By Ashraya Rao and Aayush Misra
Overseas direct investments (ODI) have gathered considerable momentum over the last decade as Indian investors are increasingly looking overseas to diversify their business, gain access to new markets, procure intellectual property and undertake research and development.
However, it is not easy to navigate the ODI regulatory regime from an investor’s perspective. Overseas investments by an Indian party are heavily regulated by the Foreign Exchange Management Act, 1999 and numerous rules and regulations issued thereunder (collectively, the ODI Regulations).
Given the complex (and, often overlapping) regulatory regime, it has become imperative for investors to seek appropriate advice on their investment. This list seeks to cover few practical considerations that are relevant from an investor’s perspective.
Understand what constitutes overseas direct investment
In simple terms, ODI constitutes investments either under the automatic route or approval route, by way of subscription to new shares or purchase of existing shares or other financial commitment such as guarantee, signifying a long-term interest in the foreign entity. Such a foreign entity can either be a joint venture (JV) or a wholly owned subsidiary (WOS).
ODI can be made by (a) an Indian party (i.e. body corporate, partnership firm, or limited liability partnership); or (b) a resident individual.
Significantly, an Indian party is generally permitted to make overseas investments up to USD 1 billion or 400% of its net-worth (being the financial commitment limit (FC Limit)). By contrast, individuals can make offshore investments up to USD 250,000 annually under the liberalised remittance scheme (LRS). Investments above these thresholds require a specific approval from the Reserve Bank of India (RBI).
Consider the issues relating to the conversion of existing loans provided into shares
Loans given to a JV or WOS can be converted into equity or compulsorily convertible preferred stock under the automatic route.
However, the ODI Regulations do not provide guidance on the valuation methodology or if fair market value should be adopted for determining the number of resultant shares. While this could suggest that the parties are free to determine the valuation methodology and the fair market value, it is preferable to exercise caution.
ODI by means of swap of shares of Indian companies
The ODI Regulations recognize the swap of shares (i.e. the acquisition of the shares of the overseas entity by way of exchange of the shares of the Indian party) as a permissible source for funding overseas investment.
However, due to inconsistency between the ODI Regulations and regulations governing foreign investment in India, swap transactions for transfer (and issuance of non-capital instruments) remain a challenge.
Application of financial caps to indemnities
An indemnity provided on behalf of its JV, WOS or SDS should not expressly be considered as a financial commitment by the Indian party. However, in practice, RBI doesn’t distinguish between a performance guarantee (a recognized type of financial commitment) and indemnities and may consider the latter provided on behalf of the JV, WOS or SDS as a financial commitment by the Indian party, which is subject to the FC Limit.
Accordingly, Indian parties that are contemplating giving indemnities or those who have already given an indemnity must ensure that the FC Limits will not be breached in a possible pay-out and relevant filings are duly undertaken.
Challenges in implementing deferment of consideration
Investors prefer a deferred consideration mechanism to pay the acquisition cost over multiple tranches, normally upon the satisfaction of identified events to de-risk their investment.
The ODI regime is unusually silent on this point and since transfer of securities is a capital account transaction, it is recommended that the Indian party obtain RBI’s approval before implementing any such mechanism or consider alternate structures.
Know the restrictions and exemptions available to individual investments
The limit on resident individuals also applies for the value of shares acquired (i) in part or full consideration of the professional services rendered to the foreign entity; (ii) in lieu of director’s remuneration; or (iii) as qualification shares for holding the post of a director.
However, there is no limit on the value of shares that can be acquired: (i) by an individual employed by an Indian branch office or subsidiary of a foreign entity pursuant to a global employee stock option scheme offered by the foreign entity; or (ii) pursuant to a rights issue conducted by the foreign entity. While externalization has been successfully implemented in the past, the various challenges involved to make it effective should be duly considered by new investors.
Check if your investment will qualify as a portfolio investment
The ODI Regulations do not explain what constitutes a portfolio investment. In general parlance, portfolio investment is widely understood as a treasury or financial investment (irrespective of the quantum) which does not come with any management rights. Subject to this, while it is arguable that an Indian party can invest overseas without being subject to the applicable ODI provisions, it is not clear if the RBI will accept this interpretation.
Ashraya Rao is an Associate Partner and Aayush Misra is a Principal Associate at law firm Khaitan & Co. Views expressed in this article are the personal views of the authors.