What is FDI?

Foreign Direct Investment (FDI) happens when a company from one country invests in a business in another country, with the intention of acquiring a lasting interest. The OECD (Organisation for Economic Co-operation and Development) defines a "lasting interest" as an ownership stake of at least 10% in the voting power of the foreign business.

FDI plays a key role in India's economic growth. Foreign companies invest in Indian startups and existing businesses, providing them with additional capital. The Reserve Bank of India (RBI) regulates FDI under the Foreign Exchange Management Act (FEMA) 2000.

How to Invest in India with FDI

There are two main routes for foreign companies to invest in India:

  • Automatic Route: This simplified route allows for investment without prior government approval for certain sectors.
  • Approval Route: Some sectors require government approval before investment can proceed.

In Foreign Direct Investment (FDI) for India, there are two main ways foreign companies can invest:

1. Automatic Route:

  • This is a simplified process that allows for quicker and easier investment without prior approval from the Indian government.
  • It applies to specific sectors considered non-sensitive and allows for 100% foreign ownership in most cases.

Advantages of Automatic Route:

  • Faster and less bureaucratic process
  • Encourages quicker investment decisions
  • More attractive option for foreign companies seeking speed and ease

Examples of Sectors under Automatic Route (may vary):

  • Agriculture and Animal Husbandry
  • E-commerce activities (with conditions)
  • Healthcare
  • Textiles and Garments
  • Capital Goods

2. Approval Route:

  • This route requires government approval before a foreign company can invest.
  • It applies to sectors considered more sensitive or where the government wants to maintain some control.
  • The approval process can be more time-consuming and involve scrutiny of the investment proposal.

Sectors with Automatic Route for 100% FDI:

  • Agriculture and Animal Husbandry
  • E-commerce activities
  • Healthcare
  • Textiles and Garments
  • Capital Goods

Compliance Requirements under FEMA

Companies that receive FDI in India need to comply with FEMA regulations. Here are some key compliances:

  • Annual Return on Foreign Liabilities and Assets (FLA): This report details all FDI received or held by the Indian company.
  • Annual Performance Report (APR): Companies with overseas investments must submit a report on the performance of those ventures.
  • External Commercial Borrowings (ECB): Borrowers must report details of any loans taken from foreign lenders.
  • Share Transaction Reporting: Companies receiving FDI or Indian companies investing abroad must report share transactions to the RBI.
  • ODI Form: Companies making outward investments must submit a form with details of the investment.

By understanding FDI regulations and compliance requirements, foreign companies can take advantage of the opportunities India offers.

Benefits and Challenges of FDI in India

Benefits of FDI in India

  • Increased Capital: FDI brings in much-needed financial resources for Indian companies, fostering growth and expansion.
  • Technological Advancement: Foreign companies often bring advanced technologies and expertise, which can improve the quality of Indian products and services.
  • Job Creation: FDI can lead to the creation of new jobs, both directly within the foreign invested companies and indirectly in supporting industries.
  • Improved Infrastructure: Foreign investment can contribute to the development of India's infrastructure, such as transportation and communication networks.
  • Increased Competition: FDI can lead to increased competition in the Indian market, which can benefit consumers through lower prices and better quality goods and services.
  • Enhanced Exports: Foreign companies may leverage their existing international networks to help Indian companies export their products and services more effectively.

 2. Overseas Investment

"Overseas Investment" (OI) refers to financial commitments and Overseas Portfolio Investment by a resident of India, as defined in Rule 2(1)(r) of the FEM (Overseas Investment) Rules, 2022. OI should be in bona fide business activities and subject to restrictions.

 

Meaning of ‘Financial Commitment’

"Financial commitment" refers to the total amount invested by a person residing in India through Overseas Direct Investment (ODI), debt (other than Overseas Portfolio Investment) in a foreign entity/entity and includes non-fund-based facilities extended to or on behalf of such foreign entities, as per Rule 2(1)(f) of the FEM (Overseas Investment) Rules, 2022.

An Indian entity may lend or invest in debt instruments issued by a foreign entity or extend non-fund-based commitments to or on behalf of a foreign entity, including overseas SDSs of such Indian entity, under these conditions:

  • The Indian entity is eligible to make ODI.
  • The Indian entity has made ODI in the foreign entity.
  • The Indian entity has acquired control in the foreign entity before making such financial commitment.

