New ODI Regulations Framework
On August 22, the Reserve Bank of India (RBI) came up with a new set of Overseas Direct Investment (ODI) Regulations to simplify the existing regulations and realign them to the current business and economic dynamics. RBI has effectively combined the erstwhile FEMA (Transfer or Issue of Foreign Security) Regulations, 2004 (ODI regulations) and FEMA (Acquisition and Transfer of immovable property outside India) Regulations, 2015. These are now covered under FEMA (Overseas Investment) Rules, 2022 (OI Rules) and FEMA (Overseas Investment) Regulations, 2022 (OI Regulations). OI Rules cover the permissions, conditions and restrictions concerning Overseas Direct Investment (ODI). It also covers the pricing guidelines and rules concerning the transfer, liquidation and restructuring of such investments. These rules have been framed by the Central Government and will be administered by the Reserve Bank of India. OI Regulations, on the other hand, provide the conditions for undertaking financial commitment, investment in debt instruments, consideration in case of acquisition or transfer of a foreign entity, obligations of Persons Resident in India, reporting requirements, etc. RBI has also issued the FEMA (Overseas Investment) Directions, 2022 (OI Directions) to cover the operational requirements. The changes are quite welcoming as they provide more clarity over the rules, lesser restrictions on investments and simpler reporting requirements. Let’s understand some of the key changes in the ODI regulations in this article.
Overseas Direct Investment (ODI) vs Overseas Portfolio Investment (OPI)
Under the new regulations, the two terms – Overseas Direct Investment (ODI) and Overseas Portfolio Investment (OPI) have been distinctively defined. The classification is important as there are different investment limits for each type. ODI has been defined to include any investment that results in (a) acquisition of equity in an unlisted foreign entity, (b) subscription to the Memorandum and Association of a foreign entity, (c) acquisition of 10% or more paid-up equity in case of a listed foreign entity, (d) acquisition of control where investment is less than 10% in the equity of a listed foreign entity. Importantly, once an investment qualifies as ODI, it remains the same, even if the percentage falls below 10% in the case of listed companies, or if the control is lost. OPI, on the other hand, has been defined as investments other than ODI in foreign securities. However, it does not include any unlisted debt instruments or any security issued by an Indian Resident, not located in the IFSC. It has been clarified that original investment by a resident in India in a listed company would be considered OPI, even if the company is delisted. The definition of OPI has made it clear that portfolio investments can be made in both listed and unlisted spaces.
Meanwhile, the definition of control has also been inserted. According to the definition, control may be direct or indirect and shall be evident from the right to appoint a majority of directors, or to control management or policy decisions, whether such right is exercised by a person or persons acting individually or in concert. The mode of exercising control could be by way of shareholding, management rights, shareholder agreements, voting agreements entitling to vote for 10% or more, or in any other manner. The concept of control is relevant for determining the eligibility to invest in debt instruments, for lending, guaranteeing, or identifying a subsidiary and step-down subsidiary of a listed foreign entity.
The new rules also substitute the terms JV and WOS with a single term ‘Foreign Entity.’ Foreign Entity is defined to comprise entities with limited liability, formed/ registered/ incorporated outside India or in an International Financial Services Centre (IFSC), and also unincorporated entities with core activities in the strategic sector. The strategic sector includes energy, and natural resources sectors such as Oil, Gas, Coal, Mineral Ores, submarine cable system and start-ups.
Layering and Round Tipping Structures
Round tripping is a practice where funds are transferred from one country to another and thereafter transferred back to the origin country for purposes. Many companies used such structures for money laundering or tax concessions and therefore, RBI has always prohibited such transactions. Under the erstwhile ODI Regulations prohibited setting up Indian subsidiaries through its foreign WOS or JV, and also prohibited the acquisition of a WOS or investment in JV that already had direct/indirect investment in India under the automatic route. In such cases, the Reserve Bank of India provided approvals on a case-to-case basis, depending on the merits of the case. Under the new regime, such prohibition is applicable only when it results in a structure with more than two layers of subsidiaries. Further, the restriction is now applicable only when there is an inward remittance in India. However, these exemptions shall not be available to a resident individual who exercises control in the foreign entity. Effectively, the new rules make it easy for round-tipping structures while exercising caution and permitting a maximum of only two layers of investment.
Key changes in ODI regulations
Foreign securities by way of gift – Under new regulations, a resident individual can acquire foreign securities by way of a gift from a relative, or a person who is resident outside India after compliance with Foreign Contribution (Regulations) Act, 2010. Earlier, general permission was granted to resident individuals for acquiring foreign securities by way of a gift from a person resident outside India.
ODI in Financial Services – Indian entities (except individuals) involved in any business, can now make overseas direct investment in a foreign engaged in financial services activity except for banking or insurance. This shall be allowed only if the Indian entity has net profits during the preceding three financial years. Earlier, only those entities that were engaged in financial services could enter into such investments.
Acquisition of Immovable Property – Under new regulations, a person can acquire immovable property outside India jointly with a relative who is a person resident outside India, even if there is an outflow of funds. The condition related to the ‘no outflow of funds’ has been removed.
Investment in Overseas Startups – As per the new Regulations, any ODI in startups (recognised as a startup under the laws of such country) can be made by an Indian entity only from the internal accruals. In the case of resident individuals, such investments can be made from their own funds. Investments in startups, being risky, are prohibited if made by securing loans.
Acquisition of shares by way of ESOPs – Any resident being a director or employee of an Indian entity can acquire shares or interest in an overseas entity, if such plan or benefit has been offered by the overseas entity on a global basis. Earlier, the rules dealt only with ESOPs, however, the new rules also cover employee benefits. There are no restrictions concerning remittance or outflow of funds.
Restructuring of the balance sheet – Earlier unlisted companies were permitted to write off capital and other receivables up to 25 % of the equity investment with prior approval from RBI. Now, the new rules, do not require RBI approvals for such restructuring if the diminution in the outstanding value is proportionate to the losses. However, a certificate from a registered valuer or certified public accountant of the host country would is required where the diminution exceeds USD 10 million, or 20% of the total outstanding dues of an Indian company or investor.
Investment in IFSC – A new schedule has been introduced in the regulations providing rules concerning investment in IFSC. The rules require approval from the regulator where the application would be disposed of in 45 days, or deemed to be approved otherwise. Indian entities can also invest in IFSC without any net profit criteria and regardless of their nature of business. Resident individuals are also allowed to contribute to an investment fund or vehicle in an IFSC.
Valuation and pricing – Earlier valuation of shares was required to be obtained from a Merchant Banker (investment exceeding USD 5 million) or from a CA/CPA. Now, the responsibility has been transferred to the Authorised Bank to ensure the pricing is as per internationally accepted standards and at arm’s length.
Transfer and liquidation – The Indian entity has to stay invested for at least one year from the date of making ODI before making any transfer or liquidation in the overseas entity. Full disinvestment is permitted only when there are no equity or debt outstanding dues, and when no approval is required from RBI for any write-off.
Deferred payments – Deferred payment of overseas direct investment is now permitted if a definite period is provided in the agreement in case of equity, with securities being issued/ transferred upfront.
Reporting requirements – ODI and OPI are now expected to be reported in Form FS and Form OPI. Annual Performance Reports (APR) are to be filed by December 31, unless the foreign company’s accounting year ends on December 31. If the accounting year ends on December 31, the report can be filed by December 31 next year.