Overseas Investment Rules under FEMA, 1999

The Ministry of Finance (MoF), the Government of India, and the Reserve Bank of India (RBI) have notified the Foreign Exchange Management Overseas Investment (OI) Rules/ Regulations/ Directions 2022 as part of the Ease of Doing Business initiative. The Indian Government (GOI) has framed/ consolidated the Outward Investments Rules/ Regulations in accordance with the amendments to the Foreign Exchange Management Act (FEMA) 2015, as part of a comprehensive effort to simplify these Rules/ Regulations, in consultation with the Reserve Bank of India (RBI). In this article, we will discuss amendments in Overseas Investment Rules under FEMA, 1999

Short Glimpse

The Foreign Exchange Management (Overseas Investment) Rules, 2022 (ODI Rules) were notified by the Ministry of Finance on August 22, 2022, and will supersede the Former Regulations. In addition, the RBI published the Foreign Exchange Management (Overseas Investment) Regulations, 2022, to supplement the ODI Rules (ODI Regulations). The RBI also issued the Foreign Exchange Management (Overseas Investment) Directions, 2022. (ODI Directions). It is worth noting that Overseas Investment by Indian Parties was previously governed by the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (Foreign Security Regulations) and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015 (Property Regulations) (collectively called Erstwhile Regulations).

The need for changing and notifying the Rules arose from the fact that it was long overdue, and with the change in business needs, evolving needs of business entities in India and abroad, and an integrated global network and market, it was necessary to notify the new Rules. As a result, the Government of India undertook a thorough exercise to simplify these Regulations in consultation with the Reserve Bank of India. Additionally, it was thought that the Indian business entity needed to join a large global conglomerate in order to unlock its worth.

Key changes under the Overseas Investment Rules under FEMA, 1999

The following new overseas regime has been announced by the Central Government and Reserve Bank of India, replacing the previous system, in the spirit of liberalization and to encourage ease of doing business.

• The “Foreign Exchange Management (Overseas Investment) Rules, 2022” were released by the central government ( Dealing with Non-Debt Instruments).
• Under Central Government Notification No. G.S.R. 646, the RBI published “Foreign Exchange Management (Overseas Investment) Regulations 2022” (Dealing with Debt Instruments) (E).
• Under RBI (Notification No. FEMA 400/2022-RB), the RBI has issued “Foreign Exchange Management (Overseas Investment) Directions 2022” (Dealing with Directions to be Followed by Authorised Dealer-Banks).

The new rule makes it easier for Indian residents to invest abroad, covers a larger range of economic activities, and minimizes the requirement for obtaining specific permissions. The new system will ease the burden of compliance and related expenses.

The amendments under the Rule “Overseas Investment Rules under FEMA, 1999”

The Foreign Exchange Management (Overseas Investment) Rules, 2022 have been notified by the Department of Economic Affairs in light of global market integration and the requirement for Indian corporations to have a global effect. By streamlining the law and offering clarification on the concerns surrounding overseas direct investment, the guidelines that have been notified are forward-looking and favor Indian corporations (ODI).

The following changes to the Rule are listed:

• Round-tripping is a structure in which an investment is made in a foreign entity that afterward makes investments or receives investments in the home nation. The RBI made it clear in the ODI FAQ that the structure needs to receive prior clearance from the RBI. The following structure, up to two layers of subsidiaries, is permitted according to the guidelines. a positive step by the government to make it easier for Indian start-ups and businesses to receive funding from PE and VC investors.
• The guidelines clarify the Foreign Portfolio Investment (FPI), which was previously unclear because it was not specified by the regulation. FPI refers to investments that are less than 10% of the paid-up equity capital of a listed foreign entity or investments that do not include control in the paid-up equity capital of a listed foreign entity.
• “Disinvestment” refers to the partial or whole extinction of rights to equity capital acquired in accordance with these regulations;
• The regulations have changed the requirements that must be met when any Indian resident makes a financial commitment or undertakes disinvestment.
  • • Has an account that appears to be an unprofitable asset; or 
    • Any bank classifies them as deliberate defaulters;
• The requirement that the RBI must approve any restructuring of an overseas entity’s balance sheet that involves a capital write-off of more than 25% of the investment has been eliminated by the guidelines. According to the guidelines, a valuation report must be filed in cases of diminution of the entity where the original investment was more than USD 10 million or when the amount of such diminution exceeds 20% of the total value of the outstanding dues.
• The rule states that ODI investments in start-ups recognized under the host nation’s or host jurisdiction’s laws, as the case may be, shall be made by an Indian entity only from internal accruals, whether from the Indian entity or group or associate companies in India and in the case of resident individuals, from such an individual’s own funds.
• The rule makes it clear that a resident individual may receive gifts of foreign securities from relatives who live in India. Prior to now, gifts from any person may be used to acquire foreign securities. The rule further states that, in compliance with FCRA, a resident individual may receive gifts of foreign securities from people who reside outside of India.
• The newly announced guidelines are in line with the present commercial and economic trends and will help India become a global impact producer.