This is specified in RBI Direction No. 1(viii) of the FEM (Overseas Investment) Directions, 2022.

2.1 Foreign Entity

A "Foreign entity" is an entity formed, registered, or incorporated outside India, including International Financial Services Centres with limited liability. The limited liability restriction does not apply to entities in strategic sectors, as defined in Rule 2(1)(h) of the FEM (Overseas Investment) Rules, 2022.

Meaning of ‘Limited Liability’

"Limited liability" refers to structures like limited liability companies or partnerships where the liability of the resident in India is defined and limited. For a foreign entity being an investment fund or vehicle regulated by the host jurisdiction's financial sector regulator and set up as a trust outside India, the liability of the Indian resident is limited to their interest or contribution in the fund. Additionally, the trustee of such a fund must be a person resident outside India, as stated in RBI Direction No.1(i) of the FEM (Overseas Investment) Directions, 2022.

2.2 Strategic Sector

The term "Strategic sector" encompasses energy and natural resources sectors such as oil, gas, coal, mineral ores, submarine cable systems, startups, and any other sectors or sub-sectors deemed essential by the Central Government, according to Rule 2(1)(z) of the FEM (Overseas Investment) Rules, 2022.

RBI guidelines regarding strategic sectors state that the requirement for a limited liability structure of foreign entities is not mandatory for those engaged in core activities within any strategic sector. Therefore, Overseas Direct Investment (ODI) can be made in such sectors even in unincorporated entities. Indian entities are also permitted to participate in consortia with international operators to construct and maintain submarine cable systems on a co-ownership basis. Authorized Dealer (AD) banks may facilitate remittances for ODI in strategic sectors after confirming that the Indian entity has obtained necessary permissions from the relevant authority, where applicable, per RBI Direction No.1(ii) of the FEM (Overseas Investment) Directions, 2022.

2.3 Investment Only in Foreign Entities Engaged in Bona Fide Business Activity

Except where otherwise specified in the FEM (Overseas Investment) Rules, 2022 or the FEM (Overseas Investment) Regulations, 2022, any investment made outside India by a resident of India must be in a foreign entity engaged in bona fide business activities. This can be direct, through a step-down subsidiary (SDS), or a special-purpose vehicle, subject to the limits and conditions specified in the FEM (Overseas Investment) Rules, 2022 and related regulations. The structure of such a subsidiary or SDS of the foreign entity must comply with the structural requirements applicable to foreign entities. Overseas investments or transfers of such investments, including swaps of securities, in a foreign entity formed, registered, or incorporated in Pakistan or any other jurisdiction as determined by the Central Government from time to time, require prior approval from the Central Government, as per Rule 9(1) of the FEM (Overseas Investment) Rules, 2022.

Meaning of ‘Bona Fide Business Activity’

For the purposes of Rule 9(1), "bona fide business activity" refers to any business activity permissible under the laws in force in both India and the host country or jurisdiction, as explained in the Explanation to Rule 9(1) of the FEM (Overseas Investment) Rules, 2022.

Definitions:

  • Subsidiary or Step-Down Subsidiary (SDS): An entity where the foreign entity exercises control, defined under Rule 2(1)(y) of the FEM (Overseas Investment) Rules, 2022.
  • Host Country or Host Jurisdiction: The country or jurisdiction, including International Financial Services Centres, where the foreign entity is formed, registered, or incorporated, as defined in Rule 2(1)(i) of the FEM (Overseas Investment) Rules, 2022.

3. Meaning of ‘Financial Commitment’

The term "Financial commitment" refers to the total amount of investment made by a resident of India through Overseas Direct Investment (ODI), debt (excluding Overseas Portfolio Investment) in foreign entities where ODI is made and includes non-fund-based facilities extended to or on behalf of such foreign entities. This definition is provided in Rule 2(1)(f) of the FEM (Overseas Investment) Rules, 2022.

