FEMA

Overseas Direct Investment in Wholly Owned Subsidiaries

Background of Overseas Direct Investment

Overseas Direct investment forms the backbone of the Indian economy. Due to this form of investment, the Government of India can promote global business and entrepreneurship.

The following activities are developed and improved as a result of Overseas Direct Investment:

To improve the Indian economy, RBI has liberalized the norms related to capital account and current account transactions.

What is Overseas Direct Investment?

The Overseas Direct Investment refers to the investment made by an entity that can be a company, partnership, or an individual in the foreign Joint Venture or Wholly Owned Subsidiary. Overseas Direct Investment, also known as ODI, has to be differentiated with the term Foreign Direct Investment (FDI). Foreign direct investment is considered an inbound investment made by a foreign company in the securities of the Indian company. ODI is an outward investment made in the securities of a foreign wholly-owned subsidiary.  ODI can be understood as a direct investment outside India by subscribing to the capital or the Memorandum of Association (MOA) in the foreign entity. The norms of ODI also cover the purchase of existing shares in a foreign entity.

The central regulatory authority for Overseas Direct Investment is the Reserve Bank of India (RBI). Apart from this institution, Authorised Dealers (AD) Category- I carry out remittances made by resident entities. According to the Foreign Exchange (Transfer or Issue of Foreign Security) Regulations, 2004, an overseas direct investment can be made in a wholly-owned subsidiary or a joint venture. The RBI amends this regulation from time to time.

Section 11 of the Foreign Exchange Management Act gives powers to the RBI to issue directions to authorized dealers. Authorized dealers make sure that investments made under the ODI route comply with the rules established by RBI. Reporting instructions are present under the RBI Master Direction 2016 for Overseas Direct Investment.

What activities or sectors are not allowed for ODI?

An Indian Party is not allowed to make investments or financial commitment in a wholly-owned subsidiary or a joint venture engaged in the following:

• Real Estate Activities;
• Trading Activities related to Transferable Development Rights; and
• Banking Business.

Real estate activities would not include the construction and development of townships, residential complexes, and commercial premises.

An overseas entity that has some form of direct or indirect equity partnership through an Indian entity would not be allowed to offer Indian Rupee (such as Indian Rupee Exchange) without the prior permission of the RBI.

If the above activities are carried out without the RBI’s permission, it will lead to non-compliance with the relevant provisions of FEMA^[1].

Requirement of Permission

Permission is required if an individual or resident individual, wants to acquire securities.

Securities are acquired in the following manner:

• Funds maintained out of the resident foreign currency account;
• Some form of a bonus on existing holding in foreign shares; and
• Foreign currency resources outside India, when an individual is not permanently a resident in India

Routes for making Overseas Direct Investment

An Indian party or Indian Entity is allowed to invest either through the following routes:

• Automatic Route- No prior permission is required under this route from the government of India.
• Approval Route- Under this route, prior permission is required from the government of India.

The RBI allows overseas direct investment by a resident Indian in a wholly-owned subsidiary as per the ceiling limit. The Reserve Bank of India amends the limit on the amount of ODI from time to time. After 2014, any form of investment made by the Entity exceeding USD 1 Billion requires prior approval from the government. This would also cover any form of investment which comes under the purview of the automatic route under FDI (400% as per the worth of the company from the last audited balance sheet)

Procedure for making the Application

An application for overseas direct investment must be made on Form ODI. The Entity or party investing must fill the form and provide the necessary documents as required by the authorized dealer (category –I).

Investment made by the Indian party should be in the following manner:

• Equity Shares or CCPS (Compulsory convertible Preference Shares);
• Preference shares;
• Amount of loan;
• Guarantee which is taken; and
• Guarantee, issued by the bank on account of the Wholly Owned Subsidiary of the Indian Party, provided a counter-guarantee that supports the guarantee.

Loan or a guarantee can only be extended if there is some form of equity participation between the Indian Company and the overseas wholly-owned subsidiary. If there is no form of equity participation between the parties, then the Indian Entity can seek prior permission from the RBI for the same. Such approvals will be sent to authorized banks present in the foreign country. Authorized banks in foreign countries will ensure that there are no issues where equity participation is not present.
An Indian entity can issue a corporate guarantee or personal guarantee.

The following considerations have to comply while issuing a guarantee:

• The creation of a guarantee or any form of charges must come under the limit for the Indian party.
• A guarantee cannot be open-ended. This means that amount of guarantee and period of the guarantee is specified.
• If a performance guarantee is used, and the limit is breached, then prior permission from the RBI is required for the same.

