Overseas Investment Rules Bring Round Tripping Relief, Commercial Flexibility; But Frown On Startup Bets


The finance ministry has notified the rules for overseas direct investment by Indian businesses and financial commitments they can make by way of debt, guarantees, pledges etc. The approach is broadly in line with the draft framework that was floated for consultation in August last year, with a few surprising twists.

Overseas direct investment stood at $1.41 billion in June 2022 compared to $3.43 billion in June 2021, as per the Reserve bank Of India’s data. Singapore, Mauritius, the U.S., the Netherlands and the U.K. are the top five destinations which receive investments from Indian entities, with financial, insurance, business services, manufacturing, and wholesale/retail trade as the top sectors of choice.

Here are the key changes to the way Indian businesses invest overseas:

As exists for inbound investments, numerical thresholds have been brought in to distinguish overseas portfolio investment from overseas direct investment. This is in line with the draft proposals.

As per the new framework, up to 10% equity in a foreign listed entity will qualify as OPI. More than 10% in a listed entity or any amount of equity investment in an unlisted entity will be seen as ODI.

Specifically, ODI has been defined as-

  • Investment of 10% or more of the paid-up equity capital in a listed foreign entity, or

  • Acquisition of control in a listed foreign entity. Control will mean the right to appoint majority of the directors, management control, 10% or more of voting rights etc, or

  • Investment in unlisted equity capital of a foreign entity, or

  • Subscription to the Memorandum of Association of a foreign entity.

Anything that’s not ODI, will be seen as OPI.

The key implication of the change is that any non-controlling investment of less than 10% made by Indian entities in foreign listed companies will not be counted towards the ceiling of 400% of net worth of the investing Indian entity which is otherwise applicable to strategic ODI investments under automatic route, Dhruv Singhal, partner at Cyril Amarchand Mangaldas, said.

The reference is to the provision that says an Indian corporate entity can make an overseas investment of up to 400% of its net worth, as per the last audited balance sheet, under automatic route.

An Indian entity investing in a foreign company which invests or already has investments in India is typically referred to as round-tripping. For any such investment, so far, prior approval was required from the Reserve Bank of India.

The language of the new rules suggests that a resident Indian can make such an investment without prior RBI approval as long as the entire structure doesn’t have more than two layers of subsidiaries, Moin Ladha, partner at Khaitan & Co., opined.

The provision says-

Illustratively, Ladha pointed out, an Indian entity ‘A’ can invest in a foreign subsidiary ‘X’ which can in turn invest in a subsidiary in India, without RBI approval. Of course, this needs to meet the conditions of bona fide business, he added.

This is a significant change, Singhal added, since there were regulatory challenges for Indian entities investing into overseas investments and joint ventures where the overseas company also had an India business downstream. ‘Whilst this remains a developing area, we see this as a very positive move which will greatly improve ease of doing business internationally for Indian companies’.

This has come on two fronts –

First, deferred payments have now been permitted for overseas direct investments, subject to certain conditions. For instance, seller must issue/transfer foreign securities equivalent to the amount of total consideration upfront; full consideration that has to be paid must be as per pricing guidelines, etc.

So far, if an Indian business was buying shares of an overseas entity, it had to pay entire consideration upfront. The new rules have made way for deferred consideration.

The second flexibility has come for overseas direct investments by way of swapping securities. So far, the language said swap of shares.

Previously, there was ambiguity on the extent and manner in which an Indian business could acquire shares in an overseas entity by paying for such investment by way of swap of securities.

Singhal said that as a thumb rule, this was being limited to swap by way of only fresh issue of equity shares of the acquiring Indian company. So, an Indian company, which desired to acquire shares of an overseas entity without paying cash consideration, could only do so by issuing its own equity shares, and was not allowed to instead transfer shares of another company already held by it, he explained.

Now, the scope of such swap deals has been broadened to “swap of securities”.

Indian businesses can invest up to 400% of their net worth overseas. The new rules take away this leveraging ability for investments in overseas startups. Now, investments in overseas startups can only be made from internal accruals.

The provisions says-

So far, an Indian business could invest both borrowed and own funds in capital abroad, Ladha pointed out. It seems the government doesn’t want Indian businesses to make these risky bets so far as startups are concerned, he added.

Besides these, the new rules also specify –

  • Overseas investments, in excess of the limits, can be made in strategic sectors like energy, natural resources etc. under approval route.

  • Conditions that need to be fulfilled before making financial commitments by way of debt, guarantees, pledge etc. Currently, an Indian entity is permitted to give loans or guarantee in favour of an offshore entity in which it has equity participation. Now, the threshold has been made stringent to say financial commitments can be given only in cases where the offshore entity is controlled by the Indian party.

  • An Indian non-financial sector entity can make direct investment in a foreign entity engaged in financial services (except banking, insurance), without prior approval. This was not permitted so far.


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