An Analysis of India’s New FDI Policy: Are there any Grey Areas?

Ayushi Upadhyay
National Law University, Delhi

The outbreak of Novel Coronavirus jeopardized not only the life of individuals but also the economy of all the countries. That’s why the governments have been in an effort to control the situation. One such effort on the part of Indian government is contained in the Press Note (3) dated 17 April, 2020, released by the Department for Promotion of Industry and Internal Trade under which the regulatory framework for foreign investments in India has been revised. 

As per the Press note, foreign investment by any entity situated in the countries that share land border with India or if the beneficial owner of the investment, be it entity or citizen is a citizen of such country that shares land border with India, then prior government approval shall be necessary. Also, the transfer of existing or future FDI in an Indian entity, either directly or indirectly which changes the beneficial ownership will also require prior government approval. 

The Press note states that this step has been taken in order to curb the opportunistic takeovers of Indian companies in the backdrop of the economic turbulence round the globe. Now, the automatic route under which only the central bank was needed to be informed after the investment of money, has been blocked for the countries that share land border with India. Though, India shares land border with seven countries, this move seems to be aimed at China only because investment from Pakistan was already subject to scrutiny and the other five countries have not bought Indian assets in the past. Supposedly, Indian government got alarmed by the fact that recently, People’s Bank of China invested in 1.01% shares of HDFC Bank which is India’s biggest mortgage bank. 

However, this change in the FDI Policy did not go uncriticised by China. A statement from Chinese Embassy termed it as violative of WTO principles of non-discrimination and against free and fair trade, general trend of liberalisation and also alleged it to be non-conformative of the consensus of G20 leaders to maintain a free and fair-trade environment.   

But India countered the criticism by stating that the new FDI rules mandating the prior government approval do not deny permission or result in an equity cap or restriction but only provide for an approval process which is formally different and hence, not violative. It also needs to be noted that several countries like Germany and Australia have also tightened their policies relating to FDI in order to ensure the protection of their companies. 

This article is not an attempt to criticise or bring out the bright parts of this new FDI policy, rather it is an attempt to highlight a few grey areas of the new FDI regulations which are a source of ambiguity for the businesspersons and the various start-ups etc., that are running helter-skelter because of the same. 

After the issuance of the Press Note on April 17, Foreign Exchange Management (Non-debt Instruments) Rules, 2019, (FEMA Rules) were amended on April 22, to give effect to the changes. Each stakeholder had waited for the Rules, thinking it would clear the air but FEMA Rules as amended on 22 April did not offer any clarity. 

The first grey area relates to the interpretation of the terms ‘indirectly’, ‘beneficial ownership’ and ‘takeover/acquisition’. The scope of these terms has not been clarified under the new rules. There is yet no clarity in regard to the point that what percentage of shareholding in an investment would amount to beneficial ownership as in case of several Indian tech-companies, ownership of even a single share would constitute beneficial ownership and thus, requiring prior government approval. No distinction has been mentioned in the Press Note in regard to minority control and passive investment, so it seems as if, it is all encompassing. Moreover, it is left unspecified whether the changes apply to certain specific sectors or to all the sectors. 

The root this ambiguity lies also in the fact that there exist two criteria for determining beneficial owners. Currently, there are two ‘beneficial ownership’ tests- one under the Companies Act and the other under Anti-money laundering rules. FEMA Notification does not clarify who would be regarded as a beneficial owner and which test would be used. 

It is also not clear if these amended rules apply to such cases where the global acquisitions by the entities from bordering countries will result in indirect acquisition of Indian subsidiaries. And even if approval is required, who will apply for it, Indian entity or the investing entity. There is also lack of clarity regarding the issue how would an Indian entity which is a subsidiary of a Chinese corporation raise its capital in future because even in the case of disapproval by the government for future fund raising will not change the fact that its parent company is a Chinese corporation. 

Further, the Press Note also does not define the term- ‘takeover/acquisition’. The note construes takeover only by the way of acquisition of shareholding in any entity but it must be noted that takeover or control can be acquired by an investor in many other ways like acquisition of management rights, voting rights and appointment of directors etc. 