Authorized dealer (Category-I) can also provide any form of bank guarantee or the SDLC to a wholly-owned subsidiary in India, which has some form of business connection abroad if there is compliance with the terms of the regulations. Where corporate guarantees are used, this must be reported in Part-I of Form ODI. Reporting this can be carried out through the authorized bank. Any form of guarantees issued in favour of the wholly-owned subsidiary should be according to the RBI (Department of Banking Regulation) norms.

The party making any form of investment must not be in the export caution list or under investigation from any form of central authority. All transactions related to overseas direct investment in the wholly-owned subsidiary must be through the authorized banks. In case the amount of investment in the foreign entity is more than USD 5 million, then the valuation must be carried out by a SEBI registered merchant banker. The valuation in a foreign country can be carried out by a chartered accountant of that country or a certified public accountant.

Investment by a Partnership Firm in Wholly Owned Subsidiary

A partnership firm is also an entity that can invest in a wholly-owned subsidiary. If this occurs, the partners of the partnership firm would have to hold the shares of the foreign firm. This would only be allowed if the foreign country regulations allow the partners to hold such shares.

An entity registered in India can also acquire shares in a foreign company to exchange ADR and GDR. However, the conditions as per the Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993, have to be adhered to.

The ADR/GDR must be according to the following:

• These global depository receipts have to be registered in a stock exchange outside India.
• Global depository receipts must be issued for acquisition.

Overseas Direct investment through Special Purpose Vehicles

Overseas Direct Investments can be routed through a special purpose vehicle (SPV) by the Indian Entity. However, the Indian Entity must not appear in the caution list of the exporter or be subjected to any formal investigation by any higher authority.

Corporate Guarantee for a Step-down Subsidiary of the Wholly Owned Subsidiary

An Indian Entity can issue a corporate guarantee on account of the step down wholly owned subsidiary if the wholly-owned subsidiary is acting as a Special Purpose Vehicle. However, the Indian party issuing corporate guarantee has to be under the Automatic route and subject to the minimum financial limit. These guarantees must be reported on Form ODI.

A corporate guarantee can be issued on the second level step down wholly-owned subsidiary. However, prior approval is required from the government (Approval Route). This can happen only if the Indian subsidiary has 51% indirect control over the foreign wholly-owned subsidiary.

Funding Method

Overseas Direct investment funding can be carried out in the following ways:

• By drawing of a foreign currency or foreign exchange from an authorized bank in India;
• Through capitalization of exports;
• By share swap mechanism;
• Through maturity or any form of proceeds from External commercial borrowings or foreign currency convertible bonds; and
• Through the exchange of ADRs and GDRs.

Investments in the Financial Sector

When an Indian Party invests in a company that engaged in finance outside India, the following additional conditions have to be adhered:

• Indian Entity must be registered with the respective financial services authority outside India;
• The Indian party has earned its revenue and net profit from financial services activities outside India;
• Prior permission is taken by the Indian Party to carry out activities both in India and abroad; and
• The Indian party has followed the prudential norms which are laid down by the regulator.

Any form of extra investment carried out by the Wholly Owned subsidiary must also comply with the above conditions.

Overseas Direct Investment by a Proprietorship Concern or Trust Body

Proprietorship Firms or Trusts can also make investments in a foreign-controlled wholly-owned subsidiary.  Trusts or Concerns registered for carrying out services related to manufacturing, education, and medical sectors are allowed to make overseas direct investment. However, the ODI must be made in the same sector outside India. Prior permission of the RBI is required for this purpose.

Approval from RBI

Approval from the RBI would be required for cases not covered above. Along with Form ODI, the Indian Entity must provide the requisite documentation. The form must be submitted through the authorized bank.

The following factors would be considered by the RBI while seeking approval for the overseas direct investment:

• The business of the Wholly Owned Subsidiary outside India;
• Any form of the contribution the wholly-owned subsidiary has on the economic outlook in India;
• Track record and financial position of the foreign and Indian Entity; and
• Experience and expertise of the Indian party carrying out the business of the wholly-owned subsidiary outside India.

Post Investment Changes and Restructuring in Overseas Direct Investment

If there are any forms of post-investment changes in the wholly-owned subsidiary formed by the Indian Entity, the same must be reported to the RBI. This must be reported to the RBI through the authorized dealer within 30 days of such change. This compliance is mandatory for a wholly-owned subsidiary.

Indian companies that have more than 51% ownership in a wholly-owned subsidiary are allowed to write off capital and receivables such as loans, technical know-how, and any management fee concerning the wholly-owned subsidiary.

Are resident individuals allowed to make an overseas direct investment in wholly owned subsidiaries?

A resident individual would come under the meaning of an Indian party. Therefore, a resident individual can invest in a foreign-owned wholly-owned subsidiary. The investment must be made in CCPS or equity shares. The maximum limit that is allowed under this investment is as per the liberalized remittance scheme^[2] (LRS), which is USD 250000.

Conclusion