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The Devious Rules and Regulations Surrounding ODI through FDI Transactions


Any Overseas Direct Investment (ODI) which takes place through Foreign Direct Investment (FDI) transactions is referred to as “round tripping”. Round Tripping means the inflow of funds to a company from which it was originally outflow. Round tripping transactions had a checkered past and were looked at with suspicion. Round Tripping transactions were per se not considered as bonafide transactions. Round tripping is regulated by the Foreign Exchange Management Act of 1999 (FEMA). The Reserve Bank of India (RBI)[1] has the power to formulate rules, regulations and guidelines in this regard. India has witnessed a shift in the approach towards round tripping. With the introduction of the new ODI framework, a liberal view was adopted in matters relating to round tripping. The new ODI framework issued by RBI in August 2022 includes:

  1. The Foreign Exchange Management (Overseas Investment) Rules, 2022;
  2. The Foreign Exchange Management (Overseas Investment) Regulations, 2022;
  3. The Foreign Exchange Management (Overseas Investment) Directions, 2022;

To properly understand the change in approach, it is necessary to examine the old as well as the new ODI framework.

Old ODI Framework

Under the old framework, the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 governed ODI. Even though these regulations were silent on round tripping, the round tripping transactions were penalized by applying Regulation 6 (2) (ii) or Regulation 5 along with Regulations 13 and 15. As per section 6 (2) (ii), any resident Indian was allowed to directly invest in a Joint Venture (JV) or a Wholly-owned Subsidiary (WOS) abroad, subject to a condition that such direct investment is made in the overseas JV or WOS. In addition to this, regulation 5 (1) prohibited an Indian party to invest overseas unless permitted under the FEMA, rules, regulations, or directions framed under it or by express approval of the RBI. RBI neither considered such transactions bonafide nor permitted them under the automatic route. The entities who were caught undertaking such transactions were penalized. However, the term bonafide was not defined hence, it was entirely dependent upon RBI’s discretion. In case of any deviation to adhere to the reporting requirements, penalties were imposed on the Indian entity. If the amount involved in the contravention is quantifiable, then up to three times the sum involved in the contravention can be imposed, and if the sum involved in the contravention is not quantifiable, then an amount up to INR 2,00,000/- can be imposed. An additional amount of up to INR 5000/- can be imposed every day during which the contravention continues.

New ODI Framework

The new framework has introduced significant changes in the ODI Framework. A definition of “subsidiary” has been inserted under Rule 2(1) (y) of the ODI Rules which has been adopted from section 2 (87) of the Companies Act, 2013. A subsidiary means a company over which a foreign company has control. Even the term “control” has been defined under the new ODI framework. Control means the right to appoint the majority of the directors or control management or policy decisions exercisable by a person or persons acting independently or all of them. It also includes any control arising by way of shareholding or management rights or shareholder’s agreement or voting agreements that gives them 10% or more of voting rights or it can be in any other manner as may be prescribed. However, when we look at the Companies Act of 2013, “subsidiary” is defined as a company in which the holding company controls the composition of the Board of Directors or exercises or controls more than 50% of the total voting power. Analysing both definitions brings us to the conclusion that a foreign company could be considered a subsidiary under the ODI framework even if it does not meet the 50% criteria prescribed under the Companies Act, 2013. Another insertion by RBI in the new ODI Framework is the definition of “bona fide business activity” which means any business activity permissible under any law in force in India as well as in the host country. The most important amendment brought by the new ODI Framework is it liberalizes the norms for overseas investment. Rule 19 (3) of the ODI Rules provides that financial commitment up to two layers of subsidiaries is permitted in a foreign company that has invested or is willing to invest in India either directly or indirectly.  The restriction on the number of layers of subsidiaries is similar to the restrictions under the Companies (Restriction on Number of Layers) Rules, 2017. As per the two-layer subsidiary requirement, the transactions permissible are described below:

In the above diagram, the Indian company RST Ltd. can indirectly invest in the Indian company HIJ Ltd by investing via XYZ Ltd viz; a US-based company and has indirect control over XYZ Ltd in India through MNO Ltd in Mauritius. The number of subsidiaries involved in the above transaction are two i.e. the MNO Ltd in Mauritius and the HIJ Ltd. Hence, this is a permitted transaction as per the new ODI framework. However, if one more subsidiary company would have been involved, the transaction would have become impermissible. Let’s understand by way of an example given below:

In the above diagram, RST Ltd cannot indirectly invest in HIJ Ltd through XYZ Ltd in the USA as the number of subsidiaries involved are three i.e. XYZ Ltd in the USA, LMN Ltd in Mauritius and PQR Ltd in Singapore. This is beyond the permissible layer of subsidiaries.

Concerns raised by the new Framework

  1. As per Rule 2 (1) of the Company Rules, WOS as well as the overseas entities having more than two layers of subsidiaries, are exempt if it is permitted by the foreign laws applicable. However, no such exemption is provided in the new ODI framework. Hence, a contradiction arises between the two sets of rules.
  2. Rule 6 (3) of the Draft rules expressly prohibited round tripping for tax avoidance or tax evasion purpose. However, this rule has been omitted in the new ODI rules which may formalize the objective of regulators to promote bona fide round tripping transactions and fraudulent behaviour leading to tax evasion.


In summation, it can be said that the new ODI framework, even though a welcome change, raises concerns relating to inconsistencies across different laws. Earlier, the RBI dealt with inconsistencies by issuing FAQs. However, this time FAQs are not advisable as FAQs are informal guidelines and are prone to different interpretations and confusion. It will be more effective if RBI amends the applicable framework to address the inconsistencies and conflicts in the prevailing law. If not, then ODI through the FDI route would remain devious like it is currently. 

Read our Article: Foreign Investment in India and its Regulatory Framework

Ankita Tiwari

Ankita is an Advocate and has joined Enterslice as a Legal Researcher. Her work focuses on General Civil and Commercial laws, Corporate Taxation Laws, Labour and Employment Laws and Dispute Resolution. She is a law graduate from School of Law, University of Petroleum and Energy Studies. Prior to joining Enterslice, Ankita has the experience of practicing law in Delhi and Odisha.

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