Foreign Investment in India & Compounding Some Issues for consideration By Neeta Behramfram RBI, New Delhi.

Foreign Investment in India&

Compounding

Some Issues for consideration By Neeta Behramfram

RBI, New Delhi

BASICS

• What is Foreign Investment ?• Why Foreign Investment ?• Types of Foreign Investment

i) Foreign Direct Investment- Strategic long term relationship or lasting interestii) Foreign Portfolio Investment- Higher returns

Legal and Regulatory framework

• Foreign investment in India is governed by of Section 6 (3) of the Foreign Exchange Management Act, 1999, which covers Capital Account Transactions.

• Regulations - Notification No. FEMA 20/2000-RB dated May 3, 2000 covers the aspects relating to Foreign investment in India.

• prescribes the mode of investments i.e. manner of receipt of funds, issue of shares / type of instruments and reporting of the investments to the Reserve Bank.

– – Press Notes– Press Releases– Clarifications

Circulars

• RBI issues notifications and AP (DIR Series) circulars from time to time which the procedural and operational aspects.

• These generally follow the changes made in the FDI policy or the procedural changes to be brought in.

FDI Policy

• Foreign Direct Investment (FDI) in India is governed by the FDI Policy announced by the Government of India and the provisions of FEMA) 1999.

• Consolidated policy announced by Dept. of Industrial Policy and Promotion (DIPP), Ministry of Commerce and Industry – on 31st March and 30th September

• Last policy annoucement on 31.1.2011 effective from 1.4.2011

FDI Policy 2011

Three new issues• Convertible instruments – the conversion cn

be based on a formula decided upfront• Pre-incorporation expenses can be capitalised

with approval from FIPB• Import dues can be capitalised by companies

not in SEZs with approval from FIPB.

FEMA 20

The six schedules of the FEMA notification No. 20 dt.3.5.2000 prescribe the mode of investments by different class of investors and the reporting to RBI. Schedule 1 Foreign Direct Investment by personsresident outside India. The reporting requirement under para 9(1)(A) and 9 (1)(B) of Schedule 1

• 1 "

Schedules Schedule 2

• Foreign Portfolio investment by FIIs registered with SEBI.

• Reporting to RBI by SEBI on a daily basis.

Schedule 3

Investment by NRIs on a Stock Exchange in India under Portfolio Investment Scheme.

SchedulesSchedule 4• Investment by NRIs on Non-Repatriation

basis.• No reporting to RBI in FCGPR

Schedule 5• Other investments (G-Sec, NCDs, etc) by

FIIs and NRIs

Schedules

Schedule 6• Foreign Venture Capital Investments (SEBI

registered) in IVCF/ IVCU • RBI permission for opening of special accounts

with designated AD Cat. I bank• Concessions regarding pricing, compliance

with Press Note 1 of 2005• Reporting to Central Office through Custodian

Bank

Reporting of inflow

• Under para 9 (1) (A) of Schedule 1• Through AD Cat I bank within 30 days from

date of receipt of inward remittance by normal banking channel / debit to NRE/FCNR account

• In prescribed format along with FIRC and KYC report on remitter / investor

• Purpose of remittance in FIRC• UIN is allotted

Allotment of equity instruments

• In terms of AP (DIR Series) circular No. 20 dated 14. 12.2007, time limit of 180 days from the date of receipt of inward remittance for allotment of equity instruments against all remittances pending allotment for less than 180 days as on 29.11.2007 and those received subsequently.

• Non-allotment within 180 days / allotment after lapse of 180 days without RBI approval – contravention of Para 8 of schedule 1 of FEMA 20

Reporting of allotment

• In form FCGPR within 30 days from date of allotment through AD cat.I bank

• Along with Fair valuation certificate from CA• Certificate from CS in stipulated format• Copy of FIPB appoval, if under approval route• In case of allotment against inflow received

prior to June 1, 2008, FIRC and KYC

FCGPR

• Complete in all respect• Correct NIC code• Post issue share structure must tally for un-

listed companies• UIN for inflow• Declaration part of FCGPR – Press Note 1 of

2005, SSI unit, rights issue, bonus issue

FCGPR

• Real estate development – Undertaking regarding compliance with Press Note 2 of 2005.

• In cases of merger/amalgamation – No inflow, Copy of Court order required which would give

the ratio for allotment. • Conversion of ECB– no inflow reported to

Regional Office – but FCGPR filed with RO along with CA certificate and copy of ECB returns submitted to Central Office, Mumbai.

Issues for clarification

Investment under Schedule 4

• Whether an NRI, under Sch. 4 of FEMA 20, can invest in Multiple Brand Retail trading, Lottery, Gambling/Betting etc. as well ?

