Downstream investments & regulations under FEMA 1999

Dear Friends,

You are aware that investment in Indian Company can be made by a Non-resident as well as a resident person or entities. Any investment by non-resident in India is called Foreign Direct Investment and regulated by RBI,FDI Guidelines. On the other hand investment by a resident in Indian entities can also be divided into two categories such as investment by resident and non-resident. Suppose an entity A Ltd., has received foreign investment by complying FDI Policies and it has investment in B Ltd., in this case,its investment in B Ltd., will be considered as Indirect Foreign Investment.

Downstream generally means, the flow towards the stream or along with the water stream.

Downstream Investment under FEMA,1999 means investment by an Indian entity having FDI into another Indian entity. The first foreign investment is called Foreign Direct Investment and later one is called Foreign Indirect Investment.

INDIRECT FOREIGN INVESTMENT - has been defined in Regulation 14(1)(v) of FEMA Notification No. 20 as under: "'Indirect foreign investment' means entire investment in other Indian companies by an Indian company (IC), having foreign investment in it provided;

(a) Indian Company is not 'owned and controlled' by resident Indian citizens and/or Indian Companies which are owned and controlled by resident Indian citizens or

(b) where the Indian company is owned or controlled by non-residents.

However, as an exception, the indirect foreign investment in the 100% owned subsidiaries of operating-cum-investing/investing companies will be limited to the foreign investment in the operating-cum-investing/ investing company."

THE RBI FAQ on Foreign Investment in India

Downstream investment is investment made by an Indian entity which has total foreign investment in it or an Investment Vehicle in the capital instruments or the capital, as the case may be, of another Indian entity. If the investor company has total foreign investment in it and is not owned and not controlled by resident Indian citizens or is owned or controlled by persons resident outside India then such investment shall be "Indirect Foreign Investment" for the investee company.

Please Note that: an Indian company (owned or controlled by persons resident outside India or not owned and not controlled by resident Indian citizens (FOCC)) investing in instruments other than capital instruments of another Indian company will not be treated as downstream investment.

Downstream investment made in accordance with the guidelines in existence prior to February 13, 2009 would not require any modification to conform to these regulations. All other investments, after the said date, would come under the ambit of FEMA 20(R).

Downstream investments made between February 13, 2009 and June 21, 2013 which were not in conformity with these regulations should have been intimated to the Reserve Bank by October 3, 2013, for treating such cases as compliant with these regulations.

The RBI vide Notification No. FEMA 278/2013-RB dated 7^th June, 2013 effective from 13^thFebruary, 2009 revised guidelines pertaining to calculation of Indirect Foreign Investment. In above example if there any Foreign Investment in company A Ltd., then Down Stream Investment made by A Ltd., further in Indian company B Ltd., should checked for all the necessary reporting, route and all the other necessary conditions which are applicable to it.

It means investment made by A Ltd., in company B Ltd., should also be governed by rules and regulations applicable for accepting FDI in India and first we have to check whether A Ltd., is construed as Foreign-Owned or Controlled Company(FOCC).

LET'S ANALYZE RULES ON DOWNSTREAM INVESTMENTS

Indirect Investment

As defined in the FEM(Transfer or Issue of Security by a Person Resident Outside India ) Regulations, 2000

"Indirect Foreign Investment", means entire investment in other Indian Companies by an Indian Company, having Foreign Investment in it, provided Indian Company is not ' owned and controlled', by resident Indian citizens o where the Indian Company is owned and controlled by non-residents."

Control

As defined in the FEM(Transfer or Issue of Security by a Person Resident Outside India ) Regulations, 2000;

"Control", shall include the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements".

For the purpose of LLP, control means right to appoint majority of Designated Partners, where such Designated Partners, with specific exclusion to others, have control over all policies of the LLP.

Owned

A company is considered as 'Owned' by resident Indian citizens if more than 50% of the capital in it is beneficially owned by resident Indian citizens and / or Indian companies, which are ultimately owned and controlled by resident Indian citizens.

A Limited Liability Partnership will be considered as owned by resident Indian citizens if more than 50% of the investment in such an LLP is contributed by resident Indian citizens and/or entities which are ultimately 'owned and controlled by resident Indian citizens' and such resident Indian citizens and entities have majority of the profit

An Indian Company in which more than 50% of the Capital is beneficially owned by non-residents,is called a company owned an controlled by non-residents.

