FDI & its compliances- Law at glance

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  1. Overview

FDI is abbreviated for Foreign Direct Investment. As name depicts it means inflow of funds in India from outside India. Because it’s purpose is investment in equity/securities compulsorily convertible in equity, it is a capital account transaction as per section 2(e) of FEMA, 1999. FDI is foreign source of funds. 

  1. Definition

The term FDI is not defined in Foreign Exchange Management Act, 1999. But it is defined in Rule 2(r) of The FEM (NDI) Rules, 2019 which is made pursuant to section 46 of FEMA. In aforesaid rule FDI is defined as “FDI means investment through equity instruments by a person resident outside India in an unlisted Indian company; or in 10% or more of the post issue paid –up equity capital on a fully diluted basis of a listed Indian company”.

  1. Laws applicable

The Foreign Exchange Management Law is a wider term. It consist of Act, Rules, Regulations & Master circulars. Central Legislature had provided law in the form of Act (FEMA, 1999) which is the base and central government and RBI is authorised further to regulate and manage the transaction and make necessary law regarding the same. Hence various Rules and Regulations are made by Central Government and RBI respectively.  There is plethora of law governing the FDI transactions. Following law will be applicable on the entity raising FDI:

  1. The FEMA, 1999
  2. The FEM (NDI) Rules, 2019
  3. The FEM (Permissible Capital Account Transactions) Regulations, 2000
  4. The FEM (Manner of Receipt & Payment) Regulations, 2016
  5. The FEM (Mode of payment & Reporting of NDI) Regulations, 2019
  6. FDI Policy issued by DPIIT
  1. Available routes

Route means the way through which FDI can be raised. There are two types of routes/way available to raise FDI. One is automatic route and other is approval route.

Automatic Route: When there is no requirement to obtain prior approval of government/RBI for raising FDI then it is called FDI raised through automatic route.

Government Route: when there is a requirement to obtain prior approval of government/RBI for raising FDI then it is called approval route.  Following FDIs are encompassed in this route:

  1. FDI from Pakistan and Bangladesh and other countries which shares land border with India.
  2. Aggregate foreign portfolio investment up to 45% of Paid up share capital on a fully diluted basis or sectoral cap, whichever is lower, shall not require approval. Provided that there shall not be transfer of ownership or control to a PROI. In remaining case approval required.
  • 11 Sector/activity like mining, defence, print media, civil aviation etc. as mentioned in schedule –I of The FEM (NDI) Rules, 2019.
  1. Restrictions in raising FDI

Law states various conditions which have to be complied. Here restriction means those conditions. Like sectoral cap, prohibited sectors etc. For better understanding these restrictions can be classified as (i) Country specific (ii) Sector specific (iii) Entity specific (iv) Transaction specific restrictions.

(i) Country specific restrictions: – FDI from the person or entity situated in a country which shares land border with India required government approval. (Proviso 1 of Rule 6(a) of FEM (NDI) Rules, 2019.

(ii) Sector specific restrictions: – It can be further classified into 3 types.

(A) Prohibited Sectors: – FDI in following sectors is prohibited.

  • Lottery Business including Government/private lottery, online lotteries, etc.
  • Gambling and Betting including casinos etc.
  • Chit funds
  • Nidhi company
  • Trading in Transferable Development Rights (TDRs)
  • Real Estate Business or Construction of Farm Houses

‘Real estate business’ shall not include development of townships, construction of residential /commercial premises, roads or bridges and Real Estate Investment Trusts (REITs) registered and regulated under the SEBI (REITs) Regulations 2014.

  • Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes
  • Activities/sectors not open to private sector investment e.g.(I) Atomic Energy and (II) Railway operations (other than permitted activities mentioned in para 5.2).
  • Foreign technology collaboration in any form including licensing for franchise, trademark, brand name, management contract is also prohibited for Lottery Business, Gambling and Betting activities.

(B) Sectors having conditional permission: – Certain sectors have maximum sectoral cap and entry route conditions. Those sectors are enumerated in a table stated in Schedule 1 of The FEM (NDI) Rules, 2019.

(C) Open ended sectors: – Sectors which are neither mentioned in the list of prohibited sectors not enumerated in table stated in Schedule 1 of The FEM (NDI) Rules, 2019, are allowed up to 100% FDI through automatic route.

(iii) Entity Specific restrictions: – These are called entity specific conditions because there are special norms for some kinds of entity like eligibility of entity which can raise / invest in FDI. For better understanding we can divide these conditions in two parts i.e. conditions applicable on investee entity and conditions applicable on investor entity.

A. Conditions applicable on investee entity: –

a) Eligible investee entity: –

S. No.

Entity

Law

1

Indian Company

Indian company registered as per Companies Act, 2013 or earlier is eligible to raise FDI subject to sector cap, route and pricing guidelines.

2

Partnership/Proprietary firm

Only NRI can invest in the capital on only on non-repatriation basis subject to sector cap, route, pricing guidelines. Prior government approval is required if FDI is given by other than NRI or by NRI on repatriation basis. FEM (Investment in Firm or Proprietary concern in India) Regulations, 2000 shall be applicable.

