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How to invest in India? Things every foreign investor should know

By Mayank Goyal July 27, 2016


A company/person may decide to invest in a foreign company/organisation to maximize profits or for some other similar reasons. Generally, there are three ways in which a company can make that investment, i.e., FDI (Foreign Direct Investment), FPI (Foreign Portfolio Investment), and commercial loans.

 

Foreign Direct Investment (FDI)

FDI is an investment in a business by an investor from another country for which the foreign investor has control over the company purchased. The Organization of Economic Cooperation and Development (OECD) defines control as owning 10% or more of the business.

Further, as per RBI, if the investment is made in equity shares, fully and mandatorily convertible preference shares and fully and mandatorily convertible debentures then only the foreign investment would be FDI. Partly paid equity shares and warrants issued by an Indian shall also be treated as eligible FDI instruments, subject to compliance with the FDI scheme. There are also some sectors where FDI is prohibited through either of the routes, mentioned here (mentioned in Ans 5, last accessed on 6th July, 2016). The steps to be allowed after FDI is made through either of the routes is also mentioned in the above link (in Ans 6).

FDI has become a major source of foreign investment in India in the last two decades due to various policy reforms and also the evolving business environment in the country. India is moving from having most businesses being family run towards more publicly held businesses today. FDI can be done by setting up a subsidiary company in India (as per the Companies Act, 2013) or joint venture with Indian/foreign companies in India.

There are two ways in which an FDI investment can be made in India, (i) government route, and (ii) automatic route;

i. Government Route: In some sectors, the list of which is provided here (under the header ‘SECTORS REQUIRING CENTRAL GOVERNMENT APPROVAL’, last accessed on 6th July, 2016), the foreign investor has to get prior approval from the Government. These applications are processed by Foreign Investment Promotion Board (FIPB). Application for the same can be made in Form FC-IL.

ii. Automatic Route: All the items not mentioned in the above route come under this. There is no requirement of prior approval of government for FDI in activities/sectors under this route.

The company receiving the investment still has to report the FDI and issue of shares to the Reserve Bank of India, regardless of whether the FDI was made through the automatic route or the government route.

A company may also decide to open up a branch/liaison/project office.

a. Liaison Office: can be opened to undertake liaison activities for the purpose of representing the company, promoting import/export, promoting collaborations on company’s behalf, cooperation in communication with Indian companies.

Prior approval from RBI required (steps mentioned here, under Ans 1), which is usually granted for a period of three years. However, they are not allowed to earn income in India and their role is limited to collection of information on market opportunities and providing company and its products’ information to prospective clients in India.

b. Branch Office:  can be opened to conduct business in India after getting specific approval from RBI (steps mentioned here, under Ans 1) and certificate of establishing place of business in India from Registrar of Companies. It can undertake activities like:

# Import & export of goods

# Rendering services

# Carrying out research work for the parent company

# Promoting collaborations on behalf of parent company

# Representing parent company in India and acting as buying/selling agent

# Providing IT services and developing software in India

# Providing technical support for products supplied

# Foreign airline / shipping company

However, there are certain restrictions on branch office, like:

# They are not allowed to engage in any retail trading activities in India.

# No manufacturing or processing activities can be carried out by them in India.

# Profits earned are freely remittable, after payment of taxes.

c. Project Office: Usually a prior approval of RBI is required to set up a project office. It can be set up by a foreign company (steps mentioned here, under Ans 8) to execute a project in India awarded by an Indian company. It is just treated as an extension of the company as it is set up to carry out that specific work and therefore, is taxed at the rate applicable to foreign companies.

They are allowed to acquire property for their own use and carry out the works related to the project. They are also permitted to open non-interest bearing INR current accounts to carry out their operations.

                               

Foreign Portfolio Investment (FPI)

Those foreign investors who wish to invest in a company in India but only for a short duration of time are termed as FPI. They do not wish to stay around for long, unlike FDI, and have the tendency to pull out their money from the market after they have generated sufficient returns on their investments. They are not even interested in having a controlling stake in the company and therefore, generally, hold less than 10% shares in the company.