3.1 Financial Commitment by Indian Entity through Modes Other than Equity Capital

An Indian entity is permitted to lend or invest in debt instruments issued by a foreign entity or extend non-fund-based commitments to or on behalf of a foreign entity, including overseas step-down subsidiaries of the Indian entity, under the following conditions within the prescribed financial commitment limit as per the FEM (Overseas Investment) Rules, 2022:

  • The Indian entity must be eligible to make Overseas Direct Investment (ODI).
  • The Indian entity must have already made ODI in the foreign entity.
  • The Indian entity must have acquired control over the foreign entity at the time of making such financial commitments. This is governed by Regulation 3(1) of the FEM (Overseas Investment) Regulations, 2022, issued by RBI.

Financial commitments under Regulations 4 (debt), 5 (guarantees), 6 (pledge and charge), and 7 (acquisition by deferred payment) are included in the calculation of the financial commitment limit specified in Regulation 3(1), as per Regulation 3(2) of the FEM (Overseas Investment) Regulations, 2022, issued by RBI.

Meaning of ‘Indian Entity’

The term "Indian entity" includes:

  • A company as defined under the Companies Act, 2013
  • Any body corporate incorporated under applicable laws
  • A Limited Liability Partnership (LLP) formed under the Limited Liability Partnership Act, 2008
  • A partnership firm registered under the Indian Partnership Act, 1932. This definition is provided in Rule 2(1)(j) of the FEM (Overseas Investment) Rules, 2022, consistent with RBI Direction No.1(iv) of the FEM (Overseas Investment) Directions, 2022.

3.2 Financial Commitment by Indian Entity through Debt Instruments

An Indian entity may lend or invest in debt instruments issued by a foreign entity, provided that such loans are backed by a loan agreement where the interest rate is set on an arm's length basis. In this context, "arm's length" means a transaction conducted between unrelated parties to avoid conflicts of interest. This regulation is specified in Regulation 4 of the FEM (Overseas Investment) Regulations, 2022, issued by RBI.

RBI directions regarding financial commitments through debt state that Authorized Dealer (AD) banks must facilitate outward remittances for financial commitments through debt only after obtaining necessary agreements/documents to ensure the legitimacy of the transaction. Additionally, an Indian entity is prohibited from directly lending to its overseas step-down subsidiaries, and individual residents are restricted from making financial commitments through debt, as per RBI Direction No.21(3) of the FEM (Overseas Investment) Directions, 2022.

3.3 Financial Commitment through Guarantee for Overseas Investment

Regulation 5(1) of the FEM (Overseas Investment) Regulations, 2022, issued by RBI, outlines the types of guarantees that may be issued to or on behalf of a foreign entity or any of its step-down subsidiaries (SDS) by an Indian entity:

  • Corporate or performance guarantees by the Indian entity.
  • Corporate or performance guarantees by a group company of the Indian entity in India, provided it is a holding company (holding at least 51% stake) or a subsidiary company (in which the Indian entity holds at least 51% stake), or a promoter group company which is a body corporate.
  • Personal guarantees by the resident individual promoter of such an Indian entity.
  • Bank guarantees backed by a counter-guarantee or collateral from the Indian entity or its eligible group company issued by a bank in India.

Key Provisions and Guidelines:

1. Guarantee by Group Company: If a guarantee is issued by a group company, it independently counts towards the utilization of its financial commitment limit. For a resident individual promoter, the guarantee counts towards the financial commitment limit of the Indian entity. This is governed by Regulation 5(2) of the FEM (Overseas Investment) Regulations, 2022.

2. Promoter Group Definition: The term "promoter group" is defined as per the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018, as explained in the Explanation to Regulation 5(2) of the FEM (Overseas Investment) Regulations, 2022.

3. Open-Ended Guarantee: No guarantees are allowed to be open-ended, as stated in Regulation 5(3) of the FEM (Overseas Investment) Regulations, 2022.

4.Treatment of Invoked Guarantees: When a guarantee is invoked, the amount invoked ceases to be considered part of the non-fund based financial commitment and is treated as a debt commitment, as per Regulation 5(4) of the FEM (Overseas Investment) Regulations, 2022.

5. Joint Guarantees: Joint guarantees issued by multiple Indian entities are considered 100% guaranteed by each guarantor and counted towards their individual limits, according to Regulation 5(5) of the FEM (Overseas Investment) Regulations, 2022.

