Laws on Indirect Foreign Investments in India: Lawyers Advice
When an Indian company having foreign investment is owned or controlled by a foreign entity, invests in another Indian company then such investment is called Indirect Foreign Investment or Downstream Investment. Foreign entities are permitted to invest in India either directly by way of Foreign Direct Investment (FDI) or indirectly by Indirect Foreign Investment. Such Indirect Foreign Investment can be carried out as an alternative to Foreign Direct Investment (FDI). Such investments must comply with the Foreign Exchange Management Act (FEMA) and the Securities and Exchange Board of India (SEBI) guidelines and must notify the Reserve Bank of India (RBI).
An important example of such indirect foreign investment could be with respect to the US based company Walmart, and its investment in Flipkart India. Walmart being a US company, invested in Flipkart India thus, having ownership in this E-Commerce entity. This Indian company having foreign investment further invested by way of a stock transaction in another Indian company called Myntra. This investment is called Indirect Foreign Investment where an eligible Indian entity having foreign investment, invests in another Indian company.
Indirect Foreign Investment is also sometimes called Foreign Portfolio Investment which is investing in financial assets such as stocks or debt instruments such as bonds of companies which are located in another country.
Some advantages of carrying out Indirect Foreign Investment are as follows:
1) The investor company can have more knowledge by understanding the local ways of carrying out businesses in the country.
2) Escaping from potential uncertainties in the investee company’s country.
3) Steep growth of the Investor company.
4) Managing the uncertainty and probable risks.
5) Greater flow of equity capital.
6) Enhanced competition in the marketplace in the investee company’s country.
Some disadvantages of carrying out Indirect Foreign Investment are as follows:
1) Government policies and restrictions on entering the market.
2) Cost of production of business entities could increase or relatively decrease due to economic and political conditions.
3) Problems of inflation.
4) A possible impact on exports to the investor country due to certain barriers imposed by the investee company’s country.
As per the recent FDI Policy, the guidelines for calculating the total Indirect Foreign Investment of a company are as follows:
1) Foreign investment through the Indian company investing in another Indian company would not be considered for calculating Indirect Foreign Investment in case the investing Indian company is owned and controlled by Indians citizens or Indian companies.
2) However, where the investing Indian company is either owned or controlled by a foreign entity, the entire investment by the company into the intermediate Indian company would be considered as Indirect Foreign Investment. It is necessary to note that such guidelines will not apply to the Insurance Sector and will continue to be governed by the relevant Regulation.
According to the Reserve Bank of India (RBI) Notification 2018, the following are certain conditions applicable to Indirect Foreign Investment:
1) Foreign investment in India is permitted upto 100% under the automatic route. However, it is subject to the applicable laws and regulations, securities and other conditions.
2) Sectors or activities which are not prohibited under the Reserve Bank of India Notification No. FEMA 20(R), Regulation 15 shall be permitted 100% Foreign Investment under the automatic route, subject the relevant laws and regulation, securities and other conditions.
3) The investee Indian company must have approval of the Board of Directors as well as a Shareholders Agreement of the investing Indian entity, if the investment is considered as Indirect Foreign Investment for the investee company.
4) Downstream investment treated as Indirect Foreign Investment for the investee Indian company made prior to 13th February, 2009 would not be required to conform to the Reserve Bank of India Notification No. FEMA 20(R). Investments after the said date would fall under Notification No. FEMA 20(R).
For the purpose of reporting the various types of Foreign Investment in India in an Indian entity, RBI has introduced a Single Master Form (SMF). Companies which would not comply with this regulation would not receive foreign investment including indirect foreign investment and would remain non-compliant with FEMA and other regulations made thereafter. The necessary form for downstream investment (Foreign Indirect Investment) is provided under the RBI Notification- Reporting in Single Master Form under Form DI respectively.
Since investments that can be done directly, can also be done indirectly. Indirect Foreign Investment may be a complex rule but the investors must ensure necessary compliance with the rules and regulation as and when notified by FEMA and RBI. If there is proper compliance with the rules, the foreign investors could hold a dominant position in the market.
1) Foreign Direct Investment Policy,
2) Reserve Bank of India (RBI) Notification 2018,
3) Reserve Bank of India Notification No. FEMA 20(R),
4) RBI Notification-Reporting in Single Master Form,
Authored By: Adv. Anant Sharma & Sameera Singal