New Overseas Direct Investment Guidelines (India)

Introduction:

Overseas investment by resident Indians has been regulated by the Government of India in conjunction with the country’s central bank, the Reserve Bank of India.

The relevant regulations have recently been overhauled.

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On 22 August 2022, the Ministry of Finance, Government of India, and the Reserve Bank of India issued a new set of guidelines regulating Overseas Direct Investment by resident Indian persons.

These consist of:

• The Foreign Exchange Management (Overseas Investment) Rules, 2022 (“ODI Rules”), issued by the Ministry of Finance;
• The Foreign Exchange Management (Overseas Investment) Regulations, 2022 (“ODI Regulations”), issued by the Reserve Bank of India; and
• The Foreign Exchange Management (Overseas Investment) Directions, 2022, also issued by the Reserve Bank of India.

These supersede:

• The Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004;
• The Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015; and
• The Master Direction – Direct Investment by Residents in Joint Venture/Wholly Owned Subsidiary Abroad.

(together, the “Superseded Provisions”).

Overseas Direct Investment:

Under the ODI Rules, Overseas Direct Investment (“ODI”) has been defined as investment in/by:

• acquisition of unlisted equity capital of a foreign entity,
• subscription as part of the memorandum of association of a foreign entity (listed or unlisted),
• investment in 10% or more of the capital of a listed foreign entity or
• investment with control in a listed foreign entity, even if such investment is less than 10%.

The word “control” for the purpose of item 4 above has been defined as the right to appoint a majority of the directors or to control management or policy, directly or indirectly, including by virtue of shareholding or management rights or shareholders’ agreements or voting agreements that entitle the controlling person to 10% or more of voting rights or in any other manner. This principle is a new one not envisaged by the framework of the Superseded Provisions.

ODI may be made by various methods such as:

• subscription,
• acquisition by bidding and tenders,
• through rights issues and bonus shares,
• capitalisation of amounts due to the investor,
• securities swaps, and
• mergers, demergers and similar schemes of arrangement.

Additionally, the ODI Regulations defines “financial commitment” as the aggregate amount of investment by ODI, debt other than Overseas Portfolio Investment, and non-fund-based facility or facilities extended by it to all foreign entities, by an Indian resident.

Importantly, it also allows an Indian resident to invest in debt instruments of a foreign entity provided it is:

• normally eligible to make ODI;
• has ODI in that foreign entity; and
• has acquired control over that foreign entity.

Debt instruments are defined under the ODI Rules as

• Government bonds;
• corporate bonds;
• all tranches of securitisation structure which are not equity tranches;
• borrowings by firms through loans; and
• depository receipts whose underlying securities are debt securities.

The ODI Rules also refer to Overseas Portfolio Investment (“OPI”). This is any investment other than ODI in foreign securities. OPI however does not include unlisted debt instruments or any security issued by a person resident in India who is not in an International Financial Services Centre (as defined by the International Financial Services Centres Authority Act, 2019.

Foreign Entity:

The reference to a “foreign entity” is a key difference from the Superseded Provisions. A foreign entity has been defined as one that is formed, registered or incorporated outside India, with limited liability.

The Superseded Provisions did not make reference to a mere “foreign entity” but specifically to a joint venture or a wholly owned subsidiary. The change therefore means that overseas investment as described above in any foreign entity, defined as an entity formed or incorporated abroad outside India with limited liability, will fall under the ambit of the ODI Guidelines.

The restriction of limited liability however does not apply to entities involved in certain strategic sectors, such as energy and natural resources, submarine cable system and start-ups and other sectors deemed as such by the Government.

Bona Fide Activity:

The ODI Rules also prescribe that, normally, overseas investments by a person resident in India may be made only in foreign entities that are engaged in bona fide business activities, either directly or through a step-down subsidiary or a special purpose vehicle.

Pricing Guidelines:

The ODI Rules state that any issue or transfer of equity capital of a foreign entity, from a non-resident or an Indian resident, to an Indian resident who is eligible to make such investment, or from a resident to a non-resident, shall be made on an arms’ length basis.

Arms’ length pricing shall be arrived at as per any internationally accepted valuation method. This is a new concept introduced by the ODI Guidelines.

Re-investment in India/Round Tripping:

Earlier, an Indian entity could not invest in a foreign subsidiary or joint venture abroad that in turn had investments in India. This has now been permitted as long as the resultant structure does not have more than two layers of subsidiaries.

Further, the limit of two layers, does not apply to banking companies, non-banking financial companies that are considered systemically important, insurance companies and government companies.

Prohibitions in Sectors/New Sectors:

Under the ODI Rules, a resident Indian person is still restricted from investing in a foreign entity that is engaged in real estate activity, gambling, or dealing in financial products linked to the Indian currency.

However, investment in financial services has been liberalised. Indian entities engaged in financial services may make investments in a foreign entity in financial services if it has net profits in the last three years, is regulated in India, and has obtained approvals from regulators in India and the host jurisdiction for the financial activity.

An Indian entity not engaged in financial services can also invest in a foreign entity in financial services other than banking or insurance, as long as it has posted net profits in the previous three years. Overseas investment by banks and non-banking financial investments shall however be subject to additional specific cond9itions.

This is a significant change, as under the Superseded Provisions, only Indian entities engaged in financial services could make investment in a financial services entity abroad.

Investment by Individuals:

Resident Indian individuals are specifically permitted to make ODIs, subject to certain restrictions. They may also obtain foreign securities by gifts from Indian resident relatives, or by inheritance, whether from a relative or not, and whether resident in India or not. in

Immovable Property:

The restrictions on acquisition of immovable property outside India have also been liberalised. A resident Indian person mat acquire immovable property on a lease of not more than five years without restriction. Also, a person resident in India may acquire immovable property outside India by inheritance or gift or purchase from a person resident in India who had lawfully acquired it.

A resident may also acquire immovable property abroad from a person resident outside India, by inheritance, purchase by foreign exchange held in a specified account or by purchase from funds sent under the Liberalised Remittance Scheme of the Reserve Bank of India, jointly with a relative resident outside India, or out of the income or sale proceeds of assets, other than ODI, acquired overseas.

Conclusion:

The new ODI guidelines introduce certain new concepts such as overseas portfolio investments, and also clarify the ambit of overseas direct investments. Resident Indians seeking to invest abroad now have greater freedom and less restriction, on par with other countries that have liberalised their overseas investment laws.