TerraLex Guide to Foreign Direct Investment - NEW

Foreign direct investment (i.e., investment through equity shares (including equity shares that have been partly paid), fully and mandatorily convertible debentures, fully and mandatorily convertible preference shares and share warrants ("Equity Instruments") by a person resident outside India ("Non-Resident") in an unlisted Indian company or in 10% (ten per cent) or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company) ("FDI") is regulated at the national level in accordance with the provisions of the Foreign Exchange Management Act, 1999 ("FEMA"), the rules and regulations framed thereunder, including Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 ("NDI Rules"), and the circulars, notifications, orders and clarifications issued in relation to the same ("FDI Regulations").

The FDI Regulations set out certain sectors / activities in which FDI is prohibited ("Prohibited Sectors"). Non-Residents cannot invest in an Indian entity engaged in a Prohibited Sector. Except Prohibited Sectors, investment is permitted either without any further approval ("Automatic Route"), or with government approval ("Government Route") in all other sectors / activities ("Permitted Sectors"). Certain Permitted Sectors are also subject to specific investment limits and other conditionalities.

In addition, investment in the capital of an Indian limited liability partnership ("LLP") is also considered as 'foreign investment' for the purpose of the NDI Rules. Such investment can be undertaken through transfer of ownership, control or subscription of the instrument relating to control and ownership in such entities.

Lastly, investment by an Indian entity, which is foreign owned and controlled, in another Indian entity will also be treated as indirect FDI in relation to such other Indian entity.

For other instances of investment controls / similar regimes to the FDI Regulations, please refer to our response to Question 17 below.

The key authorities for administration and enforcement of the FDI Regulations are the Department for Promotion of Industry and Internal Trade ("DPIIT") (under the aegis of the Ministry of Commerce and Industry), Reserve Bank of India ("RBI"), the Directorate of Enforcement ("DOE") and in certain circumstances, specific ministries / government departments ("Competent Authorities").

DPIIT: The DPIIT formulates policy decisions in relation to the foreign investment regime in India. Its policy decisions are subsequently incorporated into law through amendments to the NDI Rules. Additionally, DPIIT is the nodal authority for facilitating the approval of investments being undertaken through the Government Route (including coordination with the Competent Authorities whose approval is required in certain circumstances).

RBI: The RBI is charged with the administration of the FDI Regulations and is empowered to interpret and issue directions, circulars, instructions, clarifications, as it may deem necessary in this regard.

DOE: The DOE is the primary authority for enforcement of the FDI Rules.

Competent Authorities: Under the FDI Regulations, the approval of certain sector-specific Competent Authorities is required before an investment can be undertaken (for example, the approval of the Ministry of Defence is required for investments in Indian entities engaged in the Indian defence sector).

Prior to determining the thresholds for FDI review, the parties to a FDI transaction must ascertain whether the proposed investee entity is engaged in a Prohibited Sector or a Permitted Sector.

In case the investee entity is engaged in a Prohibited Sector then the FDI transaction cannot be undertaken.

In case the investee entity is engaged in a Permitted Sector, the requirement of an FDI review will be driven by the following factors:

(a) Identity of the Non-Resident: The nature of the Non-Resident assumes significance in certain cases. After the introduction of Press Note 3 of 2020, the following transactions can only be undertaken via the Government Route: (i) investment by a Non Resident which is an investor from a country which shares a land border with India ("LBC"); (ii) investment by a Non Resident which is a beneficial owner situated in/ is a citizen of an LBC; and (iii) direct / indirect transfer of ownership of any existing / future FDI which results in a change of beneficial ownership such that the beneficial ownership resides with a Non Resident situated in an LBC / citizen of an LBC ("PN3 Approval"). For instance, if a Non-Resident is incorporated in the United States, but the beneficial ownership of such Non-Resident resides with an individual / corporation situated in the Republic of China, then PN3 Approval will be required.

(b) Type of investee entity: The nature of the investee entity assumes significance in certain cases. For instance, LLPs are only permitted to receive investment under the Automatic Route in sectors where there are no performance-linked conditions. On the other hand, FDI in certain entities such as trusts and societies is not permitted.

