Foreign Direct Investment

Author : V S Warrier

Foreign direct investment (FDI) is direct investment by a company in production located in another country either by buying a company in the country or by expanding operations of an existing business in the country. Foreign direct investment is done for many reasons including to take advantage of cheaper wages in the country, special investment privileges such as tax exemptions offered by the country as an incentive for investment or to gain tariff-free access to the markets of the country or the region. Foreign direct investment is in contrast to portfolio which is a passive investment in the securities of another country such as stocks and bonds.

As a part of the national accounts of a country FDI refers to the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, other long-term capital, and short-term capital as shown the balance of payments. It usually involves participation in management, joint-venture, transfer of technology and expertise. There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow (positive or negative) and “stock of foreign direct investment”, which is the cumulative number for a given period. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movements.
A foreign company planning to set up business operations in India may:
· Incorporate a company under the Companies Act, 1956, as a Joint Venture or a Wholly Owned Subsidiary.
· Set up a Liaison Office / Representative Office or a Project Office or a Branch Office of the foreign company which can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office or Other Place of Business) Regulations, 2000.
An Indian company may receive Foreign Direct Investment under the two routes as given under:
1. Automatic Route
FDI up to 100 per cent is allowed under the automatic route in all activities/sectors except where the provisions of the consolidated FDI Policy, paragraph on ‘Entry Routes for Investment’ issued by the Government of India from time to time, are attracted.
FDI in sectors /activities to the extent permitted under the automatic route does not require any prior approval either of the Government or the Reserve Bank of India.
2. Government Route
FDI in activities not covered under the automatic route requires prior approval of the Government which is considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, and Ministry of Finance. Application can be made in Form FC-IL, which can be downloaded from http://www.dipp.gov.in. Plain paper applications carrying all relevant details are also accepted. No fee is payable.
Indian companies having foreign investment approval through FIPB route do not require any further clearance from the Reserve Bank of India for receiving inward remittance and for the issue of shares to the non-resident investors.
The Indian company having received FDI either under the Automatic route or the Government route is required to report in the Advance Reporting Form, the details of the receipt of the amount of consideration for issue of equity instrument viz. shares / fully and mandatory convertible debentures / fully and mandatory convertible preference shares through an AD Category –I Bank, together with copy/ ies of the FIRC evidencing the receipt of inward remittances along with the Know Your Customer (KYC) report on the non-resident investors from the overseas bank remitting the amount, to the Regional Office concerned of the Reserve Bank of India within 30 days from the date of receipt of inward remittances.
Further, the Indian company is required to issue the equity instrument within 180 days, from the date of receipt of inward remittance or debit to NRE/FCNR (B) account in case of NRI/ PIO.
After issue of shares / fully and mandatory convertible debentures / fully and mandatory convertible preference shares, the Indian company has to file the required documents along with Form FC-GPR with the Regional Office concerned of the Reserve Bank of India within 30 days of issue of shares to the non-resident investors.
Download the Advance Reporting Form Here
However FDI is prohibited under the Government Route as well as the Automatic Route in the following sectors:
1. Retail Trading (except single brand product retailing)
2. Atomic Energy
3. Lottery Business
4. Gambling and Betting
5. Business of Chit Fund
6. Nidhi Company
7. Agricultural (excluding Floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisciculture and cultivation of vegetables, mushrooms, etc. under controlled conditions and services related to agro and allied sectors) and Plantations activities (other than Tea Plantations) (cf. Notification No. FEMA 94/2003-RB dated June 18, 2003).
8. Housing and Real Estate business (except development of townships, construction of residen­tial/commercial premises, roads or bridges to the extent specified in Notification No. FEMA 136/2005-RB dated July 19, 2005).
9. Trading in Transferable Development Rights (TDRs).
10. Manufacture of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes.
After investment is made under the Automatic Route or with Government approval a two-stage reporting procedure has to be followed :.
· On receipt of share application money :
1. Within 30 days of receipt of share application money/amount of consideration from the non-resident investor, the Indian company is required to report to the Regional Office concerned of the Reserve Bank of India, under whose jurisdiction its Registered Office is located, the Advance Reporting Form, containing the following details :
2. Name and address of the foreign investor/s;
3. Date of receipt of funds and the Rupee equivalent;
4. Name and address of the authorized dealer through whom the funds have been received;
5. Details of the Government approval, if any; and
6. KYC report on the non-resident investor from the overseas bank remitting the amount of consideration.
· Upon issue of shares to non-resident investors:
Within 30 days from the date of issue of shares, a report in Form FC-GPR- PART A together with the following documents should be filed with the Regional Office concerned of the Reserve Bank of India.
· Certificate from the Company Secretary of the company accepting investment from person’s resident outside India certifying that:
The company has complied with the procedure for issue of shares as laid down under the FDI scheme as indicated in the Notification No. FEMA 20/2000-RB dated 3rd May 2000, as amended from time to time.
The investment is within the sectoral cap / statutory ceiling permissible under the Automatic Route of the Reserve Bank and it fulfills all the conditions laid down for investments under the Automatic Route, namely-
a) Non-resident entity/ies – (other than individuals), to whom it has issued shares have existing joint venture or technology transfer or trade mark agreement in India in the same field and Conditions stipulated at Paragraph 4.2 of the Consolidated FDI policy Circular of Government of India have been complied with.
OR
Non-resident entity/ ies – (other than individuals), to whom it has issued shares do not have any existing joint venture or technology transfer or trade mark agreement in India in the same field.
Note – For the purpose of the ‘same’ field, 4 digit NIC 1987 code would be relevant.
b) The company is not an Industrial Undertaking manufacturing items reserved for small sector.
OR
The company is an Industrial Undertaking manufacturing items reserved for the small sector and the investment limit of 24 per cent of paid-up capital has been observed/ requisite approvals have been obtained.
c) Shares issued on rights basis to non-residents are in conformity with Regulation 6 of the RBI Notification No FEMA 20/2000-RB dated 3rd May 2000, as amended from time to time.
OR
Shares issued are bonus shares.
OR
Shares have been issued under a scheme of merger and amalgamation of two or more Indian companies or reconstruction by way of de-merger or otherwise of an Indian company, duly approved by a court in India.
OR
Shares are issued under ESOP and the conditions regarding this issue have been satisfied.

