India: ECB – A Game Changer?

ECBs (External Commercial Borrowings) are commercial loans raised by eligible Indian entity (Borrower) from a recognised Non-resident Lender (Lender) and should confirm to certain parameters like permitted end-use, minimum average maturity period, all-in-cost ceiling etc. as defined under the ECB regulations framed by The Reserve Bank of India. As opposed to the very strict regime of regulating ECB of earlier times, the regulations on ECB have been relaxed to a substantial extent. It is rapidly emerging as an alternative form of investing in India for foreign entities. It is no longer required for the foreign companies to keep investing their 'capital' in their Indian subsidiaries/entities in the form of Foreign Direct Investment (FDI). The revised and liberal guidelines on ECB gives lucrative option to these foreign entities to 'lend' and not 'invest' their funds in the form of ECB and they can withdraw these lending back from India on completion of the tenure of the ECB.

ECB can either be in any freely convertible foreign currency or it can be in Indian Rupees. In the below note, we shall discuss the regulations as are applicable to ECB in freely convertible foreign currency:

Forms of ECB: ECB can be in the forms of Loan, issue of bonds or debenture (other than compulsory and fully convertible debentures), Foreign currency convertible bonds, foreign currency exchangeable bonds, finance lease etc. A Trade credit beyond 3 years is also regarded as an ECB.

Eligible Indian entity: All entities eligible to receive Foreign Direct Investment (FDI in Equity shares) are eligible to receive ECB. This has substantially expanded the defination of an 'eligible entity'. This has opened up the scope of borrowing in the form of ECB by any Indian entity who is eligible to receive FDI. In addition, certain specific entities like SIDBI, Port Trust of India and Units in SEZ are also regarded as eligible to receive ECB.

Non-Resident Recognised Lender: The Recognised Lender should be a resident of an FATF (Financial Action Task Force) or IOSCO (International Organisation of Securities Commission's) Compliant country. This basically does not permit investments by any entity who is resident of the countries that do not comply with FATF or IOSCO regulations.

An individual is only permitted to lend if they are foreign equity holder. They may also subscribe to the bonds/debenture listed abroad.

Restriction on End-use: One of the most critical issues in this regulation is about the utilisation of the funds received in the form of ECB. Following are the activities that are specifically prohibited for end-use of funds:

• Real estate activities;

Any activity of construction or development of industrial park/ integrated townships/ SEZ are not regarded as real estate activity. Further, purchase or long-term lease of industrial land as part of new project or modernisation of expansion of existing units or any activity which are considered as infrastructure activity will also not be regarded as real estate activity.

• Investment in capital market;
• Investment in equity share capital of another Indian company;
• Working capital or general corporate purpose except in certain circumstances;
• Repayment of Rupee loans for purposes other than 'Capital Expenditure' except in certain circumstances;
• On-lending to other companies.

Therefore, any funds received in the form of ECB, cannot be applied for any of the purposes as mentioned above. It is important to reiterate that the ECB for utilisation of funds towards working capital or general corporate purpose is permitted only if the ECB is from a foreign equity shareholder. 

Minimum Average Maturity Period (MAMP): Another extremely important and critical aspect to be considered is about the tenure of the ECB. The regulation mandates that an ECB must have a minimum period of maturity depending up on the business activity of the borrower company, the recognised lender and most importantly, the purpose for which the ECB is accepted.

• If the Indian borrowing company is a manufacturing company, the minimum average maturity period of the ECB must be as follows:

• Lender is Foreign Equity holder and end use of funds is for capital expenditure, the tenure is minimum of 1 year;
• Lender is Foreign Equity holder and end use of funds is for Working capital or General corporate purpose, the tenure is minimum of 5 years;
• Lender is not a foreign equity holder and end use of funds is for Capital expenditure, the tenure is minimum of 3 years;
• Lender is not a foreign equity holder and end use of funds is for Working capital or General corporate purpose, the tenure is minimum of 10 years;

• If the Indian borrowing company is NOT amanufacturing company, the tenure of ECB is as follows:
• Lender is Foreign Equity holder and end use of funds is for capital expenditure, the tenure is minimum of 3 years;
• Lender is Foreign Equity holder and end use of funds is for Working capital or General corporate purpose, the tenure is minimum of 5 years;
• Lender is not a foreign equity holder and end use of funds is for Working capital or General corporate purpose, the tenure is minimum of 10 years;

In addition to the above, ECB can be taken for repayment of Rupee Loan availed domestically for the purpose of capital expenditure with a maturity period of 7 years.

Similarly, ECB can be taken for repayment of Rupee Loan availed domestically for the purpose other than capital expenditure with a maturity period of 10 years.

As one can understand from the above, the tenure of the ECB will depend up on many factors and therefore it is important to comprehend the precise use of these funds, the status of the lender and of course the busines activity of the borrowing company and can accordingly determine the tenure of the ECB.

One can also very clearly understand from the above that the Government has liberalised their policy to encourage foreign investment through ECB route in manufacturing as well as non-manufacturing sectors. For a manufacturing sector, the tenure of the ECB can be as low as just one year. This is very attractive option to the FDI in a sense that foreign entities can infuse funds under the ECB route, which essentially is a Loan, so that the funds can be returned back on completion of the tenure and in accordance with the terms and conditions of their agreement.

All-in-cost ceiling: Since this is a Loan, interest may be paid to the lending company, depending up on their agreement on the rate of interest. However, the All-in-cost cannot exceed 450 basis point over the last 6 months LIBOR rate. The All-in-cost would include rate of interest, other fees, expenses, charges, guarantee fees, if any. However, the above ceiling does not include the withholding tax. It is pertinent to note that the interest on ECB will be taxable in India as per the prevalent withholding tax rates in accordance with the Double Tax Avoidance Agreement between India and the country of resident of the Lender.

It is also expressly clarified that the proceeds of ECB cannot be used for payment of any interest or charges or any cost related to the all-in-cost.

Limit and Coverage: The above guidelines are applicable to get ECB up to USD 750 million per financial year. If ECB is received from foreign equity holder, ECB liability – Equity ratio has to be under 7:1. This essentially mean that ECB cannot be more than 7 times the equity investment made by the foreign entity in the borrowing entity. This ratio, however, does not apply for ECB up to USD 5 million.

It is pertinent to mention here that one will have to be careful about the 'Thin Capitalisation' norms under the domestic Income Tax Act. If the interest cost on ECB is high, the borrower will have to be vary about the possibility of disallowance of the interest cost under the computation of taxable income.

Other Procedural aspects:

A contract between the borrower and lender specifying various terms and conditions of the ECB must be entered into and submitted to the RBI/AD Bank.

An application needs to be made in Form ECB specifying all the terms and conditions of the contract. Once the approval is given by the Bank/RBI, an LRN (Loan Registration number) will be allotted and only thereafter the borrower can withdraw the funds remitted by the lender into their bank account.

Every month, a Return in Form ECB2 has to be filed with the AD Bank specifying various financials and activities of the company as regards receipts and usage of ECB funds. This return has to be verified and certified by a Chartered Accountant.

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.