comments on dipp circular
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8/6/2019 Comments on DIPP Circular
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G-60(LGF),eastofkailash,newdelhi-110065
Tel:+91-11-40634891 Fax:+91-11-46107210
February 15, 2011
To,
Department of Industrial Policy & Promotion,
Ministry of Commerce & Industry,
Udyog Bhawan, New Delhi- 110011.
Attention: Mr. Deepak Narain (Director)
Dear Sir,
Re: Comments on the Circular 2 of 2010- Consolidated FDI Policy issued on 30.09.2010
We are law firm based at New Delhi. We refer to thePress Release dated January 14, 2011
inviting comments on Circular 2 of 2010- Consolidated FDI Policy on 30.09.2010 (the
“Circular”) released by the Department of Industrial Policy & Promotion, Ministry of
Commerce and Industry ( “DIPP”).
We are happy to provide you our comments and would be grateful if you could consider our
following comments, while finalizing the next edition of Consolidated FDI Policy Circular:
1. Legal Basis of the FDI Policy
1.1 A plain reading of paragraph 1.1.5 of the Circular seems to suggest that DIPP believes
that the legal basis of the FDI policy issued by DIPP is the Foreign Exchange
Management Act, 1999 (“FEMA”). This belief needs a review in light of the analysis
in paras 1.2 to 1.12 below.
1.2 Section 46 of FEMA empowers the Central Government to make rules to carry out
the provisions of FEMA. Similarly, Section 47 of FEMA empowers the Reserve Bank
of India (“RBI”) to make regulations to carry out the provisions of FEMA. Section
46(2) empowers the Central Government to make rules, inter alia, to impose
reasonable restrictions on current account transaction under section 5, whereas section
47(2) empowers the RBI to make regulations on capital account transactions. A clearharmonious construction of the two provisions would suggest that at least to the
extent enumerated in Section 46 and section 47, there should be no overlap in the
powers of the Central Government and the RBI to make delegated legislations. This
would mean that on the matters specifically set out in Section 46(2), Central
Government (and not the RBI) is empowered to make rules, while on the matters set
out in Section 47(2) of FEMA, RBI (and not the Central Government) is empoweredto make regulations.
1.3 Section 47(2) of FEMA, inter alia, provides that the RBI may make regulations to
provide for the permissible classes of capital account transactions, the limits of
admissibility of foreign exchange for such transactions, and the prohibition,restriction or regulation of certain capital account transactions under Section 6.
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Transfer or issue of security by persons resident outside India is a deemed capitalaccount transaction under Section 6 of FEMA.
1.4 In exercise of their respective powers, the Central Government has, very rightly,
issued Foreign Exchange Management (Current Account Transactions) Rules, 2000,
whereas Foreign Exchange Management (Permissible Capital Account Transaction),
Regulations, 2000 has been issued by RBI for regulating capital account transactions.
1.5 Investment in India by a person resident outside of the following nature is recognized
as a capital account transaction under Schedule II of Foreign Exchange Management
(Permissible Capital Account Transaction), Regulations, 2000:
1.5.1 issue of security by a body, body corporate or an entity in India and investment
therein by a person resident outside India; and
1.5.2 investment by way of contribution by a person resident outside India to the capital
of a firm or proprietorship concern or an association of person in India.
1.6 In light of the above, a view that the FDI Policy has been issued under FEMA may
run counter to the scheme set out under FEMA. Very clearly, the scheme of
distribution of powers between the RBI and the Central Government under FEMA is
that RBI regulates capital account transactions, and the Central Government regulates
current account transactions. RBI may, however, consult with the Central
Government in regulating the capital account transactions.
1.7 The only reference to the FDI Policy under various regulations issued under FEMA
may be found in Schedule-I of the Foreign Exchange Management (Transfer or Issue
of Security to persons resident outside India) Regulations (“Transfer Regulations”).
Para 2 of Schedule 1 of the Transfer Regulations makes a reference to the “IndustrialPolicy and Procedures as notified by Secretariat for Industrial Assistance (SIA) in the
Ministry of Commerce and Industry, Government of India”, which is often referred to
as the FDI Policy.
