Handbook for
Foreign Exchange Laws
of India
:Mr. Ricky Chopra
INDEX Introduction: What is Foreign Investment Evolution of Foreign Exchange Laws in India Regulatory Framework for Foreign Investment in India Various Routes for Foreign Investment in India Types of Foreign Investment Sectors in Which Foreign Investment is Prohibited in India Sectoral Caps for Foreign Investment Pricing Norms Reporting Requirements Ricky Chopra International Counsels’ Edge over Foreign Investment Laws Conclusion
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Introduction:
What is Foreign Investment? Foreign investment is usually understood to mean the phenomenon through which an entity of one country seeks to establish its presence in another country. This could be driven by various motives. For examples, a manufacturing entity looking to establish a giant manufacturing might favour a country with easy availability of land, labour and raw materials. If the same are not readily available, in the country of its establishment, it looks to set up its manufacturing unit in a country where these factors are favourable. Though it might entail costs at the outset, strategic foreign investment has always proved to bringin savings.
Evolution of Foreign Exchange Laws in India With the industrial revolution and growth in international trade, the British colonial government in India had inserted certain basic provisions relating to foreign exchange in the Defence of India Rules, 1939. However, the need was felt for a more comprehensive framework in independent India to boost development and the economy. Therefore, the Foreign Exchange Regulation Act, 1947 was enacted. Later on, this was replaced by a more enhanced version in 1974 by the Foreign Exchange Regulation Act, 1973. In the early 1990s, the government which had until then maintained a protective policy, decided to overhaul the same and open the economy by removing trade barriers and other restrictions that prevented abundant foreign investment. The Foreign Exchange Regulation Act, 1973 treated violations as a criminal oence which according to the Tarapore Committee created great impediments for attracting foreign investment in India. Therefore, the same was ďŹ nally replaced by the Foreign Exchange Management Act, 1999 which came into eect in 2000 and is still in force in India. It provides for only civil and pecuniary liabilities instead of criminal liabilities as was there in
the erstwhile Act of 1973.
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Regulatory Framework for Foreign Investment in India The Foreign Exchange Management Act, (1999) which came into force in 2000 is the umbrella legislation which governs the major aspects relating to foreign investment in India. In addition to this, based on whether the investment is debt based or non-debt based, it shall be governed either by the Foreign Exchange Management(Debt Instruments) Rules, 2019 or the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 respectively. External Commercial Borrowings (ECB are a type of foreign investment in the form of debt instruments and the Reserve Bank of India (RBI) is the concerned regulatory authority responsible for making rules for ECB etc. Therefore, for the latest regulatory regime governing external commercial borrowings, one must refer to the RBI Master Directions in respect of the same. Similarly, in the case of foreign exchange instruments which are non-debt based, for example, equity based foreign investment, the Central Government has control over majority of aspects pertaining to the same. The Department for Promotion of Industry and Internal Trade (DPIIT) which is a department of the Ministry of Commerce and Industry of the Central Government, issues Press Notes on a regular basis to notify the people of any change on the FDI policy along with consolidated FDI policies once in a while. The most recent change in FDI policy was made in July 2020, and the last consolidated policy was released in 2017. Therefore, any latest changes in the FDI policy must be tracked through press releases of the DPITT.
Various Routes for Foreign Investment in India Based on whether the foreign investment requires prior authorization or approval by the Central Government, it can be classiďŹ ed as either under the automatic route (when prior approval is not required) and the approval route (when prior authorization is required).
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Automatic Route Under the automatic route, the foreign investor does not require prior approval of either the RBI or from the Central Government to enter the Indian capital markets. This usually occurs when a foreign investor subscribes to shares in an Indian company under the permitted sector, within the threshold limit directly from the open market or through private placement.
Approval Route As mentioned earlier, under the approval route prior authorization from the government needs to be taken. The procedure to be followed in this regard (which takes approximately takes 10 weeks) has been briefly discussed below: The prospective investor must make an application on the portal of the Foreign Investment Facilitation Portal, available at www.fifp.gov.in/. This would require online submission of supporting documents and information regarding the credibility of the investor.
The DPIIT then identifies the concerned Ministry/ Department and thereafter, forwards the proposal to them. In addition, once the proposal is received, the same would also be circulated online to the RBI within 2 days for comments from FEMA perspective.
The DPIIT is required to provide its comments within 4 weeks from receipt of an online application, & Ministry of Home Affairs (if applicable) is required to provide comments within 6 weeks.
Pursuant to the above, additional information/ clarifications may be asked from the applicant which is to be provided within 1 week.
Proposals involving an FDI exceeding INR 50 billion are also required to be placed before the Cabinet Committee of Economic Affairs.
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Types of Foreign Investment FDI: A Foreign Direct Investment (FDI) is the most popular form of foreign investment. It occurs when a foreign entity or individual acquires stake in an Indian entity. The various kinds of equity instruments which can be issued for the purpose of Foreign Direct Investment (FDI) include equity shares, compulsorily convertible debentures, fully and compulsorily convertible preference shares, share warrants, depository receipts, or foreign currency convertible bonds.
An FDI may further be divided into two types- greenfield FDI and brownfield FDI. A greenfield investment refers to the type of foreign direct investment (FDI) where a company establishes operations in a foreign country from scratch. A brownfield investment is a type of foreign direct investment where a company invests in an existing d=facility to start its operation in the foreign country.
FPI: The SEBI (Foreign Portfolio Investment) regulations 2014, require a foreign investor willingto invest through the FPI route to first register itself as an FPI with the SEBI. The FPI Regulations classify an eligible applicant into Category I and category II investors depending upon how regulated those entities are and the degree of control the government can exercise on them for example, whereas foreign central banks fall under Category I FPI, the more self-regulated entities like mutual funds fall under Category II. An investor would therefore first have to gauge the category it falls under and accordingly the regulations shall apply to it.
