With a view to liberalize and promote ease of doing business in India, the Central Government and the Reserve Bank of India (RBI) have simplified the existing framework for overseas investment by persons resident in India and has notified the Foreign Exchange Management (Overseas Investment) Rules, 2022 (OI Rules) read with the Foreign Exchange Management (Overseas Investment) Regulations, 2022 (OI Regulations) and the Foreign Exchange Management (Overseas Investment) Directions, 2022 (OI Directions) in supersession of 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 (collectively OI Rules, OI Regulations and OI Directions are referred to as the (OI Regime).

While clarity on certain aspects may be forthcoming in the near future, prima facie some of the key observations under the OI Regime are as follows:

Overseas Direct Investment (ODI) in financial services activity: An Indian entity which is not engaged in financial services activity in India has been permitted to make ODI in a foreign entity which is directly or indirectly engaged in financial services activity (except banking or insurance), subject to the condition that such Indian entity has posted net profits during the preceding three financial years. This was earlier not permitted and is likely to open doors for many Indian entities looking to invest in overseas financial services activities.

It is also interesting to note that the condition relating to obtaining of approval (as may be required) from regulators of relevant financial services activities, in India and host country/jurisdiction for engaging in such financial services activities in the host country/jurisdiction, (as applicable to an Indian entity engaged in financial services activities which intends to undertake such activity), is currently not applicable to an Indian entity which proposes to undertake financial services activity in host country/jurisdiction and is not engaged in the same in India.

Prior to the OI Regime, an Indian entity engaged in the financial services activity had to mandatorily obtain approval from the Indian regulator and regulator of host country/jurisdiction for undertaking financial services activity in the host country/jurisdiction. Under the present OI Regime, regulatory approval only if required, under Indian law or laws of the host country/jurisdiction, will need to be obtained. Family offices will likely explore this opportunity to invest overseas in financial services activity through their core investment company (CICs) and nonbank financial company (NBFCs).

Clarity on definitions of Overseas Direct Investment (ODI) and Overseas Portfolio Investment (OPI):

Overseas Direct Investment (ODI) has been defined as:

  • acquisition of any unlisted equity capital (equity shares, perpetual capital, irredeemable or in the nature of fully and compulsorily convertible); or
  • subscription as a part of the Memorandum of Association of a foreign entity, or
  • with respect to listed foreign entity
    • investment in 10% or more of the paid-up equity capital of a listed foreign entity, or
    • investment with control where investment is less than 10% of the paid-up equity capital of a listed foreign entity. Control in this context shareholders agreement or voting agreements that entitle the holder to 10% or more of voting rights in the listed foreign company.
    • ODI investments will continued to be treated as such even where the above limits fall.

Overseas Portfolio Investment (OPI) has been defined as:

  • investment, other than ODI, in foreign securities, but does not include
    • investment in any unlisted debt instruments; or
    • any security issued by a person resident in India who is not in an international financial services centre (IFSC).
    • any derivatives unless otherwise permitted by RBI; or
    • any commodities including Bullion Depository Receipts (BDRs)

OPI by a person resident in India in the equity capital of a listed entity, even after its delisting shall continue to be treated as OPI until any further investment is made in the entity.

Further, both in case of Indian entity and Resident Individuals specific investments have been identified as ODI and/or OPI. By defining the terms ODI and OPI, the Government has brought clarity on the distinction between the two, which has for long been debatable.

ODI-FDI investments: The OI Regime has permitted persons resident in India to make financial commitments in foreign entities that have invested prior to or invest into India at any time post such investment, either directly or indirectly, through structures with up to two layers of subsidiaries. By restricting only the number of layers and not investment into India, it prima facie appears that investment by a person in Indian in foreign entity which invests back in India has been permitted by the Government.

However, resident individuals can make overseas investments by way of ODI only in an operating foreign entity (not engaged in financial services activity) which does not have subsidiary or step down subsidiary where the resident individual has control (as defined in the OI Regime) in foreign entity.

Deferred payment of consideration: The OI Regime has permitted deferred payment of consideration for acquisition or transfer of foreign securities, subject to certain conditions, which was earlier not permitted.

Write-off on account of disinvestment: The OI Rules have dispensed with the requirement of approval for write-off on account of disinvestment. This is expected to make the process of disinvestment much faster and smoother.

Pricing to be at arms' length: The OI Rules require pricing to be done on arms' length basis for any issue or transfer of equity capital of a foreign entity from a person resident outside India or a person resident in India to a person resident in India who is eligible to make such investment or from a person resident in India to a person resident outside India. The onus has been put on the AD bank to ensure compliance with arm's length pricing taking into consideration the valuation as per any internationally accepted pricing methodology for valuation. Considering that the AD Banks will have flexibility to decide on this aspect, it is preferable that RBI specifies the guiding principles to determine 'arms length pricing'.

ODI in Start- Ups: ODI in start-ups is permitted to be made only out of internal accruals of the investing entity or own funds of the resident individual. As per the OI Rules, this investment is permitted in 'start-ups' recognised as such under the laws of the host country/host jurisdiction. Not many countries specifically define what is or is not a 'start-up', so in any country where there is no specific definition, this condition becomes infructuous. The RBI may need to clarify its position in this regard.

Grandfathering of transactions: The OI Regime mentions that any investment or financial commitment outside India made in compliance with the earlier regime and held as on the date of publication of the OI Rules shall be deemed to have been made under the OI Regime. However, if any investments or financial commitments have been made in the past which was not in accordance with the then prevailing law, then the OI Regime will not be applicable and specific compounding application will need to be made for the same.

Discontinuation of utilization of subsidiary / holding net worth: Prior to the OI Regime, an Indian entity for purposes of overseas investments, could utilize the net worth of its Indian subsidiary/holding company to the extent not availed of by the holding company or the subsidiary company, subject to certain conditions. However, the OI Directions now specify that the concept of utilizing the net-worth of subsidiary / holding company by the Indian entity has been discontinued. This would impact large conglomerates where subsidiaries are typically used to structure foreign investments.

The OI Regime is expected to open avenues for investment by Indian residents in foreign country/jurisdiction, which were earlier restricted, and provide array of opportunities while structuring transactions.

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