The Ministry of Finance, on October 15, 2019, notified Sections 139, 143 and 144 of the Finance Act, 2015 which had proposed certain amendments to Section 6 (Capital Account Transaction), Section 46 (Power of Central Government to make rules) and Section 47 (Power of RBI to make regulations) respectively, of the Foreign Exchange Management Act, 1999.
These amendments have, inter alia, resulted in a power shift from the RBI to the Central Government, enhancing the latter's involvement in the foreign exchange transactions. A bifurcation of instruments into debt instruments and non-debt instruments has been introduced and while the RBI (in consultation with the Central Government) is assigned the responsibility to draft regulations for debt instruments, the Central Government (in consultation with the RBI) is entrusted with the power to frame rules for non-debt instruments. It is however interesting to note that the Central Government is empowered to determine which all instruments would be classified as the debt instruments.
Exercising the above power, the Central Government notified the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 ("NDI Rules") on October 17, 2019 superseding the erstwhile Foreign Exchange Management (Transfer of Issue of Security by a Person Resident outside India) Regulations, 2017 ("TISPRO") and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018.
Further, to put things into perspective, the RBI also notified the Foreign Exchange Management (Debt Instruments) Regulations, 2019 superseding TISPRO, and the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019, which provides for reporting requirements in relation to any investment made under the NDI Rules.
As a most recent development, the Central Government has notified the Foreign Exchange Management (Non-Debt Instruments) (Amendment) Rules, 2019 ("Amendment Rules") on December 5, 2019. These Amendment Rules, inter alia, primarily incorporates the provisions of the Press Note 4 of 2019, recently announced by the Department for Promotion of Industry and Internal Trade ("PN4"), which were not reflected in the NDI Rules.
While there has not been a drastic revamp of foreign investment regime, we have discussed below some of the key changes that come forth with the NDI Rules read with Amendment Rules.
- Key changes in the definitions:
- Debt and Non-Debt Instruments: The NDI Rules provide for an exhaustive list of instruments as 'non-debt instruments' and defines 'debt instruments' as all instruments falling outside the category of non-debt instruments. This needs to be read along with the list of debt instruments and non-debt instruments notified by the Central Government on October 16, 2019.
- Equity Instruments: The NDI Rules replaced the term 'Capital Instruments' in TISPRO with 'Equity Instruments'.
- Hybrid Securities: The NDI Rules introduced the concept of Hybrid Securities as optionally or partially convertible preference shares or debentures or any other such Government specified instruments, which can be issued to a person resident outside India.
However, the term Hybrid Securities has not been used anywhere in the NDI Rules.
- Investment Vehicle: The definition of Investment Vehicle under TISPRO was amended by the NDI Rules to include mutual funds which invest more than 50% in equity governed by the SEBI (Mutual Funds) Regulations, 1996. The same has been deleted by Amendment Rules and the erstwhile definition of the Investment Vehicle under TISPRO has been restored.
- Sector specific changes
- E-Commerce: The NDI Rules has limited the purview of E-Commerce entities to companies incorporated under the Companies Act, 1956 or the Companies Act, 2013, conducting e-commerce business and it no longer includes a foreign company or an office, branch or agency in India, owned or controlled by a person resident outside India, conducting the e-commerce business.
Further, the Amendment Rules has inserted a condition that e-commerce marketplace entity with FDI shall have to obtain and maintain a report of statutory auditor by September 30 of every year for the preceding financial year confirming compliance of the e-commerce guidelines. This would ensure compliances of the FDI Policy in the e-commerce sector.
- Other Sectors: The liberalised FDI norms in the sectors of coal mining, contract manufacturing, single-brand retail trading (SBRT) and digital media, as announced vide PN4, have been incorporated in the NDI Rules by the Amendment Rules.
However, the recent notification from the Department of Financial Services, setting a 100% cap for insurance intermediaries do not find a place in the NDI rules.
- Foreign Portfolio Investors ("FPIs")
Under TISPRO, the default aggregate limit for investments made by FPIs in an Indian company was 24%. The provision relating to the increase in the aggregate limit of 24% by the Indian company up to the sectoral cap/ statutory ceiling, as applicable, with the approval of its board of directors and its members through a resolution and a special resolution, respectively, which was deleted under the NDI Rules, has now been restored by the Amendment Rules.
NDI Rules has brought about a substantial change in the Schedule II stating that effective from April 1, 2020, the aggregate limit would be the sectoral cap applicable to such Indian company. An Indian company may, with the approval of its board of directors and members, by a resolution and a special resolution, respectively: (i) decrease the aggregate limit before March 31, 2020 to a lower threshold of 24% or 49% or 74% as deemed fit, or (ii) increase the aggregate limit to 49% or 74% or the sectoral cap or statutory ceiling respectively as deemed fit. However, once the aggregate limit is increased, the limit cannot be reduced later.
If the investments exceed the prescribed limits, FPIs will have the option to divest its excess holdings within 5 trading days, failing which, the entire investment in the company will be considered as FDI.
If the investment falls under a category where FDI is prohibited, the aggregate FPI limits is capped at 24%.
An FPI has now been allowed to purchase units of domestic mutual funds or Category III AIF or offshore fund for which no objection is issued in accordance with the SEBI (Mutual Fund) Regulations, 1996, which in turn invest more than 50% in equity instruments and may also purchase units of REITs and InvIts, all on repatriation basis.
- Pricing Guidelines (Convertible Instruments)
The conditions in relation to convertible instruments of upfront determination of the price/ conversion formula and that the price at the time of conversion should not be lower than the FMV at the time of the issue of such instrument, as was provided in the TISPRO, did not form part of the NDI Rules.
The Amendment Rules have however reinstated these conditions in the NDI Rules.
- Few other key amendments
- FVCIs may invest in equity, equity-linked instruments or debt instruments of Indian start-ups irrespective of the sectors. Under TISPRO the term 'securities' was used. Also, the words 'irrespective of the sectors' is a new addition.
- NRIs and OCIs can now invest in units of domestic funds which invest more than 50% in equity and OCIs can now enrol for the National Pension Scheme governed and administered by Pension Fund Regulatory and Development Authority of India.
- The requirement of a certificate from a statutory auditor in order to issue shares by a wholly owned subsidiary to its foreign holding company, against the pre-incorporation and pre-operative expenses, has been omitted from the NDI Rules. Also, the explanation regarding as to what can classify as pre-incorporation or pre-operative expenses has not been included in the NDI Rules. It is unclear why such omissions were made.
Our two cents
In our view, streamlining the powers of RBI and the Central Government shall bring more clarity and transparency in the foreign exchange regulation and avoid any regulatory overlaps.
The segregation of TISPRO to form the regulations on non-debt and debt instruments seems to be a progressive move towards improved efficiency in regulating foreign investments.
The Amendment Rules have restored certain provisions from TISPRO which were not reflected in the NDI Rules, hence ironing some ambiguities. However, we can expect further amendments and clarifications coming up for further simplifying the regime for the foreign investors.
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