FVCI: The investments by a foreign investor in Indian Venture Capital Undertakings (VCU) and Venture Capital Funds (VCF)are governed by Foreign Exchange Management regulations and Securities Exchange Board of India regulations. The foreign country investing in the Venture Capital in India is called as the Foreign Venture Capital Investor (FVCI).The term FVCI has been defined under the SEBI (Foreign Venture Capital Investor) Regulations 2000 to mean:
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“an investor incorporated or established outside India, which proposes to make investments in venture capital fund(s) or venture capital undertakings in India and is registered under the FVCI Regulations”
It is mandatory for a foreign investor that it should have got itself registered with SEBI before it proceeds to make investment in Venture Capital Company of India. Registration with the SEBI is only permitted if the entity satisfies the ‘fit and proper’ criteria for an FVCI.
Sectors in Which Foreign Investment is Prohibited Foreign Direct Investment is prohibited in the following sectors: lottery business including Government/private lottery, online lotteries, etc.;
gambling and betting including casinos, etc.;
chit funds;
Nidhi company no specific exception under the Rules.
trading in transferable development rights;
real estate business or construction of farm houses not including development of townships, construction of residential /commercial premises, roads or bridges and Real Estate Investment Trusts (REITs) registered and regulated under the SEBI (REITs) Regulations 2014;
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manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes;
activities/sectors not open to private sector investment, e.g. atomic energy and railway transport (other than construction, operation and maintenance of the following: (a) suburban corridor projects through public private partnership; (b) high speed train projects; (c) dedicated freight lines; (d) rolling stock including train sets, and locomotives/coaches manufacturing and maintenance facilities; (e) railway electriďŹ cation; (f ) signaling systems; (g) freight terminals; (h) passenger terminals; (i) infrastructure in industrial park pertaining to railway line/sidings including electriďŹ ed railway lines and connectivity to main railway line; and (j) mass rapid transport systems); and (ix) Foreign technology collaboration in any form including licensing for franchise, trademark, brand name, management contracts is also prohibited for lottery business, gambling, and betting activities.
Sectoral Caps for Foreign Investment The DPIIT has put in place caps or maximum limits on foreign investment which can be made in every sector. Therefore, every foreign investor which seeks to invest in India must be mindful of these thresholds. Although it is not possible to exhaustively list the caps for all sectors, the caps for some of the major sectors have been mentioned below: Sectors which permit 100% FDI through the automatic route- textiles and garments, tourism and hospitality, thermal power, petroleum and natural gas, roads, highways and railway construction etc.
Sectors which permit 49% FDI through the automatic route- telecom, petroleum reďŹ ning, defence services etc.
Sectors which permit 74% FDI- biotechnology, healthcare, pharmaceuticals etc.
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Sectors which permit 100% FDI through the approval route- print media, mining, retail food products etc.
Sectors which permit 26% FDI through the approval route-– multi brand retail trading, digital media etc.
Pricing Norms The Reserve Bank of India has put in place detailed directions for pricing of all foreign investment transactions. The crux of the pricing guidelines being that when a foreign entity seeks to purchase securities of an Indian entity, the SEBI guidelines provide for a floor price below which they cannot be sold, however, when a foreign entity seeks to sell its shares to an Indian entity, a ceiling price is usually prescribed beyond which the same cannot be sold.
In case of purchase of stocks not available on a recognised stock exchange the price is calculated as per fair valuation done by a SEBI registered merchant banker. In case of partly paid equity shares and share warrants, the foreign investor is required to pay 25% of the consideration for the security upfront.
Reporting Requirements Earlier, the reporting requirements for a foreign transaction were scattered and people had to fill too many forms to comply with all reporting requirements. However, realizing the inconvenience that it was causing to both Indian and foreign entities and with a view to increase foreign investment in India, now a uniform system has been introduced for all reporting requirements. The entities are just required to fill out one Single Master Form (SMF). Most of the obligations relating to reporting have been imposed on Authorized Dealer (AD) Banks, through which a foreign investment transaction is usually routed. In case of transfer of capital securities of an Indian entity to a foreign investor, the Form-TRS needs to be filled. The form-CGR signed by the Managing Director or the Secretary of the Company needs to be filled in within 30 days of the www.rcic.in
date of issue of capital instruments. All forms and reporting documents are required to be submitted to the concerned department of the RBI through the AD Bank.
Ricky Chopra International C o u n s e l’s E d g e o v e r Fo r e i g n Investment Practice Since its inception, foreign exchange is one area over which RCIC has always had a stronghold. Therefore, we have a robust team committed specifically to advise our global client base on the nitty-gritties of foreign investment laws. From giving customized advice regarding which strategy of foreign investment would prove most beneficial to the client, to the regulatory filings and compliances, our specialized team for foreign investment is well-equipped to deal with all legs of the transaction. More so, in cases of strategic investors, our team which believes in developing long-term relations, also helps the entities in exiting the foreign investment in India after sufficient profits have been earned.
Conclusion Foreign investment is arguably one of the most dynamic commercial laws and therefore, it is very important to keep track of constant changes in the FDI policy. This is also because the executive authorities have been conferred with substantial powers by way of delegated legislation to modify foreign investment regime in India. Therefore, even a major overhaul in the policy is brought about by a mere circular of the DPIIT or a notification of the RBI instead of by way of an elaborate parliamentary amendment to the parent statute. This makes it difficult sometimes for practitioners in the field to come across a comprehensively compiled legislation as there are way too many sources to be relied upon. Therefore, both strategic and institutional foreign investors often deem it appropriate to rely on expert legal advice. www.rcic.in
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