• Whether any reporting / compliances requirements under Sch. 4 of FEMA 20 ?

Issues for clarification• Whether FC-TRS formalities shall be required for

transfer of shares from Resident to Non-Residents when the shares transferred shall be held by the Non Resident on Non-Repatriation basis? Consideration shall be paid by the Non Resident from his NRO account.

• Once a resident goes out of India for uncertain period, his/her Indian account is automatically termed as NRO Account. If the NRI makes investment out of this NRO account, will it be treated as FDI and called for compliance of FC-GPR etc.

Issues for clarification

Intimation to RBI for inward remittance - Can intimation to AD be made from a designated Bank / Branch (handling FC-GPR) which is different from receiving Bank / Branch?Filing of FC-GPR - Can consolidated form be filed through a Bank/Branch consolidating all remittances received by different Banks / Branches of same Bank?

Reporting to RBI

Time limit of 30 days under para 9 (1)(A) and 9(1)(B) of Sch. 1 to FEMA 20 i.e. intimation of receipt of funds/Form FC-GPR at RBI Regional office or at AD.

• Is there any relaxation in genuine cases of delay by AD forwarding papers to RBI?

Utilisation of FDI funds & refund

• In cases where money is utilized and thereafter refunded within 180 days from the date of receipt of the inward remittance, whether this would mean temporary funding by foreign investor/collaborator in contravention of ECB guidelines.

• Are there any reporting requirements when refund is made?

Issues for clarification

• An engineering consultancy services company has been awarded a turnkey contract for erection of a plant. While reporting in FC GPR, how the same should be dealt with as Services and Turnkey Erection Contract may fall in different NIC Codes?

• If an NRI makes investment out of NRE account, what will be the position?

Query• Whether a Section 25 Company limited by

Shares (not for Profit Company) and carrying out activities akin to consultancy in social sector can issue shares under Automatic Route or under Approval Route?

Queries• Whether a Company who was granted approval to

set up an IT project some 11 years back by FIPB/ SIA also need to file Annual Return of Assets & Liabilities each year by July 15?

• Does the merger of an overseas wholly owned subsidiary (no shares would be issued to overseas entity/shareholders post merger) with its Indian parent require any prior approval from RBI?  The overseas entity, as part of its assets, holds investment in Indian companies, cash and intangibles and does not hold any immovable property overseas.

Queries - Rights Shares

• Whether non-existing non-resident shareholders allowed to apply for issue of additional shares / convertible debentures / preference shares over and above their rights share entitlements?

• Is it possible for unlisted private/public entities to allot additional allocation to the non-resident investor/collaborator of unsubscribed portion of rights issue belonging to the promoters group, where the price of shares offered on rights basis is much below the pricing guidelines/ norms of RBI/SEBI?

Queries - Rights Shares

• The price of shares offered on rights basis by the Indian company to non-resident shareholders in the case of shares of a company not listed on a recognised stock exchange in India, shall be at a price which is not less than the price at which the offer on right basis is made to the resident shareholders. Then why RBI insists on valuation certificate as per DCF? Can the shares be allotted for less than the DCF value?

Transfer of Securities• W.e.f. October 2004, general permission fo

transfer of shares from Resident to Non Resident (except in financial services sector, investment under Approval route and OCBs)

• Gen. Permission for transfer by way of sale or gift from NR to Resident

• Gen. Permission for transfer from NRIs to NRIsReporting in FCTRS within 60 days for above

transfers.• Gen. Permission also for NR (other than NRIs/

OCBs) to NR - No reporting in FCTRS

Issues for clarification

• Can a NRI residing in US sell shares of an Indian software company to a US Citizen or a US Company without taking prior approval of RBI and retain sale proceeds abroad?

• Can a Resident Indian sell shares of an Indian software company to a US Citizen or a US Company without taking prior approval of RBI?

Basics - OCB

• Overseas Corporate Bodies (OCBs) - a company, partnership firm, society and other corporate body owned directly or indirectly to the extent of at least sixty per cent by Non-Resident Indians and includes overseas trust in which not less than sixty per cent beneficial interest is held by NRIs

• OCBs have been de-recognised as a class of investors in India with effect from September 16, 2003.

OCB

Erstwhile OCBs which are incorporated outside India and are not under adverse notice of RBI can make fresh investments (including on rights basis) as incorporated non-resident entities - • with the prior approval of Government of India if

the investment is through Government Route• with the prior approval of Reserve Bank if the

investment is through Automatic Route.

OCB

• However, no permission required for issue of bonus shares.

• For disinvestment by OCBs – permission of RBI required to open NRO account to credit sale proceeds.

• Prior permission required even for transfer of shares.