TOTAL FOREIGN INVESTMENT = Direct + Indirect Foreign Investment by Indian companies.

COUNTING OF DIRECT AND INDIRECT FOREIGN INVESTMENTS

Direct Investment

All investments directly by a non-resident entity into the Indian Company would be counted towards Foreign Investment.

It means all investments received by an Indian Company from non-resident entities regardless of whether the said investments have been made under different schedules of the Notification No. FEMA. 20/2000-RB dated 3^rd May,2000, as amended from time to time.

Indirect Investment

The Foreign Investment through investing Indian Company would not be considered for calculation of Indirect Foreign Investment in case of Indian companies are 'owned and controlled, by resident Indian Citizens. Only investment of those Indian companies in other Indian Companies are considered,while calculating Indirect Foreign Investment, which are ' owned and controlled ' by non-residents and these investing Indian Companies has accepted FDI.

The entire investment by an Indian investing company 'owned and controlled' by non-resident into another Indian Company will be considered as 'Indirect foreign investment'.

Please Note: As an exception, the indirect foreign investment in only 100% owned subsidiaries of operating cum investing/investing companies will be limited to foreign investment in the operating cum investing/investing company. The exception is available only in those cases, where entire capital of downstream company is owned by the investing company. It means downstream company must be 100% subsidiary of investing company.

PROCEDURE OF CALCULATION OF INDIRECT FOREIGN INVESTMENT

LET'S consider an example - XYZ Ltd., an Indian company already have FDI to the tune of 30% of the Capital and which also has investment through an investing Company ABC Ltd., having foreign investment, the following would be the method of calculation;

1. Where ABC Ltd., has FDI less than 50%, the company XYZ would not be taken as having any Indirect Foreign Investment through company ABC Ltd.

Where Indian Co. is not owned or controlled by Non-resident entity
NON RESIDENT ENTITY (Outside India)

Direct Foreign Investment 49% in Capital of ABC Ltd.,in India
ABC LTD. (49% FDI)

Indirect Foreign Investment 51% in the Capital by ABC LTD.
XYZ LTD. (51% by ABC LTD.)

Total Foreign Investment in Company XYZ LTD= Direct Investment (30%)(already have) + Indirect Investment (0%)= 30% of the Capital.

2. Where ABC Ltd., has FDI 75%, the company XYZ would be taken as having any Indirect Foreign Investment through company ABC Ltd(suppose ABC LTD., has invested 26% ).

Where Indian Co. is owned or controlled by Non-resident entity
NON RESIDENT ENTITY (Outside India)

Direct Foreign Investment 75 % in Capital of ABC Ltd.,in India
ABC LTD. (75% FDI)

Indirect Foreign Investment 26% in the Capital by ABC LTD.
XYZ LTD. (26% by ABC LTD.)

Total Foreign Investment in Company XYZ LTD= Direct Investment (30%)(already have) + Indirect Investment (26%)= 56% of the Capital.

3. Where company XYZ Ltd., is Wholly Owned Subsidiary of company ABC Ltd., (i.e. it hold 100% shares of company XYZ Ltd.) then only 75% would be treated as Indirect Foreign Equity and balance 25% will be treated as resident held equity.

NOTE: in this case there is no direct investment from outside,since 100% capital is held by ABC Ltd.

Where Indian Co. is owned or controlled by Non-resident entity
NON RESIDENT ENTITY (Outside India)

Direct Foreign Investment 75 % in Capital of ABC Ltd.,in India
ABC LTD. (75% FDI)

Indirect Foreign Investment 100% in the Capital by ABC LTD.
XYZ LTD. (100 % by ABC LTD.)

Total Foreign Investment in Company XYZ LTD= Direct Investment (0%)+ Indirect Investment (75%)= 75% of the Capital.

DOWNSTREAM INVESTMENT BY AN LLP

Downstream investment by an LLP not owned and not controlled by resident Indian citizens, or owned or controlled by persons resident outside India, is allowed in an Indian company operating in sectors where foreign investment up to 100 % is permitted under automatic route and there are no FDI linked performance conditions. Indian entity however cannot borrow and invest such borrowed funds. They can raise debt for their business, but not for further downstream investments.

