FDI rules in India: A need for clarity

China expressed serious displeasure at India at the WTO discussions earlier this month. It is angry with India for putting restrictions on FDI from countries that share a land-border with it, claiming it as discriminatory toward it and violative of the WTO’s principle of non-discrimination.

India has strongly rebutted this; but China remains firm on its stand. China’s pain point is the Government of India’s (GOI) notification that tightened FDI rules to prevent opportunistic takeovers or acquisitions of Indian companies during COVID-19 pandemic. That was done in the wake of People’s Bank of China raising its stake in HDFC. Although, that was a small hike in stake, it was thought of as enough to to cause concern to the Union government, prompting it to come up with these restrictions. The notification doesn’t mention any country and covers all countries sharing land-border with India, but China is furious as this adversely affects its commercial relations with India.

Readers may recall that on April 17, 2020, GoI had issued the Press Note 3 (PN) to amend the FDI policy. Within days of that, the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 were amended and the new policy came into force from April 22, 2020. It provided that an entity of a country, which shares land border with India or is the beneficial owner of an investment in India and is situated in or is a citizen of any such country, can invest in India only with prior approval of GoI.

It has been almost a year now, and, not surprisingly, a constant question has been: What’s happened to investments since this policy change? How has PN been interpreted? It seems GoI hasn’t approved any proposal so far. In fact, additional restrictions have been put on Chinese firms from participating in Indian public procurement bids unless necessary approvals are obtained.

This caused anxiety among FDI investors. Stuck in this situation, particularly with no guidance on what’s meant by beneficial ownership, these investors ran pillar to post to find what is allowed and what is banned under this PN.
Bereft of clarity, investors have been taking refuge in the views taken by their bankers (perhaps RBI has also blessed those views) that handle their FDI remittances. It is clear that FDI made directly by an entity based in a country that shares land border with India is not allowed. But, it is the concept of ‘beneficial ownership’ that is confusing.

By strict interpretation, beneficial ownership (BO) will mean holding of even one share of an overseas entity that invests in an Indian company. But this will be too rigid and will defeat the policy’s intent. A liberal and a reasonable concept of BO provided in RBI’s KYC Directions, 2016, looks more acceptable. Here, the BO is pegged at holding that is upward of 25% of shares or capital or profits of a company or being able to exercise control over the overseas investing entity. Control means the right to appoint majority directors or to control management or policy decisions.

If viewed from this perspective, an overseas entity that is owned to the extent of 25% of shares or above or is controlled by an entity situated in or by a citizen of a country that shares a land-border with India, will be hit by the PN and will thus require GoI’s approval. Conversely, no approval of GoI will be required, if the BO is not so held.

In the context of control, a critical issue that arises is whether a portfolio manager (PM) or general partner (GP) of a PE fund will be said to be controlling that fund, such that if its PM or GP is a citizen of these restricted countries, then that PE fund will also get hit by PN. Control means controlling management or policy decisions. Any investment decision taken by PM or GM regarding PE fund’s investee companies or how the PE fund should vote on resolutions of its investee companies are decisions taken by the PM in the role of a PM (just like a CEO takes decisions); that does not mean that PM is controlling the management or policy decisions in the manner contemplated in the
definition of control. PM’s role is administrative and not of someone controlling management or policy decisions. So, in such situations, the PE fund should be allowed to invest in Indian companies.

Partner, J Sagar Associates. Views are personal