Issues for clarification

• Can a NRI sell shares of an Indian software company to an OCB without taking prior approval of RBI?

• Can an OCB sell shares of an Indian software company to a US Citizen or a US Company without taking prior approval of RBI?

Issues for clarification Creating voting rights disproportionate to shareholding

(differential voting rights): Ownership by ‘non-resident entities’ is defined in relation to the equity interest which is beneficially owned by the non-residents; and not as per voting rights. Unlisted public and private companies have created structures in sectors under automatic route like minimum capitalization (NBFC and Real Estate) and Telecom sector up to 49%, wherein differential voting shares with different nominal amounts have been used to attract lower voting rights but with dis-proportionate higher paid-up share values thereby misrepresent actual beneficially interest.

• Is this permitted or are there any checks at RBI to flag such structuring?

Issues for clarification• FDI in the Insurance sector, as prescribed in the Insurance Act,

1999, is allowed under the automatic route. This will be subject to the condition that Companies bringing in FDI shall obtain necessary license from the Insurance Regulatory & Development Authority for undertaking insurance activities. The Insurance Regulatory & Development Authority (Insurance Brokers) Regulations, 2002 prescribe a cap of 26% for foreign investment for licensing of the activity. The Insurance Regulatory & Development Authority (Licensing of Corporate Agents) Regulations, 2002 has no restrictive clause on foreign investment.

• Whether ‘Insurance sector’ would include the ‘Insurance Broking’ and the ‘Insurance Corporate Agents’? And FDI % caps/norms for each one of them?

Issues for clarification

• Whether downstream investments can be made by Indian companies (with FDI) in unincorporated joint venture Special Purpose Vehicle e.g. partnership firm, AoP (prevalent in real estate and infrastructure businesses)?

Issues for clarification

• Why does a subscriber to Memorandum of Association called for chartered accountant’s certificate by DCF method, when any way that has to be at face value?

• Is it possible for unlisted private/public entities to allot additional allocation to the non-resident investor/collaborator of unsubscribed portion of rights issue belonging to the promoters group, where the price of shares offered on rights basis is much below the pricing guidelines/ norms of RBI/SEBI?

Query - pricing

• Recent example in public domain being JT International India Pvt. Ltd. engaged in manufacture of cigarette, a prohibited sector, which on 25.03.2010 allotted 100,00,000 equity shares to JT International Holding BV, Netherlands @ Rs. 299 per shares; and on the same date, allotted to Indian Resident 100,00,000 equity shares @ Re. 1 only (without any premium). The shares were neither allotted on ‘Rights Issue basis’ nor as ‘Private Placement/ Preferential Allotment’.

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• Another example is a company engaged in Private Security Agencies to which the Private Security Agencies (Regulation) Act, 2005 apply, reduced foreign paid-up share capital from 100% to 49% by issuing shares on March 30, 2010 to three Indian companies owned by lawyers/consultants advisors to the said Company by issuing shares at par nominal value of Rs. 10 each whereas book value as per last audited accounts as on March 31, 2009 was Rs. 2042 and earnings per share of Rs. 72 per share. The new shares are to rank parri-passu with existing shares. The shares were allotted on ‘Private Placement/ Preferential Allotment’ basis.

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• Recently in an approved single brand retail case with 51% FDI, the Indian JV partner was a private limited company owned by an advocate advising the foreign investor. 51% shares were allotted to foreign investor at a premium of Rs. 182 whereas the Indian JV partner was allotted at par value of Rs. 10 each share. The company has four foreign national directors i.e. controlled by foreigners/entity. Interest free unsecured has been provided by the foreign investor. In reality Indian JV partner is dormant.

How does RBI look into these cases from valuation and Policy perspective?

Procedural aspects

• Is there a procedure for issue of Duplicate FIRC? Is it possible to amend the purpose of inward remittance in FIRC to reflect true intend post issue of original FIRC by Bank?

• In case of inconsistencies between the Master Circular dated July 01, 2011 issued by RBI vis-à-vis the Consolidated FDI Policy Circular 1 of 2011 dated March 31, 2011; which one will prevail:i) Sector-specific policy under FDI Circular over Master Circular, andii) Procedures and specific requirements for RBI approval under Master Circular over FDI Policy.

Other issues

• What are the consequences if an Indian software company has shown foreign currency in hand in its Balance Sheet at the close of the financial year which were returned by its employee on returning back from foreign travel?

• If an Indian company is a part of a group of companies, adjustment of amount receivable/payable within the group.

Other issues

• An Indian Company has been awarded turnkey project in US by an Offshore Company. Supply of components and engineering services will be provided by Offshore companies in US and in other foreign jurisdictions. Consideration shall be paid both in forex and INR. How to repatriate the funds to Offshore companies for supply of components and rendering engineering services overseas directly?

