In order to protect the weakened companies from international corporate raiders, given the falling prices of the COVID-19-hit India Inc, the ministry of commerce and industry issued press note no 3
dated 17 April 2020, making it mandatory for any country which shares a land border with India or where the beneficial owner of an investment into India is situated or is a citizen of any such country, to invest only via the government route
Government approval will also be mandatory for a subsequent transfer of ownership, direct or indirect, in which the beneficial ownership moves from India to an entity:
a. that is of a country that shares land border with India;
b. whose beneficial owner is situated in or is a citizen of any such country.
The mechanism to identify transfer of shares between two persons, both resident outside India, is difficult to be monitored.
The amendment will be effective from the date of Foreign Exchange Management Act (FEMA) notification. With the implementation of the amendments made to the Finance Act, 2015 the Central government has the power to issue rules in relation to non-debt instruments. Rule 6 of FEMA (non-debt instruments) Rules, 2019 (NDI Rules) provides conditions pursuant to which a person resident outside India can invest in India. A necessary amendment to Rule 6 of NDI Rules is awaited, which could be the effective date of the amendment.
The press note mandates government approval even for cases where the beneficial owner of the investment is situated or is the citizen of a country sharing land border with India, even though the term ‘beneficial owner’ has not been explained. Whether the threshold for determining beneficial ownership will be the same as that provided under the know your customer (KYC) guidelines or that provided under Section 90 of Companies Act in relation to significant beneficial interest, is not clear.
Restriction on FDI (& not FPI)
Under NDI Rules, foreign direct investment (FDI) is distinct from foreign portfolio investment (FPI). A person resident outside India may hold foreign investment either as FDI or as FPI in any particular Indian company. 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. FPI means any investment made by a person resident outside India through equity instruments where such investment is less than 10% of the post issue paid-up share capital on a fully diluted basis of a listed Indian company or less than 10% of the paid-up value of each series of equity instrument of a listed Indian company.
In view of aforesaid and the press note, the approval will be required in case of:
a. any investment made in equity instruments of an unlisted company; or
b. investment made in 10% or more of the post-issue paid-up equity capital on a fully diluted basis of a listed Indian company.
Fully diluted basis means taking into account all the possible conversion on account of issuance of warrants, ESOPs, Convertible securities issued by the listed company from time to time.
Investments other than FDI
While the press note expressly restricts investments by way of FDI, given the intent, this should equally apply to downstream investments made by entities that are owned and/ or controlled by entities or persons of a country that shares a land border with India or whose beneficial owner is situated in or is a citizen of any such country.
Downstream investment results in indirect foreign investment. While the press note expressly restricts investments by way of FDI, given the intent, this should equally apply to downstream investments made by entities that are owned and/ or controlled by entities or persons of a country that shares land border with India or whose beneficial owner is situated in or is a citizen of any such country.
As per the fact sheet on foreign direct investment (FDI) released by the department for the promotion of industry and internal trade (DPIIT), updated to December 2019
, none of the countries sharing a land border with India feature in the list of the top-10 investing countries: China (No. 18), Nepal (No. 103), Afghanistan (No. 112) and Bangladesh (No. 142). The investments routed from other countries must not have been captured above.
Across the Globe
European Union (EU)
FDI screening regulation covers foreign direct investments from third countries, i.e. those investments “which establish or maintain lasting and direct links between investors from third countries including state entities, and undertakings carrying out an economic activity in a member state.”
Under the FDI screening regulation, member states may take measures to prevent a foreign investor from acquiring or taking control over a company if such acquisition or control would result in a threat to their security or public order. This includes the situation where such threats are linked to a public health emergency.
As regards investments that do not constitute FDI, i.e., portfolio investments, they may be screened by the member states in compliance with the treaty provisions on free movement of capital. Portfolio investments, which do not confer on the investor effective influence over the management and control of a company, are generally less likely than is FDI, to invite restrictions regarding security or public order. However, where they represent an acquisition of at least qualified shareholding that confers certain rights on the shareholder or connected shareholders under the national company law (e.g., 5%), they might be of relevance in terms of security or public order.
The Foreign Investment Review Board (FIRB) revised the threshold which applies in determining whether particular foreign investments are subject to Australia’s foreign investment framework to $0. By temporarily reducing the foreign investment thresholds, the Australian government will ensure appropriate supervision over all proposed foreign investments during this time. It also issued Foreign Acquisitions and Takeovers Amendment (Threshold Test) Regulations 2020.
To ensure sufficient time to screen applications, the timeline has been extended to six months from the date of payment of the application fee.
FIRB will consider refunding the fee paid in case any applicant wishes to withdraw the application.
While the intent is to align with the global initiative and protect the companies from hostile takeover by predators trying to encash on low valuations, there is a need to plug the gap by taking into account investments by FPI and downstream investment by entities ultimately owned and/or controlled by an entity situated in or by a citizen of a country sharing a land border with India.
(The writer is senior partner with Vinod Kothari & Company)