foreign Investment Promotion Board ("FIPB") in all cases will henceforth be required for the transfer of ownership or control of existing Indian companies from Indian residents to non-residents. It further provides that where an Indian company is being established with foreign investment and non-resident ownership or control of such company is contemplated in sectors which have prescribed sectoral caps, then prior FIPB approval will be required. Importantly, these provisions do not apply to transfer of ownership in sectors where 100% FDI is permitted under automatic route.

Accordingly, it has been clarified that in cases involving transfer of ownership or control, in sectors with caps on FDI like defence production, insurance, telecommunication etc, a prior approval of FIPB/Government is required.

Press Note 4 of 2009 ("PN 4")

Background

Notoriously famous for being an obstinate regulatory hurdle in many cases was Press Note 3 of 1997 which inter-alia, provided that setting-up of 100% foreign owned holding company in India and all subsequent downstream investments would require prior approval of the FIPB. It was followed with Press Note 9 of 1999, with the intention of, "further simplifying the investment procedures for downstream investment" referring to Press Note 3 of 1997. It provided that foreign owned Indian holding companies could make downstream investments in activities falling under the automatic route without FIPB approval, subject to satisfying certain conditions.

Both these Press Notes use the term 'foreign owned holding company'. Interestingly, neither the term "foreign owned" nor 'holding company' had been defined in these Press Notes or under FEMA. As per general inference and common understanding, foreign owned came to be considered as majority owned by non-residents and holding company as one whose primary activity is that of holding investments and earning dividend and capital appreciation thereon.

While Press Note 9 of 1999 was not per se retrograde, the interpretation lent to this guideline recently by the government created confusion. All Indian companies with foreign investment, irrespective, of its quantum were expected to seek FIPB approval before making downstream investment. As per this stand of the FIPB, in addition to complying with other requirements of Press Note 9 of 1999, the Indian company with a foreign shareholding, was to obtain the status of 'operating cum holding company', before making downstream investments. To the dismay of the investors, most of them being Indian companies, this view of FIPB was extended to sectors falling under the automatic route and where the downstream investments were made in the sectors covered under the automatic route.

PN 2 notified in February 2009 clarified the method of calculation of foreign investment and when read in conjunction with PN 4 issued subsequently, provides some degree of clarity in respect of downstream investment.

PN 4 pursuant to which Press Note 9 of 1999 stands deleted, clarifies that downstream investment by Indian companies owned and controlled by non-residents must be in compliance with existing FDI policy on entry routes, conditions, sector caps etc. Thus indirect investment through an Indian company owned by and controlled by non-residents will be required to adhere to all norms that relate to FDI. Interestingly, however, an Indian company with less than 50 per cent foreign holding and controlled by resident Indian citizens, as set out in PN 2 may be permitted to make investments in sectors where FDI is restricted or capped.

Operating Company, Operating cum Investing Company and Investing Company

Further, PN 4 has for the first time provided definitions of an operating company and an investing company. An operating company is an Indian company which undertakes operations in various economic activities and sectors and an investing company is an Indian company that holds investments in another Indian company, directly or indirectly, other than for trading of such holdings/securities.

As per guidelines stated in PN 4, foreign investment in an operating company and an operating cum investing company will have to be in accordance with entry routes, sector caps and other applicable conditionalities. An Indian company owned and controlled by non-residents is permitted to make downstream investments in Indian operating companies as well as operating cum investing companies subject to existing FDI policy. In case of operating cum investing companies, the subject Indian companies into which downstream investments are made by such companies will also have to comply with the relevant FDI regulations.

Foreign investment in investing companies require prior FIPB approval, regardless of the amount or extent of foreign investment. The Indian companies into which downstream investments are made by such investing companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps in regard of the sector in which the subject Indian companies are operating.

Further, for any foreign investment in a company which is neither an operating company nor has made any downstream investments – the popularly referred as "shell" company, prior approval of the FIPB will be required.

It has been clarified that FIPB approval would be required for downstream investments by operating-cum-investing companies only if such approval is required as per the applicable FDI regulations relating to entry route, caps and other conditions. In case of non operating companies or pure investing companies FIPB approval will be required, irrespective of the quantum of investment.

PN 4 also provides that downstream investments are to be made subject to certain conditions, such as, interalia, that the DIPP, SIA and FIPB shall have to be notified of all downstream investment within 30 days of such investment and the investing companies would have to bring in requisite funds from outside India and not leverage funds from domestic market for such investments.

Press Note 9 of 1999 mandated expansion of equity base of the downstream company through acquiring new shares of the downstream company. The language of PN 4 does not specifically require issue of new shares by the downstream company and seems to thus allow transfer of existing shares.

Conclusion

The Press Notes are a welcome step to the extent that they have in a limited way been able to address confusions and concerns in regards to indirect foreign investment through Indian entities. However, while the Press Notes were notified with the object of bringing about "clarity, uniformity, consistency and homogeneity" into the exact methodology of calculation of foreign investment and downstream investments, they have also given rise to some significant questions:

  • The term 'beneficial ownership' in context of foreign investment in sectors with FDI caps, used in PN 2 has not been defined. It is unclear as to how existing beneficial ownership beyond the FDI caps as per the previous Press Notes be calculated and if these breach the current Press Notes, how they will be treated.
  • There is lack of clarity on how investments in Indian companies such as those by foreign venture capital investors through wholly owned venture capital funds be treated. This gains particular significance given that such vehicles have been used to route significant investments into Indian sectors, which have FDI caps.
  • PN 4 requires FIPB approval for "shell" companies or the companies that are neither operating nor investing companies. A possible interpretation is that FIPB approval is required for the formation of any new Indian company with foreign shareholding. Further, companies that are incorporated on behalf of foreign investors by residents for operational ease and ownership subsequently transferred before the actual commencement of business may also require FIPB approval prior to transfer.

It, therefore, appears that the Press Notes have resulted in the unsettling of many settled positions, while at the same time giving some much needed clarifications on some oft debated issues. Given the significance of FDI to the Indian economy it is now imperative that Indian Government clarifies its position in respect of the questions raised above.

Footnotes

1. Foreign Direct Investment ("FDI") in India is regulated through the provisions of Foreign Exchange Management Act, 1999 ("FEMA") and the Rules and Regulations notified under FEMA by the Reserve Bank of India as well as well as the Press Notes issued by the Department of Industrial Policy and Promotion ("DIPP"), Ministry of Commerce and Industry, Union Government.

2. Resident Indian Citizen shall be interpreted in line with the definition of a person resident in India as per FEMA 1999 and the Indian Citizenship Act, 1955.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions