Ease of Investing in Foreign Countries: An Analysis of the ODI Rules and Regulations 2022

Dia Shetty

Associate, GameChanger Law Advisors 

Gauri Sainath 

Associate, GameChanger Law Advisors

 

Introduction

The Government of India in consultation with the Reserve Bank of India (“RBI”) has notified the following rules and regulations relating to Overseas Direct Investment (“ODI”) in order to provide a simplified legislation of the existing framework for overseas investment and promote ease of doing business and partaking in overseas transactions:

1.  The Foreign Exchange Management (Overseas Investment) Rules, 2022 (“ODI Rules”);
2. The Foreign Exchange Management (Overseas Investment) Regulations, 2022 (“ODI Regulations”); and 
3. The Foreign Exchange Management (Overseas Investment) Directions, 2022 (“ODI Directions”) (collectively referred to as “ODI Laws”).

In light of this, this note seeks to highlight the key changes that were brought about by the ODI Laws and its impact on Indian entities. The first part of the note deals with key definitions that have been introduced by the ODI Laws. The second part deals with the general rules governing ODI, how an ODI can be made and the restrictions thereof. In the third part of this note, the authors provide their own analysis of the ODI Laws, and relating to this part, the authors then provide recommendations in order to avoid further confusion of these provisions, in the fourth part of this note. 

I. Key Changes brought about by the ODI Laws

A. Introducing Key Definitions 

 

S.No.	Term	Explanation
1.	Foreign Entity	In the previous regime, Indian parties were only permitted to extend a loan or guarantee to or on behalf of a foreign joint venture or a wholly owned subsidiary. These concepts have now been substituted with the term ‘foreign entity’, thereby now expanding the scope of entities that Indian parties can make an ODI in. A foreign entity refers to entities formed, registered or incorporated outside India.
2.	Control	Control means: the right to appoint majority of the directors; to control management; or  control policy decisions that are exercisable by a person, by virtue of their: (a) shareholding; (b) management rights; (c) shareholders’ agreements; or (d) voting agreements, that entitle them to 10% or more of voting rights or in any other manner in the entity.
3.	Subsidiary and Step-Down Subsidiary	Subsidiary or a step-down subsidiary means an entity in which the foreign entity has control.
4.	Overseas Direct Investment (“ODI”)	ODI means investment by way of: acquisition of unlisted equity capital of a foreign entity; subscription as a part of the memorandum of association of a foreign entity; investment in 10% or more of the paid-up equity capital of a listed foreign entity; or investment with control where investment is less than 10% of the paid-up equity capital of a listed foreign entity.
5.	Overseas Portfolio Investment (“OPI”)	OPI refers to any investment other than ODI, in foreign securities. Essentially, an Indian entity can make an OPI in a foreign entity in which the Indian entity owns less than 10% of equity.

 B. General Rules Governing ODI

1. Which Indian party can make an ODI? Do all ODIs require prior approval from the RBI or the Central Government?

 An ODI can be made by: a) an Indian entity, b) a resident individual, c) registered Trust or society, or d) mutual funds, venture capital funds or alternative investment funds. An Indian party can only make an ODI in a foreign entity carrying bona fide business activity, permissible under Indian law and the host country. An ODI can be made through either of the two routes:

i. Automatic Route: Indian parties do not require any prior permission/approval from the RBI or the Central Government for making ODI in a foreign entity.

ii. Approval Route: For specified overseas investments, Indian parties are required to present their proposal to their designated Authorized Dealer (“AD”), after which the RBI or the Central Government, as the case may be, shall scrutinize the proposal, specific recommendations of the designated AD bank along with supporting documents.  

2. Is an Indian party required to obtain permission from the Central Government before making an ODI in certain countries?

The ODI Rules specify that any ODI being made in a foreign entity formed, registered or incorporated in Pakistan, and any other jurisdiction that may be advised by the Central Government, will require prior approval of the Central Government.

3. What are the restrictions in making an ODI in foreign entities?

Indian parties are restricted to make an ODI in any foreign entity that is engaged in (a) real estate; (b) gambling; and (c) dealing with financial products linked to the Indian Rupee without prior approval of the RBI.

4. Under what circumstances does a person resident in India have to obtain a ‘No Objection Certification’ (“NOC”)?

Any person resident in India who (a) has an account appearing as a Non-Performing Asset; or (b) is classified as willful defaulter; or (c) who is under investigation by a financial sector regulator/ investigative agency is required to obtain an NOC. 

This has to be done through a written application from the lender bank, regulatory body, or investigative agency. If such Authority does not furnish the certificate within 60 (sixty) days, then it is presumed that there was no objection. This NOC provision has been inserted for the benefit of ensuring that the investigation taking place in India is not negatively impacted by such Indian investors remitting funds in foreign entities. 

5. Can an ODI be made in start-ups?

ODI in start-ups have to be made from internal accruals from the Indian entity/group/associate companies in India and in regard to resident individuals, from the own funds of such individuals. Prior to the transaction, the AD Bank has to obtain a certificate in relation to this from the statutory auditors/chartered accountants of the Indian investor.

6. Can a person resident in India acquire immovable property outside India?

Yes, a person resident in India can acquire immovable property outside India without prior permission of the RBI provided it is on a lease basis for not more than 5 (five) years. Further, acquisition of immovable property outside India can take place out of the income or sale proceeds of the assets, other than ODI, that have been acquired overseas.

7. What is the eligibility for ODI other than through equity capital?

As per the new ODI Regulations, an Indian entity may lend to, invest in, or extend non-fund-based commitments in any debt instrument issued by a foreign entity provided that: 

i. It is eligible to make ODI;

ii. It has acquired control of such foreign entity; and

iii. The ODI has been made in the foreign entity.

Further, the interest rates should be determined on an arm’s length basis.

8. What are the pricing guidelines stipulated as per the ODI Laws?

The price ascertained on an arm’s length basis shall be used for the issue or transfer of equity capital of a foreign entity from: a) a person resident outside India or a person resident in India to a person resident in India who is eligible to make such an investment, or b) a person resident in India to a person resident outside India.

9. What are the obligations of a person resident in India in respect to making an ODI?

 The following are the obligations of the Indian investor making an overseas investment: 

i. Submit bank share certificates or any other relevant documents as per applicable legislation of the host country to the AD, as evidence, within 6 (six) months from the date of effecting remittance or the date on which the dues are capitalized or the date on which the amount due was allowed to be capitalized. 

ii. Obtain, from a designated AD Bank, a Unique Identification Number (“UIN”) from the RBI for the foreign entity in which the ODI is intended to be made prior to sending outward remittance or acquisition of equity capital in a foreign entity, whichever is earlier.

iii. Shall designate an AD bank and route all transactions relating to a particular UIN through such AD. 

iv. Shall repatriate to India all the dues receivable from the foreign entity, within 90 (ninety) days from the date when such receivables fall due or the date of transfer or disinvestment or the date of actual distribution of assets made by the official liquidator.

v. Shall make remittance towards earnest money deposit or obtain a bid bond guarantee from an AD bank for participation in bidding or tender procedure for the acquisition of a foreign entity.

10.What are the reporting requirements under the new ODI Regulations?

An Indian resident acquiring equity capital in a foreign entity or overseas direct investment is required to submit an ‘Annual Performance Report’ (“APR”) by the last day of December every year for each foreign entity.

This APR requirement will not apply in situations when a) an Indian resident holds less than 10% of the equity capital in foreign entity without exercising control, b) there are no other financial commitments besides equity capital, or c) a foreign entity is in the process of being liquidated.

11. What happens in case there is a delay in reporting?

The Indian investor will have to pay a late submission fee in the event that the reporting is delayed. This submission may be used for a maximum of 3 (three) years following the submission or filing date. 

12. Have the ODI Laws permitted round tripping without prior approval from the RBI?

To begin with, round-tripping relates to a situation that occurs when an Indian party invests in a foreign entity, that has already invested in India. Up until the ODI Laws, the RBI previously clarified that such transactions would fall under the category of the ‘Approval Route’. 

The RBI has now taken a more liberalized approach, as the new ODI Rules have permitted Indian parties to make such an investment without the prior approval of the RBI, provided that the entire structure does not result in more than two layers of subsidiaries. Thus, an Indian investor can now, either directly or indirectly, invest in less than 10% equity in a foreign entity, that already holds investments in India; provided it does not result in more than two layers of subsidiaries. 

13. Are deferred payments allowed under the new ODI Regulations?

Yes, the option of deferred payment option is now allowed for acquiring and transferring foreign securities without the approval of RBI.

14. How are roll-over guarantees treated as per the ODI Laws?

A Rollover Guarantee is an unconditional payment and performance guarantee that is executed by the Guarantor for the benefit of the Lender. The new ODI Laws stipulate that a rollover of a guarantee that does not increase the original guarantee’s value will not be regarded as a new financial commitment.

II. Analysis 

In relation to subsidiaries or step-down subsidiaries, these entities are also expected to comply with the structural requirements of a foreign entity, unless the foreign entity’s core activity is in the strategic sector. As a consequence, this means that the subsidiary or step-down subsidiary will have to be entities with limited liability, and must be formed, registered or incorporated outside India or an International Financial Services Center.

The changes brought about to the concept of round-tripping have raised more questions than answers. The restriction on the ‘two-layer’ subsidiary raised many concerns at the moment. The RBI has not clarified which level the layer is to be considered from- whether it should be counted from the foreign entity itself or begin from the Indian entity. Apart from that, there is an ambiguity as to whether the prohibition on multi layered structures includes those multi layered structures that are outside the Indian territory or not. If this restriction applies solely to the layers outside the India jurisdiction, then Indian investors may be permitted to have two layers of investments- one in the foreign entity and one of its step-down subsidiaries outside India, before investing back in India. Such a transaction would not require prior RBI approval. 

III. Recommendations:

Following our analysis above, we recommend that the RBI clarifies the following points in order to avoid any confusion around the ODI Laws:  

1. In relation to obtaining a NOC, the RBI should clarify whether a NOC should be obtained for the entire group in cases where this provision attracts a group company or an affiliate. 
2. Regarding the round tripping provision, the RBI should clarify the ambiguities around the ‘two-layer’ subsidiary restriction; as to which level the layer is to be considered from.  
3. Another clarification that is required is whether the prohibition on multi layered structures is inclusive of those multi layered structures that are outside the Indian territory.

IV. Conclusion 

The new framework has clarified ambiguities that were present in the previous framework. Additionally, certain transactions relating to overseas investment that were previously handled through the approved route have been switched to the automatic route, which will immensely help in the ease of doing business. With the introduction of the ODI Laws, the whole process of making an ODI by Indian parties has been liberalized, streamlined, simplified, and it has also significantly reduced the need of RBI and/or Central Government approvals. However, while the new framework will help in exponentially increasing the ease of doing business outside India, the above-mentioned recommendations need to be addressed by the RBI to avoid ambiguities in the ODI Laws.