6. Performance Guarantees: In the case of performance guarantees, 50% of the guaranteed amount is counted towards the financial commitment limit, per Regulation 5(6) of the FEM (Overseas Investment) Regulations, 2022.

7. Roll-Over of Guarantees: The roll-over of guarantees is not considered a new financial commitment, provided the roll-over amount does not exceed the original guarantee amount, as specified in Regulation 5(7) of the FEM (Overseas Investment) Regulations, 2022.

 

RBI Directions:

Under RBI Direction No.21(4) of the FEM (Overseas Investment) Directions, 2022:

  • The validity period of a performance guarantee is determined by the contract completion timeline.
  • Remittance of funds from India due to the invocation of a performance guarantee does not require prior RBI approval.
  • Invoked guarantees are treated as debt commitments and must be reported in Form FC.
  • Roll-over of guarantees is not considered a new financial commitment but must be reported in Form FC.
  • Group companies and resident individual promoters may issue guarantees in compliance with OI Regulations, with such guarantees counting towards their respective financial commitment limits and requiring appropriate reporting.

These provisions ensure clarity and regulation in the issuance and management of guarantees for overseas investments by Indian entities.

3.4 Financial Commitment through Pledge or Charge

According to Regulation 6 of the FEM (Overseas Investment) Regulations, 2022, issued by RBI, an Indian entity that has made Overseas Direct Investment (ODI) by investing in equity capital in a foreign entity may:

  • Pledge of Equity Capital: Pledge the equity capital of the foreign entity where ODI is made, or its step-down subsidiary outside India, held directly by the Indian entity in the foreign entity and indirectly in step-down subsidiary, in favor of:
  • An AD bank or a public financial institution in India,
  • An overseas lender for fund-based or non-fund-based facilities for itself or any foreign entity where ODI is made,
  • A debenture trustee registered with SEBI for fund-based facilities for itself.
  • Creation of Charge: Create a charge by way of mortgage, pledge, hypothecation, or similar mode on:
  • Its assets in India, including assets of its group company or associate company, promoter, or director, in favor of an AD bank or public financial institution in India or an overseas lender.
  • Assets outside India of the foreign entity or its step-down subsidiary (SDS) in favor of an AD bank in India or a public financial institution in India, as security for fund-based or non-fund-based facilities for itself or any foreign entity where ODI is made.
  • A debenture trustee registered with SEBI in India for fund-based facilities for itself.

 

Key Provisions and Guidelines:

1. Financial Commitment Limit: The value of the pledge or charge, or the amount of the facility, whichever is less, is reckoned towards the financial commitment limit applicable at the time of pledging or charging, provided the facility has not already been reckoned towards the limit.

2. Overseas Lender Restrictions: Pledges or charges in favor of overseas lenders must not be from countries or jurisdictions where financial commitments are not permissible under the FEM (Overseas Investment) Rules, 2022.

3. Compliance: The creation or enforcement of pledges or charges must comply with the provisions of the Act, rules, regulations, or directions issued thereunder.

4. Negative Pledge: The negative pledge or negative charge created by an Indian entity for participation in bidding or tender procedures is not reckoned towards the financial commitment limit.

RBI Directions:

Under RBI Direction No.21(6) of the FEM (Overseas Investment) Directions, 2022:

  • The value of the pledge or charge, or the amount of the facility, is considered towards the financial commitment limit, ensuring compliance with regulations.
  • Pledges or charges to overseas lenders must adhere to permissible jurisdictions.
  • Creation or enforcement of pledges or charges must comply with relevant regulatory provisions.
  • Assets under charge must not be securitized.
  • Duration of the charge should align with the facility period.
  • Enforcement of domestic asset charges requires transfer to an Indian resident.
  • Pledge of shares of an Indian company to an overseas lender must comply with FEMA provisions under FEM (Non-Debt Instruments) Rules, 2019.

3.5 Acquisition or Transfer of Equity Capital by Deferred Payment

Where a resident in India acquires equity capital through subscription or purchase from a non-resident, and the payment is deferred as per the agreement:

  • Foreign securities equivalent to the total consideration must be transferred upfront by the seller to the buyer.
  • Full consideration payment must comply with applicable pricing guidelines.