1.8 The reference in para 2 is more in the nature of recognition of an existing policy,
rather than a delegation to the Government of India to make the FDI Policy. It may be
pertinent to note that it is a settled principle under administrative law that a delegate
cannot further sub-delegate, unless the legislation empowers it to sub-delegate. Since
RBI is the authority under FEMA, which has been entrusted with the power to make
delegated legislation on capital account transactions, in absence of a clear authority to
sub-delegate under FEMA, it cannot further sub-delegate that power to any otherauthority (including the Government).
1.9 Further, the FDI policy has been in existence even before introduction of FEMA andthe rules and regulations issued thereunder. It was earlier pronounced in the form of
Press Notes issued by the DIPP. Therefore, the argument that FEMA is the legal basis
for the FDI Policy becomes even weaker.
1.10 There is a view that the Central Government derives its power to pronounce the FDI
Policy under the Industries (Development & Regulation) Act, 1951 (“IDRA”).
Another view suggests that Central Government is empowered to make policy
decisions under the executive powers of the Union set out in Article 73, of the
Constitution of India.
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1.11 It is important for the DIPP to identify the legal regime under which it derives theauthority to pronounce the FDI Policy. The issue is not merely academic, as it may
have serious implications on the enforceability of the FDI Policy. Some of the
consequences are outlined below:
1.11.1 If para 2 of Schedule 1 of the Transfer Regulations is the basis of the FDI Policy,
then it is pertinent to note that Schedule 1 of the Transfer Regulations has limited
application to investments under the FDI Scheme. However, the FDI Policy set
out in Circular clearly goes beyond Schedule 1 of Transfer Regulations, and even
regulates foreign investment under the portfolio investment scheme (namelySchedule 2 of the Transfer Regulations), NRI investment under the portfolio
investment scheme (namely Schedule 3 of the Transfer Regulations), and FVCI
investment under the venture capital investment route (Schedule 6 of the Transfer
Regulations). An extreme view may suggest that violation of the FDI Policy so
long as it does not pertain to foreign investments in Schedule 1 may not attractpenal provisions under FEMA, as by virtue of para 2 of Schedule 1 Central
Government’s authority extends only to Schedule 1 investments. If this view isupheld in a court of law, then there will be no violation of FEMA if the
investments under other schedules (except Schedule 1 of the Transfer
Regulations) are not compliant with the FDI Policy.
1.11.2 If IDRA is the legal basis for the FDI Policy, the penal consequences of breach of
the FDI Policy will have to be found under IDRA. In such cases, consequences
under FEMA can, at best, extend to the violations of the FDI Policy for
investments under Schedule 1 of the Transfer Regulations.
1.11.3 If the executive powers of the Union is the basis of the FDI Policy, the penalconsequences will be further diluted. In this scenario as well, the violation of the
FDI Policy only to the extent of investments under Schedule 1 of the Transfer
Regulations will be actionable under FEMA.
1.12 In light of the above, we request the DIPP to consider this issue and clearly identifythe legislative authority under which the FDI Policy is being issued, particularly with
a view to make its breach actionable under law.
2. Investment by Foreign Venture Capital Investors
2.1 Paragraph 1.1.2 of the Circular recognizes foreign investment only under two routes
viz. (i) Foreign Direct Investment (“FDI”); and (ii) Foreign Portfolio Investment.
2.2 FEMA read with the Transfer Regulations, recognizes investment by Foreign Venture
Capital Investors registered with SEBI (“FVCI”) in Indian venture capital funds and
venture capital undertakings, as a separate route of foreign investment (under
Schedule 6 of the Transfer Regulations).
2.3 Reference of FVCI has also been made in following paragraphs of Circular:
2.3.1 FVCI has been defined under paragraph 2.1.16.
2.3.2 Paragraph 3.1.6 dealing with the eligibility conditions for investing in India allows
FVCI to invest as registered FVCI and also as a non-resident entity under FDI
route, subject to applicable regulations issued by Securities and Exchange Board
of India (“SEBI”) & Reserve Bank of India (“RBI”) and the FDI policy.
