Flash Alert: Simplification and Liberalisation of Foreign Direct Investment – Non-Debt Instrument Rules
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- On August 20, 2024
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In line with the Ministry of Finance and Central Government’s ongoing efforts to simplify, clarify, and liberalize the provisions of the Foreign Exchange Management Act, 1999, and its related Rules and Regulations, the Ministry of Finance has issued amendments to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (hereinafter referred to as the ‘Principal Rules’).
The Central Government announced Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024 (hereinafter referred to as the ‘Amended Rules’) on August 16, 2024.
A summary of the amendments is encapsulated below:
Introduction of New Rules or Clauses
| Sr. No | Insertion of New Rule / Clause | Description of New Rule / Clause | ||||||||||||||||||||
| 1 | New Clause under Rule 2 – Definition of Control | ‘Control’ shall have the same meaning as assigned to it in the Companies Act, 2013 and for the purposes of Limited Liability Partnership, shall mean the right to appoint a majority of the designated partners, where such designated partners, with specific exclusion to others, have control over all the policies of an LLP.
Consequentially, the definition of control has been omitted from and sub-clause (d) defining control under sub-rule (7) of Rule 23 and in clause (ii) to sub-paragraph (a), in paragraph (1) to Schedule II. |
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| 2 | New Rule 9A – “Swap of equity instruments and equity capital” below Rule 9 –‘Transfer of equity instruments of an Indian company by or to a person resident outside India’ | Swap of equity instruments and equity capital –
The transfer of equity instruments of an Indian company between a person resident in India and a person resident outside India may be by way of–– (i) swap of equity instruments in compliance with the rules prescribed by the Central Government and the regulations specified by the Reserve Bank from time to time; (ii) swap of equity capital of a foreign company in compliance with the rules prescribed by the Central Government, including the Foreign Exchange Management (Overseas Investment) Rules, 2022, and the regulations specified by the Reserve Bank from time to time: Provided that prior Government approval shall be obtained for transfer in all cases wherever Government approval is applicable. Explanation. – For the purposes of this clause, the expression “equity capital” shall have the same meaning as assigned to it in the Foreign Exchange Management (Overseas Investment) Rules, 2022, as amended from time to time.’’ |
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| 3 | Addition of Table White Label ATM Operations (WLAO)” of Sector under Schedule I under the “Other Financial Services” sector |
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Substitution / Amendment in Existing Rules or Clauses
| Sr. No | Current Rule / Clause under Principal Rules | Substituted / Amended Rule / Clause under Amended Rules | Specific Comments |
| 1 | Clause (an) under Rule 2 defines a startup company as –
“startup company” means a private company incorporated under the Companies Act, 2013 and identified under G.S.R. 180(E), dated the 17th February 2016, issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry |
“startup company” means a private company incorporated under the Companies Act, 2013 (18 of 2013) and identified as “startup” under the notification of the Government of India number G.S.R. 127 (E), dated the 19th February 2019 issued by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, as amended from time to time.
Consequentially, the definition of startup has also been deleted from sub-paragraph (iii) in Paragraph (1) to Schedule VII. |
The amendment has widened the definition of a startup. |
| 2 | Proviso to Rule 9(1) –
Prior government approval shall be obtained for any transfer in case the company is engaged in a sector that requires government approval. |
Prior Government approval shall be obtained for transfer in all cases wherever Government approval is applicable. | The amendment broadens the mandate to require prior government approval for all transfers where such approval is applicable, regardless of the sector. |
| 3 | Explanation in Sub-clause (i) of Sub-rule (7) of Rule 23 –
“indirect foreign investment” means downstream investment received by an Indian entity from –
(A) another Indian entity (IE) which has received foreign investment and (i) the IE is not owned and not controlled by resident Indian citizens or (ii) is owned or controlled by persons resident outside India; or (B) an investment vehicle whose sponsor or manager or investment manager (i) is not owned and not controlled by resident Indian citizens or (ii) is owned or controlled by persons resident outside India. Provided that no person resident in India other than an Indian entity can receive Indirect Foreign Investment; |
An investment made by an Indian entity that is owned and controlled by a Non-Resident Indian or an Overseas Citizen of India, including a company, a trust, and a partnership firm incorporated outside India and owned and controlled by a Non-Resident Indian or an Overseas Citizen of India, on a non-repatriation basis in compliance with Schedule IV of these rules, shall not be considered for calculation of indirect foreign investment. | The proposed amendment redefines the criteria for calculating indirect foreign investment |
| 4 | In Paragraph (1), sub-paragraph (d) –
