(In the following post, Abhishek Tripathi, an independent legal practitioner, and Mani Gupta, an Associate at Luthra & Luthra examine some complexities in the regulations pertaining to FDI in trusts)
The recently notified Consolidated FDI Policy of the Government of India (“FDI Policy”), in para 3.3.3, prescribes that ‘FDI in Trusts other than VCF is not permitted.’ This is an insertion that was hitherto non-existent in the various press notes of the Government of India governing foreign direct investment (“FDI”). This assertion of (presumably) an existing prohibition raises some fundamental questions on the legal and regulatory treatment of various forms of contributions in trusts.
FDI has been defined in para 2.1.12 to mean an ‘investment by non-resident entity/person resident outside India in the capital of an Indian company under Schedule I of FEM (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000’. Therefore, the definition of FDI in the FDI Policy itself contemplates investments in companies alone, and not in trusts, societies or other similar entities.
Interestingly, the definition of ‘security’ under the Foreign Exchange Management Act, 1999 (“FEMA”) has merely incorporated mutual fund units or units of UTI as securities. Units of any other trusts should not fall within the meaning of ‘security’ under FEMA. ‘Units of a trust’ simpliciter do not find mention in the definition of ‘security’ under FEMA. The definition is worded in the most exhaustive manner. It is reproduced below for the ease of reference:
“‘Security’ means shares, stocks, bonds and debentures, Government securities as defined in the Public Debt Act, 1944 (18 of 1944), saving certificates to which the Government Savings Certificates Act, 1959 (46 of 1959) applies, deposit receipts in respect of deposit of securities and units of Unit Trust of India established under sub-section (1) of section 3 of the Unit Trust of India Act, 1963 (52 of 1963) or of any mutual fund and includes certificates of title to the securities, but does not include bills of exchange or promissory notes other than Government promissory notes or any other instrument that may be notified by the Reserve Bank as security for this purpose.”
‘Transfer or issue of security by a person resident outside India’ has been deemed as a capital account transaction under FEMA. RBI has issued the FEM (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000, which regulates the transfer and issuance of securities to persons resident outside India. The only reference to units of trust in the said regulations can be found in the form of permission to Foreign Venture Capital Institutions to purchase units of a venture capital fund. Issuance of units of a trust to persons resident outside India per se has not been regulated or prohibited, and rightly so, as such units are not security.
It will be open to debate if transfer or issuance of units of a trust, if not a security, can be construed as a capital account transaction. After all, units issued by a trust are moveable properties. Transfer of all forms of moveable properties (other than those mentioned in Section 6 of FEMA, such as securities and foreign securities) is considered as a current account transaction. Unless prohibited, current account transactions are considered permitted. Therefore, it is plausible to argue that under FEMA issuance of units of a trust to persons resident outside India many not have required prior approval of the Reserve Bank of India (“RBI”), or the Foreign Investment Promotion Board (“FIPB”).
It is important to recognize, however, that distribution of economic units by trusts by way of sale of units may attract the regulatory supervision of SEBI, and through SEBI’s regulations, foreign investment in such units may be regulated/ prohibited. Alternatively, as stipulated in the definition of ‘security’ itself, it is open to RBI to notify units of a trust, as a security under FEMA.
If the view that subscription to units of trust is not a capital account transaction is accepted, transactions in such units can be regulated by the Central Government (in consultation with the RBI). The Foreign Exchange Management (Current Account Transaction) Rules, 2000 does not prescribe prohibitions on the amount of inward remittance that can come in for the purposes of a current account transaction. Challenges, however, may arise if the non-resident intends to sell the economic interest in the trust, if tradable, to another trust, or if the trust is to distribute the benefits to the non-resident and it needs to make a remittance outside India. While, this specific category has not been regulated under the Current Account Transaction Rules, it is likely that the authorized dealers may not permit any remittance under the automatic route on that account.
It can be argued that by exercising its executive powers under the Constitution of India, the Government is well within its rights to regulate investment in India through trusts. The prohibition under the FDI Policy can possibly be justified on that count. Though, if a person resident outside India brings in FDI (whatever the regulator may mean it to be) in a trust, its consequences are unclear. Penal consequences under FEMA should not apply, considering that the prohibition does not flow from FEMA or rules and regulations made thereunder.
Further, the FDI Policy itself is unclear about what may constitute as FDI in Trusts. Trusts receive contributions in various forms and at various stages. Some of the contributions may not result in any economic interest or gain in the hands of the contributor. At the stage of formation of the trust, the settlor conveys certain property to the trustee(s) to be kept in trust for the beneficiaries. The settlor, unless the trust is revocable at his/her will or he/she is a beneficiary in the trust, may not have any interest in the trust property or its proceeds, after the trust has been created. A trust may receive subsequent contributions as well in the form of gifts and charitable donations. There is a regulatory regime under Foreign Contribution Regulation Act, 1976 (“FCRA”) that regulates receipt of charitable contributions by public charitable trusts. FDI regime that seeks to regulate proprietary investment in India, for acquisition of an asset, should not regulate non-proprietary investments, which is anyway regulated under FCRA.
That leaves only the investments by non-resident into trusts for acquisition of an economic interest in the trust property or its proceeds. That may have been the intended target of the prohibition. However, it may be useful if the matter is clarified. In addition, it may be worthwhile for the RBI to notify acquisition of instruments representing interests in a trust property to be securities under FEMA to remove the ambiguity on this issue.
– Abhishek Tripathi & Mani Gupta