CONDITIONS FOR DOWNSTREAM INVESTMENTS BY INDIAN COMPANIES

1. The Downstream Investments should have the approval of the Board of Directors as also a Shareholders' Agreement, if any.

2. Downstream investments may be made within foreign equity levels permitted for different activities under the automatic route.

3. The Downstream Investment involving setting up of an Export Oriented Units (EOU)/Software Technology Parks (STP) /Electronic Hardware Technology Parks (EHTP) project or items involving compulsory licensing, SSI reserved items, acquisition of existing stake in an Indian company by way of transfer/ as also buyback shall not be eligible for automatic approval and shall require prior approval of Foreign Investment Promotion Board (FIPB)/Government.

4. Issue/transfer/pricing/valuation of shares shall be in accordance with SEBI/RBI guidelines

5. For the purpose of downstream investment, the Indian entity making the downstream investment shall bring in requisite funds from abroad and not use funds borrowed in the domestic markets. These guidelines were first issued by DIPP in 2009 vide their Press Note 4 and was thereafter incorporated by RBI in FDI Regulations.

6. Downstream investments can be made through internal accruals. Internal accruals mean profits transferred to reserve account after payment of taxes. DIPP issued these guidelines vide Press Note 12 of 2009 and was thereafter incorporated by RBI in FDI Regulations.

7. Further, raising of debt and its utilisation shall be in compliance with FEMA Act, rules or regulations made thereunder.

8. Capital instrument of an Indian company held by another Indian company which has received foreign investment and is not owned and not controlled by resident Indian citizens, or is owned or controlled by persons resident outside India may be transferred to:

i) A person resident outside India, subject to reporting requirements in Form FC-TRS;

ii) person resident in India subject to adherence to pricing guidelines;

iii)An Indian company which has received foreign investment and is not owned and not controlled by resident Indian citizens or owned or controlled by persons resident outside India.

9. The first level Indian company making downstream investment shall be responsible for ensuring compliance with the provisions of these regulations for the downstream investment made by it at second level and so on and so forth.

10. The first level company shall obtain a Certificate to this effect from its Statutory Auditor on an annual basis and compliance of these regulations shall be mentioned in the Director's Report in the Annual Report of the Indian company. In case statutory auditor has given a qualified report, the same shall be immediately brought to the notice of the Regional Office (RO) of the Reserve Bank in whose jurisdiction the Registered Office of the company is located and shall also obtain acknowledgement from the RO.

REPORTING REQUIREMENTS

As per Regulation-13.1.11 of FEMA FDI Regulations, 2017, an Indian company making downstream investment in another Indian company which is considered as indirect foreign investment for the investee company in terms of FDI Regulations, shall intimate the Secretariat for Industrial Assistance, DIPP and file "Form DI" within 30 days of such investment and, even if capital instruments have not been allotted along with the modality of investment in new/existing ventures (with/without expansion programme).

With effect from 1st September,2018, an Indian entity or an Investment Vehicle making downstream investment in another Indian entity which is considered as indirect foreign investment for the Indian entity in terms of Regulation 14 of FEMA FDI Regulations,2017 shall file "Form DI with the Reserve Bank of India (RBI) within 30 days from the date of allotment of capital instruments."

CONSEQUENCES OF NON-REPORTING

In case of non-reporting of Foreign Investment received, it shall be treated as a contravention of the provisions made under FEMA. It may be required to compound the contraventions made under FEMA regulations either by suo moto or by notice from RBI. For compounding the contraventions, an application has to be filed with RBI RO as per the prescribed procedure. In some cases of non-reporting, we may be required to submit compounding application to Central Office of RBI.

In case, the company has contravened the provisions, Late Service Fee (LSF) at the rates prescribed can be paid without opting for compounding.

DISCLAIMER: the article produced here is only for information and knowledge of readers. The views expressed in this article are personal views of the author and same will not be considered a professional advice. The article has been prepared on the basis of material available on various forums at the time of preparation. It is advisable to consult with professional for more understanding of the subject matter.