Following the issue of a government press release relating to the calculation of indirect foreign investment, the Ministry of Commerce and Industry has issued two new press notes on the subject.
Press note 2 clarifies how to calculate the level of indirect foreign investment in an Indian company and press note 3 contains guidelines for the transfer of ownership or control of Indian companies that are engaged in sectors that have sectoral caps prescribed for foreign investors.
The press notes provide definitions that were missing in the government’s original press release. They redefine the framework for calculating foreign indirect investment in Indian operating companies that have received investments from Indian holding companies.
Press note 2 includes new definitions of the terms “owned” and “controlled”. For the purpose of calculating the level of indirect foreign investment, the term “owned by resident Indian citizens” means that resident Indian citizens beneficially own more than 50% of the equity interest in the holding company. “Controlled by resident Indian citizens” means that resident Indian citizens have the power to appoint a majority of directors of the holding company.
The operating company will not be considered to have any indirect foreign investment as long as the holding company, in which there may be a degree of foreign investment, is determined by the new guidelines to be owned and controlled by resident Indian citizens.
However, any foreign investment in the holding company will be considered for the purpose of calculating indirect foreign investment in the operating company if the holding company is not owned or controlled by resident Indian citizens on a look-through basis, or if the holding company is owned or controlled by non-resident entities. In such a case, the entire investment by the holding company in the operating company will be classified as indirect foreign investment.
Press note 2 also states that if an operating company is 100% owned by the holding company, the level of indirect foreign investment in the operating company will be taken as the percentage of actual foreign investment in the holding company. This method of calculation is applicable for each layer of investment in an Indian company.
All types of foreign investment, including foreign direct investment, financial institutional investment, foreign venture capital investment, non-resident investment, American depository receipts, global depository receipts, foreign currency convertible bonds, convertible preference shares and convertible debentures, will be considered when making the calculations.
For sectors in which government approval is required, full details of all foreign investment, including ownership, control and any shareholder agreements that affect appointments to the board of directors or voting rights in the holding company must be disclosed. For sectors such as insurance, where the method for calculating foreign investment is prescribed under sector-specific rules, the policy and methodology outlined in press note 2 does not apply.
Section 187 C of the Companies Act, 1956, states that if a person is holding the shares of a company as a nominee of the registered owner, then the beneficial interest in such shares is vested with the registered owner. However, press note 2 maintains that any shares held by a nominee on behalf of the original owner shall be counted as foreign investment, regardless of whether the investment was made by a resident Indian citizen or not.
Unlike press note 2, press note 3 does not apply to sectors or activities for which there are no caps on foreign investment. It clarifies that for companies engaged in sectors with existing caps, approval from the Foreign Investment Promotion Board (FIPB) is required if the company has received any foreign investment or is owned or controlled by a non-resident entity. FIPB approval is also necessary if a company that is owned and controlled by resident Indian citizens is in the process of being transferred to non-resident entities, either through fresh foreign investment, or, when such transfers come into effect, through a direct acquisition or corporate reorganization.
Before these press notes were issued, many observers expressed concerns that if minority investor protection rights provided to non-residents in holding companies were construed as “control”, then virtually all investments by holding companies in operating companies would qualify as indirect foreign investment. However, holding companies have been defined as companies that have made investments through equity shares, preference shares or compulsory convertible debentures in an operating company. Since optionally convertible debentures (OCDs) have not been included in this definition, ambiguity remains as to whether an investment in an operating company in the form of OCDs would qualify as foreign investment.
The legislative and regulatory update is compiled by Nishith Desai Associates, a Mumbai-based law firm. The authors can be contacted at firstname.lastname@example.org. Readers should not act on the basis of this information without seeking professional legal advice.