(I) BACKGROUND

The Foreign Exchange Management Act, 1999 ("FEMA") was, pursuant to the Finance Act, 2015, amended on October 15, 2019, to grant powers to the Reserve Bank of India ("RBI") to prescribe permissible class(es) of capital account transactions related to debt instruments (in the form of regulations); while the Central Government were given powers to deal with permissible capital account transactions not involving debt instruments (in the form of rules).

In light of the above, on August 22, 2022, the Central Government issued the Foreign Exchange Management (Overseas Investment) Rules, 2022 ("OI Rules") while the RBI issued the Foreign Exchange Management (Overseas Investment) Regulations, 2022 ("OI Regulations") and the Foreign Exchange Management (Overseas Investment) Directions, 2022 ("OI Directions"). These new rules and regulations superseded the erstwhile FEMA (Transfer or Issue of Any Foreign Security) Regulations, 2004 and directions framed thereunder ("Erstwhile ODI Regulations") and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015.

Briefly, the OI Rules deal with overseas investments using non-debt instruments, including investments in the equity capital of foreign entities, capital participation in limited liability partnerships, units of AIF or REITs etc.1, while the OI Regulations deal with debt instruments. The OI Regulations and OI Directions also provide clarity on the procedure for making such overseas investments.

The OI Rules, OI Regulations and OI Directions are effective immediately i.e., on the date of publication in the Official Gazette.

(II) KEY AMENDMENTS2

1. Definition of 'Overseas Direct Investment' and 'Overseas Portfolio Investment':

1.1. The OI Rules and OI Regulations now differentiate between direct investment and portfolio investment. The ODI investment is defined as (a) any investment in an unlisted foreign entity; (b) 10% or more of the equity capital3 of a listed company; or (c) less than 10% of the equity capital of a listed company along with 'control'.

1.2. Any investment apart from the ODI investment will be termed as an OPI. It also excludes any investment in unlisted debt instruments or securities issued by an IFSC.

1.3. Apart from this, overseas investments made by mutual funds, AIFs or VCFs are treated as OPIs.

Note: The differentiation between ODI and OPI seems to have been based on the lines of foreign investment and foreign portfolio investment. The Erstwhile ODI Regulations excluded portfolio investment from ODI, however, it was not very clear what exactly fell within the purview of 'portfolio investment'.

In the present regime, the term 'equity capital' is defined broadly to include equity shares or any type of compulsorily convertible instruments, and hence overseas investments are permitted in all such instruments, while under the Erstwhile ODI Regulations, investments in only equity shares and compulsorily convertible preference shares were allowed.


2. Definition of 'control' and 'subsidiary':

2.1. The OI Rules introduces the definitions of 'control' as under:

""control" means the right to appoint majority of the directors or to control management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders' agreements or voting agreements that entitle them to ten per cent. or more of voting rights or in any other manner in the entity;" (emphasis supplied).


2.2. This definition is mainly aligned to the definition of 'control' as set out in the Companies Act, 2013, however, the shareholding threshold has been reduced to 10%, which otherwise typically is 50% or more under the Companies Act, 2013 and certain other regulations.

2.3. A linked item would be the definition of 'subsidiary', which would in the context of OI Rules and Regulations mean "an entity in which the foreign entity has control".

Note: The intention of the broader definitions of 'control' and 'subsidiary' seems to differentiate between ODI and OPI investments by Indian parties. This will have significant implications in the determination of subsidiaries and step-down subsidiaries.


3. ODI investment conditions:

3.1. Types of issuances: Any ODI can be made by an Indian entity by way of subscription, acquisition through bidding or tender process, acquisition by rights issue or bonus issuance, capitalization due towards an Indian entity in accordance with FEMA extant regulations on the same, swap of securities or merger, demerger or scheme of arrangements.

Note: The broad reading of the clause does not clarify whether the swap of securities can be in form of primary or secondary swap. The FEMA (Non Debt Instrument) Rules, 2019 provide that a swap of shares is usually permitted when there is a primary swap sought to be undertaken.


3.2. Financial commitment: The total financial commitment made by an Indian entity will not exceed 400% of its net worth (as defined in the Companies Act, 2013) as on the date of the last audited balance sheet. Any investments by Maharatna, Navratna, Miniratna or subsidiaries of such public sector undertakings in foreign entities engaged in strategic sectors4 are not subject to the above limits.

Note: The definition of 'net-worth' under the Erstwhile ODI Regulations only included paid-up capital and free reserves. However, under the OI Rules, this has been aligned with the definition under the Companies Act, 2013 which includes securities premium as well. This change in definition may boost the overseas commitment limits permissible under the OI Rules.


3.3. Investments in strategic sectors and start-ups: The OI Rules permit overseas investments only in foreign entities that have limited liability. However, investments in entities engaged in 'strategic sectors' which includes start-ups recognized under the host country/ jurisdiction, need not necessarily be structured as an entity having limited liability. However, overseas investments in start-ups of host countries can be made by an Indian entity (or group or associates in India) or resident individuals, only through internal accruals or owned funds, respectively.

Note: Start-ups, as a different class of companies, were not recognised in the Erstwhile ODI Regulations. Providing an exception for investing in start-ups which may have unlimited liability may also boost cross-border investments. However, it remains to be seen as to what will be considered as a start-up, which is solely dependent on the legal framework of the host country. It will be great to see how this plays out and whether Indian parties enthused to exploit this structure.


3.4. The Erstwhile ODI Regulations restricted investments in countries identified by FAFT as non-cooperative countries and territories, which exemption has not been continued in the present regime. However, overseas investments or transfer of such investments in Pakistan or any other jurisdiction as may be advised by the Government of India would require prior government approval.

3.5. Any financial commitment by an Indian entity exceeding USD 1 (one) billion in a financial year will require prior RBI approval, even if the investments are under the automatic route, which position continues from the Erstwhile ODI Regulations.

4. Overseas portfolio investments:

4.1. Any Indian entity cannot make OPI above 50% of the net worth as on the date of its last audited balance sheet.

4.2. Listed companies can make OPI including by way of re-investment5, while unlisted Indian entities can make OPI only under rights issue or bonus issuance, capitalization due towards an Indian entity in accordance with FEMA extant regulations on the same, swap of securities or merger, demerger or scheme of arrangements. Further, all overseas investments by mutual funds, AIFs or VCFs will also be treated as OPI.

Note: Only listed companies were permitted to undertake portfolio investments under the Erstwhile ODI Regulations. Now, even an unlisted company may undertake OPI investments, in extremely limited circumstances. All investments by SEBI registered mutual funds, AIFs and VCFs will also be deemed as OPIs.


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Footnotes

1. Please see Rule 5 which lists down debt instruments and non-debt instruments.

2. Please note that the list of amendments is not meant to be exhaustive but only sets out the major amendments. Kindly reach out to us separately for a more focused/detailed discussion on this.

3. This is defined to mean means equity shares or perpetual capital or instruments that are irredeemable or contribution to non-debt capital of a foreign entity in the nature of fully and compulsorily convertible instruments.

4. 'strategic sector' is defined to include energy and natural resources sectors such as oil, gas, coal, mineral ores, submarine cable system and start-ups and any other sector or sub-sector as deemed necessary by the Central Government;

5. 'Reinvestment' means that the OPI proceeds are exempted from repatriation provisions as long as such proceeds are reinvested within the time specified for realisation and repatriation as per Notification No. FEMA 9(R)/2015-RB namely, Foreign Exchange Management (Realisation, repatriation and surrender of Foreign Exchange) Regulations, 2015.

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.