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Successes and failures in the RBI’s draft regulation, 2021 governing overseas investments

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The Reserve Bank of Indias (RBI) Draft Rules / Regulations, 2021 on Overseas Investments and Non-Debt Instruments Overseas Investments have an interesting bearing on the standards governing business.

Financial commitment

A condition for making financial commitments on behalf of a foreign entity is that the Indian entity has made equity investments and has also acquired control of those foreign entities. This could pose problems in cross-border transactions, as certain circumstances in a merger and acquisition / joint venture transaction might require stakeholders to agree to provide financial support and commitment to the business. For example, for an Indian stakeholder who owns a significant stake in the business but does not control it, the inability to make a financial commitment may be a cause for concern.

To calculate the financial commitment limit, the considerations are: investment in the share capital of foreign entities; lending or investing in debt securities issued by the arm’s length foreign entity; and collateral commitments, including corporate guarantee / performance guarantee / personal guarantees and bank guarantees, as well as the pledge or charge on the assets of Indian entities. With regard to guarantees, it is specified that personal guarantees will count for the financial commitment of Indian entities; and where a guarantee is invoked, to that extent it will be considered a loan and not an unfunded commitment.

ODI and OPI defined

Foreign direct investment (ODI) is defined as the acquisition of equity in an unlisted foreign entity, or the subscription to a memorandum of association of foreign entities, or the investment in 10% or more of the paid-up share capital of a listed foreign entity, or where the Indian investor has or acquires control, directly or indirectly, in the foreign entity.

Overseas portfolio investment (OPI) means an investment, other than ODI, in foreign securities, including units of exchange-traded funds and certificates of deposit that are listed on a recognized stock exchange outside the United States. ‘India, but not in securities issued by a person resident in India (other than an IFSC).

While the ODI is taken into account in the financial commitment, the OPI is not included.

An Indian resident may make or hold investments abroad through the acquisition of private equity shares, qualifying shares or shares / interests under an ESOP, and such an acquisition will be treated as an IPO if the shares / interests acquired by such an individual do not exceed 10% of the paid-up capital / shares of foreign entities.

Price standards governing investments abroad

Any issuance or transfer of foreign capital from (i) a person residing outside India to a person residing in India, or (ii) a person residing in India to another person residing in India, or (iii) a person residing in India to a person residing outside India will be subject to pricing standards. In the case of listed foreign securities, the price must be in accordance with the stock exchanges of the host countries concerned. In the case of unlisted foreign securities, the price should be within 5% of fair value obtained on an arm’s length basis, in accordance with any internationally accepted pricing methodology. The appraisal must be certified by an appraiser registered in accordance with the Companies Act 2013 or by an appraiser registered with the regulatory authority of the host jurisdiction to the satisfaction of Bank AD (authorized dealer), and the certificate must not be older than six months. before the date of the transaction.

Good faith and non-evasion test

The draft regulations stipulate that any investment made by a person resident in India must be made in a foreign entity carrying on business in good faith, either directly or through a resigning subsidiary. Good faith business activity is defined as any legally permitted business activity both in India and in the host jurisdiction.

It is also clarified that a financial commitment of Indian residents in a foreign entity which has invested or is investing in India and which is designed for tax avoidance / tax evasion purposes at the time of making such financial commitment, or at any time by following, either directly or indirectly, is not permitted, and any violation of this rule will be considered a serious violation.

A combined reading would confirm that when the investment is in good faith and is not designed for tax evasion / avoidance, there will be no general circumvention issues.

Gifts

An Indian resident can acquire an overseas investment without limitation by way of inheritance from a person residing in India or a person residing outside India. However, such a gift from a person residing outside of India is only permitted if that person is a relative as defined, and subject to the stipulated limit, by the RBI.

The road ahead

The regulatory framework proposals indicate that the RBI intends to promote the ease of doing business. Once finalized and notified, these regulations should help all stakeholders to structure their investments and related matters with greater clarity and certainty.



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