Foreign-owned Indian companies allowed to invest downstream news
05 March 2009

The government has allowed foreign companies to make direct investment in downstream activities, subject to sectoral and overall limits, by merely informing the Reserve Bank of India (RBI) rather than seeking prior FIPB approval for making any such investments.

The companies will, however, be required to inform the board, department of industrial policy and promotion (DIPP) and the secretariat for industrial assistance (SIA) about its investments within 30 days of funding the project.

Last week, the government had issued an instruction (Press Note 4) doing away with the FIPB approval for downstream investments. But, it was silent on the cases pending with the board.

A foreign-owned or controlled Indian company that either runs a business or runs a business and also invests in other companies down the line will no longer have to seek clearance, according to the press note.

Reports, meanwhile, said the department of economic affairs in the finance ministry had supported a proposal for share swap in Indian companies between foreign investors, subject to meeting SEBI's valuation guidelines and honouring tax liabilities involved in the transaction.

The report said the share-swap deals with foreign firms would facilitate merger and acquistion activity that has been hampered by a severe credit crunch.

SEBI is currently framing norms for such transactions ahead of approval by the department of industrial policy and promotion, it added.

The FDI policy, in its present form is vague on share swap deals, companies involved will have to obtain RBI's approval, as required under the provisions of the Foreign Exchange Management Act.

While RBI has been liberal in approving such deals till recently, the central bank has recently been directing all such share-swap applications to FIPB. The board, however,  has not approved many such proposals due to the absence of policy guidelines.

The department of industrial policy and promotion under the ministry of commerce and industry has, meanwhile, issued guidelines for transfer of ownership or control of Indian companies in sectors with caps from resident Indian citizens to non-resident entities.

At present, the transfer of shares from residents to non-residents, including acquisition of shares in an existing company, is on the automatic route, subject to the sectoral policy on FDI. The department has issued guidelines for transfer of ownership or control of Indian companies in sectors with caps from resident Indian citizens to non-resident entities following concerns over recent acquisitions of certain Indian companies by non-resident entities in sectors with caps.

An Indian company may be taken as being:

  • `owned' by resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens, if more than 50 per cent of the equity interest in it is beneficially owned by resident Indian citizens and Indian companies, which are owned and controlled ultimately by resident Indian citizens;
  • `controlled' by resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens, if the resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens, have the power to appoint a majority of its directors.

Further, for the above purpose, an Indian company may be taken as being:

  • ''owned'' by 'non resident entities', if more than 50 per cent of the equity interest in it is beneficially owned by non-residents
  • ''controlled'' by 'non resident entities', if non-residents have the power to appoint a majority of its directors.

Foreign investment shall include all types of foreign investments i.e. FDI, investment by FIIs, NRIs, ADRs, GDRs, Foreign Currency Convertible Bonds (FCCB) and convertible preference shares, regardless of whether the said investments have been made under Schedule 1, 2, 3 and 6 of FEMA (Transfer or Issue of Security by Persons Resident Outside India) Regulations.

In sectors with caps, including interalia defence production, air transport services, ground handling services, asset reconstruction companies, private sector banking, broadcasting, commodity exchanges, credit information companies, insurance, print media, telecommunications and satellites, government approval/FIPB approval would be required in all cases where:

An Indian company is being established with foreign investment and is owned by a non-resident entity or

An Indian company is being established with foreign investment and is controlled by a non-resident entity or

The control of an existing Indian company, currently owned or controlled by resident Indian citizens and Indian companies, which are owned or controlled by resident Indian citizens, will be/is being transferred/passed on to a non-resident entity as a consequence of transfer of shares to non-resident entities through amalgamation, merger, acquisition etc. or

The ownership of an existing Indian company, currently owned or controlled by resident Indian citizens and Indian companies, which are owned or controlled by resident Indian citizens, will be/is being transferred/passed on to a non-resident entity as a consequence of transfer of shares to non-resident entities through amalgamation, merger, acquisition etc.

It is clarified that these guidelines will not apply for sectors/activities where there are no foreign investment caps, that is, 100 per cent foreign investment is permitted under the automatic route.

Downstream investment by Indian companies which are 'owned and controlled' by resident Indian citizens, irrespective of their foreign shareholding, would not, however, be considered as indirect foreign investment.