3

Trusts

Investment by a person resident outside India is not permitted in Trusts other than in ‘VCF’ registered and regulated by SEBI and ‘Investment vehicle’

4

LLP

Schedule VI of FEM (NDI) Rules, 2019 states provision regarding this. Foreign Investment is permitted under the automatic route in Limited Liability Partnership (LLPs) operating in sectors/activities where 100% FDI is allowed through the automatic route and there are no FDI-linked performance conditions.

5

Investment Vehicle

An entity being ‘investment vehicle’ registered and regulated under relevant regulations framed by SEBI or any other authority designated for the purpose including Real Estate Investment Trusts (REITs) governed by the SEBI (REITs) Regulations, 2014, Infrastructure Investment Trusts (InvIts) governed by the SEBI (InvIts) Regulations, 2014, Alternative Investment Funds (AIFs) governed by the SEBI (AIFs) Regulations, 2012 is permitted to receive foreign investment from a person resident outside India (other than an individual who is citizen of or any other entity which is registered / incorporated in Pakistan or Bangladesh) in the manner and subject to the terms and conditions specified under Schedule VIII of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019.

6

Start-up companies

Start-ups can issue equity or equity linked instruments or debt instruments to FVCI against receipt of foreign remittance, as per the Schedule VII of Foreign Exchange Management (Non-Debt Instruments) Rules, 2019. In addition, start-ups can issue convertible notes to person resident outside India subject to the Rule 18 of FEM (NDI) Rules, 2019.

7

Other entities

FDI in resident entities other than those mentioned above is not permitted.

b) Other conditions: –

  • If entity engaged in sectors as mentioned in clause 6 (ii) (A) & (B) then entity has to comply with respective sector specific conditions.
  • Pricing norms as mentioned in Rule 21 of FEM (NDI) Rules, 2019 shall be adhered mandatorily.
  • Following instruments can be issued in consideration of FDI
  • Equity Shares
  • Fully, compulsorily and mandatorily convertible preference shares
  • Fully, compulsorily and mandatorily convertible debentures
  • Depository Receipt subject to compliance with DR Scheme, 2014
  • FCCB subject to compliance with FCCB & Ordinary Shares (Through DR Mechanism) Scheme, 1993

B. Conditions applicable on investor entity: –

S. No.

Investor

Law

1

PROI

Generally all PROI are eligible to invest through FDI subject to FEM (NDI) Rule, 2019 in automatic route except person/entity resident/controlled by a person of country which share land border with India.

2

OCI/NRI

Rule 12 + Schedule 3 & 4 of FEM (NDI) Rules, 2019

3

FVCI

Rule 16 + Schedule 7 of FEM (NDI) Rules, 2019

4

FPI

Rule 10 + Schedule 2 of FEM (NDI) Rules, 2019

 

.

iv. Transaction Specific restrictions

Transactions

Law

Right /bonus Issue

Rule 7 & 7A of FEM (NDI) Rules, 2019

ESOP/Sweat equity shares

Rule 8 of FEM (NDI) Rules, 2019

6. Reporting requirements

Whenever Indian entity is raising FDI then it has responsibility to comply with statutory reporting requirements. For this purpose RBI promulgated The FEM (Mode of payment & Reporting of NDI) Regulations, 2019. As per these regulations following compliances are required.

S. No.

Regulation no.

Form

Compliance

1

3.1 (I) (A) (2)

SH-1

Equity instruments shall be issued to PROI within 60 days of receipt of consideration.

2

4 (1)

FC-GPR

Shall be filed by Indian entity with RBI through AD-Bank within 30 days of allotment of equity instruments.

3

4 (2)

FLA

Indian company or LLP which received FDI shall file this return with RBI annually on or before 15th day of July of each year.

4

4 (4)

ESOP

Indian company issuing ESOP as per NDI rules shall file this form within 30 days of issue of ESOP.

5

4 (6)

LLP (I)

A LLP received FDI as capital contribution shall file this form within 30 days of receipt of FDI.

6

4 (7)

LLP (II)

The Disinvestment/transfer of capital contribution or profit share between a resident and a non-resident (or vice-versa) shall be filed in this form within 60 days from the date of receipt of funds. The Onus of reporting is on resident transferor/transferee.

7

4 (8)

LEC(FII)

The AD-bank shall report to RBI in this form the purchase/transfer of equity instruments by FPIs on the stock exchanges in India.

8

4 (9)

LEC(NRI)

The AD-bank shall report to RBI in this form the purchase/transfer of equity instruments by NRI or OCI on the stock exchanges in India.

9

4 (10)

InVI

An investment vehicle which has issued its units to a person resident outside India shall file this form within 30 days of issue of units.

10

4 (11)

DI

An Indian entity, making downstream investment in another Indian entity which is considered as indirect foreign investment for investee Indian entity, shall file this form with RBI within 30 days of allotment of instruments.

Note: – An intimation is required to be filed by the same Indian entity as above on FIFP portal also regarding downstream investment.

11

4 (12)

CN

The Indian Start-up company issuing Convertible Notes to a PROI shall file this form within 30 days of such issue.

Note: All aforesaid forms other than LEC (FII) & LEC (NRI) shall be filed through single master form (SMF) facility of firms portal.

For more details regarding filing of forms read other article “Procedure of filing of FC-GPR”.