Companies are in urgent need of funds and given the same, necessary clarifications by the governments on bonafide concerns of foreign investors may prove to be a healing balm.
- Atul Pandey
The government of India’s plans to screen foreign direct investments from countries sharing a land border were formalised on 22 April 2020, when the Ministry of Finance notified the Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2020 (FEMA Amendment). Given the enormous amounts of investments pumped in by Chinese investors into Indian companies in the recent past, this move has caused enormous consternation amongst the Chinese investor community at large, even causing the Chinese government to issue a strongly worded rejoinder. While the stated intention behind these curbs has been to curb opportunistic takeovers/acquisitions of Indian companies due to the COVID pandemic, given the current level of Chinese investments in the country, the ambiguous drafting of the FEMA Amendment has given rise to more questions than answers.
A mere perusal of the FDI statistics from China reveals the gravity of the issue- government data reveals that India received FDI worth $ 2,342.03 million between April 2000 and December 2019. Chinese investors have invested amounts approximating USD 4 billion in Indian start ups and a majority of the unicorns in India have considerable Chinese-funding, with Alibaba and Tencent leading the way. These numbers further do not take into account, Chinese investments routed through tax friendly jurisdictions like Mauritius and Cayman Islands. Chinese investments also lead the way in consumer electronics and are slowly expanding into other sectors like automobiles. The FEMA Notification has now placed any such future Chinese investments in a state of limbo, and caused major ripples in the investor community, who till now, have been extremely bullish on their India outlook.
While Government sources have repeatedly indicated that the decision to screen investments from China was not a spur of the moment decision but was after due deliberations with all stakeholders, however, the language of the FEMA Amendment at present belies the stated intention of the government and certain critical ambiguities may stonewall genuine investors.
- The FEMA Amendment makes it clear that foreign direct investments (FDI) either by way of fresh investment by Chinese entities or transfer of shareholding by existing shareholders (including existing Chinese investors) to Chinese shareholders or to entities whose beneficial holding may be held by entities based in China) will now be screened. This effectively excludes investments by Foreign portfolio investment (FPI)/ Foreign Venture Capital Investor (FVCI) from the ambit of FEMA Amendment.
Considering that the stated intention has been to prevent opportunistic takeovers, screening future rounds of funding or acquisitions by Chinese investors in companies with existing Chinese investments should have been excluded. Additionally, while investment in any units of an investment vehicle including Alternate Investment Funds (AIF) are not covered under the FEMA Amendment, it is not clear if any AIF having Chinese investments can make downstream investments in India (subject to such AIF having an investment manager which is Indian owned and controlled).
- Ambit of ‘Beneficial Ownership’: In terms of FEMA Notification, prior government approval will be required for any FDI wherein the ultimate beneficiary is a Chinese entity. However, the FEMA Notification does not describe into mode of determination of ‘beneficial ownership’, While reference may be made to the definition of beneficial interest as set out in the Companies Act 2013 or the Prevention of Money-Laundering Act 2002 (the thresholds under the Prevention of Money-Laundering Act 2002 have been earlier applied by the RBI for KYC purposes), a precise definition of further beneficial ownership will be critical, considering that investors often have complicated layers of structures spread across multiple jurisdictions.
The question of beneficial ownership becomes more complex in case of Chinese limited partners (LPs) and general partners (GPs), participating in investment vehicles which have Indian investments. A literal reading of the FEMA Amendment would cover all funds that have Chinese LPs and at this moment, it is unclear as to whether Chinese LPs having no significant control should also be covered.
- Investments from Hong Kong: Hong Kong is a Special Administrative Region of China, effectively enjoying a high degree of autonomy from the central government under the “One Country Two Systems” principle. The FEMA Notification covers investments from such countries which share a land border with India. While the FEMA notification does not clarify whether the new curbs will also cover the investments from Hong Kong, which is a special administrative region of China, the Indian government has generally distinguished between Hong Kong and China as two separate jurisdictions in its tax treaties. In addition, Hong Kong is a member of the World Trade Organisation in its own right and participates in the WTO as a separate customs territory whereas China separately became a member of the WTO on 11 December 2001.
Given the popularity of Hong Kong as a major holding company jurisdiction, a clear clarification that Hong Kong is not covered within the ambit of these new curbs may provide substantial relief to investors. In any case, if the beneficial owner of investments from Hong Kong is determined to be Chinese, the curbs under the FEMA Notification will continue to apply.
The introduction of the FEMA Amendment follows similar FDI related curbs introduced by other jurisdictions like European Union, Australia, Germany, Spain and Italy. However, given the Indian governments aggressive outreach in promoting India as an investor friendly nation, such sudden change in foreign investment laws substantially hurts investor confidence in the policies of the government. It is no secret that companies which have been hit hard by the COVID pandemic are in urgent need of funds and given the same, necessary clarifications by the governments on bonafide concerns of foreign investors may prove to be a healing balm.
- Atul Pandey is Partner, Khaitan & Co LLP. Views expressed are the author’s own.