Key Conditions and Procedures:

  • Indemnification: The buyer may be indemnified by the seller up to a mutually agreed amount and under specified terms and conditions in the agreement, compliant with FEMA provisions.
  • Verification by AD Bank: AD banks verify transaction bona fides from underlying agreements/documents for deferred payment consideration.
  • Reporting Requirements: Deferred consideration payments are treated as non-fund-based commitments initially and reported accordingly in Form FC. Subsequent payments convert these commitments into equity and must comply with pricing guidelines upfront.

These regulations and directions ensure transparency and compliance in the acquisition and financing aspects of overseas investments by Indian entities.

4. Overseas Portfolio Investment (OPI)

Definition of Overseas Portfolio Investment:

"Overseas Portfolio Investment" or "OPI" refers to investments in foreign securities by a resident of India, excluding Overseas Direct Investment (ODI). It specifically excludes unlisted debt instruments or securities issued by Indian residents not in an International Financial Services Centre (IFSC). Investments by Indian residents in the equity capital of a listed entity, even after delisting, continue to be classified as OPI until further investment is made in the entity. The term "debt instruments" refers to instruments specified under rule 5(A) of the FEM (Overseas Investment) Rules, 2022.

Definition of Equity Capital:

"Equity capital" encompasses equity shares, perpetual capital, irredeemable instruments, or contributions to non-debt capital of a foreign entity in the form of fully and compulsorily convertible instruments. Instruments that are redeemable, non-convertible, or optionally convertible are treated as debt under the OI Rules/Regulations/Directions.

4.1 RBI Directions on OPI

Under RBI Direction No.1(x) of the FEM (Overseas Investment) Directions, 2022:

  • Prohibited Investments: OPI cannot be made in unlisted debt instruments, securities issued by Indian residents outside IFSCs, derivatives (unless permitted by RBI), or commodities including Bullion Depository Receipts (BDRs).
  • Treatment of Delisted Entities: Investments in listed equity capital of entities, even post delisting, continue as OPI until further investment is made, which would then be classified as ODI.
  • Reinvestment and Exemptions: Listed Indian companies can reinvest OPI proceeds under Schedule II of the OI Rules, exempted from repatriation provisions if reinvested within the specified time frame per FEM Regulations, 2015. Unlisted Indian entities may also invest under Schedule II.
  • Investment in Investment Funds: Investments in units of regulated investment funds overseas are considered OPI. Listed Indian companies and resident individuals can invest in such funds outside IFSCs, while unlisted Indian entities can do so within IFSCs under Schedule V, subject to applicable limits.
  • Resident Individuals and LRS: Resident individuals may invest in OPI within the Liberalized Remittance Scheme (LRS) limit specified in Schedule III. Additionally, investments through sweat equity shares, minimum qualification shares, ESOPs, or Employee Benefits Schemes up to 10% of the paid-up capital of foreign entities qualify as OPI if without control.
  • Investment by Mutual Funds and Others: Investments in securities specified by SEBI for Mutual Funds (MFs), Venture Capital Funds (VCFs), and Alternative Investment Funds (AIFs) registered with SEBI are considered OPI under Schedule IV.

4.2 Definition of Debt Instruments

As per Rule 5(A) of the FEM (Overseas Investment) Rules, 2022, debt instruments include:

  • Government bonds
  • Corporate bonds
  • Securitization structures excluding equity tranches
  • Firm borrowings through loans
  • Depository receipts backed by debt securities

4.3 Definition of Non-debt Instruments

As per Rule 5(B) of the FEM (Overseas Investment) Rules, 2022, non-debt instruments include:

  • Investments in equity of incorporated entities (public, private, listed, and unlisted)
  • Participation in Limited Liability Partnerships
  • Instruments recognized under the Foreign Direct Investment policy
  • Investments in units of Alternative Investment Funds, Real Estate Investment Trusts, and Infrastructure Investment Trusts
  • Investments in units of mutual funds and Exchange-Traded Funds investing more than fifty percent in equity
  • Equity tranche of securitization structures
  • Direct acquisition, sale, or dealing in immovable property
  • Contributions to trusts
  • Depository receipts issued against equity instruments

These definitions and guidelines provide clarity on the categorization and regulation of overseas investments by Indian residents, ensuring compliance with applicable FEMA provisions and regulatory frameworks.

