Indirect investment into Indian operating companies that are the subject matter of sectoral percentage caps on foreign investment has always been a vexed question. For instance, if a foreign company invests directly into an Indian operating company, and also invests in another Indian company that in turn invests into the operating company, how should the investments be treated for the purpose of determining the percentage of foreign investment? The rules in this area have evolved over a period of time, and the policy often varies according to the specific industry sector. For example:
(i) in the telecom sector, the cap of 74% includes both direct and indirect foreign shareholding, where indirect shareholding includes the proportionate foreign component of shareholding in an Indian entity that is holding shares in a telecom company;
(ii) in investing companies in the infrastructure / services sector (except telecom):
“Where there is a prescribed cap for foreign investment, only the direct investment will be considered for the prescribed cap and foreign investment in an investing company will not be set off against this cap provided the foreign direct investment in such investing company does not exceed 49% and the management of the investing company is with the Indian owners.”
(iii) the rules in the insurance sector have additional specifications as they are also governed by regulations of the Insurance Regulatory Development Authority (IRDA).
With a view to “simplify, streamline and rationalize the methodology of calculation of indirect foreign investment across sectors leading to investor friendly, credible and predictable regulations”, the Government of India, through the Cabinet Committee on Economic Affairs, has today approved adoption of new guidelines (see press release).
The salient features of the guidelines are as follows:
Calculation on Total Foreign Investment
The press release states:
“- All investment directly by a non-resident entity into the Indian company would be counted towards foreign investment.
– The foreign investment through the investing Indian company would not be considered for calculation of the indirect foreign investment in case of Indian companies which are ‘owned and controlled’ by resident Indian citizens and Indian companies which are ‘owned and controlled’ ultimately by resident Indian citizens.
– For cases where this condition is not satisfied or if the investing company is owned or controlled by ‘non resident entities’ the entire investment by the investing company into the subject Indian Company would be considered as indirect foreign investment.”
An exception is made for 100% subsidiaries of Indian investing companies as such downstream investments are akin to investment in the investing companies.
Transfer of Ownership from Residents to Non-residents
On this count, the guidelines provide for the following in sectors where there is a cap on foreign investment:
(a) Government/FIPB approval would be required in all cases where an Indian company is being established with foreign investment and is owned or controlled by a non-resident entity; and
(b) Government/FIPB approval would also be required when shares in such Indian companies owned or controlled by Indians are being transferred “as a consequence of transfer of shares to non-resident entities through amalgamation, merger, acquisition, etc.
While a detailed analysis of these guidelines would be necessary, some quick thoughts are as follows:
1. The streamlining of the rules on indirect foreign investments across sectors would help as it creates a uniform regime as opposed to the current position where the rules differ from sector to sector. This may also partially serve to put to rest the issue of ‘downstream investments’ and ‘foreign owned Indian holding companies’ in Press Note 9 of 1999 that has been the subject-matter of great debate among Indian practitioners over the last year or so.
2. The applicability of the new guidelines depends largely on whether the Indian investing company is ‘owned and controlled’ by Indian residents or by non-resident entities. There is no guidance yet on interpretation of the expressions ownership and control. Is it majority ownership or any ownership? Is it de jure control or de facto control? These aspects need to be clearly articulated failing which there could be significant ambiguities in interpretation.
At the risk of nitpicking, some provisions of the guidelines refer to “ownership and control” while others refer to “ownership or control”. Although it appears as a minor issue of semantics, there could be a vast difference in the outcome.
3. Indirect foreign investment seems to require FIPB approval, and cannot be brought in under the automatic route. This applies for both new investments by foreign entities in Indian investing companies as well as acquisitions of existing shares. The only exception is where the investing company is owned and controlled by Indian resident. The larger policy question here is whether this therefore expands the scope of FIPB review or at least maintains status quo. The objective of the new guidelines is to “facilitate greater foreign capital inflows and send a positive signal in the present difficult economic scenario”. But, whether this objective can be achieved with an expansionary approval process remains a key question.