· Shares have been issued in terms of SIA/FIPB approval No. ——————— dated ——————–
· Certificate from Statutory Auditors/ SEBI registered Category – I Merchant Banker / Chartered Accountant indicating the manner of arriving at the price of the shares issued to the person’s resident outside India.

Following are the guidelines for transfer of existing shares from non-residents to residents or residents to non-residents;
A. Transfer of shares/ fully and mandatory convertible debentures from Non-Resident to Resident:
The term ‘transfer’ is defined under FEMA as including “sale, purchase, acquisition, mortgage, pledge, gift, loan or any other form of transfer of right, possession or lien” {Section 2 (ze) of FEMA, 1999}.
The FEMA Regulations give specific permission covering the following forms of transfer i.e. transfer by way of sale and gift. These permissions are discussed below:
i. Transfer of shares/ fully and mandatory convertible debentures by way of sale:
A person resident outside India can freely transfer shares/ fully and mandatory convertible debenture by way of sale to a person resident in India as under:
· Any person resident outside India (not being a NRI or an erstwhile OCB), can transfer by way of sale the shares/ fully and mandatory convertible debentures to any person resident outside India or an NRI may transfer by way of sale, the shares/ fully and mandatory convertible debentures held by him to another NRI only provided that the person to whom the shares are being transferred has obtained prior permission of the Central Government to acquire the shares if he has previous venture or tie up in India through investment in shares or debentures or a technical collaboration or a trade mark agreement or investment by whatever name called in the same field or allied field in which the Indian company whose shares are being transferred is engaged.
· Any person resident outside India may sell shares/ fully and mandatory convertible debenture acquired in accordance with the FEMA Regulations, on a recognized Stock Exchange in India through a registered broker.
· Any person resident outside India may also sell share or convertible debenture of an Indian company to a resident subject to adherence to pricing guidelines, documentation and reporting requirements as specified from time to time.
· Shares/convertible debentures of Indian companies purchased under Portfolio Investment Scheme by NRIs and erstwhile OCBs cannot be transferred, by way of sale under private arrangement.
ii. Transfer of shares/ fully and mandatory convertible debentures by way of Gift:
A person resident outside India can freely transfer shares/ fully and mandatory convertible debentures by way of gift to a person resident in India as under:
· Any person resident outside India, (not being a NRI or an erstwhile OCB), can transfer by way of gift the shares/ fully and mandatory convertible debentures to any person resident outside India;
· a NRI may transfer by way of gift, the shares/convertible debentures held by him to another NRI only, provided that the person to whom the shares are being transferred has obtained prior permission of the Central Government to acquire the shares if he has previous venture or tie up in India through investment in shares or debentures or a technical collaboration or a trade mark agreement or investment by whatever name called in the same field or allied field in which the Indian company whose shares are being transferred is engaged.
· Any person resident outside India may transfer share/ fully and mandatory convertible debentures to a person resident in India by way of gift.