 

4.4 Procedure for Overseas Portfolio Investment by an Indian Entity

The provisions outlined in Schedule II of the FEM (Overseas Investment) Rules, 2022 are as follows:

- Limitation on OPI: An Indian entity may engage in Overseas Portfolio Investment (OPI) up to a maximum of 50% of its net worth as per its last audited balance sheet, subject to conditions specified in Schedule II.

- OPI by Listed Indian Companies: Listed Indian companies are permitted to undertake OPI, including reinvestment activities.

- OPI by Unlisted Indian Entities: Unlisted Indian entities are restricted to making OPI under specific clauses (iii), (iv), (v), and (vi) of paragraph 1(2) of Schedule I.

Definition of Net Worth: "Net worth" is defined as per section 2(57) of the Companies Act, 2013. For registered partnership firms or Limited Liability Partnerships (LLPs), it comprises the sum of partners' capital contributions and undistributed profits, adjusted by deducting accumulated losses, deferred expenditures, and miscellaneous expenditures not written off, based on the latest audited balance sheet.

Last Audited Balance Sheet: This refers to the audited balance sheet dated no more than eighteen months before the transaction date.

Listed and Unlisted Indian Company: A "Listed Indian company" is one that has its equity shares or fully and compulsorily convertible instruments listed on a recognized stock exchange in India. Conversely, an "unlisted Indian company" is interpreted accordingly under the rules.

 

5. No Objection Certificate Requirement

Under Rule 10(1) of the FEM (Overseas Investment) Rules, 2022, any resident of India who:

  • Has an account classified as a non-performing asset,
  • Is classified as a wilful defaulter by a bank, or
  • Is under investigation by financial regulatory or investigative agencies in India such as the CBI, ED, or SFIO,

must obtain a No Objection Certificate (NOC) from the respective lender bank, regulatory body, or investigative agency before undertaking any financial commitment or disinvestment under the FEM (Overseas Investment) Rules, 2022 or the FEM (Overseas Investment) Regulations, 2022.

Proviso: If the lender bank or regulatory body fails to issue the certificate within sixty days from the receipt of the application, it shall be presumed that there is no objection to the proposed transaction.

Issuance of NOC: The NOC issued under Rule 10(1) must be addressed by the lender bank, regulatory body, or investigative agency to the designated Authorised Dealer Category-I (AD bank), with an endorsement to the applicant.

 

6. Pricing Guidelines for Equity Transfer of Foreign Entities

Unless otherwise specified in the FEM (Overseas Investment) Rules, 2022, the transfer or issuance of equity capital of a foreign entity:

  • From a non-resident to a resident of India, or
  • From a resident of India to a non-resident,

must adhere to pricing determined on an arm's length basis.

AD Bank Responsibility: Before facilitating such transactions under Rule 16(1), the AD bank must ensure compliance with arm's length pricing, considering valuation methodologies accepted internationally.

These rules and guidelines ensure transparent and compliant procedures for Indian entities engaging in Overseas Portfolio Investment and related financial transactions under FEMA regulations.

6.1 RBI Directions on Pricing Guidelines

RBI Direction No.12 of FEM (Overseas Investment) Directions, 2022 provides the following guidelines regarding pricing:

1. Compliance Responsibility: Before facilitating any overseas investment transaction, the Authorised Dealer (AD) bank must ensure compliance with the provisions outlined in Rule 16 of the Overseas Investment (OI) Rules. The AD bank shall formulate a board-approved policy within two months from the date of these directions, guiding the documents required. This policy may include internationally accepted valuation methodologies.

2. Policy Scenarios: The policy may also outline scenarios where valuation may not be mandatory, such as transfers due to mergers, amalgamations, or demergers approved by competent courts or where prices are readily available on recognized stock exchanges. Additionally, it shall specify supplementary documents like audited financial statements of the foreign entity to validate transactions involving write-off of investments.

