1.1 The FEMA 1999 amended by the Finance Act 2015 to realign powers between Central Government (CG) and RBI. Certain amendments were in the following sections of the Foreign Exchange Management Act, 1999.
Section 6 - Capital Account Transaction
Section 46 - Power of Central Government to make rules and
Section 47 - Power of RBI to make regulations
1.2 Now capital instruments issued under Foreign Exchange Management Act, 1999 (FEMA) has been classified in two parts as debt and non-debt instruments.
1.3 The RBI (in consultation with the CG) is entrusted with the responsibility to draft regulations for debt instruments while the Central Government (in consultation with the RBI) is entrusted with the power to frame rules for non-debt instruments.
1.4 By notification dated 17 October 2019 the central government has notified Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules) and rescinded the FEMA TISPRO regulations.
1.5 On notification dated 16 October, 2019 the MINISTRY OF FINANCE (Department of Economic Affairs) has disclosed the following instruments as Debt instruments and Non-Debt Instruments.
Debt Instruments: -
Government bonds
Corporate bonds
All tranches of securitisation structure which are not equity tranche;
Borrowings by Indian firms through loans
Depository receipts whose underlying securities are debt securities.
Non -Debt Instruments: -
all investments in equity in incorporated entities (public, private, listed and unlisted);
capital participation in Limited Liability Partnerships (LLPs);
all instruments of investment as recognised in the FDI policy as notified from time to time;
investment in units of Alternative Investment Funds (AIFs) and Real Estate Investment Trust (REITs) and Infrastructure Investment Trusts (InVITs);
investment in units of mutual funds and Exchange-Traded Fund (ETFs) which invest more than fifty per cent in equity;
the junior-most layer (i.e. equity tranche) of securitisation structure;
acquisition, sale or dealing directly in immovable property;
contribution to trusts;
depository receipts issued against equity instruments.
2. Foreign direct investment - Scope and coverage of FDI and FPI
2.1 If the foreign portfolio Investment exceeds to 10% or more then it is reclassified as Foreign Direct Investment. But if FDI falls below 10% then it should not be reclassified as the FPI.
2.2 Reporting requirement in FDI: -
Pricing as per SEBI regulations
FC-GPR reporting required
2.3 Reporting requirement in FPI: -
Pricing as per SEBI regulations
FC-GPR reporting not required
3. Who can Invest?
3.1 Any Non-resident Entity van invest except Citizen or an entity incorporated in Bangladesh or Pakistan need prior government approval but Citizen or an entity incorporated in Bangladesh or Pakistan cannot invest in the Defense, Space and Atomic energy even with approval
Definition of Equity Instruments
3.2 The definition of “capital instruments” has been replaced with the term “equity instruments” throughout the NDI Rules.
3.3 Equity instruments mean equity shares, convertible debentures, preference shares and share warrants issued by an Indian company;
Explanation: -
Equity shares issued shall include equity shares that have been partly paid.
Fully, compulsorily and mandatorily convertible debentures.
Fully, compulsorily and mandatorily convertible preference shares.
Price on the date of conversion should be more than the FMV on issue date)
In case of share warrants, at least twenty-five per cent of the consideration shall be received upfront and the balance amount within eighteen months of the issuance of share warrants.
Equity instruments can contain an optionality clause subject to a minimum lock-in period of one year or as prescribed for the specific sector, whichever is higher, but without any option or right to exit at an assured price.
Partly paid shares shall be fully called-up within twelve months of such issue. Twenty- five per cent of the total consideration amount (including share premium, if any) shall be received upfront.
Issuance of equity shares
3.4 Consideration must be for cash. The non-cash considerations are allowed by FDI policy if the investee company is engaged in an automatic route sector as follows: -
In lieu of External commercial borrowing
For import of capital goods and machinery
Share swap if Indian company is in automatic route sector
For pre- incorporation or pre-operative expenses incurred by the said non-resident entity up to a limit of 5% of its authorized capital or USD 500,000 whichever is less subject to the condition that company should be
- wholly owned subsidiary set up in India by a NR entity
- operating in a sector where 100 percent foreign investment is allowed in the automatic route
- no FDI linked performance conditions
3.5 Valuation of issue price of FDI shares should be as per SEBI guidelines in case of listed companies. In case of unlisted companies, valuation should be at
- arms’ length price basis
- Any internationally accepted pricing method
- Valuation certificate by CA
3.6 Shares must be issued within 60 days of the funds.
4. Tightened Norms for FDI from neighboring countries with a view to curb “opportunistic takeovers or acquisitions”
4.1 The press note-3 has been released on 17 April,2020 by the Department for Promotion of Industry and Internal Trade (DPIIT) and amended the Consolidated FDI policy, 2017 which came into effect from 22 April,2020.
