Foreign investment,
entry routes and reporting.

The Foreign Exchange Management Act, 1999 replaced the earlier control-based regime with a management-based one, and it works through delegated legislation rather than through the Act alone. The Foreign Exchange Management (Non-debt Instruments) Rules, 2019 govern investment in equity instruments, and the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 govern how consideration moves and what is reported. The Consolidated FDI Policy issued by the Department for Promotion of Industry and Internal Trade, updated by press notes, states the position sector by sector. Every transaction also runs through an authorised dealer category-I bank, and that bank has to be satisfied before anything moves. In practice that means the bank sets the documentary standard: know-your-customer material on the remitter, the inward remittance advice, the valuation certificate, the corporate authorisations, and the declarations in the reporting form. A transaction that is correct in law and short of one of those documents does not complete on the day it was meant to.

Investment falls under the automatic route, where no prior approval is required and compliance is demonstrated through subsequent reporting, or the government route, where approval must be obtained before the investment is made. A small number of sectors are prohibited altogether. The prohibited list is set out in the Non-debt Instruments Rules, 2019 and the Consolidated FDI Policy, and lottery and gambling businesses, chit funds, nidhi companies and the manufacture of tobacco products are among the activities it covers. Others are permitted subject to caps, to conditions on the activity, or to approval above a threshold, and the conditions attached to a sector can be more restrictive in effect than the cap itself. Where a company carries on more than one activity, the most restrictive position applicable to any of them tends to drive the analysis, so each revenue line is worth checking separately rather than the business as a whole. The sector position is stated in the Consolidated FDI Policy and in the press notes that update it, and a press note can move it between the term sheet and completion. On a transaction that will take months to close, the route is re-checked before the money moves rather than relied on from the opinion given at the start.

The analysis runs against the real activity and revenue mix. The objects clause is drafted to be wide and tells you almost nothing.

A separate requirement applies to investors from countries sharing a land border with India, and to investments where the beneficial owner is situated in or is a citizen of such a country. Press Note 3 of the 2020 series brought these within the government approval route regardless of sector, given effect through the amendment to the Non-debt Instruments Rules, 2019, and beneficial ownership has not been defined for this purpose. The test reaches beneficial ownership rather than only the immediate investor, so the ownership chain above a fund or holding company has to be examined, and it applies to transfers of existing holdings as well as to fresh investment. That makes it a diligence exercise as much as a legal one, since the answer sits in a register or a fund structure somebody else controls. Government route applications are made through the Foreign Investment Facilitation Portal and processed by the administrative ministry concerned, with security clearance where required. The ownership chain has to be documented in the application, and an incomplete account of it is a common reason for an application sitting unanswered.

Timelines vary considerably, which is a matter for the conditions precedent and the long stop date.

What the investment is made in matters as much as how much. The rules recognise a defined set of equity instruments: equity shares, fully and compulsorily convertible preference shares, fully and compulsorily convertible debentures, and share warrants, each subject to conditions on subscription and conversion. The compulsory conversion feature is the point. An optionally convertible instrument, or one carrying an assured return, is not an equity instrument, and would have to be structured, if at all, under the external commercial borrowing framework, subject to its own eligibility, pricing and end-use conditions. This is where investor expectations formed in other jurisdictions cause difficulty, because a redeemable preference instrument with a fixed coupon is an ordinary structure in many markets and simply is not available as foreign direct investment here. The conversion formula also has to be capable of being applied, which means the price or the basis for arriving at it is fixed upfront. The investment documents and the instrument have to be read together as well, since an exit right expressed as a fixed sum can pull an instrument out of the equity framework however the instrument itself is labelled.

Convertible notes are available for investment in eligible start-ups on specified terms. Partly paid shares and warrants are subject to conditions on payment of the balance consideration, and a condition missed turns a compliance question into a remediation exercise.

Pricing guidelines run in one direction: a resident must not be disadvantaged. Under the pricing guidelines in the Non-debt Instruments Rules, 2019, where equity instruments are issued or transferred to a person resident outside India the price must not be below the fair value, and where a non-resident transfers to a resident the price must not exceed fair value, subject to the carve-outs the rules provide. Fair value for an unlisted company is determined by any internationally accepted pricing methodology applied on an arm’s length basis and certified by a valuer of a category specified in the rules. For listed companies the SEBI framework applies, and rights issues, bonus issues and share swaps each have their own treatment.

