Downstream Investments and its Reporting to DPIIT

Ankita Tiwari

06 Jun, 2024

Foreign Investors can invest in India either directly or indirectly. Direct Investment by a foreign investor in an Indian entity is known as Foreign Direct Investment (FDI), and where investments are channelled through an entity in India, then it is known as the downstream investment. Downstream investments are a means to deploy surplus funds from the Indian subsidiary to achieve the investment goals of foreign investors in India. Downstream Investment is the indirect foreign investment in an Indian company that results in investment by other Indian companies with foreign investments in it. Further, downstream investment as defined in the FDI Policy 2020 is an indirect foreign investment by an eligible Indian entity into another Indian company or LLP by way of subscription or acquisition. 

In India, downstream investment is regulated by the Foreign Exchange Management Act of 1999 and the rules and regulations framed thereunder, especially Rule 23 of the Foreign Exchange Management (Non-Debt Instruments) Rules of 2019. As per this rule, the Indian subsidiaries of foreign investors are treated differently when it comes to further investment activities in India, as compared to other Indian entities. This is done solely to regulate the downstream investments. If an Indian entity not owned and controlled by resident Indian citizens or is owned and controlled by persons resident outside India, receives foreign investment then such an entity will be considered a foreign-owned or controlled company (FOCC). When an FOCC acquires equity instruments of another Indian company or contributes towards capital of LLP, then it becomes a downstream investment. All the FDI conditions relating to entry routes, sectoral caps, pricing norms, and other conditions apply to downstream investments also. Due to unclear guidance from regulators on some key aspects, the implementation of downstream investment transactions has been adversely affected. This is despite the fact that the differential treatment of FOCC from other Indian entities has been a welcome move. This blog is divided into two parts: One deals with the conditions for downstream investments and the other deals with the reporting requirements of downstream investments.

What are the conditions for Downstream Investments by Indian Companies?

1. Before making a downstream investment, prior approval of the Board of Directors is required and Shareholder’s agreement if any.
2. Downstream investment can be made within the foreign equity levels allowed for different activities under the automatic route.
3. For downstream investment involving setting up of Export Oriented Units or Software Technology Parks Electronic Hardware Technology Parks projects or items pertaining to compulsory licensing, acquisition of an existing stake in an Indian entity by way of transfer or buyback shall not be permitted through automatic route and will require prior approval of the Foreign Investment Promotion Board or Government.
4. Any issue, transfer, pricing, or valuation of shares shall be as per the SEBI or RBI guidelines.
5. Any Indian entity making downstream investments shall have to arrange requisite funds from abroad and not use the borrowed funds in the domestic market. Guidelines relating to this were issued by the Department of Industrial Policy and Promotion (DIPP) vide Press Note 4 in 2019, and thereafter it was incorporated by RBI in FDI Regulations.
6. Downstream investments can be made via internal accruals which means by transfer of profits to the reserve account after payment of taxes. Vide Press Note 12 of 2009 which was later incorporated by the RBI in FDI Regulations.
7. Raising Debt and its utilization shall be done as per Foreign Exchange Management Act (FEMA) along with the rules and regulations framed thereunder.
8. Any capital instrument of an Indian company held by another Indian company that has received foreign investment and is not owned or controlled by a resident Indian or is owned or controlled by a foreign resident may be transferred to:
9. A non-resident Indian subject to fulfilling the reporting requirements under Form FC-TRS; or
10. An Indian resident subject to the adherence to pricing guidelines; or
11. An Indian company that has received foreign investment and is not owned or controlled by resident Indians or is owned and controlled by non-resident Indians.
12. In every downstream investment, the first-level Indian company is responsible for ensuring compliance with the provisions of these regulations for the downstream investment made by it at the second level and so on.
13. The first-level company has to obtain a certificate from the statutory auditor regarding compliance with the provisions, on an annual basis and compliance with these regulations shall also be mentioned in the Director’s report in the Annual Report of the Indian company. Where the statutory auditor gives a qualified report the same shall be immediately brought to the notice of the Regional Office of the RBI in whose jurisdiction the Registered Office of the company is located and shall also obtain acknowledgement from the Regional Office.

What are the Reporting Requirements of Downstream Investment?

All reporting relating to foreign investment is done on the Foreign Investment Reporting and Management System (FIRMS) Portal. The FIRMS Portal was introduced by RBI. Under Regulation 13 of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (FEMA (FDI) Regulations of 2017) an Indian company making a downstream investment to another Indian company is considered an Indirect Foreign Investment for the investee company and as per the FDI Regulations, it shall be responsible to intimate the Secretariat for Industrial Assistance, DIPP, and file FORM DI within 30 days from the date of such investment, even if the capital instrument has not been allotted along with the modality of investment in new or existing ventures. Further, from 1^st September 2018 an Indian entity or an investment vehicle while making a downstream investment in another Indian entity considered as an indirect foreign investment for the Indian entity as per Regulation 14 of FEMA (FDI) Regulations, 2017, shall file Form DI with the RBI within 30 days from the date of allotment of capital instruments.

Any failure to report or non-reporting of any Foreign Investment received, shall be considered as a contravention of the provisions of FEMA. These contraventions can be compounded under FEMA Regulation either by suo moto or after receiving notice from RBI. To compound the contravention of non-reporting, the contravenor has to submit a compounding application to the Central Office of RBI. If the contravenor does not want to undergo the compounding process, then the contravenor may simply skip the compounding process by paying the Late Submission Fees (LSF) at the prescribed rates.

Conclusion

At last, it can be said that the downstream investment reporting requirement is quite simple and straight, but it is the applicability of the provisions which must be thoroughly analyzed, and documents should be arranged beforehand to avoid any delay in reporting.

Read our Article:Compounding of Contraventions under FEMA