An Indian company may issue, subject to compliance with the conditions prescribed by the Central Government and/or the Reserve Bank from time to time, equity instruments to a person resident outside India if the Indian investee company is engaged in an automatic route sector, against – (i) swap of equity instruments; or (ii) import of capital goods or machinery or equipment (excluding second-hand machinery); or (iii) pre-operative or pre-incorporation expenses (including payments of rent etc.) Provided that the Government approval shall be obtained if the Indian investee company is engaged in a sector under the Government route and the applications for approval shall be made in the manner prescribed by the Central Government from time to time. |
An Indian company may issue, subject to compliance with the rules prescribed by the Central Government and the regulations specified by the Reserve Bank from time to time, equity instruments to a person resident outside India against, –
(i)swap of equity instruments; or (ii)import of capital goods or machinery or equipment (excluding second-hand machinery); or (iii)Pre-operative or pre-incorporation expenses (including payments of rent, etc.); (iv)swap of equity capital of a foreign company in compliance with the rules prescribed by the Central Government, including Foreign Exchange Management, including Foreign Exchange Management (Overseas Investment) Rules 2022, and the regulations specified by the Reserve Bank from time to time. Explanation. – For the purposes of this clause, the expression “equity capital” shall have the same meaning as assigned to it in the Foreign Exchange Management (Overseas Investment) Rules, 2022, as amended from time to time:
Provided that government approval shall be obtained in all cases wherever government approval is applicable and the applications for approval shall be made in the manner prescribed by the Central government from time to time. |
The amendment to Schedule I expands the conditions for issuing equity instruments to foreign residents if the Indian investee company is engaged in the Automatic route sector. |
| 5 | Amendment to Schedule I – Entry Routes for Foreign Investments in paragraph (3), in clause (a), for sub-clause (iii) –
Aggregate foreign portfolio investment up to forty-nine percent of the paid-up capital on a fully diluted basis or the sectoral or statutory cap, whichever is lower, shall not require Government approval or compliance of sectoral conditions as the case may be, if such investment does not result in the transfer of ownership and control of the resident Indian company from resident Indian citizens or transfer of ownership or control to persons resident outside India and other investments by a person resident outside India shall be subject to the conditions of Government approval and compliance of sectoral conditions as laid down in these rules. |
The aggregate foreign portfolio investment up to the sectoral or statutory cap shall not require Government approval or compliance with sectoral conditions, as the case may be, if such investment does not result in the transfer of ownership and/ or control of the resident Indian company from resident Indian citizens to persons resident outside India and other investments by a person resident outside India shall be subject to the conditions of Government approval and compliance of sectoral conditions as laid down in these rules. | The amendment increases the threshold for foreign portfolio investments exempt from government approval. |
KNAV Comments:
- The amendment to the Principal Rules is a positive development that offers several benefits, such as:
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- Simplification and Clarification: Addressing ambiguities to make it easier for businesses and investors to navigate foreign direct investment in India.
- Enhanced Investment Climate: Creating a more favourable environment for foreign investors, which may increase both foreign direct investment (FDI) and foreign portfolio investment (FPI).
- Reduced Uncertainty: Providing clearer guidelines and rules to reduce investor uncertainty and encourage more investments.
- Improved Transparency: Offering clarificatory guidelines to enhance the transparency of the regulatory framework, making it easier to understand and comply with the rules.
- The revised rules may offer expanded opportunities for foreign investment, including new sectors and financial instruments. Increased foreign investment can drive economic growth, generate job opportunities, and boost overall economic activity.
- Clarifications regarding the swap of equity instruments and equity capital will enhance operational efficiency, allowing companies greater flexibility in structuring their foreign investments. Additionally, the amended rules will provide greater consistency and predictability in foreign exchange regulations, aiding businesses and investors in planning and compliance.
- Improved clarity and liberalization in the Principal Rules will enhance the monitoring and oversight of foreign direct investments, leading to better regulatory compliance and reduced misuse.
- Overall, aligning the Principal Rules with international best practices and standards can make the country’s foreign exchange regulations more compatible with global norms. This will enhance its appeal as an investment destination, foster a more investor-friendly environment, boost foreign investment, and support economic growth while ensuring effective regulation and compliance.
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