Foreign Investments from Neighbouring Countries in India

Ankita Tiwari

19 Apr, 2023

India has a comprehensive Foreign Direct Investment (FDI) Policy. FDI Policy permits foreign investments in India under two routes i.e. automatic route and the government approval route. In the year 2020, the government amended the FDI Policy and imposed stricter norms on foreign investors from neighbouring countries. Subsequently, even the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI Rules) were also amended. To align with these amendments, a series of amendments were introduced by the Ministry of Corporate Affairs (MCA) pertaining to foreign investments from neighbouring countries.

To prevent hostile takeovers of Indian companies by foreign investors from neighbouring countries, the DPIIT amended the FDI policy vide Press Note No. 3 dated 17^th April 2020. As per the amendment, foreign investors from neighbouring countries are permitted to invest in India only with prior government approval. In the erstwhile regime, only individuals and entities from Pakistan and Bangladesh were required to obtain government approval before investing in India. However, pursuant to the amendment, investments from individuals or entities from Pakistan, Afghanistan, China, Bhutan, Nepal, Myanmar, and Bangladesh can invest in India only after obtaining government approval.

Amendment in FDI Policy

If foreign investors from neighbouring countries want to invest in India, they will have to get prior approval from the Government of India before  investing in the shares of an Indian company. The amendment will apply in two cases:

1. When the shares are purchased directly from the company; or
2. When the shares are purchased from existing shareholders

Pursuant to the amendment in the FDI Policy, subsequent changes were also made by the Ministry of Corporate Affairs^[1] in the Company Law Rules. These amendments have been discussed in detail below:

Amendment by MCA

Indian companies accepting foreign investments in the form of share issues should check if the shareholder confirms the status of the proposed shareholder. In the case of a foreign investor from a neighbouring country, the company has to ensure that approval from the government has been acquired by the proposed shareholder. To ensure government approval, the MCA has introduced mandatory reporting compliance in the NDI Rules. The mandatory reporting requirements implemented by MCA are as follows:

1. Incorporation
   To ensure foreign investors from neighbouring countries obtain necessary government approval under NDI Rules, the MCA amended its Companies (Incorporation) Rules, 2014 from 1^st June 2022 onwards. This amendment requires the foreign investors to declare whether they are required to obtain approval from the Indian Government, and if yes, then the incorporation form, I.e., SPICe+, should be attached.
   In addition to the above, a security clearance has to be obtained from MHA. The security clearance along with a declaration regarding the same has to be attached to the  incorporation form. This amendment was brought by the Companies (Incorporation) Second Amendment Rules, 2022. which came into effect on 1^st June 2022.
2. Private Placement
   If the proposed allottee or foreign investor is from a neighbouring country and is investing through a private placement, the government’s approval must be attached to the private placement offer and application form under PAS-4.Under the application form, foreign investors from neighbouring countries should make a declaration regarding the applicability of NDI rules. This amendment was made pursuant to the Companies (Prospectus and Allotment of Securities) Amendment Rules, 2022 effective from 5^th May 2022.
3. Transfer of shares
   For the transfer of shares to a foreign investor from a neighbouring country, government approval is required to be obtained by such a foreign investor as per the NDI Rules. The government’s approval should be attached to the share transfer form SH-4. Pursuant to the amendment in the Companies (Share Capital and Debentures) Rules, 2014, effective from 4^th May 2022, the transferee is mandated to give a declaration if NDI Rules apply to him.
4. Merger
   If an Indian Company merges with an entity incorporated in a neighbouring country, then it will have to obtain government approval under the NDI Rules. This approval should be submitted to the National Company Law Tribunal (NCLT) along with the merger application and Form CAA-16. This amendment was made vide Companies (Compromises, Arrangements, and Amalgamations) Amendment Rules, 2022 effective from 4^th May 2022.
5. Appointment of Director in a Company
   If a foreign investor from a neighbouring country wants to become a director of an Indian Company, he or she has to obtain security clearance from the Ministry of Home Affairs (MHA).the approval from MHA has to be attached by the director along with the consent letter under DIR-2. This amendment was made by the Companies (Appointment and Qualification of Directors) Amendment, 2022 from 1^st June 2022.
6. Application for Director Identification Number (DIN)
   Where a foreign investor from a neighbouring country applies for a DIN, the individual has to attach the security clearance granted by MHA. The security clearance is to be submitted along with the DIN application under Form DIN-3. A declaration in this regard is also required to be inserted in the e-Form DIR-3, see Companies (Appointment and Qualification of Directors) Amendment Rules, 2022 with effect from 1^st June 2022.

What were the reasons behind the above Amendments?

1. It is a protectionist government policy resulting particularly due to the rising stake of the People’s Bank of China in HDFC from 0.8% to 1.01%.
2. Several Chinese companies such as Alibaba, Tencent, and Xiaomi, have invested heavily in India and also hold substantial stakes in companies like PayTm, Big Basket, Zomato, and Ola. The amendment will keep a check on the future capital inflow into such companies with existing foreign investors from neighbouring countries.
3. It protects vulnerable Indian companies from foreign hostile takeovers.
4. This amendment was brought in at the time of pandemic when the foreign investments from neighbouring countries prompted concerns about the likelihood of such investments leading to foreign control of Indian entities.
5. It is a tactful way to preserve the Indian entities amidst the geo-political situation between India and its neighbouring countries.
6. It will also protect the sovereignty of India as the inflow of foreign investments from such countries may be used for terror funding, etc.

Conclusion

To protect Indian entities from opportunistic takeovers, India amended its FDI Policy. This move will prevent foreign investors from neighbouring countries from actively investing in Indian start-ups, eroding the Indian-ness of Indian entities. This move was taken during the pandemic to protect Indian entities whose valuations have been hit given the correction in equity markets arising from the pandemic and lockdown. However, it will have a long-lasting beneficial effect. The intention behind the amendment is to preserve the Indian manufacturing and technology sectors.

Read our Article: All you need to know about Foreign Investment