A portion of consideration may be deferred or placed in escrow within the limits the rules allow, which is what makes an indemnity holdback workable on a cross-border deal.

Reporting is a recurring source of later difficulty on otherwise clean transactions. Filings are made through the Reserve Bank’s FIRMS portal using the Single Master Form, and the investee company must first register its Entity Master. Issue of equity instruments to a non-resident is reported in Form FC-GPR. A transfer between a resident and a non-resident is reported in Form FC-TRS, and that obligation generally sits with the resident party. Companies that have received foreign investment file an annual Foreign Liabilities and Assets return, and where the return is filed on unaudited figures a revised return follows once the audited figures are available. Each of these filings runs to a period set by the reporting regulations, and the period and its starting point are checked against the regulations rather than assumed from the completion date. The Entity Master has to be kept current, because the later filings are validated against what it holds, and a company that has changed its capital structure without updating it will find out at the worst moment. Where the investee company has no finance function of its own, responsibility for this work belongs in the transaction documents rather than in an assumption about who is doing it.

Delay is fixable. A late submission fee mechanism allows certain filings made after the prescribed period to be regularised, subject to the prescribed limits, and it does not reach every delayed filing. More substantive contraventions of FEMA, 1999 may be compounded before the Reserve Bank under Section 15, which is a formal process ending in an order and a penalty rather than an administrative waiver, and the compounding rules and the allocation of jurisdiction turn on the amount and the nature of the contravention. Unreported allotments from earlier rounds are picked up in a buyer’s diligence and can become a condition precedent on a later transaction.

Unfiled FC-GPRs and stale Entity Master records are recurring compliance gaps.

Investment by an Indian company that is itself owned or controlled by non-residents into another Indian company is indirect foreign investment, and it is regulated. Whether an entity is owned or controlled is determined by the definitions in the Non-debt Instruments Rules, 2019, which turn on beneficial ownership of the equity instruments and on control over the appointment of directors or over management or policy decisions. Where an Indian entity meets those definitions, its investment into a second Indian entity must comply with the entry route, sectoral cap, pricing guidelines and other conditions that would apply to a direct investment from abroad, and it is reported in Form DI within the period prescribed. Downstream investment may not be funded from borrowings raised in the domestic market. Holding structures assembled without this in mind often leave a subsidiary two levels down carrying an obligation nobody assigned to it. The status can also change without any fresh investment at all, for instance where a resident shareholder sells down and the foreign holding crosses the threshold, and the group then picks up obligations it did not have the month before.

Several features of an Indian transaction surprise first-time acquirers. Duty on the issue and transfer of securities in dematerialised form is levied at uniform rates under the Indian Stamp Act as amended and collected through the depositories, while duty on other instruments remains largely a state matter and depends on where the instrument is executed and on what it covers. Transfers of physical shares use a prescribed instrument of transfer that must be executed and stamped, while dematerialised shares move through the depository system. Every company must have at least one director who has stayed in India for a minimum number of days during the financial year, under Section 149(3) of the Companies Act, 2013. Payments to non-resident sellers attract withholding under the Income-tax Act, 1961, and the rate and incidence depend on the applicable treaty and on the certification procedure for lower or nil deduction, while the indirect transfer provisions can bring an offshore share sale within Indian tax subject to the prescribed thresholds and exemptions. An allotment also runs on the private placement procedure under the Companies Act, 2013, with its own resolutions and forms.

The negotiating positions follow from that. Approval risk is better allocated expressly than left to a general efforts clause: who applies, who bears the cost, what happens if approval arrives with conditions attached, and whether either party may walk away. Repatriation of sale proceeds and dividends runs through the authorised dealer bank against the required documentation and tax certification, and the agreement can identify that documentation rather than leave it to be found at completion. Policy in this area also changes by press note and by amendment to the rules more often than most statutes do, so a position taken on an earlier transaction should be re-verified against the framework in force now.