B. Transfer of shares/ fully and mandatory convertible debentures from Resident to Non-Resident:

i. Transfer of shares/ fully and mandatory convertible debentures by way of sale – General Permission under Regulation 10 of Notification No. FEMA 20/2000-RB dated May 3, 2000
A person resident in India may transfer by way of sale to a person resident outside India any shares/ fully and mandatory convertible debenture of an Indian company whose activities (other than financial service sector activities) fall under the Automatic Route of the FDI Scheme provided the parties concerned comply with the FDI sectoral limits, pricing guidelines, documentation and reporting requirements for such transfers, as may be specified by the Reserve Bank of India, from time to time.

However, the above general permission is not available where:
a) The transfer of shares/ fully and mandatory convertible debentures falls within the provisions of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, as amended from time to time.
b) The transfer of shares/ fully and mandatory convertible debentures is at a price which does not adhere to the pricing guidelines specified by the Reserve Bank of India from time to time.
c) The activity of the Indian investee company falls outside the automatic route and where FIPB approval has been obtained for the said transfer.

A person resident in India who proposes to transfer security by way of gift to a person resident outside India [other than erstwhile OCBs] shall make an application to the Central Office of the Foreign Exchange Department, Reserve Bank of India furnishing the following information, namely:
· Name and address of the transferor and the proposed transferee
· Relationship between the transferor and the proposed transferee
· Reasons for making the gift.
· In case of Government dated securities, treasury bills and bonds, a certificate issued by a Chartered Accountant on the market value of such securities.
· In case of units of domestic mutual funds and units of Money Market Mutual Funds, a certificate from the issuer on the Net Asset Value of such security.
· In case of shares/ fully and mandatory convertible debentures, a certificate from a Chartered Account on the value of such securities according to the guidelines issued by the Securities & Exchange Board of India or the Discount Free Cash Flow Cash (DCF) method with regard to listed companies and unlisted companies, respectively.
· Certificate from the Indian company concerned certifying that the proposed transfer of shares/convertible debentures, by way of gift, from resident to the non-resident shall not breach the applicable sectoral cap/ FDI limit in the company and that the proposed number of shares/convertible debentures to be held by the non-resident transferee shall not exceed 5 per cent of the paid up capital of the company.

The transfer of security by way of gift may be permitted by the Reserve bank provided;
a) The donee is eligible to hold such security under Schedules 1, 4 and 5 to Notification No. FEMA 20/2000-RB dated May 3, 2000, as amended from time to time.
b) The gift does not exceed 5 per cent of the paid up capital of the Indian company/ each series of debentures/ each mutual fund scheme
c) The applicable sectoral cap/ foreign direct investment limit in the Indian company is not breached.
d) The donor and the donee are relatives as defined in section 6 of the Companies Act, 1956.
e) The value of security to be transferred by the donor together with any security transferred to any person residing outside India as gift in the calendar year does not exceed the rupee equivalent of USD 25,000.
f) Such other conditions as considered necessary in public interest by the Reserve Bank.

In case the transfer does not fit into any of the above categories, either the transferor (resident) or the transferee (non-resident) can make an application to the Reserve Bank for permission for the transfer of shares. The application has to be accompanied with the following documents:
· A copy of the FIPB approval (if required).
· Consent letter from transferor and transferee clearly indicating the number of shares, name of the investee company and the price at which the transfer is proposed to be effected.
· The present/post transfer shareholding pattern of the Indian investee company showing the equity participation by residents and non-residents category-wise.
· Copies of the Reserve Bank of India’s approvals/ acknowledged copies of FC-GPR evidencing the existing holdings of the non-residents.
· If the sellers/ transferors are NRIs / OCBs, the copies of the Reserve Bank of India’s approvals evidencing the shares held by them on repatriation / non-repatriation basis.
· Open Offer document filed with the SEBI if the acquisition of shares by non-resident is under SEBI Takeover Regulations.
· Fair Valuation Certificate from the SEBI registered Category-I-Merchant Banker or Chartered Accountant indicating the value of shares as per the following guidelines;
a) Where shares of an Indian company are listed on a recognized stock exchange in India, the price of shares transferred by way of sale shall not be less than the price at which a preferential allotment of shares can be made under the SEBI Guidelines, as applicable, provided that the same is determined for such duration as specified therein, preceding the relevant date, which shall be the date of purchase or sale of shares.
b) Where the shares of an Indian company are not listed on a recognized stock exchange in India, the transfer of shares shall be at a price not less than the fair value to be determined by a SEBI registered Category – I – Merchant Banker or a Chartered Accountant as per the Discounted Free Cash Flow (DCF) method.

