The recently released overseas direct investment rules by Indian entities/persons in foreign entities are quite pragmatic. They clarify and have liberalised many ambiguous provisions. At the same time, few new provisions have come which could make overseas investment tough. The Ministry of Finance notified the Foreign Exchange Management (Overseas Investment) Rules, 2022 on August 22. Soon thereafter, Reserve Bank of India (RBI) enacted Foreign Exchange Management (Overseas Investment) Regulations, 2022 and Foreign Exchange Management (Overseas Investment) Directions, 2022.
A key amendment has pegged “control” to a new concept, where an Indian entity acquiring 10% or above of the voting rights of any foreign entity will mean to have acquired its control. This is wider than the existing law that treats control to mean a right to appoint majority directors on a company’s board or to control management or policy decision of an entity. The definition of foreign subsidiary or foreign step-down subsidiary has been linked to this new definition of control. Consequently, now holding of 10% or above will make foreign entity or its step-down subsidiary as a subsidiary of the acquiring Indian entity. Until now, subsidiary meant an entity in which the other entity held majority shareholding (means more than 50% or which had a right to appoint majority directors).
The concept of overseas direct investment (ODI) and overseas portfolio investment (OPI) are now clearly and correctly distinguished. Without this distinction, it was confusing to distinguish ODI and OPI. Now, any investment made in “unlisted foreign entities”, irrespective of investment/shareholding level, will mean to be ODI. In addition, ODI would also mean any acquisition of 10% or above of share capital of a “listed foreign entity” or when the acquisition is less than 10% but “control” is acquired, still it will be an ODI. Therefore, acquisition of 10% or above or acquisition of control in a “listed foreign entity” is presumed to be of a strategic nature, thus treated as an ODI. Investment in listed entities which are treated as ODI at the time of original ODI will continue to be treated as ODI, notwithstanding that shareholding of Indian entity in foreign listed entity subsequently falls below 10% or when the control is subsequently lost. This means shareholding falling below 10% or losing of control will not change the character of the original investment from ODI to OPI.
OPI means any investment which is not an ODI. Therefore, OPI means any investment in “listed foreign entities” which is less than 10% and when no control is acquired. Like in case of ODI, in OPI too, investment in a listed foreign entity qualifying as OPI will continue to be OPI even if subsequently the foreign listed entity is delisted (i.e., when foreign entity’s status is changed from listed to an unlisted entity). As provisions relating to ODI and OPI have different treatment, a clear distinction between the two concepts is critical. Therefore, clear definitions of these concepts will prove to be very helpful for interpreting these concepts.
“Foreign entity” has a new definition now which emphasises that a foreign entity must have limited liability of its members/shareholders. Therefore, Indian entity that is limited liability company or limited liability partnership will qualify as foreign entity. The reason to emphasise this appears to be that in no circumstances should Indian entity’s liability as a shareholder of the foreign entity be unlimited. The liability must only limit to any capital being unpaid by the Indian entity and nothing beyond. There is one exception to this rule. Those entities whose core activity is in a strategic sector can have unlimited liability of its shareholders. 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 Government of India.
The concept of pricing of acquisition has now been linked to arm’s length pricing determined by a valuer. Further, these overseas rules have taken a leaf out of the FDI policy’s, to exclude “leasing activity” of a developed real estate from the meaning of real estate activity. Other than this exclusion for leasing activities, overseas investment cannot still be made in other real estate activities.
Until now, any ODI which would result in any form of investment being routed, directly or indirectly, back into India (i.e., round tripping of funds) was banned. Now the new rules permit this indirect investment but only up to two layers of investment. It suffers from one ambiguity on how to calculate two layers. Will foreign entity in which ODI is made will be counted as one level or only entities beyond the first level foreign entity will only be counted? It is best that a line of clarification is issued by the RBI for ease of implementation.
Lalit Kumar, Partner at JSA Advocates & Solicitors