7. Transfer of Investment or Liquidation

Under Rule 17 of the FEM (Overseas Investment) Rules, 2022:

7.1. General Transfer: A resident of India holding equity capital in compliance with the Rules may transfer such investment adhering to investment or disinvestment limits, pricing guidelines, documentation, and reporting requirements as specified in the Regulations.

7.2. Transfer Eligibility: Such transfers can be made to eligible residents in India or residents outside India.

7.3. Special Cases: Transfers due to mergers, amalgamations, demergers, or buybacks of foreign securities must obtain approval from competent authorities under applicable laws in India or the host country.

7.4. Conditions for ODI: For disinvestments related to Overseas Direct Investments (ODI):

  • The transferor must not have outstanding dues for receipt, other than those arising from equity or debt investments (e.g., export receivables).
  • The transferor must have maintained the investment for at least one year from the date of making the ODI, except in cases of mergers, demergers, or amalgamations where there is no change or dilution in the Indian entity's aggregate equity holding.

5.Restrictions: Investment or transfer not permitted if the initial investment was unauthorized under FEMA regulations.

8. Restructuring of Overseas Direct Investment (ODI)

Rule 18 of the FEM (Overseas Investment) Rules, 2022 allows restructuring of the balance sheet of a foreign entity by a resident of India who has made ODI, subject to the following conditions:

  • Loss Incurrence: The foreign entity must have incurred losses in the previous two years as evidenced by its last audited balance sheets.
  • Compliance Requirements: Compliance with reporting and documentation requirements is mandatory.
  • Diminution in Value: The total value of outstanding dues towards the Indian resident, due to equity and debt investments, should not exceed the proportionate amount of accumulated losses after restructuring.
  • Certification Requirement: In cases where the diminution exceeds USD 10 million or 20% of the total outstanding dues, a certified valuation by a registered valuer under the Companies Act, 2013, or an equivalent authority in the host jurisdiction is necessary. This certification, dated within six months of the transaction date, must be submitted to the designated AD bank.

These rules ensure transparent and compliant procedures for the transfer, liquidation, and restructuring of investments made by Indian residents in foreign entities under FEMA regulations.

8.1 RBI Directions on Restructuring

RBI Direction No.14 of FEM (Overseas Investment) Directions, 2022 provides guidelines on restructuring as follows:

1. Permitted Restructuring: A resident of India who has made Overseas Direct Investment (ODI) in a foreign entity may allow the restructuring of the foreign entity's balance sheet under Rule 18 of the OI Rules. The aggregate investment in both equity and debt of the foreign entity will determine the proportionate amount of accumulated losses. However, if the restructuring pertains solely to equity, only the investment in equity will be considered for computing proportionate losses.

2. Certification Requirements: The certificate required under Rule 18 of the OI Rules must specify:

  • The amount of accumulated losses based on the foreign entity's audited balance sheet.
  • The proportionate amount of accumulated losses based on the share of the Indian entity/investor.
  • The diminution in the value of outstanding dues towards the Indian entity/investor after restructuring, ensuring it does not exceed the proportionate amount of accumulated losses.

3. Exclusions: These provisions do not apply if the assets are revalued in the books of the Indian entity without restructuring the foreign entity's balance sheet.

9. Restrictions and Prohibitions in Overseas Direct Investment (ODI) or Financial Commitment

Under Rule 19 of the FEM (Overseas Investment) Rules, 2022:

1. Prohibited Activities: No resident of India shall engage in ODI in a foreign entity involved in:

  • Real estate activities.
  • Gambling in any form.
  • Dealing with financial products linked to the Indian rupee without specific RBI approval.

The term "real estate activity" excludes township development, construction of residential or commercial premises, roads, or bridges for sale or lease.

2. RBI Directions on Restrictions: AD banks are prohibited from facilitating transactions involving foreign entities engaged in activities mentioned under Rule 19(1) of the OI Rules or located in jurisdictions advised against by the Central Government under Rule 9(2) of the OI Rules. Financial products linked to the Indian rupee include non-deliverable trades on foreign currency-INR exchange rates and Indian market-linked stock indices.