In case of transfer of shares between resident and non-resident the transaction should be reported by submission of form FC-TRS to the AD Category – I bank, within 60 days from the date of receipt/remittance of the amount of consideration. The onus of submission of the form FC-TRS within the given timeframe would be on the resident in India, the transferor or transferee, as the case may be.
The sale consideration in respect of the shares purchased by a person resident outside India shall be remitted to India through normal banking channels. In case the buyer is a Foreign Institutional Investor (FII), payment should be made by debit to its Special Non-Resident Rupee Account. In case the buyer is a NRI, the payment may be made by way of debit to his NRE/FCNR (B) accounts. However, if the shares are acquired on non-repatriation basis by NRI, the consideration shall be remitted to India through normal banking channel or paid out of funds held in NRE/FCNR (B)/NRO accounts.

The sale proceeds of shares (net of taxes) sold by a person resident outside India) may be remitted outside India. In case of FII the sale proceeds may be credited to its special Non-Resident Rupee Account. In case of NRI, if the shares sold were held on repatriation basis, the sale proceeds (net of taxes) may be credited to his NRE/FCNR (B) accounts and if the shares sold were held on non repatriation basis, the sale proceeds may be credited to his NRO account subject to payment of taxes. The sale proceeds of shares (net of taxes) sold by an erstwhile OCB may be remitted outside India directly if the shares were held on repatriation basis and if the shares sold were held on non-repatriation basis, the sale proceeds may be credited to its NRO (Current) Account subject to payment of taxes, except in the case of erstwhile OCBs whose accounts have been blocked by Reserve Bank.

All foreign investments are freely repatriable (net of applicable taxes) except in cases where:
a) the foreign investment is in a sector like Construction and Development Projects and Defense wherein the foreign investment is subject to a lock-in-period; and
b) NRIs choose to invest specifically under non-repatriable schemes.

Further, dividends (net of applicable taxes) declared on foreign investments can be remitted freely through an Authorised Dealer bank.

Following are the guidelines on issue and valuation of shares in case of existing companies;
1. The price of shares issued to persons resident outside India under the FDI Scheme shall not be less than :
· the price worked out in accordance with the SEBI guidelines, as applicable, where the shares of the company is listed on any recognized stock exchange in India;
· the fair valuation of shares done by a SEBI registered Category – I Merchant Banker or a Chartered Accountant as per the discounted free cash flow method, where the shares of the company is not listed on any recognized stock exchange in India; and
· The price as applicable to transfer of shares from resident to non-resident as per the pricing guidelines laid down by the Reserve Bank from time to time, where the issue of shares is on preferential allotment.
2. The price of shares transferred from resident to a non-resident and vice versa should be determined as under:

i) Transfer of shares from a resident to a non-resident:
· In case of listed shares, at a price which is not less than the price at which a preferential allotment of shares would be made under SEBI guidelines.
· In case of unlisted shares at a price which is not less than the fair value as per the Discount Free Cash Flow (DCF) Method to be determined by a SEBI registered Category-I- Merchant Banker/Chartered Accountant.

ii) Transfer of shares from a non-resident to a resident – The price should not be more than the minimum price at which the transfer of shares would have been made from a resident to a non-resident.
In any case, the price per share arrived at as per the above method should be certified by a SEBI registered Category-I-Merchant Banker / Chartered Accountant.

Following are the regulations pertaining to issue of ADRs/GDRs by Indian companies
Indian companies can raise foreign currency resources abroad through the issue of ADRs/ GDRs, in accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the Government of India there under from time to time.
A company can issue ADRs / GDRs, if it is eligible to issue shares to persons resident outside India under the FDI Scheme. However, an Indian listed company, which is not eligible to raise funds from the Indian Capital Market including a company which has been restrained from accessing the securities market by the Securities and Exchange Board of India (SEBI) will not be eligible to issue ADRs/GDRs.
Unlisted companies, which have not yet accessed the ADR/GDR route for raising capital in the international market, would require prior or simultaneous listing in the domestic market, while seeking to issue such overseas instruments. Unlisted companies, which have already issued ADRs/GDRs in the international market, have to list in the domestic market on making profit or within three years of such issue of ADRs/GDRs, whichever is earlier.
After the issue of ADRs/GDRs, the company has to file a return in Form DR as indicated in the RBI Notification No. FEMA.20/ 2000-RB dated May 3, 2000, as amended from time to time. The company is also required to file a quarterly return in Form DR- Quarterly as indicated in the RBI Notification ibid.
There are no end-use restrictions on GDR/ADR issue proceeds, except for an express ban on investment in real estate and stock markets.
Erstwhile OCBs which are not eligible to invest in India and entities prohibited buying, selling or deal in securities by SEBI will not be eligible to subscribe to ADRs / GDRs issued by Indian companies.
The pricing of ADR / GDR issues including sponsored ADRs / GDRs should be made at a price determined under the provisions of the Scheme of issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the Government of India and directions issued by the Reserve Bank, from time to time.
Sponsored ADR/GDR: An Indian company may sponsor an issue of ADR/ GDR with an overseas depository against shares, held by its shareholders at a price to be determined by the Lead Manager. The operative guidelines for the same have been issued vide A.P. (DIR Series) Circular No.52 dated November 23, 2002.