4.2 In pursuant to the press note:
An entity situated in a country which shares land border with India, or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, is inter alia permitted to invest in Indian entities only under the government approval route.
Further, any transfer of ownership of any existing or future foreign direct investment (FDI) in an entity in India (directly or indirectly) resulting in the beneficial ownership falling within the purview of the above restrictions, would require the government’s approval.
Even if direct investor is from a country who is not sharing land borders with India, but it ultimate parent company is of a country who shares land borders with India, then the restriction would apply.
4.3 The government had awakened after raising the stake in HDFC from 0.8% to 1.1% by People’s Bank of China through open market purchases which triggered the introduction of this change.
5. Sectoral caps
Sectoral cap for the sectors specified in the table is the limit indicated against each sector. The total foreign investment shall not exceed the sectoral limit
Wherever there is a requirement of minimum capitalization, it shall include premium received.
Company in which the operation has not started yet may get FDI subject to the following conditions:-
- If activities are under Automatic route
- No FDI linked performance condition
- No downstream investment
- When company commences operation, it shall have to comply sectoral caps and conditions
The onus of compliance with the sectoral caps on such foreign investment and attendant conditions shall be on the company receiving foreign investment.
6. Convertible Notes
PROI may purchase convertible notes issued by an Indian startup company for an amount of twenty-five lakh rupees or more in a single tranche.
Maximum 5 years conversion option
Government approval necessary if company is in sector with government route
Further, issue of equity shares against such convertible notes shall be in compliance with the entry route, sectoral caps, pricing guidelines and other attendant conditions for foreign investment.
7. FDI Prohibited sectors
Following sectors are specifically prohibited from receiving any FDI either directly or indirectly:-
a) Lottery business including Government or private lottery, online lotteries
b) Gambling and betting including casinos, etc.
c) Chit funds / Nidhi company
d) Trading in Transferable Development Rights
e) Real estate business or construction of farm houses
f) Activities or sectors not open to private sector investment e.g. (I) Atomic energy (II) Railway operations
g) Manufacturing of cigars, cheroots, tobacco
h) Foreign technology collaborations in any form is also prohibited for lottery business and gambling and betting activities.
Exception: - Real estate business shall not include development of townships, construction of residential or commercial premises, roads or bridges and Real Estate Investment Trusts (REITs) registered and regulated under the SEBI (REITs) Regulations, 2014.
8. FDI in the Investment company
Government approval is necessary for if core investment companies (CICs) and NBFC not registered as RBI
Investing companies registered as Non-Banking Financial Companies (NBFCs) with the Reserve Bank, shall be under 100% automatic route
9. Indirect FDI
9.1 Indirect FDI means that if an entity who receives FDI and in turn makes downstream investment in another Indian Entity, then such downstream investment is Indirect FDI
9.2 The second level company also need to comply with the entry route, sectorial caps, pricing guidelines and other FDI linked performance conditions
9.3 The first level company must comply with
Board resolution approving the Indirect FDI
Shareholders agreement
Cannot raise funds for investments via domestic market
Can use internal accruals or foreign funds
Shall obtain auditor certificate and report in the director report
In case of qualified report then inform regional office of RBI
9.4 Indirect foreign investment received by a wholly owned subsidiary of an Indian company shall be limited to the total foreign investment received by the company making the downstream investment (first level Co).