An Indian company is considered to be "owned" by resident Indian citizens if more than 50 per cent of the equity in that company is held by resident Indian citizens, and it is considered to be "controlled" by resident Indian citizens if majority of the directors are nominated by resident Indian citizens. In order to avoid the classification of downstream investment in the investee company as indirect foreign investment, both the conditions of ownership and control as stated above must be satisfied. If the investing company is either owned or controlled by a non resident, then its entire investment in the Indian investee company is considered to be foreign investment.

Downstream investments by Indian investing companies either owned or controlled by non-residents is deemed as indirect foreign investments in the investee companies. In such cases, the entire investment made by the Indian investing company in the downstream company will be treated as indirect foreign investment. (i.e. if the investment by the Indian company (owned or controlled by non-residents) in the downstream company is 60 per cent then the indirect foreign investment in the downstream company will be considered to be 60 per cent).

Thus foreign investment in an Indian company will include both direct investment and indirect foreign investment i.e. investment through another Indian investing company and such indirect foreign investment would be calculated in the manner stated above.

In Indian companies in sectors that attract FDI caps, the balance equity above the stipulated FDI caps must be beneficially held or owned by resident India citizens or Indian companies that are both owned and controlled by Indian resident citizens. Accordingly, companies in sectors with 49 per cent FDI caps like broadcasting, credit information etc, will have to be owned and controlled by the resident Indian citizens or Indian companies owned and controlled by resident Indian citizens.

In sectors which have prescribed sectoral caps, prior approval of the Foreign Investment Promotion Board in all cases will henceforth be required for the transfer of ownership or control of existing Indian companies from Indian residents to non-residents. It further provides that where an Indian company is being established with foreign investment and non-resident ownership or control of such company is contemplated in sectors which have prescribed sectoral caps, then prior FIPB approval will be required. Importantly, these provisions do not apply to transfer of ownership in sectors where 100 per cent FDI is permitted under automatic route.

Accordingly, it has been clarified that in cases involving transfer of ownership or control, in sectors with caps on FDI like defence production, insurance, telecommunication etc, a prior approval of FIPB/government is required.

Downstream investment by Indian companies owned and controlled by non-residents must be in compliance with existing FDI policy on entry routes, conditions, sector caps etc. Thus indirect investment through an Indian company owned by and controlled by non-residents will be required to adhere to all norms that relate to FDI. Interestingly, however, an Indian company with less than 50 per cent foreign holding and controlled by resident Indian citizens may be permitted to make investments in sectors where FDI is restricted or capped.

An Indian company owned and controlled by non-residents is permitted to make downstream investments in Indian operating companies as well as operating cum investing companies subject to existing FDI policy. In case of operating cum investing companies, the subject Indian companies into which downstream investments are made by such companies will also have to comply with the relevant FDI regulations.

Foreign investment in investing companies require prior FIPB approval, regardless of the amount or extent of foreign investment. The Indian companies into which downstream investments are made by such investing companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps in regard of the sector in which the subject Indian companies are operating.

Further, for any foreign investment in a company which is neither an operating company nor has made any downstream investments the popularly referred as "shell" company, prior approval of the FIPB will be required.

It has been clarified that FIPB approval would be required for downstream investments by operating-cum-investing companies only if such approval is required as per the applicable FDI regulations relating to entry route, caps and other conditions. In case of non operating companies or pure investing companies FIPB approval will be required, irrespective of the quantum of investment.

Downstream investments are to be made subject to certain conditions, such as, interalia, that the DIPP, SIA and FIPB shall have to be notified of all downstream investment within 30 days of such investment and the investing companies would have to bring in requisite funds from outside India and not leverage funds from domestic market for such investments.

There is lack of clarity on how investments in Indian companies such as those by foreign venture capital investors through wholly owned venture capital funds be treated. This gains particular significance given that such vehicles have been used to route significant investments into Indian sectors, which have FDI caps.

FIPB approval for "shell" companies or the companies that are neither operating nor investing companies. A possible interpretation is that FIPB approval is required for the formation of any new Indian company with foreign shareholding. Further, companies that are incorporated on behalf of foreign investors by residents for operational ease and ownership subsequently transferred before the actual commencement of business may also require FIPB approval prior to transfer.


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Foreign-owned Indian companies allowed to invest downstream