9.1 Investment in Start-ups Only from Internal Accruals

Under Rule 19(2) of the FEM (Overseas Investment) Rules, 2022:

  • ODI in start-ups recognized under the laws of the host country must be funded by Indian entities solely from internal accruals, including those from group or associate companies in India. For resident individuals, funding must come from personal funds.
  • Funding Restrictions: Such investments cannot be financed with borrowed funds. Before facilitating transactions, AD banks must obtain a certificate from the statutory auditors or chartered accountants of the Indian entity/investor confirming the source of funds.

9.2 Restrictions on Structures with More Than Two Layers of Subsidiaries

Under Rule 19(3) of the FEM (Overseas Investment) Rules, 2022:

- Prohibited Financial Commitments: No resident of India shall make financial commitments in a foreign entity that results in a structure with more than two layers of subsidiaries, directly or indirectly affecting investments into India.

- Exceptions: This restriction does not apply to specific categories of companies listed under Rule 2(2) of the Companies (Restriction on Number of Layers) Rules, 2017, including banking companies, systematically important non-banking financial companies registered with RBI, insurance companies, and government companies as defined under the Companies Act, 2013.

9.3 RBI Directions on Restrictions on Layers of Subsidiaries

RBI Direction No.22(2) of FEM (Overseas Investment) Directions, 2022 clarifies that:

- Financial commitments by residents of India in foreign entities resulting in more than two layers of subsidiaries are not permitted under Rule 19(3) of the OI Rules.

- Further Restrictions: No additional layer of subsidiaries shall be added to existing structures with two or more layers of subsidiaries post the notification of the OI Rules/Regulations. The term "subsidiary" is defined as per the OI Rules, which includes entities where the foreign entity holds a stake of 10% or more.

9.4 Implications of Restrictions on Subsidiary Layers

The RBI's imposition of a two-layer subsidiary limit on overseas investments aims to enhance transparency, control, and risk management. This restriction has several implications:

1. Structural Changes:

  • Restructuring Existing Structures: Companies with more than two layers of subsidiaries will need to restructure their investments to comply with the new regulations. This might involve divesting certain holdings or merging entities.
  • Investment Planning: Companies planning future overseas investments will need to carefully consider the structure of their investments to avoid violating the subsidiary limit.

2. Operational Challenges:

  • Increased Complexity: Managing investments across multiple jurisdictions can become more complex with fewer layers.
  • Potential for Higher Costs: Restructuring investments or establishing new entities to comply with the regulations might incur additional costs.

3. Impact on Investment Decisions:

  • Limited Investment Options: The restriction on subsidiary layers might limit investment opportunities, especially in complex global value chains.
  • Focus on Core Operations: Companies may be encouraged to focus on core operations and divest non-core assets to comply with the regulations.

4. Regulatory Compliance:

  • Enhanced Scrutiny: Companies will need to ensure strict compliance with the subsidiary limit to avoid penalties.
  • Regular Monitoring: Regular reviews of investment structures will be necessary to identify and address potential compliance issues.

5. Potential for Regulatory Easing:

While the current regulations impose strict limits, there is a possibility of future relaxations or exemptions for specific sectors or circumstances. Companies should stay updated on regulatory changes.

Overall, the two-layer subsidiary limit introduces challenges for businesses with complex global operations. However, it also promotes greater transparency and control, which can be beneficial in the long run.

Conclusion

Foreign Direct Investment (FDI) and Overseas Direct Investment (ODI) are critical components of India's economic landscape, facilitating capital inflows, technology transfer, and job creation. The Indian government has implemented a regulatory framework to govern these investments, aiming to balance economic growth with investor protection and national interests.

The comparison between NBFCs and banks highlights the distinct roles they play in the financial system, with banks operating under stricter regulations due to their systemic importance. The introduction of FDI and ODI regulations further shapes the investment landscape, with the government carefully balancing the need to attract foreign capital with safeguarding domestic interests.

The recent imposition of restrictions on subsidiary layers underscores the government's focus on transparency and control in overseas investments. While these regulations may present challenges for businesses, they also promote a more structured and regulated investment environment.

As India continues to evolve as a global economic player, the interplay between FDI, ODI, banking, and NBFC sectors will be crucial in shaping the country's economic trajectory. The government's ability to balance regulatory oversight with investor-friendly policies will be instrumental in attracting sustainable and long-term foreign investments.