10. Right issue and Bonus issue
A PROI holding investment in shares may make investment in equity instruments as a right issue or a bonus issue, provided that
The offer should comply the Companies Act, 2013
Such issue shall not result in a breach of the sectoral cap
In case of a listed Indian company, the rights issue to PROI shall be at a price determined by the company
In case of an unlisted Indian company, the rights issue shall not be at a price less than the price offered to persons resident in India
11. Issue of ESOP and Sweat equity share
An Indian company may issue ESOPs /sweat equity to its employees or directors of its holding company or joint venture or wholly owned overseas subsidiary or subsidiaries who are resident outside India
The scheme must be as per the SEBI regulations or the Companies (Share Capital and Debentures) Rules, 2014
The ESOPs or sweat equity shares issued are in compliance with the sectoral cap applicable to said company.
If FDI in company which is on Govt. route sector then CG approval is required
Prior approval of CG is required if ESOP to be issued to citizens of Bangladesh or Pakistan
12. Merger/Demerger and Amalgamation
The transfer or issue to comply with the entry routes, sectoral caps or investment limits
If the percentage is likely to breach the sectoral caps in transferee company then necessary approval from the CG is required
The transferor or the transferee company shall not engage in any prohibited sector.
The scheme should be approved by NCLT or other competent authority.
13. Investment by NRI or OCI on non-repatriation basis
The investment shall be deemed to be domestic investment.
NRI or an OCI, including a company / trust / partnership firm incorporated outside India and owned and controlled by NRIs or OCIs, may invest on non-repatriation basis the following instruments: -
- equity instrument issued by a company
- units issued by an investment vehicle
- The capital of LLP/Partnership firm/proprietary concern.
- convertible notes issued by a startup company
shall not make any investment in a Nidhi company / agricultural or plantation activities / real estate business / construction of farm houses / dealing in transfer of development rights.
Investment in NCD / RPS / OCD is not allowed
No filing for FDI and should not be counted as FDI / Indirect FDI
Can invest in tobacco / gambling / lottery sectors and sectors not open to private investment
Sale proceeds from NR Investment must be credited to NRO A/c
Can invest in multi-brand retailing, telecom, airlines.
14. Investment in a Limited Liability Partnership (LLP)
A PROI (other than a citizen or entity of Pakistan or Bangladesh) not being a Foreign Portfolio Investor (FPI) or a Foreign Venture Capital Investor (FVCI), may contribute to LLP operating in sectors where foreign investment up to 100 per cent is permitted under automatic route and there are no FDI linked performance conditions.
Downstream investment by LLP owned or controlled by NR is allowed only 100 per cent investment permitted under automatic route and there are no FDI linked performance conditions.
Automatic route Conversion of company into LLP or vis-e-versa is possible only if
- Sector where FDI up to 100% on auto route
- No FDI linked performance conditions
Investment in a LLP is subject to the compliance LLP Act, 2008.
Investment in by way of capital contribution / acquisition or transfer of shares not be less than the fair price worked out as per any valuation norm which is internationally accepted and Valuation certificate CA or by a practicing Cost Accountant is required
Transfer In case of Resident to NR shall be for a consideration not less than the fair price of capital contribution or profit share of a LLP.
15. Investments by Foreign Portfolio Investors
RFPI is Registered Foreign Portfolio Investors registered with SEBI
may purchase units of REITs / InVITs / AIF Cat III
The individual limit is 10 percent and aggregate limit is 24 percent respectively of the total paid-up equity capital on a fully diluted basis / debenture / PSC / warrant
RFPI can invest in listed shares by way of IPO / FPO / Rights / Pvt placements etc.
Amendment in sectorial limits
Before March 2020: -
o aggregate limit is 24 percent
o It can be increased to the sectorial caps by special resolution
From April 2020: -
o the aggregate limit shall be the sectoral caps
o the aggregate limit in a sector where FDI is prohibited shall be 24 percent.
o Company can decrease threshold limit of 24% or 49% or 74% with special resolution before 31 March, 2020
o decreased threshold limit can be increased to 49% or 74% sectoral cap with special resolution
o once the aggregate limit has been increased to a higher threshold, company cannot reduce the same
If breach of the prescribed limit then the FPIs are required to divest their holdings within 5 trading days from the date of settlement of the trades causing the breach else investment becomes FDI and cannot make further FDI
Must trade delivery basis on market and cannot short sell except through SLBM.