The second grey area is concerned with the Special Administrative Regions (SARs) of China. When government had mandated the prior approval from Reserve Bank of India for the Chinese investors for the purpose of acquisition of immovable property, they had specifically mentioned and called out Hong Kong and Macau, which are Chinese SARs but this specific call-out is missing from the Press Note dated 17 April which places restrictions only on China and does not have a mention about the Chinese SARs. This leads to the uncertainty about the requirement of government approval for investments coming from these SARs as they do not share land border with India but still, they are regarded as a part of China and different treatment is provided for different aspects, for instance, the rules for establishment of branch or project office treat Hong Kong and China as different entities but certain trade-related guidelines treat them as the same. 

Moreover, the concerns are not limited only to SARs but also there is another region which though not a SAR, creates ambiguity in regard to these new rules. The region is Taiwan. In recent years, India has witnessed investments from Taiwan in the sectors such as infrastructure and energy. As a WTO member, India has not recognised it as an independent country and has accepted the sovereignty of China over the region but still India has a tax treaty with Taiwan. This creates the confusion if the investments from Taiwan would be requiring a prior government approval under the new FDI rules or not. 

The third ambiguity is about the companies which are already underway the process of incorporation and the incorporation certificates are yet to be issued. It is not clear whether government approval would be required in these cases if the foreign investors are situated in countries mentioned in the Press Note. 

Then the fourth point of lack of clarity is related to Foreign Portfolio Investment (FPI). Rule 6(a) of the FEMA Rules was amended to introduce the new regulations. The amendment to this rule and the Press Note used the term FDI which suggests that the restrictions are only for the investments structured as FDI i.e. investment in the unlisted companies and 10% or more of the post issue paid-up equity capital investment in a listed Indian company. But what about the Foreign Portfolio Investment which is less than 10% in listed Indian company or investment under the FVCI (Foreign Venture Capitalist Investment) Route which are regulated by the SEBI (Securities and Exchange Board of India). There is much confusion about the applicability of these rules to FPI and FVCI. Many corporations have reached out to the government for clarification. If the government wants to stop the neighbouring investors from mopping up the stakes in listed companies, then the change only in FDI Policy is not enough, FPIs also need to be covered in the same way. 

The fifth concern is about the LLPs (Limited Liability Partnerships) as the current reading of the amended rules excludes them and other entities. Many have sought clarification in this regard. It is not clear if these restrictions would be applicable to the “foreign investments” in LLPs that are not FDI as the Press Note has no mention of the same but the term “foreign investment” has been defined under the Rules as any investment made by a person who is a resident outside India on a repatriable basis in equity instruments of an Indian company or to the capital of a LLP. The Press Note describes the changes as a move to curb the opportunistic takeovers of Indian companies but does not make any reference to LLPs and amends Rule 6(a) which only deals with investments in equity instruments of Indian companies under the Schedule I of Rules. 

The sixth subject of uncertainty is the follow-on investments. The Rules do not clarify if the fresh infusion of funds by existing investors i.e. follow-on investment, in the case when there is no change in the shareholding percentage would attract the new approval requirements or not. Also, there is ambiguity regarding the issue whether the existing investors from China, can raise the fund by ways of rights issue or will they have to undergo the approval process, same as that of the other new investors. 

There is another issue which though, not a grey area, needs attention, that is, will this new FDI policy that provides for added scrutiny, be able to curb the opportunistic acquisitions. This seems a bit unlikely given that a large proportion of the FDI into India is routed through multi-layered structures of the low-tax jurisdictions like Hong Kong, Singapore and Mauritius. Also, attempts in past to dig deep into the beneficiaries behind these flows have borne no fruits and instead policymakers had to pull back at the first signal of push-back from the foreign investors. 

Along with all these ambiguities and uncertainties, the new FDI policy creates instability and confusion amongst the businesspersons and hence, for maintaining stability and eliminating confusion out of the business and investment arena in these already difficult times of a pandemic, it becomes very essential for the Government to remove the air of ambiguity around the new FDI policy at the earliest.  

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