Significant changes in the new Overseas Investments Framework

The following are the significant changes in the new Overseas Investment Framework:

The ODI Rules’ Rule 2(1)(q): The term “ODI” is now clearly defined to cover, among other things, investments totaling 10% or more of a listed foreign entity’s paid-up equity capital as well as investments made with control but totaling less than 10% of that entity’s paid-up equity capital.
In other words, when an investment made by an Indian resident into the equity capital of a foreign company is designated as an ODI, it will remain such even if it drops below 10% of the paid-up equity capital or if the Indian resident loses control over the foreign company. A person residing in India must be in control of the foreign entity in the event that investment is made in its debt instruments.
Investments made as part of a foreign firm or entity’s memorandum of association or as unlisted equity capital purchases are also included in the definition of ODI.
Additionally, the former restrictions included direct foreign investment made by an Indian party in a joint venture (JV) or wholly owned subsidiary. These terminologies have been modified, and the concept phrase of “foreign entity,” which refers to a company created, registered, or incorporated outside of India with limited liability, has replaced both JV and WOS under the new amendment. As a result, per the aforementioned definition, investments in any foreign entity with limitless responsibility are prohibited. A member of an International Financial Services Center is also included (IFSC) in India.

“Indian Entity” is used in place of “Indian Party.”: Under the new regime, the concept of “Indian Entity,” which shall mean a Company or a Limited Liability Partnership or a Partnership Firm or a Body Corporate incorporated under any law currently in effect, has replaced the concept of “Indian Party (IP),” wherein all investors from India in a foreign entity were collectively considered to be IP. Each investor entity must be treated as a distinct Indian entity.

Investments eligible for Overseas Investment: Overseas Investment (OI) is defined as a financial commitment and an overseas portfolio investment made by an Indian resident.
Financial Commitment refers to the total amount of investment made by an Indian resident in the following ways:

• Overseas Direct Investment (ODI)
• Debt in a foreign entity or entities in which ODI is formed (other than OPI).
• Non-funding facilities provided to or on behalf of such foreign organizations or entities.

The total financial commitment made by an Indian entity in all foreign entities at the time of executing such commitment cannot exceed 400% of its net worth as of the date of the most recent audited balance sheet or as specified by the RBI. It is worth noting that the previous legislation allowed for an unlimited number of holdings as well as subsidiaries for calculating the 400% maximum of the Indian Party’s net worth. The difference is that only the net value of the investor entity (Indian Entity) is now taken into account. Corporate Guarantees by certain group businesses are also permitted. It should be emphasized, however, that they will be counted against the use of such group firms’ financial obligation.

Takeaway

While the spirit and goal of the reworking of the rules regulating foreign investment are commendable, it should be highlighted that, according to the OI Directions, AD Banks have substantial flexibility in determining how to comply with these restrictions. It is best to offer clarifications about the KYC requirements for “round-tripping” structures, the scope of start-ups, the applicability of the two-layer rule to other structures, and the FCRA’s applicability to share gifts as soon as feasible. Overall, there is no denying that the relevant standards have been simplified. The former regime’s practical problems have been acknowledged, and significant concessions have been made.

As a result, the recently notified OI Regime, 2022 seeks to clarify and simplify a number of aspects of the prior foreign investment regime. In other words, these regulations broaden the number of options open to Indian residents seeking appropriate investment possibilities abroad. For companies affected by mergers and acquisitions or entrepreneurs looking to start a business, there is a clear framework to build on. Overall, it appears that the most recent legislation brings much-needed clarity and a breath of relief to ordinary transactions. As a result, more citizens seeking opportunities in global markets will participate in overseas investment.

Connect to the Experts at Legal Window, if you want more clarified updates regarding Overseas Investment Rules under FEMA, 1999.