By Vaibhav Gupta & Venkatraman Iyer
The Centre recently announced the draft Overseas Investment Regulations and Non-Debt Instruments-Overseas Investment Rules (New Rules). The New Rules will be finalised after public consultations (open till August 23). These will replace current regulations on acquisition/transfer by Indian corporate or individuals, of foreign securities (in force since 2004) and immovable property (revised rules in place since 2016). Thus, the New Rules would provide much-needed clarity on round-tripping, meaning of the term portfolio investments, etc.
At present, the exchange control regulations impose restrictions on full capital account convertibility, i.e., there are restrictions on both inbound and outbound capital flows. As an example, the current exchange control regulations only permit non-debt instruments such as equity and quasi-equity instruments that are fully and mandatorily convertible into equity. With respect to debt instruments, there are various restrictions imposed such as minimum maturity, end-use restrictions, etc. Thus, founders of new-age businesses are often constrained in their fund-raising efforts. Further, it is believed that such new-age businesses can get better valuations abroad due to access to specialised set of investors with deeper understanding of the digital business models. Also, the rapid internationalisation of Indian businesses has led to setting up of holding companies outside India for owning the various constituents of the business. We have also seen many Indian businesses list abroad on the overseas stock exchanges and the SPAC listings in the US have also led to heightened interest in the space. Under current regulations, there are restrictions on Indian residents setting up holding companies outside India for the purpose of owning the Indian businesses. While RBI has granted approvals for such round-trip structures in the past, such approvals have been on a selective basis and that too with restrictive conditions on future investments and repatriation of incomes back to India, etc.
The New Rules now permit both structural and fund round-tripping, so long as the structures are not designed for tax avoidance/evasion. The reluctance of the regulators to permit a round-trip structure in the past was because the tax authorities feared such structures avoided taxes (perhaps why the caveat on tax avoidance/evasion has been introduced).
However, further clarification on what constitutes tax avoidance/evasion and who will determine the same is needed. Would this be the tax authorities, or would it be RBI itself? Would RBI act once the tax authorities determine there is tax avoidance/evasion, and if so, at what stage of the process? Clarity on what tax avoidance/evasion means would be greatly desirable and would surely be a point on which multiple representations are likely. A liberal approach by RBI signals proactiveness as Indian businesses diversify for their global ambitions.
The New Rules define for the first time the term overseas portfolio investment (OPI) as investments, other than an overseas direct investment (ODI), in foreign securities which are listed. Further, ODI is defined to mean investment by way of acquisition of equity capital of an unlisted foreign entity, or subscription to the Memorandum of Association of a foreign entity, or investment in 10% or more of the paid-up equity capital of a listed foreign entity, or where control (directly or indirectly) is acquired in the foreign entity.
Thus, under the New Rules, investments in unlisted foreign entities (irrespective of the percentage of holding) are now classified as ODI. Hence, even a small holding in a large unlisted foreign company will now be treated as ODI, triggering compliance with the ODI regulatory framework. The change is likely to have a big impact on individuals investments under the LRS scheme considering such small shareholdings in unlisted foreign companies as portfolio investments. It appears that, henceforth, angel investments by individuals in unlisted companies abroad shall be made only under the ODI route. If this were to be the intent, it would certainly not be regarded as a liberalisation of existing norms. It will thus be important to clarify whether investments under LRS shall be outside the New Rules, since the ODI regulations for individuals have several restrictive covenants around setting up of downstream subsidiaries etc—matters over which the individual may have no control.
Another aspect of relevance is the remittance for the purpose of ESOPs of a foreign company by the resident employees of the Indian subsidiary. The New Rules allow such remittance, subject to the overall monetary limits under the LRS scheme. This is again a far-reaching amendment when Indian businesses are increasingly going global.
Clearly, the new regulations seek to remove bottlenecks in the way of Indian businesses’ overseas expansion and investment ambitions and are a step in the right direction. Clarity on some of the aspects may help in providing certainty in business decision-making.
The authors are Respectively, partner, and principal, Dhruva Advisors LLP
Views are personal