An observation done by the Reserve Bank of India (RBI) might change, and even derail, overseas direct investment (ODI) plans of several corporates. As per a set of ‘frequently asked queries’ on ODI released through the regulator a few months ago, no Indian corporation could acquire a stake in an offshore corporation which has investments in an Indian entity.
This shall be applicable even if an Indian corporation purchases an insignificant stake in an overseas corporation which in turn holds or picks a minority interest in another Indian corporation.
However it is intended at minimizing round-tripping of funds and cutting inflow of cheaper debt raised abroad in the form of foreign direct investment (FDI), the rule might impact genuine ODIs.
Though this was the unspecified regulatory stance, this is the first time where RBI has put it down in black and white. As per RBI, the requirements dealing with transfer as well as issue of any foreign security towards Residents do not permit an Indian party to set up Indian subsidiary through its foreign wholly-owned subsidiaries or JV nor does the provision permit an IP to obtain a wholly-owned subsidiaries or invest in JV that already has direct or indirect investment in India.
Even holding a single share is held to be as a JV. Under the circumstances, an Indian corporation purchasing as little as 1% or 2% equity in an overseas corporation under the automatic ODI route shall have to ensure that the offshore corporation doesn’t hold stake or makes no investment in another Indian entity (although it belongs towards a different business group).
Some sectors explain the local presence and have a bona fide business matter. There must certainly be a carve-out for such transactions subjected to fulfillment of set conditions. Also, this restriction must consider situations where the Indian investor has a minority holding and is not in a position in the direction of controlling the investment decisions of the overseas corporation.
It was stated that though the RBI has sought, through this clarification, towards restricting some overseas structures which were mainly set up to hold Indian assets, take advantage of beneficial tax rules while offshoring Indian wealth, the wording of the FAQ itself is unfortunate. Also, the RBI has, while trying to address round-tripping, has unintentionally compromised and called into question a number of prevailing bona fide corporate structures. Furthermore, through placing this as FAQ, and not a change in law, the RBI has also called into question past transactions. While the general intention of the RBI here is genuine, it was considered an overcorrection.
The restraint continues to be a part of the FAQ and is yet to figure in any RBI circular. However, for authorized dealers, mainly some foreign banks which favor a conservative interpretation, a FAQ is similar towards a regulatory directive. Indeed, following the FAQ, few banks (remitting the ODI) have sought after assurance or undertaking from Indian parties that the investor overseas corporations shall not invest in India. This is almost impossible if you are a small shareholder with no say in the target corporation. In a few cases, it could also impact foreign direct investment. For example, considering a group which has had success in overseas ventures and shall now like to invest some of its surplus in India? Such a regulatory stance can pose a problem.
However, the intention of RBI might be to allow ODI investments regardless of investment percentage only on a ‘strategic basis’ in which the Indian party has ‘control’ over the overseas corporation in which ODI has been made. The same appears to make certain that actions of the overseas corporation as well its downstream investments are inconsistent with ODI guidelines in terms of activities as well as reporting and ODI route is not been misused through minority stakes.
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