According to S 21 (7) of SEBI Notification (7th January, 2014), a single FPI cannot purchase equity shares amounting to more than, or equal to, 10% of the total issued capital of the company, otherwise it will come under the ambit of FDI, whose minimum limit starts from 10%. The government merged FIIs, SAs and QFIs together to form the FPI, with an investment limit of 24% in a company by all the FPIs, that can be raised up to the sectoral cap by the company. Registration of FPIs is done by Designated Depository Participants (DDPs) on behalf of SEBI, subject to certain conditions. FPIs consist of Depository Receipts (DR), Foreign Institutional Investment (FII) in debt and in equity.

They have been divided into three categories:

Category I (Low Risk) includes Government and entities like Foreign Central banks, Sovereign wealth Funds, Multilateral Organizations, etc.

Category II (Moderate Risk) includes Regulated entities such as banks, Pension Funds, Insurance Companies, Mutual Funds, Investment Trusts, Asset Management Companies, University related endowments (already registered with SEBI).

Category III (High Risk) includes all other FPIs that are not eligible for Category I and II.

Unlike the previous norms, FPIs cannot invest in unlisted shares. However, they are allowed to invest in infrastructure sector in unlisted non-convertible debentures/bonds that have been issued by Indian companies.

 

Commercial Loans

Whenever companies need to raise large amounts of money for major capital expenditures or operational costs, they tend to fund them through debt-based funding arrangement between a business and a financial institution. It is a type of foreign investment where banks from other countries invest in the form of bank loans, and are usually backed by a government.

Historically, banks used to be the major, and in some places only, source of external investment in a company. They used to be the most common kind of foreign investment until the 1980s, with a major importance in developing countries. However, with the advent of globalization, FDIs and FPIs have taken over these commercial loans as a source of investments for the companies.

Smaller businesses usually do not have access to have limited financial resources that prevents them from having access to debt and equity markets for financing, due to the high cost of raising capital. As a result, they have to rely on lending products, such as a line of credit, unsecured loans or term loans for raising funds. These are usually for a short-term and may be either secured or unsecured. They are also termed as External Commercial Borrowings in India.

In a notification issued by RBI on November 30, 2015 (RBI/2015-16/255, A.P. (DIR Series) Circular No.32), ECB is defined as “[B]orrowings raised by permitted resident entities from recognised non-resident entities. Borrowings raised under the ECB framework can have one of the following forms:

i. Bank loans;

ii. Securitized instruments (e.g. floating rate notes and fixed rate bonds, non-convertible, optionally convertible or partially convertible preference shares / debentures);

iii. Buyers’ credit;

iv. Suppliers’ credit;

v. Foreign Currency Convertible Bonds (FCCBs);

vi. Financial Lease; and

vii. Foreign Currency Exchangeable Bonds (FCEBs)”

It has further divided the ECB framework into three tracks, Track I, II and III, on the basis of type of ECB. You can find the different applicable criteria of the three tracks here.

Any freely convertible currency can be used for ECB including Indian Rupees. Indian banks, All India Financial Institutions and NBFCs are not allowed to issue guarantee, standby letter of credit, letter of undertaking or letter of comfort. The funding cap for different sectors through ECB can be seen here and here.

