FEMA Foreign Investment

Understanding the Concept of Wholly Owned Subsidiary outside India

Overseas investments in Joint ventures and Wholly Owned Subsidiaries have been recognized as an important avenue for promoting global business by Indian entrepreneurs. There are some significant benefits associated with such overseas investments, such as transfer of technology and skill, access to a wider global market, promotion of brand image, employment generation etc. Such investments are essential drivers of foreign trade.  It means investments under the automatic route or the approval route through contribution to the capital or subscription to the memorandum of a foreign entity or through the purchase of existing shares of a foreign entity, thus showing a long term interest in the foreign entity i.e., Joint Ventures or Wholly Owned Subsidiary. 

Meaning of Wholly Owned Subsidiary

Wholly Owned Subsidiary means a foreign entity formed, registered or incorporated according to the laws and regulations of the host country whose entire capital is held by the Indian party. It is a separate legal company where the common stocks are owned and controlled by the holding or the parent company. The parent company has 100% control over the entity, and such company functions in accordance with the guidance of the parent company. It may be noted that the decisions for wholly-owned subsidiaries (WOS) are taken by the parent company; however, it does have its own senior management that looks after the business operations. 

The common stocks are not publicly traded for a WOS; therefore, there are no individual shareholders. The parent company appoints its Board of Directors, but it is still treated as a separate legal entity. It means the provisions applying on the WOS shall not necessarily be applicable to the parent company.

Purpose of Wholly Owned Subsidiary

The main purpose behind incorporating Wholly Owned Subsidiaries is that-

• It diversifies the business operations of a company and creates a different channel to run it.
• It enables its parent company to operate in the foreign companies and markets.

What are the methods of funding in a Wholly Owned Subsidiary?

Investment in the Wholly Owned Subsidiaries outside India may be funded out of one or more of the following:

• Drawal of foreign exchange form an Authorised Dealer bank in India;
• Capitalisation of exports;
• Swap of shares;
• Proceeds of External Commercial Borrowings (ECB) or Foreign Currency Convertible Bonds;
• In exchange of ADRs/GDRs issued according to the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares Scheme, 1993, and the guidelines issued by the Government of India thereunder from time to time;
• Balances held in EEFC account of the Indian party;
• And the proceeds of foreign currency funds raised through issuance of ADRs/GDRs.

Procedure of making foreign investments in a Wholly Owned Subsidiary

The Indian party looking to make a foreign investment in under the automatic route must-

• Fill ODI form duly supported by documents like a certified copy of the Board Resolution, statutory auditors certificate, and valuation report.
• Approach an Authorised dealer for making the investment/remittance.

Pledging of shares of a Wholly Owned Subsidiary

The shares of WOS may be pledged by an Indian party as security for availing either fund based or non-fund based facility for itself or for the WOS from an authorized dealer/public financial institution in India or from an overseas lender provided that the overseas lender is regulated and supervised as a bank plus the Indian party’s total financial commitments stay within the prescribed limit by the RBI for overseas investment from time to time.

Conditions for an Indian Company to make an investment in a WOS abroad in the financial service sector

Only an Indian company engaged in the financial services sector activities may make an investment in a Joint venture or WOS outside India in the financial service sector provided it satisfies the following conditions:

1. It has earned net profit in the preceding three financial years from the financial service activities;
2. It is registered with the relevant regulatory authority of India for conducting financial service activities;
3. It has taken the approval for undertaking such activities form the concerned regulatory authority in India and abroad before such financial activity;
4. And it has fulfilled the prudential norms with respect to capital adequacy prescribed by the concerned regulatory authority in India.

Transfer of share or security held in a Wholly Owned Subsidiary

An Indian party can transfer by way of sale without the approval of Reserve Bank to another Indian party or to a person residing abroad any share or security held by it in the WOS or JV outside India provided the following conditions are fulfilled.

• Such sale must not result in write off of the investment made.
• The sale must be effected through a stock exchange where the shares of the foreign WOS/JV are listed.
• In case the shares are not listed on the stock exchange, and that the shares are disinvested by a private arrangement, the share price should not be less than the value certified by a CA or a Certified Public Accountant as the fair value of the shares based upon the latest audited financial statements of a JV/WOS.
• The Indian party should not have any outstanding dues by way of dividend, royalty, consultancy, or export proceeds from the JV/WOS.
• The annual performance report with the audited accounts for that year must be submitted to the Reserve Bank.
• The Indian party must not be under investigation by CBI/DoE/IRDA/SEBI or any other regulatory authority in India.

Advantages and Disadvantages of Wholly Owned Subsidiary

Advantages-

1. The primary advantage of WOS is that the parent company can exert full control over its operations in a foreign country.
2. Since the parent company has all the required permissions, there are fewer administrative difficulties encountered by the company, and therefore it can easily acquire the WOS.
3. Every aspect of the WOS is looked after by the parent company; therefore, it does not need to reveal its technology or competitive advantages to others.

Disadvantages-

1. The parent company needs to make 100% equity investment in its subsidiary. Such investments are not reasonable for small scale and medium organizations.
2. The parent organization additionally needs to tolerate entire misfortunes accruing due to the losses on its own because it owns 100% equity.
3. Few countries are reluctant to set up entirely owned subsidiaries by outsiders in their land.

Difference between Joint Ventures and Wholly Owned Subsidiaries

The two business forms, Joint Ventures (JV) and Wholly Owned Subsidiaries (WOS), are quite distinct in terms of their ownership structure, risks benefits and uses. These differences have been specified below.

• One of the significant differences between the JV and WOS is their ownership structure. A JV is a firm that is set up managed and owned by two or more companies, whereas WOS is owned by a single company that has control over it.
• WOS tends to be riskier than a JV because in JV, the risk is spread to more than one company, and if the business fails, then the losses can be divided between the companies, but in WOS, the parent firm shall absorb all losses by itself. A JV also reduces risk by usually providing access to more resources, including personnel and capital.
• Just like these two differ in risks, they also differ in their potential benefits. The benefits tend to be greater in a WOS simply because the profit doesn’t have to be shared with anyone.
• WOS is generally used in situations where the business is considered low risk, or it would be used if the company possesses required skills and knowledge, whereas JV shall be used where the company needs access to skills, knowledge, etc.

Conclusion

Wholly Owned Subsidiaries make it possible for the parent company to manage and diversify. Generally speaking, the Wholly Owned Subsidiaries retain legal control over operations, products, and processes. Some of the examples of WOS include Reliance Industrial Investments and Holdings Limited owned by Reliance Group of Companies, Concorde Motors India Ltd, owned by TATA Motors.