Compounding of contraventions

What does it mean?

• Settle an offence committed by the contravener through imposition of a monetary penalty without going in for litigation after the contravener acknowledges having committed the contravention

Compounding of contraventions

• The procedure for compounding of contraventions under FEMA, 1999 have been framed with a view to provide comfort to the citizens and corporate community by minimizing transaction costs, while taking severe view of willful, malafide and fraudulent transactions.

Nature and scope

The nature of contravention is ascertained keeping in view the following indicative points

a) whether the contravention is technical and / or minor in nature

b) whether the contravention is serious in nature and

c) whether the contravention, prima facie, involves money-laundering, national and security concerns involving serious infringement of the regulatory framework.

Contraventions

• Delay in submission of returns /statements to Central Office, Mumbai like i)Indian Company issuing shares under ADR /

GDR Scheme ii) Annual Activity Certificate by Branch Office iii) APR - Annual Performance Report (APR) on

the functioning of Indian Joint Venture (JV) /Wholly Owned Subsidiaries (WOS).

Contraventions

• Delay in submission of returns/statements to RO like i) Inflow of share application / subscription money. ii)Reporting of issue of shares by the company to a Person Resident outside India. iii)Annual Activity Certificate by Liaison Office/Project Office.

Contraventions

• Cases of contravention involving – Money Laundering, – national security concerns, – Involving serious infringements of the regulatory

frame work, – the cases where the cases for compounding have not

been filed within the stipulated period in the memorandum issued by RBI

Will be referred to under Section 37 of FEMA to DoE or to the Anti-Money Laundering Authority instituted under the PMLA, 2002.

Compounding

• Contraventions relating to any transaction under FEMA but requiring approval or permission from the Government Department concerned or any Statutory Authority as the case may be, would not be compounded UNLESS the required approval is obtained from the authorities concerned.

Compounding

• An application for compounding of a contravention to be submitted to the Compounding Authority either on being advised of a contravention through a memorandum or suo moto on being made or becoming aware of the contravention.

Penalty

The following factors, are taken into consideration for arriving at the quantum of penalty –the amount of gain of unfair advantage,

wherever quantifiable, as a result of the contravention.

the amount of loss caused to any authority / agency / exchequer ;

economic benefits accruing to the contravener from delayed compliance or compliance avoided

Penalty

the repetitive nature of the contravention, the track record and / or history of non-compliance of the contravener

contravener’s conduct in undertaking the transaction and disclosure of full facts in the application and submissions made during the personal hearing and

any other factor considered relevant and appropriate

Quantum of penalty

• up to thrice the sum involved in such contravention where the amount is quantifiable

• up to Rupees Two lakh, where the amount is not quantifiable

• where the contravention is a continuing one, further penalty which may extend to Rupees Five thousand for every day after the first day during which the contravention continues (Section 13(1), Chapter IV of FEMA,

Compounding

Foreign Direct investment:1. Filing of report beyond 30 days of receiving foreign remittance

2. Filing of Form FC-GPR beyond 30 days of allotment of shares

3. Filing of Annual Report of Assets & Liabilities by July 15

4. Filing of Form FC-TRS after 60 days for transfer of shares from resident to non-resident and vice-versa

5. Allotment not made within 180 days; either refund or allot shares and then approach for compounding

Compounding

Overseas investment:1. Report to RBI after 30 days regarding post-investment

changes in JV/WOS aboard

2. Filing evidence with RBI regarding investment abroad-after 6 months of making the investment.

3. Filing of Annual Performance Report after 60 days of finalization of accounts of the JV/WOS

Other than Procedural lapses4. Cases falling under Financial Services sector

5. Overseas regulatory approval not obtained

General:1 Loan taken by a resident individual from an NRI

relative on non-repatriable basis.2 Loan taken by an entity in India from an NRI on non-

repatriable basis-where the NRI and persons holding at least 51% of the share in the Indian entity, are relatives.

3 If an Indian company is a part of a group of companies, adjustment of amount receivable/payable within the group.

ECB1 1. ECB 2 not filed/delayed2 2. End use whether satisfied3 3. Eligible lender4 4. Drawal of loan before registration number is

allotted

Non Quantifiable contraventions

1. Liaison office continuing beyond approved period2. Liaison office carrying activities which are permitted for LO –

First convert into Branch office and go for compoundingQuantifiable contraventions1 Liaison office received remittances post expiry of approval date   Not CompoundableODI investment routed back to India as FDI – Round trippingProhibited sectorUnwinding the transactions in cases where such transactions are not permissible under FEMA, 1999 before Compounding

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