The term overseas direct investment (ODI) means an investment that occurs outside India. This term is different from the term foreign direct investment. Foreign direct investment is an investment made by a foreign entity in India.
The Overseas direct investment is understood as the form of a contribution to the capital or memorandum of association in a foreign entity. This investment can be carried out either through market purchase or private placement in a stock exchange. ODI does not include any form of portfolio investment. Overseas direct investment has to be made in joint ventures.
How is ODI regulated?
The Reserve Bank of India is the primary regulatory authority dealing with overseas direct investment. The Government of India has brought out the law for regulation of foreign exchange in the country.
This law is known as the Foreign Exchange Management Act, 1999 (FEMA). Along with FEMA, RBI brings out circulars and notifications for regulation of foreign exchange in the country. The Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 deal with overseas direct investment.
The RBI has the power to issue directions and circulars under FEMA. ODI is an investment made by an Indian Party in a Joint Venture (JV) or Wholly Owned Subsidiary (WOS) in a foreign country. Investments cannot be made by the Indian party.
They have to be routed through the Authorised Dealer (AD) (Category-I). Authorised Dealers are banks regulated by the RBI to carry out foreign exchange transactions. RBI has the power to issue directions on the operation of authorized dealers.
What are the routes for making Overseas Direct Investment?
There are two routes for making overseas direct investment in the host country.
The routes of making investment are the following:
Automatic Route- Under the automatic route, no prior approval is required from the Government of India. Therefore an entity can make 100% foreign investment under this route without the prior permission from the Government.
Approval Route– The FDI under approval route is also called the government route. Under this route, prior permission is required by the government for making an investment.
What is a Joint Venture?
The RBI has provided the meaning for a joint venture. Joint venture is a foreign company formed as per the laws of the foreign country, where an Indian party makes a direct investment. An Indian Party has to make a direct investment in a joint venture to come under the meaning of overseas direct investment.
An Indian entity has to enter into a joint venture agreement with a foreign company prior to making any form of investment. Under this agreement, the parties may or may not agree to share profits.
The following are allowed to make an investment in a joint venture:
A Partnership which is defined under the Indian Partnership Act, 1932;
A Limited Liability Partnership is defined under the provisions of the Limited Liability Partnership Act, 2008;
Any other entity which is permitted to make this investment as per the instructions of the RBI; and
A group of entities when making overseas direct investment, then all the entities would be termed as an Indian party.
The above entities are permitted to invest in a joint venture under the ODI route.
An investment is also called a financial commitment. Financial commitment can be understood as a contribution to the equity or 100 percent of the amount of guarantee or 50% of performance guarantee. This commitment is provided by the Indian party to the overseas joint venture.
What is prohibited under ODI?
The following investments are prohibited under the system of overseas direct investment:
Investment in real estate sector; and
Investment in the banking sector.
The above prohibitions on investment do not apply to construction of townships and development of residential areas.
Permission from RBI
As per the Foreign Exchange Management Act, prior permission is required from the RBI to invest in a joint venture. An Indian company has to take permission for acquiring foreign securities in a JV or WOS. General permission is granted by the Government of India for purchasing shares and securities in foreign JV.
The following methods are used to purchase foreign securities:
Foreign Securities can be purchased through funds present in the resident foreign currency account.
Foreign Securities can also be purchased through bonus issues.
Investment made by a person who is not a resident of a foreign country can invest through their foreign resources
Foreign Securities acquired as a gift from a person resident in India from a person outside India.
Acquisition of shares through the mode of inheritance.
Securities that are repurchased by a foreign company from a resident Indian under the ESOP scheme.
What are the provisions for ODI in a Joint Venture?
The following are the provisions for Overseas Direct Investment in a Joint Venture:
Investments made in Nepal must be only in Indian Rupees.
Investments made in Bhutan are allowed in Indian Rupees as well as Freely Convertible Currencies. If investments are made in freely convertible currencies, then they can be sent back (Repatriated) to India.
Investments made in countries under the radar of the Financial Action Task Force (FATF) are not allowed. Directions regarding these countries are provided by the RBI.
Investments which are made in Pakistan are subject to prior approval from the Government of India.
Investments in the oil sector are permitted under the automatic route. However, such investments require approval from the prescribed authority.
Overseas Direct Investments can be routed through a Special Purpose Vehicle (SPV). However, the Indian entity must not be subject to any form of criminal proceedings by a regulatory body. If the Indian entity is subject to criminal or enforcement proceedings, then the party has to seek approval under the approval route.