(c) Route of investment: Whether the proposed FDI falls under the Government Route or the Automatic Route will be another factor in determining the necessity of a FDI review.

(d) Adherence with pricing guidelines: An FDI review will be required in the event that a transfer between a Non-Resident and a person resident in India ("Resident") entails an inability to adhere with the relevant pricing guidelines vis-à-vis the purchase consideration for such transfer.

(e) Adherence with compliances in relation to payment of deferred consideration: A FDI review will be required if a Non-Resident seeks to defer the payment of consideration beyond the quantum or the time period stipulated under the FDI Regulations.

(f) Other conditions: Exceeding investment limits, ability to adhere with performance-linked conditions and sector-specific requirements would be other instances which may require a FDI review.

The test for FDI control is non-exhaustive and inter-alia includes the right to appoint the majority of the directors / control the management or policy decisions in an investee company (whether individually or collectively with 1 (one) or more persons). The exercise of such right can be direct / indirect, including by virtue of the investor’s shareholding or management rights or shareholders agreements or voting agreements.

Pre-closing filings.

Pre-closing filings are inter-alia required to be undertaken by submitting an application seeking prior approval for such investment, in the following instances ("Application"):

1. If PN3 Approval is required;
2. If the proposed FDI falls under the Government Route; and
3. If the proposed FDI is in excess of stipulated investment limits for Automatic Route.

In the above instances, FDI can be received by the relevant Indian entity, only once the Application has been approved.

Additionally, prior approval of the RBI is required in certain instances (for example, where the FDI transaction involves an inability to meet the stipulated pricing guidelines).

Post-closing filings.

Please note that each of the key post-closing filings described below have to be undertaken irrespective of whether the investment has been undertaken under the Automatic Route or the Government Route.

Further, each such filing forms part of a composite form filing known as the 'Single Master Form' (available at https://firms.rbi.org.in) ("SMF"). In order to file the SMF, the Indian investee entity which expects to receive FDI must file an 'entity master' on the FIRMS platform in accordance with the procedure provided in the user manual hosted on the FIRMS website.

1. Foreign Currency-Gross Provisional Return ("Form FC-GPR"). Issuance of equity instruments by an Indian company, to a Non-Resident is required to be reported within 30 (thirty) days of such issuance in Form FC-GPR in the SMF.
2. Foreign Currency-Transfer of Shares ("Form FC-TRS"). Transfer of equity instruments in an Indian company, between a Non-Resident and a Resident, is required to be reported, within 60 (sixty) days of such transfer, in Form FC-TRS in the SMF. Note, that this filing may not be required where the transfer involves a Non-Resident holding equity instruments on a non-repatriable basis.
3. Form FDI-LLP (I). An acquisition of profit share through capital contribution in a LLP by a Non-Resident, is required to be reported within 30 (thirty) days from the receipt of consideration, in Form FDI-LLP(I) in the SMF.
4. Form FDI-LLP (II). Acquisition of profit share through disinvestment or transfer in a LLP between a Non-Resident and a Resident, is required to be reported within 60 (sixty) days from the receipt of consideration, in Form FDI-LLP(II) in the SMF.

Pre-closing filings.

Under the FDI Regulations, there are no prescribed fees in connection with the Application.

Post-closing filings.

Under the FDI Regulations, there are no prescribed fees in connection with the post-closing FDI related filings. However, in case of a delay in filing, the RBI prescribes for a payment of the following late submission fees of INR 7,500 (seven thousand five hundred rupees), added to an additional amount, determined in accordance with a prescribed formulae inter alia including the period of delay, in case of a delay in filing Form FC-GPR, Form FC-TRS, Form FDI - LLP (I) and Form FDI LLP (II).

Pre-closing filings.

The key information requirements to be submitted along with the Application inter-alia include: (a) details and documents of the investor and the Indian entity, including the charter documents, financial statements, beneficial ownership and corporate authorisations; (b) agreements entered between the entities; (c) valuation certificate; (d) details of past filings in connection with FDI in the Indian entity; (e) the approvals received from authorities; and (f) a diagrammatic representation of flow of funds. Additionally, there maybe additional documents and information required where the Application involves a scrutiny by a Competent Authority from a security clearance perspective.

