Select Your Location
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) 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:
To properly understand the change in approach, it is necessary to examine the old as well as the new ODI framework.
Table of Contents
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.
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.
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 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.
Black money has been the subject of heated political debate in India for a long time. Successiv...
The Apex Court pronounced a judgement in the case titled Tata Motors Vs The Brihan Mumbai Elect...
Since economies are moving towards digitalisation and making it feasible to conduct transaction...
The Alternative Investment Funds (AIFs) Pro-rata and Pari-Passu Rights Proposal Consultation Pa...
The Financial Action Task Force, i.e. FATF (the Force), is the global money laundering and terr...
Advance tax refers to the payment of the tax liability before the end of the relevant financia...
On 11.12.15, the Hon’ble Delhi High Court (HC) pronounced a landmark judgement in the case ti...
Money laundering can be defined as the process of illegal concealment of the origin of money ob...
Every assessee in India is obligated to file an income tax return and make the timely payment o...
In the recent past, India has seen burgeoning demand for internet and smartphones. The rapid ri...
Are you human?: 1 + 3 =
Easy Payment Options Available No Spam. No Sharing. 100% Confidentiality
Since economies are moving towards digitalisation and making it feasible to conduct transactions anywhere in the wo...
02 Jun, 2023
The investment by foreign entities has significantly improved in the last few years in India. This improvement coul...
11 May, 2020
Red Herring Top 100 Asia enlists outstanding entrepreneurs and promising companies. It selects the award winners from approximately 2000 privately financed companies each year in the Asia. Since 1996, Red Herring has kept tabs on these up-and-comers. Red Herring editors were among the first to recognize that companies such as Google, Facebook, Kakao, Alibaba, Twitter, Rakuten, Salesforce.com, Xiaomi and YouTube would change the way we live and work.
Researchers have found out that organization using new technologies in their accounting and tax have better productivity as compared to those using the traditional methods. Complying with the recent technological trends in the accounting industry, Enterslice was formed to focus on the emerging start up companies and bring innovation in their traditional Chartered Accountants & Legal profession services, disrupt traditional Chartered Accountants practice mechanism & Lawyers.
Stay updated with all the latest legal updates. Just enter your email address and subscribe for free!
Chat on Whatsapp
Hey I'm Suman. Let's Talk!