Laxmi Joshi and Aditi Rani
In a bid to simplify the foreign investment norms, certain amendments were made to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“Principal Rules”)[1] on August 16, 2024, vide the notification of Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024 (“Amendment Rules”).
The key highlights of the Amendment Rules are as follows:
Swap of Equity Instrument and Equity Capital.
The most striking amendment is the introduction of cross border equity swap. Prior to the amendment, the Principle Rules only allowed swap of equity instruments of Indian companies to non-residents by way of issuance. This was conditional upon such Indian companies being under the automatic route sector wherein 100% foreign direct investment was allowed without any prior approval requirement (“Automatic Route Sector”)[2].
The Amendment Rules however permit cross-border equity capital swaps in both the Automatic Route Sectors and regulated sectors (with prior government approval where required). It also expressly permits issuance of equity instrument by the Indian company and transfer of equity instruments of an Indian company between a person resident in India and a person resident outside India, against:
a) swap of equity instruments [3]of another Indian company;
b) swap of equity capital[4] of a foreign company.
Standardizing the definition
a) “Control”
Under the Principal Rules the term “control”[5] was defined as part of the “Downstream Rules” which has now been omitted. As per the Amendment Rules, a new clause (da) has been introduced to align the definition of “control” with that under the Companies Act, 2013. The revised definition of 'control' vis-a-vis companies and limited liability partnerships (“LLPs”) is as follows:
i) For a company, control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner[6]; and
ii) For LLP, control means the right to appoint majority of the designated partners, where such designated partners, with specific exclusion to others, have control over all the policies of an LLP.
b) “Startup company”
The definition of “startup company” under the Principal Rules has been updated and refers to the term as defined under the latest notification on the topic issued by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry in 2019[7]. A “startup” company under the rules now means an entity: (i) which has been incorporated for no longer than 10 years; (ii) with turnover not exceeding INR 100,00,00,000 in any of the financial years; and (iii) which is working towards innovation, development, or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
Requirement of prior government approval
Under the Principal Rules, the transfer of equity instruments of an Indian company from a person resident outside India, not being a non-resident Indian or an overseas citizen of India or an erstwhile overseas corporate body by way of sale or gift to any person resident outside India, was generally permitted to an India company, under the Automatic Route Sector. However, prior government approval for transfer was required for Indian company engaged in sector requiring governmental approval.[8]
The Amendment Rules has broadened the proviso to cover all cases of transfer for which prior government approval will be required to be obtained. The reference to sectors requiring government approval has been omitted.
Downstream Investment Rules
Pursuant to the Amendment Rules, the investments by entities owned and controlled by Overseas Citizen of India (OCI) and Non-Resident Indian (NRI), on a non-repatriation basis will not be considered for calculation of indirect foreign investment.[9] Under the Principal Rules, this provision was limited to NRIs only. This amendment is expected to attract more investments into India by OCIs through the entities owned and controlled by them.
FPI Investment Limit
Under the Principal Rules, the threshold for aggregate investment by foreign portfolio investors (FPIs) under the automatic route is 49% of the paid-up-capital on a fully diluted basis or sectoral or statutory cap, whichever is lower. This relaxation is however allowed only if there is no transfer of ownership and/ or control of the resident Indian company from resident Indian citizens to persons resident outside India.[10] The Amendment Rules has omitted the threshold of 49%; consequently the investment by FPIs will be permitted up to the sectoral cap limit. This amendment is set to increase the flow of investments by FPIs into India.
FDI in White Label ATM Operations
100% FDI under the automatic route is permitted in White Label ATM Operations’ sector, subject to specific conditions. While this was already covered and provided for under paragraph 5.2.25 of the Consolidated FDI Policy 2020[11], it has now been notified vide the Amendment Rules and a new entry F.11 has been added under the table in Schedule 1 of Principal Rules to align the rules with the said policy.
Conclusion
The changes brought about by the Amendment Rules to the Principal Rules are welcome steps taken towards facilitating foreign investments and simplifying rules to promote greater ease of doing business. This amendment simplifies the cross-border transactions which is aimed to pave the way for global expansion of Indian companies through mergers, acquisitions and other strategic investment, enabling them to reach new markets and grow their presence worldwide.
[1] S.O. 3732(E), dated October 17, 2019, issued by the Department of Economic Affairs, Ministry of Finance.
[2] Para 1(d) of Schedule I of Foreign Exchange Management (Non-debt Instruments) Rules, 2019.
[3] As per the Rule 2(k) of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, “equity instruments” shall include equity shares, convertible debentures, preference shares and share warrants issued by an Indian company.
[4] As per the Rule 2(1)(e) of Foreign Exchange Management, (Overseas Investment) Rules, 2022, "equity capital" shall mean equity shares or perpetual capital or instruments that are irredeemable or contribution to non-debt capital of a foreign entity in the nature of fully and compulsorily convertible instruments.
[5] As provided under Explanation (d) to Rule 23 of the Principal Rules: “control” shall mean the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreement or voting agreement and for the purpose of LLP, “control” shall mean the right to appoint majority of the designated partners, where such designated partners, with specific exclusion to others, have control over all the policies of an LLP.
[6] As provided under the Section 2(27) of the Companies Act, 2013.
[7] 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.
[8] Proviso (i) to Rule 9 (1) of the Foreign Exchange Management (Non-debt Rules), 2019.
[9] Explanation, after sub-rule (7) of Rule 23 of Foreign Exchange Management (Non-debt Rules), 2019.
[10] Paragraph 3(a)(iii) of Schedule I of Foreign Exchange Management (Non-debt Rules), 2019.