Post-closing filings.

1. Form FC-GPR - The key information requirements to be submitted along with Form FC-GPR inter-alia include: (a) certification by a company secretary; (b) filings undertaken with the Registrar of Companies, Ministry of Corporate Affairs; (c) valuation certificate; and (d) details in connection with the flow of funds, including the foreign inward remittance certificate (if applicable).

2. Form FC-TRS - The key information requirements to be submitted along with Form FC-TRS inter-alia include: (a) no-objection / tax clearance certificate from the Income Tax authorities / chartered accountant; (b) acknowledgement received from the RBI previously, in connection with instrument being issued / transferred under the current transaction;(c) extracts of the agreement in connection with the current transaction; (d) filings undertaken with the Registrar of Companies, Ministry of Corporate Affairs; (e) valuation certificate; and (f) details in connection with the flow of funds, including the foreign inward remittance certificates (if applicable).

3. Form FDI-LLP(I) - The key information requirements to be submitted along with Form FDI-LLP(I) inter-alia include: (a) valuation certificate; (b) filings undertaken with the Registrar of Companies, Ministry of Corporate Affairs; (c) details in connection with the flow of funds, including the foreign inward remittance certificate (if applicable); (d) extracts of the agreement in connection with the current transaction; and (e) certain declarations to be submitted by the authorized representative of a LLP in the prescribed formats.

4. Form FDI-LLP(II) - The key information requirements to be submitted along with Form FDI-LLP(I) inter-alia include: (a) valuation certificate; (b) no-objection / tax clearance certificate from the Income Tax authorities / chartered accountants; (c) extracts of the agreement in connection with the current transaction; (d) the consent letters issued by the parties to the transfer; and (e) acknowledgment letters for the capital contribution being transferred.

Pre-closing filings.

The FDI Regulations do not stipulate as to whether the investor entity/ investee entity are obligated to make the filings. However, relevant information of the investor entity and the investee entity have to be submitted along with the Application.

Post-closing filings.

1. Form FC-GPR - The Indian company receiving FDI is required to file this form.
2. Form FC-TRS - The Resident transferor/ transferee or the Non-Resident (if it is holding the equity instruments on a non-repatriable basis), as applicable, is obligated to file this form.
3. Form FDI-LLP (I) - The LLP in receipt of the FDI is obligated to file this form.
4. Form FDI-LLP (II) - The Resident transferor / transferee is obligated to file this form.

The facility for a delayed submission of the forms through the payment of a late submission fee (as detailed in the response to Question 6 above) is available for 3 (three) years.

A failure to make the required filings, can attract a penalty of up to thrice (3x) the sum involved, if the amount involved is quantifiable. If the amount is not quantifiable, then a penalty of up to INR 2,00,000 (two lakh rupees), may be imposed. Additionally, in case of a continuing contravention, an additional penalty extending up to INR 5,000 (five thousand rupees) is payable for every day of continuation of the contravention.

However, certain contraventions of FEMA can be compounded. An indicative list of the contraventions that can be compounded is provided in the RBI's 'Master Directions- Compounding of Contraventions under FEMA, 1999' (available here < 135MD89B55F672F36443FA02C0C53DC207FFF.PDF>) ("Compounding Directions").

There are certain prerequisites that have to be fulfilled before an application for compounding can be submitted. Firstly, an applicant which has committed a similar contravention within a period of 3 (three) years from the date of the current contravention is not permitted to proceed with a compounding application. Secondly, before filing a compounding application, the applicant has to ensure that any corrective actions necessary with respect to the transactions involved in such contravention have been completed. Indicative instances of such corrective action include: (a) obtaining requisite approvals / permissions from the RBI or other concerned statutory authorities; (b) repatriation of receivables which are due; (c) compliance with reporting requirements; (d) unwinding / reversing the FDI transaction; or (d) such other corrective action as prescribed.

