Regulatory Challenges in Downstream Investments by Foreign-Owned or Controlled Companies in India

Key Takeaways:

1. Introduction:

FOCCs are Indian companies owned or controlled by a foreign entity, and when they acquire equity instruments of another Indian company or contribute towards the capital of another Indian entity, it becomes a downstream investment.

2. Regulatory Hurdles:

Regulatory Gaps in Pricing: Ambiguities exist in the treatment of FOCCs as Non-Residents (NRs) from a pricing perspective and as Indian residents from a reporting perspective, leading to counter-intuitive application of pricing guidelines.

Regulatory Gaps in Filings: The NDI Rules do not specifically provide for filing requirements when FOCC acquires equity instruments from a resident or an NR, creating uncertainty in reporting obligations.

Investment in Optionally Convertible Preference Shares (OCPS) or Optionally Convertible Debentures (OCDs): The treatment of FOCC investments in OCPS or OCDs as downstream investments is unclear, especially upon their subsequent conversion to equity shares.

Applicability of the term “other attendant conditions”: The scope of “other attendant conditions” in the context of downstream investments needs to be construed restrictively to avoid imposing burdensome regulations.

3. Conclusion:

The bifurcated treatment of FOCCs concerning pricing and reporting guidelines underscores the necessity for uniformity in their treatment, especially regarding pricing regulations. Clarity and compliance are essential to avoid burdening FOCC investments with stringent conditions applicable to Foreign Direct Investment (FDI) in the case of downstream investments.

Synopsis:

“A Regulatory Conundrum on The Dual Treatment of Foreign-Owned Or Controlled Companies under Foreign Exchange Management Act, 1999 (FEMA, 1999)” addresses the challenges and ambiguities surrounding downstream investments in India, particularly focusing on the treatment of investments originating from Foreign Owned and Controlled Companies (FOCCs) under the Foreign Exchange Management Act, 1999 (FEMA, 1999) and the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019.

1. Introduction

Foreign Owned or Controlled Entities (FOCC) are Indian companies that have received foreign investment and are owned or controlled by a foreign entity. When FOCC acquires equity instruments of another Indian company or contributes towards the capital of another Indian entity, it becomes a downstream investment. The Foreign Exchange Management Act, 1999, and the rules and regulations made thereunder provide a regulatory framework for downstream investments. However, ambiguities continue to exist with regard to the treatment of FOCCs, particularly in the context of pricing guidelines and reporting requirements.

2. Regulatory Hurdles

A. Regulatory Gaps in Pricing

The document highlights the regulatory gaps in pricing guidelines, emphasizing the ambiguity in treating FOCCs as Non-Residents (NRs) from a pricing perspective and as Indian residents from a reporting perspective. This has led to counter-intuitive application of pricing guidelines, especially in cases where FOCCs acquire shares simultaneously from residents and NRs.

B. Regulatory Gaps in Filings

The NDI Rules do not specifically provide for filing requirements when FOCC acquires equity instruments from a resident or an NR, leading to uncertainty in reporting obligations. The absence of clear guidelines for transfers between FOCCs further complicates the reporting process.

C. Investment in Optionally Convertible Preference Shares (OCPS) or Optionally Convertible Debentures (OCDs)

The treatment of FOCC investments in OCPS or OCDs as downstream investments is unclear, especially upon their subsequent conversion to equity shares. The document emphasizes the need for clarity in defining ‘capital instruments’ and recommends considering investments in OCPS or OCDs as downstream investments, particularly upon their conversion to equity shares.

D. Applicability of the term “other attendant conditions”

The document discusses the term “other attendant conditions” and recommends construing its scope restrictively to avoid imposing burdensome regulations on downstream investments.

3. Conclusion

The document concludes by emphasizing the necessity for uniformity in the treatment of FOCCs, especially regarding pricing regulations. It underscores the importance of clarity and compliance to avoid burdening FOCC investments with stringent conditions applicable to Foreign Direct Investment (FDI) in the case of downstream investments.

FAQ:

Q1: How are FOCCs classified in the context of downstream investments?

A1: Depending on specific circumstances, FOCCs may be classified as Non-Residents (NRs) in certain contexts, while in most cases, they are regarded as Indian residents as per the prevailing Rules.

Q2: Are investments in Optionally Convertible Debentures (OCDs) of domestic entities considered as downstream investments?

A2: While the treatment of FOCC investments in OCDs is unclear, it is recommended to consider such investments as downstream investments, particularly when these debt instruments are converted into equity capital.

Q3: What is the significance of the term “other attendant conditions” in the context of downstream investments?

A3: The term “other attendant conditions” refers to generic conditions applicable in the context of foreign investment regulations, and its scope needs to be construed restrictively to avoid imposing burdensome regulations.