Two-way fungibility Scheme: Under the limited Two-way fungibility Scheme, a registered broker in India can purchase shares of an Indian company on behalf of a person resident outside India for the purpose of converting the shares so purchased into ADRs/ GDRs. The operative guidelines for the same have been issued vide A.P. (DIR Series) Circular No.21 dated February 13, 2002. The Scheme provides for purchase and re-conversion of only as many shares into ADRs/ GDRs which are equal to or less than the number of shares emerging on surrender of ADRs/ GDRs which have been actually sold in the market. Thus, it is only a limited two-way fungibility wherein the headroom available for fresh purchase of shares from domestic market is restricted to the number of converted shares sold in the domestic market by non-resident investors. So long the ADRs/ GDRs are quoted at discount to the value of shares in domestic market; an investor will gain by converting the ADRs/ GDRs into underlying shares and selling them in the domestic market. In case of ADRs/ GDRs being quoted at premium, there will be demand for reverse fungibility, i.e. purchase of shares in domestic market for re-conversion into ADRs/ GDRs. The scheme is operationalised through the Custodians of securities and stock brokers under SEBI.

Foreign Currency Convertible Bonds (FCCBs) can be issued by Indian companies in the overseas market in accordance with the Scheme for Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993.
The FCCB being a debt security, the issue needs to conform to the External Commercial Borrowing guidelines, issued by RBI vide Notification No. FEMA 3/2000-RB dated May 3, 2000, as amended from time to time.

A foreign investor can invests in Preference Shares. Foreign investment through preference shares is treated as foreign direct investment. However, the preference shares should be fully and mandatory convertible into equity shares within a specified time to be reckoned as part of share capital under FDI. Investment in other forms of preference shares requires complying with the ECB norms.

A company can issue debentures as part of FDI. Debentures which are fully and mandatory convertible into equity within a specified time would be reckoned as part of equity under the FDI Policy.
An Indian company eligible to issue shares under the FDI policy and subject to pricing guidelines as specified by the Reserve Bank from time to time, may issue shares to a person resident outside India :
i. being a provider of technology / technical know-how, against Royalty / Lump sum fees due for payment; and
ii.Against External Commercial Borrowing (ECB) (other than import dues deemed as ECB or Trade Credit as per RBI Guidelines).

Provided, that the foreign equity in the company, after the conversion of royalty / lump sum fee / ECB into equity, is within the sectoral cap notified, if any.

Following are the other modes of issues of shares for which general permission is available under RBI Notification No. FEMA 20 dated May 3, 2000
· Issue of shares under ESOP by Indian companies to its employees or employees of its joint venture or wholly owned subsidiary abroad who are resident outside India directly or through a Trust up to 5% of the paid up capital of the company.
· Issue and acquisition of shares by non-residents after merger or de-merger or amalgamation of Indian companies.
· Issue shares or preference shares or convertible debentures on rights basis by an Indian company to a person resident outside India.

A foreign investor can invest in shares issued by an unlisted company in India. As per the regulations/guidelines issued by the Reserve Bank of India/Government of India, investment can be made in shares issued by an unlisted Indian company.

No foreigner can set up a partnership/ proprietorship concern in India. Only NRIs/PIOs are allowed to set up partnership/proprietorship concerns in India on non-repatriation basis.

There are no restrictions under FEMA for investment in Rights shares issued at a discount by an Indian company, provided the rights shares so issued are being offered at the same price to residents and non-residents. The offer on right basis to the persons’ resident outside India shall be:
a) In the case of shares of a company listed on a recognized stock exchange in India, at a price as determined by the company; and
b) In the case of shares of a company not listed on a recognized stock exchange in India, at a price which is not less than the price at which the offer on right basis is made to resident shareholders.

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