16. Investments by NRI or OCI on repatriation basis
The total holding by any individual NRI or OCI shall not exceed 5 percent of the total paid-up equity capital / CDs / warrant
The total holding by all NRI or OCI shall not exceed 10 percent of the total paid-up equity capital / CDs / warrant
The aggregate ceiling of 10 percent may be raised to 24 percent if a special resolution passed
NRI or an OCI may without limit purchase or sell units of domestic mutual funds which invest more than 50 percent in equity.
NRI or an OCI may subscribe to the NPS governed and administered by Pension Fund Regulatory and Development Authority (PFRDA), provided such person is eligible to invest
17. Investment by a Foreign Venture Capital Investor (FVCI)
If the investment is in equity instruments, then the sectoral caps, entry routes and attendant conditions shall apply.
Can invest in the OCPS / RPS / Debt of Venture Capital undertaking
Can invest in equity or debt instrument issued by an Indian ‘start-up’ irrespective of the sector in which the start-up is engaged.
Can transfer investment to R/NR at mutually acceptable price
No pricing requirement at the time of investment
No filing of FC-GPR
Only 10 specified sectors open for FVCI
Biotechnology / IT / Nanotechnology / Seed R&D / R&D in pharmaceutical / dairy industry / poultry industry / production of bio-fuels etc.
18. Investment by a PROI in an Investment Vehicle
A PROI or an entity (other than a citizen or entity of Pakistan or Bangladesh) or may invest in units of Investment Vehicles.
Investor can sell / transfer / redeem such units subject to the SEBI conditions.
Investment made by Inv. vehicle shall be reckoned as indirect foreign investment for the investee Indian entity if the Sponsor or the Manager or the Investment Manager is owned or controlled by PROI else investment will be treated as domestic investment.
If investment is treated as foreign then investment portfolio company must comply with the restrictions, sectoral limits, pricing guidelines, valuation norms, reporting requirements in FDI as per Schedule-1
19. Transfer of Shares
PROI not being NRI or an OCI may transfer by way of sale or gift the equity instruments to any PROI subject to the condition that if FPI exceeds the limit then it is required to divest within 5 trading days
NRI or an OCI may transfer by way of sale or gift the equity instruments to any PROI subject to the condition that if buyer is NRI and holding of NRI is more than 5% then it is required to divest - No pricing guidelines
Resident or NRI holding equity instruments on a non- repatriation basis may transfer the same to a PROI by way of gift with the prior approval of the Reserve Bank subject to the following condition
o The donee is eligible to hold such a security
o The gift does not exceed five percent of the paid-up capital of the Indian company / debentures / mutual fund scheme;
o The applicable sectoral cap in the Indian company is not breached;
o The donor and the donee shall be “relatives” as per The Companies Act, 2013;
o The value of security to be transferred during the financial year does not exceed the rupee equivalent of fifty-thousand US Dollars
20. Deferred consideration
In case of transfer of equity instruments between a resident person and PROI, an amount not exceeding twenty five percent of the total consideration
may be paid by the buyer on a deferred basis or may be settled through an escrow arrangement within a period not exceeding eighteen months from the date of the transfer agreement
may be indemnified by the seller for a period not exceeding eighteen months from the date of the payment of the full consideration, if the total consideration has been paid by the buyer
21. Pricing Guidelines
The price of equity instruments of an Indian company issued by such company to a PROI shall not be less than the price worked out in accordance with SEBI guidelines in case of a listed company
The valuation of equity instruments done as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a CA or a Merchant Banker registered with the SEBI or a practicing Cost Accountant, in case of an unlisted Indian Company
22. NCDs to FPI
FPI can invest in the listed NCDs on a repatriation basis
Can purchase Listed NCDs from market
Countrywide aggregate limit is for all NCDs and all FPIs is 4.24 lakh crore from 1 april,2020 but w.e.f 1 October ceiling limit would automatically increase to 5.41 lakh crore.
Rating agency required
Private company can issue listed NCDs
Minimum maturity is 3 years but FPI can sell the securities at domestic level before it
No sectors restrictions
Need not to be compulsory convertible like CCD
Above view are personal and should not be considered as professional advice
Sunil Maloo (JAIN)
Assisted by Akshat Shah