Indirect foreign investment policy in a state of flux

By Ravi Singhania and Sunil Kumar, Singhania & Partners

The Department of Industrial Promotion and Policy (DIPP) has issued fresh guidelines for foreign investments in sectors with caps, such as defence production, civil aviation, broadcasting, insurance and telecoms, which require approval from the Foreign Investment Promotion Board (FIPB).

Downstream investment in Indian companies by investing companies is now subject to the guidelines in press notes 2 and 3 of 2009. Press note 2 lays down guidelines for the calculation of total foreign investment, which includes foreign direct investment (FDI) and indirect foreign investments (FIDI) across all sectors and activities.

Ravi Singhania Partner Singhania & Partners
Ravi Singhania
Singhania & Partners

Press note 3 lays down guidelines to determine the transfer of ownership or control of Indian companies in industries with sectoral caps and situations which would require FIPB approval.

Press note 2 outlines the calculation for direct and indirect foreign investment in sectors with and without caps, whereas press note 3 is only applicable to sectors with caps.

Press note 2 indicates that foreign investment in an investing company whose ownership and control is in the hands of a resident Indian citizen or company will not be considered when calculating foreign indirect investment. However, if the investing company is owned or controlled by a non-resident entity, the entire investment by the investing company would be considered as indirect foreign investment.

Downstream investment by a 100% subsidiary of an investing company in India, which is owned or controlled by a non-resident entity, regardless of the percentage of equity it is contributing, would be treated as equal to the percentage of foreign equity in the investing company. Therefore, if the foreign equity in the investing company is more than 50%, the downstream investment by its subsidiary will also be treated as being more than 50%. This determination is relevant for the purposes of seeking FIPB approval.

If an investing Indian company “owned” or “controlled” by non-resident entities, puts funds into an Indian company, it would constitute an indirect foreign investment or downstream investment. According to the press notes, “owned” by non-resident entities means beneficial ownership of more than 50% of the equity in the investing company.

“Control” by non-resident entities refers to the power to appoint the majority of directors in the investing company. These two criteria as defined in the press notes are what determine whether ownership and control reside in foreign or Indian hands.

According to press note 3, FIPB approval is required in all cases where an Indian company being established with foreign investment is owned or controlled by a non-resident entity.

FIPB approval would also be required if an Indian company owned or controlled by resident Indian citizens/companies is transferred to a non-resident entity through a transfer of shares.

Sunil Kumar Partner Singhania & Partners
Sunil Kumar
Singhania & Partners

Press note 3 does not, however, affect sectors without caps and consequently holding/operating companies proposing to make downstream investments. This is regardless of the amount of investment proposed by the investing/holding company and therefore downstream investments would require FIPB approval under press note 9 of 1999.

There are speculations that the DIPP may amend press note 9 of 1999 to align it with press note 3 and bring about much needed simplification in indirect foreign investment across all sectors.

Press note 3 clarifies that FIPB approval would be required only in cases where the ownership or control is being transferred by a share-transfer to non-resident entities.

However, as press note 2 indicates, when a proposal for foreign investment is made, agreements between shareholders affecting voting rights or appointments of directors would also be required by the FIPB. Where no foreign investment is being made, such control may be transferred without FIPB approval. Therefore, it appears that no FIPB approval would be required if the investing company is transferring its ownership or control by way of an arrangement other than a transfer of shares.

Finally, the effect of press note 2 would be to presuppose the non-existence of indirect foreign investment where the investing company is not owned and controlled by non-resident entities, even though such foreign investment may be as high as up to 50%.

Surely this opens the door to foreign investment by the non-approval route into sectors subject to caps, which are currently regarded as sensitive. To conclude, we predict that press notes 2 and 3 may evolve further through creative effort on the part of its parents.

Ravi Singhania is the managing partner and Sunil Kumar is a partner in the tax practice at Singhania & Partners. The firm is headquartered in Noida and has offices in New Delhi, Mumbai, Bangalore and Hyderabad.


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