An Indian subsidiary often needs funds from its foreign parent. The money can come as equity, as a loan, or as a mix. Foreign loans to Indian companies fall under the external commercial borrowing framework of the RBI, which sets limits on who can lend, how much, the minimum tenor and the cost. This note gives a short orientation. Always check the current Master Direction before signing a loan agreement.
Equity or loan?
- Equity is reported as foreign direct investment and is subject to pricing and sectoral rules. It cannot usually be taken back except by buyback, reduction of capital or sale.
- A loan must be repaid with interest and is a liability. Interest paid abroad attracts withholding tax and transfer pricing review.
- Convertible instruments are treated as equity under FEMA and must meet the pricing rules at the time of issue.
What the ECB framework looks at
- Borrower. Most companies and some other entities are eligible, though a few classes are excluded.
- Lender. Generally, a recognised foreign lender, including a direct or indirect equity holder or a group company.
- Amount and tenor. There is an annual limit per borrower and a minimum average maturity period that depends on the type of loan.
- All-in cost. A ceiling is set over a benchmark rate.
- End use. A list of prohibited uses applies, and the proceeds cannot be used for certain activities such as investment in real estate or in capital markets.
Reporting
- A loan agreement number is obtained through the authorised dealer bank, typically by filing Form ECB with the RBI.
- Monthly return in Form ECB 2 reports transactions during the month.
- Changes in terms, such as repayment dates, need to be reported.
Tax and company law points
- Interest to the foreign lender is subject to withholding tax, and a lower treaty rate or a concessional rate may be available.
- Interest limits and transfer pricing rules apply to loans from associated enterprises.
- Money received from a parent is also reportable in Form DPT-3 under the Companies Act, as discussed in other notes on annual filings.
The author is a M.Com., FCS, LL.B., is a Partner at A2 Consultants, Hyderabad, which advises foreign companies on entering and operating in India. The views are personal and for general information only.
CAclubindia
