Investments by resident individuals in shares of foreign entities fall within the framework of either the Master Direction on Liberalised Remittance Scheme (LRS scheme) or the Master Direction on Direct Investment by Residents in Joint Venture (JV)/Wholly Owned Subsidiary (WOS) Abroad (ODI regulations), depending on the nature of the specific investment.
Based on past experiences with the implementation of these two regulations by authorized dealer banks (AD banks), it appears that the Reserve Bank of India’s (RBI) policy is to regulate portfolio investments under the LRS scheme, while investments which do not qualify as portfolio investments (because, for example, they exceed a particular size and/or provide the investor management or control rights over the foreign entity) are regulated under the ODI regulations. In theory, there is nothing wrong with this policy. However, the RBI should consider formally clarifying this policy intent.
The LRS scheme permits resident individuals to freely remit outside India amounts up to US$250,000 in a financial year for certain capital account transactions permitted under the LRS scheme. For investments abroad, the capital account transactions permitted under the LRS Scheme are: (a) acquisitions of shares of listed and unlisted overseas entities or debt instruments; (b) acquisitions of qualification shares as a director of an overseas entity; (c) acquisitions of shares in consideration for professional services to the overseas entity or in lieu of director’s remuneration; and (d) investment in units of mutual funds, venture capital funds, unrated debt securities and promissory notes. The LRS scheme requires a resident who wishes to make remittances for any of these purposes to provide a prescribed declaration for the purchase of foreign currency. Usually, AD banks require the individual to provide a signed declaration for the AD banks to confirm that the proposed investment is a portfolio investment.
Notably, the LRS scheme does not provide any guidance or definition as to what qualifies as a ‘portfolio investment’. Some AD banks require the remitter to furnish a declaration that the proposed investment will not entail holding majority shares or acquisition of management control, while others require the remitter to furnish a declaration that the proposed investment is below 5% of the total issued and subscribed capital of the company and that the individual is not a promoter or director of the company.
There is a clear difference between majority shares and a 5% stake, and between management control and being a non-executive, independent or nominee director. In general business parlance, a portfolio investment is understood as a passive investment in the securities of a portfolio company, where the investment amount or percentage is not large, and the investor does not participate in the daily management of the company. In our view, the RBI should issue guidance by defining portfolio investments and prescribing objective criteria such as shareholding percentage.
This guidance will help distinguish between portfolio investment and ODI investment, and bring regulatory certainty to the enforcement of the policy, especially in relation to valuation and disclosure requirements, which are applicable to ODI investments but not to portfolio investments under the LRS scheme.
Another ambiguity concerns remittances over the specified limit (currently US$250,000 a financial year) under the LRS scheme through the RBI’s approval route in cases of individual investments in overseas entities though we note that this ambiguity may also be addressed once portfolio investment is defined and the distinction from ODI investments is clearly established. Under the LRS scheme, a party may in theory apply to the RBI for permission where the specified limit is inadequate, but in practice one gets the sense that the RBI apparently does not even consider legitimate cases. For example, share repositioning exercises by transnational groups as part of intragroup restructuring, often to move tax domicile, typically involves surrender or forfeiture of existing shares held by resident Indian executives in a foreign parent company, for cash consideration which is subject to reinvestment in a different group entity. Such commercially appropriate and legitimate cases may not fall squarely within the ODI regulations and may also fall foul of the monetary limit under the LRS scheme. The RBI should view these cases differently so that parties do not have to resort to unnecessarily convoluted structures to work around the limit.
Vikrant Kumar and Vasudev Dibbur are partners and Bissheesh Roy is an associate at L&L Partners. The views expressed are personal and intended for general information purposes. They are not a substitute for legal advice.
9th Floor, Ashoka Estate
New Delhi – 110 001
Mumbai | Bengaluru | Hyderabad