Once the above steps have been completed, the contravention can be compounded in accordance with the conditions prescribed under Paragraph 5.4 of the Compounding Directions and taking into consideration certain indicative factors such as: (a) the undue gains made as a result of the contravention; (b) amount of loss caused to the exchequer as a result of the contravention; and (c) the track record / history of non-compliance of the applicant entity.

Apart from the penal provisions noted above, if the appropriate filings have not been made and acknowledgments of such filings have not been received from the RBI, then, challenges may arise at the time of a subsequent sale (for instance, if the Form FC-GPR filing is not made, challenges will arise in submission of Form FC-TRS at the time of transfer of the underlying equity instruments by a Resident to a Non-Resident and vice versa).

For all filings which require prior approval (refer to the instances of pre-closing filings described in the response to Question 5 above), the Non-Resident cannot make investments / undertake the specific transaction until such approval is obtained. Non-compliance with the above restriction may result in the imposition of monetary penalties (as further detailed in our response to Question 9 above). Further, from a practical perspective, the authorized dealer banks may refrain from remitting / receiving the investment amounts in case such prior approvals are not obtained.

Mandatory filings are required for all FDI transactions, in the form of pre-closing filings for certain FDI transactions and in the form of post-closing filings for all FDI transactions (refer to our response to Question 5 above). Accordingly, all FDI transactions are subject to some form of regulatory scrutiny.

The types of decisions that can be issued in relation to FDI transactions are: (a) approval with / without any additional conditionalities; or (b) rejection.

The FDI Regulations prescribe certain pre-determined conditions for investment in certain sectors. For example, FDI of upto 100% (one hundred per cent) is permitted in an Indian entity engaged in single brand retail trading through the automatic route (i.e., without any governmental approval), subject to compliance with certain applicable sectoral conditions. To the extent such pre-determined conditions are breached, the consequences described in the response to Query 9 will apply. Additionally, the approving authority (for instance, DPIIT in case of FDI via the Government Route or the RBI in case of FDI via the Automatic Route) may prescribe certain conditions (which are not provided for in the FDI Regulations) on a case-by-case basis depending on the facts and circumstances of a particular FDI transaction.

No, the FDI Regulations do not provide for a statutory right to appeal a decision in relation to a particular FDI transaction.

Pre-closing filings.

Upon submission of the Application to the DPIIT (refer to the response to Question 5 above), the following actions are required to be undertaken within the timelines prescribed below. While the standard operating procedure issued by the DPIIT provides for a cumulative time period of 12 (twelve) weeks for approval of the Application (with an additional 2 (two) weeks, in case a Competent Authority proposes either the rejection of the application or the prescription of additional conditions), such timelines are indicative and the actual timelines differ from case to case depending on the nature of and complexity of the specific transactions. The steps and timelines in relation to the Application are detailed in Annexure-V of the standard operating procedure issued by the DPIIT.

The pre-closing filings and post-closing filings described in our response to Question 5 provide for a reasonable standard of confidentiality. For instance, such filings are undertaken through secure portals which entail creation of individual accounts (which are password protected and assign unique IDs). Further, the specific terms and conditions and other details prescribed in the approvals / acknowledgments/ correspondences between the parties to a FDI transaction and the concerned regulator are not ordinarily disclosed in the public domain (other than remote instances such as litigation proceedings in relation to such transactions). However, it should be noted that while FDI inflow statistics are published on a periodic basis, the details of the individual applicants are not disclosed.

The FDI Regulations described in our response to Question 1 is the main framework for FDI in India. It should be noted that for certain sectors (e.g., defence sector, mining sector, banking and insurance sectors), compliance with sectoral regulatory laws (regarding licensing, registration and procedural requirements) is mandatory for the investee entity (regardless of its status as a recipient of FDI) and may involve obtaining approvals for change in control / management.

Additionally, for certain sectors, there are sector-specific rules for foreign investment and additional compliances for recipients of FDI. For example, the Indian Insurance Companies (Foreign Investment) Rules, 2015 requires Indian insurance companies which are recipients of FDI to ensure that a majority of their directors are resident Indians (as opposed to the general prescription of only 1 (one) resident director being required). Similarly, insurance intermediaries, which are recipients of FDI are required to obtain prior permission from the concerned Competent Authority before repatriating any dividends.