An Indian entity which is making investment in the financial services sector is subject to the following conditions:
The entity in India must be registered with the relevant financial services authority in India.
Net profit must be earned from three previous financial years from conducting financial services activities.
Prior approvals are required from financial services authorities in India and the foreign market before carrying out the activities.
The entity has fulfilled the capital requirements and the prudential norms as required by the concerned Indian regulatory authority.
Investments can be made by an Indian company in the portfolio of equity securities of the foreign company. Investments under this method can be made up to 50% of the net worth from the last audited balance sheet.
Mutual funds which are registered under Securities Exchange Board of India (SEBI) can make investments as per the directions under FEMA. However, such investments have an overall cap of USD 7 Billion.
Capitalization against the export dues, bills, and royalties can be carried out by the Indian Party. Capitalization is allowed for supply of research and development (R & D), Technical Know How and other services with the respective ceiling rates applicable.
Where there is some form of equity participation between the Indian Entity and the overseas joint venture, a loan or guarantee can be provided. The Loan/ guarantee is provided by the Indian entity to the foreign joint venture. If there is no form of equity participation between the parties, then prior approval is required from the Government of India.
Investment can also be carried out by way of swap of shares. Valuation has to be carried out for a swap of shares.
The valuation is carried out by a registered SEBI Merchant Banker. The principles of valuation have to be under the international norms of valuation. Prior approval would be required from the government for carrying out this method.
An investment can be done by a partnership firm in a Joint Venture. However, the investment must be held by the partners of the firm. The partners should hold the investment on behalf of the firm. The investment would only be allowed to be held if the regulations in the host country allow them to.
The Indian party can also acquire shares of the foreign company in exchange for ADR and GDR issued under the Foreign Currency Convertible Bonds and Ordinary Shares through (Depository Receipt Mechanism) Scheme, 1993.
Other applicable conditions for investment
Apart from the above forms of investment, the Indian party has to satisfy certain specific conditions:
The Indian entity must not be in the exporters caution list or having any form of legal proceedings against it. The proceedings must not be against the Indian Party.
The transactions and remittances must be routed through the Authorised Dealer. While conducting several transactions, the Authorised Dealer must inform the Indian party regarding the transaction.
If the investment is more than USD 5 Million, the valuation must be carried out by a SEBI registered merchant banker. The valuation must be according to international standards and must be done by a chartered accountant of the host country or a certified public accountant.
Pledge of Shares by the Indian Party
A charge can be created by an Indian party by pledging the shares of the Joint Venture/ Wholly Owned Subsidiary/ Step down Subsidiary outside India. Such pledge would be held as a security on behalf of the authorized dealer. The pledge can be used by the Indian party for availing fund based and non fund based activities for itself. The pledge can also be used for the joint venture or wholly owned subsidiary or the step down subsidiary.
The following conditions have to be satisfied for creating a pledge:
The fund based and non fund based activities carried out by the Indian entity is the financial investment carried out by the Indian Party. The investment must be according to the sectoral caps of the RBI.
If the facility is taken from the foreign market, then the same has to be supervised by a bank.
This is also subject to additional terms and conditions as per the RBI.
Sources of Funding for ODI in a JV
Under the automatic route, an investor can use the below sources of funding the investment:
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.
Compliances required to be filed for carrying out the investment
Approval from the RBI would be required. Along with Form ODI, the Indian Entity must provide the requisite documentation. The form must be submitted through the authorized bank.
Are Individuals allowed to Invest in JV through Overseas Direct Investment?
A resident individual would come under the meaning of an Indian party. Therefore, a resident individual can invest in foreign-owned joint ventures. 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 (LRS), which is USD 250000.
Overseas Direct Investment must be differentiated from Foreign Direct Investment. Eligible entities can make an investment in foreign JV/ WOS through the overseas direct investment route. An Indian entity before making an investment must follow the compliances applicable to the investment. The eligible entities allowed to make an ODI are partnership firms defined under the partnership act and LLP act. ODI is not limited to entities, but it is also applicable to resident Individuals. Individuals can make an investment of up to USD 250000 under the liberalized remittance scheme.
Varun Hariharan has completed the Legal Practice Course from BPP Law School, Manchester. He has a Masters in Commercial and Corporate Law from the Queen Mary University of London and LLB Honours from Bangor University, UK. He specialises in law related to corporate, artificial intelligence and technology law.