Foreign Exchange Management

Overseas Investment Rules and Regulations

FEMA is a small legislation but it is largely ruled by rules and regulations. The key aspect of FEMA is that RBI keeps revising the rules and regulations in consultation with the Central Government to try and make it more business-friendly. Since the enactment of FEMA in 1999 the Overseas Investment Regulations have changed thrice. Now the new Overseas Investment Rules and Regulations have been recently notified on 22^nd August 2022. The new Overseas Investment Rules and Regulations have been introduced to liberalize and promote ease of doing business in India. It simplifies the existing framework of Overseas Investment. Now Overseas Investment has been bifurcated into two portions i.e. Overseas Direct Investment (ODI) and Overseas Portfolio Investment (OPI). ODI and OPI are together known as Overseas Investment (OI). Any investment or financial commitment outside India has to be as per FEMA and the Overseas Investment Rules and Regulations.

What is the regulatory framework for Overseas Investment in India?

The Overseas Investment Framework in India is now split into three:

• The Foreign Exchange Management (Overseas Investment) Rules, 2022 (OI Rules) notified by the Ministry of Finance, Government of India;
• The Foreign Exchange Management (Overseas Investment) Regulations, 2022 (OI Regulations) notified by the Reserve Bank of India (RBI); and
• Foreign Exchange Management (Overseas Investment) Directions, 2022 (OI Directions) notified by RBI.

The new OI Rules replace the Foreign Exchange Management (Transfer or Issue of any Foreign Security) regulations, 2004, and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) regulations, 2015. Under the new OI Rules, the Ministry of Finance, Government of India has the power to regulate which was with RBI in the erstwhile Overseas Investment Framework. Some new definitions have been introduced in the new framework. Further, the new framework provides better clarity in the existing definitions. Most importantly, the new framework provides clarity on the concepts such as the liberalization of round-tripping structure, the introduction of arm’s length rule for the issue or transfer of equity capital or debt by a foreign entity, and statutory auditor’s certificate for taking-up ODI and Annual Performance Report, etc.

What are the major changes brought in by the new Overseas Investment Regime?

• Foreign entity – The new OI regime has introduced the concept of foreign entity replacing the erstwhile concept of Joint Venture and Wholly owned Subsidiaries (JV & WoS). The concept of a foreign entity is similar to the concept of JV & WoS but the new regime has explicitly introduced the requirement of ‘limited liability’ so that the liability of the Indian party is clear, identified, and limited. A foreign entity means an entity registered or incorporated outside India including the International Financial Services Centre (IFSC) having limited liability. However, the requirement of limited liability does not apply to foreign entities functioning in sectors such as oil, gas, coal, mineral ores, submarine cable system, start-ups, or any other sector as prescribed by the Central Government.
• ODI & OPI- The new OI Regime has been bifurcated between ODI and OPI by defining OPI. In the erstwhile regime only the listed entities were allowed to make OPI however, the OPI criteria have been expanded to include unlisted entities, resident individuals, mutual funds, alternative investment funds, and venture capital funds. Further, the definition of OPI defines it as any investment other than ODI, investment in any unlisted debt instruments, or any security issued by a person resident in India who is not in an IFSC.
• Control- The word ‘control’ has been defined under the new OI Regime. It is defined as the right to appoint the majority of directors or control the management or policy decisions taken by a person or a group of persons directly or indirectly including anything done by their shareholding or management rights or shareholder’s agreements or voting agreements that entitle them with 10% or more voting rights, etc. By clearly defining the threshold limit, the demarcation has been established between ODI and OPI.
• Pricing guidelines- The new OI Regime has specifically introduced the concept of pricing guidelines where subject to exceptions all equity capital issues or transfer of shares of foreign entities from persons residing outside India, from persons residing in India to persons residing in India who are eligible to make such investments, from persons residing in India to persons residing outside India, must be carried out on arm’s length basis. Further, it is the responsibility of the AD bank to ensure adherence to arm’s length price and take into account that the valuation is as per any generally recognized international pricing methodology for valuation.
• Flip Structures- The new OI Regime has recognized the flip structures. It explicitly allows an Indian entity to invest in a foreign company willing to establish a subsidiary in India subject to the condition that the overall structure does not result in more than two layers of subsidiaries.
• Investment in Financial Sector- The new OI Regime permits all Indian entities to invest in foreign entities engaged in the financial sector, except in banking and insurance activities, without seeking permission from the sector regulator. However, the investment in the financial sector is subject to the condition that such an entity should have posted net profits during the previous three financial years. In contrast, the erstwhile ODI Regime permitted the entities engaged in financial services to only invest in financial sectors outside India.
• ODI in Start-ups- The new OI Regime has allowed internal accruals in the case of Indian entities and own personal funds in the case of resident individuals to be used for overseas investments in start-ups. Such start-ups should be recognized by the host country. Further, ODI in start-ups has been differentiated from other OIs under the new OI Regime. 
• Investment by Resident Individuals- One of the major change to the OI Rules is that it has been subject to certain conditions, allowing overseas investment by resident Indians in IFSC which was earlier affected by the round trip concerns. ODI in a foreign entity including an entity engaged in financial services activity, apart from banking and insurance, can be made by a resident individual. However, the resident individual has to ensure that the investment is as per the provisions of the new OI Regime otherwise, the liberalized remittances will not be available.
• Investment in Immovable property outside India directly by an Indian Resident- The new OI framework in India allows the Indian Residents to acquire property from sale proceeds of assets overseas under the provisions of FEMA. It means that the sales proceeds from an immovable property outside India or the sale proceeds from an investment made under the OPI can be used to acquire new immovable property outside India. However, the erstwhile regime restricted it to only an Indian Resident acquiring immovable property jointly with an NRI relative. Further, this joint holding was also allowed if there was no remittance from India by the resident Indian.
•  Gifting Foreign Securities- In the earlier OI Regime, gifts of foreign securities were under general permission which confused compliance requirements when securities were gifted by non-residents to residents of Indian entities or individuals. The new OI Regime allows a Resident Individual to acquire shares by way of inheritance from a person resident in India or by way of gift from relatives who are resident Indians. However, a gift of foreign securities from a person resident outside India has to comply with the provisions of the Foreign Contribution (Regulation) Act, of 2010^[1].
• Loans and Guarantees- The new OI Regime allows Indian entities to have control over the foreign entity before providing any loans or making an investment into debt instruments or providing any other non-fund-based commitment to such a foreign entity. Even the restriction relating to step-down subsidiaries whose obligations can be guaranteed by the Indian entity has been removed. This revision encourages Indian entities to make overseas investments.
• Pledging shares and creating securities- The new OI Regime allows the creation of pledges over shares and assets of the foreign entity including the step-down subsidiaries towards a debenture trustee registered with SEBI for the fun base facilities availed by the Indian entities. In furtherance to this, the new OI Regime also allows the creation of charges over the assets of the foreign entity.

Conclusion

The new OI Regime establishes a perfect balance between providing freedom to invest and having adequate restriction and check over the investments. The requirements have been made easier and business-friendly. The flaws in the earlier regime have been taken care of and relaxations have been provided. It simplifies the erstwhile framework of foreign investments. It provides perfect opportunity for resident Indians looking for investment opportunities abroad. This will promote overseas investments in India as well.

Also Read:
A Detailed Review of Foreign Exchange Management Act 1999
Analysis of the Foreign Exchange Management (Overseas Investment) Rules, 2022
Overview of Foreign Exchange Management (Overseas Investment) Regulations 2022