 

Sources:

  1. Reserve Bank of India website, available at: https://www.rbi.org.in/ (last accessed on 6th July, 2016)
  2. FAQs on Foreign Investments in India, Reserve Bank of India website, Feb 10, 2015, available at: https://www.rbi.org.in/scripts/FAQView.aspx?Id=26 (last accessed on 6th July, 2016)
  3. FAQs on Liaison / Branch / Project Offices of foreign entities in India, Reserve Bank of India website, July 07, 2015, available at: https://www.rbi.org.in/Scripts/FAQView.aspx?Id=100 (last accessed on 6th July, 2016)
  4. What Is Foreign Direct Investment? - Definition, Advantages & Disadvantages, Study.com, available at: http://study.com/academy/lesson/what-is-foreign-direct-investment-definition-advantages-disadvantages.html (last accessed on 6th July, 2016)
  5. Make In India website, available at: http://www.makeinindia.com/home (last accessed on 6th July, 2016)
  6. Investopedia Website, available at: http://www.investopedia.com (last accessed on 6th July, 2016)
  7. Consolidated FDI Policy, Department of Industrial Policy and Promotion Ministry of Commerce and Industry Government of India, June 07, 2016, available at: http://dipp.gov.in/English/Policies/FDI_Circular_2016.pdf (last accessed on 6th July, 2016)
  8. What are the Different Types of Foreign Investment?, wiseGEEK, available at: http://www.wisegeek.com/what-are-the-different-types-of-foreign-investment.htm (last accessed on 6th July, 2016)
  9. Invest India website, available at: http://investindia.gov.in/ (last accessed on 6th July, 2016)
  10. All you need to know before Setting up a Project Office in India, The TaraSpan Blog, Jan 28, 2016, available at: http://www.taraspan.com/blog/setting-up-a-project-office-in-india/ (last accessed on 6th July, 2016)
  11. Foreign Exchange Management (Establishment in India of branch or office or other place of business) Regulations, 2000
  12. Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2000
  13. Foreign Portfolio Investor (FPI), arthapedia, available at: http://www.arthapedia.in/index.php?title=Foreign_Portfolio_Investor_(FPI) (last accessed on 6th July, 2016)
  14. Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014, Securities and Exchange Board of India, Jan 7, 2016, available at: http://www.sebi.gov.in/cms/sebi_data/attachdocs/1389083605384.pdf (last accessed on 6th July, 2016)
  15. Foreign portfolio investor, Slide Share, Apr 26, 2016, available at: http://www.slideshare.net/ShwetaGhag1/foreign-portfolio-investor (last accessed on 6th July, 2016)
  16. Notification on Investment by Foreign Portfolio Investors (FPI) in Government Securities, RBI, Oct 6, 2015, available at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10059&Mode=0 (last accessed on 6th July, 2016)
  17. Foreign Direct Investment, India in Business, Ministry of External Affairs, Govt. of India, Investment and Technology Promotion Division, Oct, 2015, available at: http://indiainbusiness.nic.in/newdesign/index.php?param=investment_landing/247/1 (last accessed on 6th July, 2016)
  18. Commercial Loan, Investopedia, available at: http://www.investopedia.com/terms/c/commercial-loan.asp (last accessed on 6th July, 2016) Overseas borrowing of companies flat in first quarter, The Hindu: Business Line, available at: http://www.thehindubusinessline.com/economy/article3742241.ece?homepage=true&ref=wl_home (last accessed on 6th July, 2016)
  19. Master Circular on External Commercial Borrowings and Trade Credits, RBI, July 01, 2013, available at: https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=8101 (last accessed on 6th July, 2016)
  20. Picture Credits: https://prashantpandyanet.wordpress.com/2016/02/10/india-the-land-of-a-billion-opportunities/

 

This Article is written by-

- Mayank Goyal (Jindal Global Law School, 4th Year)

Tags: Foreign Direct Investment , FDI , FPI , Foreign Portfolio Investment , invest in India , foreign investors in india , foreign investment , Government Route , Automatic Route , Liaison Office , Branch Office , Project Office , S 21 (7) of SEBI Notification , Category I (Low Risk) , Category II (Moderate Risk) , Category III (High Risk) , Commercial Loans , Bank loans , Securitized instruments , Buyers’ credit , Suppliers’ credit , Foreign Currency Convertible Bonds , FCCB , Financial Lease , Foreign Currency Exchangeable Bonds , FCEB


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