Hits and Misses in RBI’s 2021 Foreign Investment Draft Rules

The Draft Rules/Regulations of the Reserve Bank of Indias (RBI), 2021 on Foreign Investment and Non-Debt Instruments, Foreign Investment has an interesting impact on business standards.

Financial obligation

The condition for incurring financial obligations on behalf of a foreign entity is that the Indian entity has made equity investments and has also acquired control in such foreign entities. This can pose problems in cross-border transactions, as certain circumstances in the context of an M&A/joint venture transaction can lead to stakeholders agreeing to provide financial support and commitment to the business. For example, for an Indian stakeholder who has a significant stake in the company but does not control it, the inability to make a financial commitment could be a cause for concern.

To calculate the limit of the financial liability, the considerations are: investment in the equity capital of the foreign entity; loans or investments in debt instruments issued by the foreign entity on an arm’s length basis; and guarantee obligations, including corporate guarantee/performance guarantee/personal guarantees and bank guarantees, as well as pledge or write-off of the assets of the Indian entities. With regard to guarantees, it is clarified that personal guarantees count towards the financial commitment of the Indian entities; and when a guarantee is called, to that extent, it is considered a loan and not a non-cash commitment.

ODI and OPI defined

Overseas Direct Investment (ODI) is defined as the acquisition of shares in an unlisted foreign entity, or registration in the deed of incorporation of a foreign entity, or investment in 10% or more of the paid-up equity capital of a listed foreign entity, or where the Indian investor has or acquires, directly or indirectly, control of the foreign entity.

Overseas Portfolio Investment (OPI) means investment, other than ODI, in foreign securities, including units of exchange traded funds and depositary receipts listed on a recognized stock exchange outside India, but not in securities issued by a person who resides in India (outside an IFSC).

While ODI counts towards financial commitment, OPI is not counted.

An Indian resident may make or hold foreign investments through the acquisition of sweat equity shares, qualifying shares or shares/interests under an ESOP, and such acquisition will be treated as OPI if the shares/interests acquired by such person do not exceed than 10% of the foreign entities are paid-up capital/shares.

Foreign Investment Pricing Standards

Any issue or transfer of foreign equity from (i) a person resident outside India to a person resident in India, or (ii) a person resident in India to another person resident in India, or (iii) a person residing in India to a person residing outside India is subject to pricing standards. For listed foreign securities, the price must be in accordance with the relevant exchanges of the host country. In the case of unlisted foreign securities, the price must be within the range of 5% of the fair value achieved on an arm’s length basis, according to any internationally accepted pricing method. The valuation must be certified by a registered valuer under the Companies Act 2013 or a valuer registered with the regulatory authority in the host jurisdiction to the satisfaction of the AD (Authorized Dealer) bank, and the certificate must not be older than six months prior to the transaction date.

Bona fide and non-tax avoidance/evasion test

The draft regulations stipulate that any investment made by a person residing in India must be made in a foreign entity engaged in a bona fide business activity, either directly or through a retiring subsidiary. Bona fide business activity is defined as any business activity permitted by law both in India and in the host jurisdiction.

It also specifies that a financial commitment by Indian residents in a foreign entity that has invested or invests in India that is designed for tax evasion/tax avoidance at the time of entering into such financial commitment, or at any time thereafter, whether direct or indirect, is not permitted, and any violation under this rule will be considered a serious violation.

A combined reading would confirm that if the investment is bona fide and not intended for tax evasion/tax avoidance, there will be no overarching concerns.

Gifts

A resident of India can acquire unrestricted foreign investment through an inheritance from a person residing in India or a person residing outside India. However, such gift from a person residing outside of India is only permitted if the said person is a relative as defined and subject to the limit set by the RBI.

The road ahead of us

The proposals in the regulatory framework indicate that RBIs intend to promote the ease of doing business. Once finalized and notified, these regulations should help all stakeholders structure their investments and related matters with greater clarity and certainty.

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