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2.4 Paragraph 4.1.2 dealing with computation of the indirect foreign investment in anIndian company states that foreign investment shall include all types of foreign
investment. However, while specifying the specific schedules of the Transfer
Regulations, the same paragraph no mention has been made to Schedule 6 of theTransfer Regulations (dealing with the FVCI investments). This leads to a confusion
as to whether investment by FVCI’s investment in an Indian venture capital
undertaking or a venture capital fund under Schedule 6 of the Transfer Regulations
ought to be considered as foreign investment or not.
2.5 We believe that investment made by FVCI is one of the kinds of foreign investmentrecognized under the Transfer Regulations. There may be valid policy rationales for
treating FVCI investments independently, however, if DIPP belives that the FVCI’s
investments need to be treated differently, it needs to expressly state so in the policy.
Therefore, we request you to clarify this position under the third edition of the
consolidated FDI policy document.3. Pricing of the Convertible Capital Instruments
3.1 Paragraph 3.2.1 of the Circular provides that the pricing of the capital instruments like
compulsorily and mandatorily convertible debentures, fully, compulsorily and
mandatorily convertible preference etc. should be decided/determined upfront at the
time of issue of the instruments.
3.2 The pricing of the capital instrument can be determined upfront in any of the
following manner:
3.2.1 by fixing the conversion ratio of the convertible instruments to the equity shares to
be allotted upon conversion, or3.2.2 by upfront fixing the maximum number of equity shares that can be allotted
against all the convertible debentures issued at date of issuance.
3.3 The difference between the fixation of the pricing mechanism under point 3.2.1 and
point 3.2.2 above is following:
3.3.1 As per point 3.2.1 the exact number of equity share(s) that can be allotted againstconvertible instrument(s) is frozen. The investee company then cannot issue any
number of shares more or less than the exact number of shares frozen upfront at
the time of issuance of convertible instruments. Whereas, as per point 3.2.2 only
the maximum number of equity shares to be allotted against the total numberconvertible instruments at the time of conversion has to be fixed. The investee
company can issue any number of shares subject to the maximum of the limit
specified upfront at the time of issuance of convertible instruments.
3.3.2 The intent behind subscribing to a convertible instrument of a company as against
the equity shares, most often, is the flexibility of adjusting the number of equity
shares to be subscribed on the basis of the performance of the company in future.
Such flexibility is desirable for attracting private equity investments. The pricing
mechanism under point 3.2.2 above provides such flexibility to the investor, while
still complying with the minimum pricing requirement prescribed under the law.
Since the instrument is mandatorily convertible, there is no risk of redemption,
and therefore capital flight.
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3.3.3 In view of the above, we strongly recommend that the third edition of theconsolidated FDI policy document should clearly permit Indian companies to
comply with the pricing guidelines at the time of issuance of the instrument by
specifying the maximum number of equity shares that the convertible instrumentsshall convert into.
4. KYC requirement under Form FC-TRS
4.3 Paragraph 3.4.4(i)(h) of the Circular contemplates a situation where at the time of
transfer of shares from resident t o non-resident, the remittance receiving AD
Category-I bank is different from the AD Category-I bank handling the transfer
transaction. In such a scenario, the Circular states that Know Your Customer (KYC)
check should be carried out by the remittance receiving bank and the KYC report
shall be submitted by the customer to the AD Category-I bank carrying out thetransaction along with the Form FC-TRS. Incidentally, this stipulation is similar to the
one that has been prescribed by the RBI for transfer of shares.
4.4 Practical difficulties are faced in obtaining the KYC report from the remittance
receiving bank. Often, the when the funds hit the bank of the transferor, the transferor
is unaware whether the said funds have been received by the bank directly, or through
another Indian bank (which becomes the remittance receiving bank). Considerable
time gets spent in identifying the source of funds. Further complications arise as in
such cases the transferor (in whose bank account the funds are received) is not theclient of the remittance receiving bank. The stipulated time limit of sixty (60) days
often lapses in merely identifying the relevant bank, and thereafter tracking the
relevant transaction and obtaining the KYC certificate. Very often it is the non-
corporation of the remittance receiving AD Category-I bank that renders the customerincapable of filing form FC-TRS within the stipulated time, without any fault of their
own.
4.5 In view of the same, we strongly recommend that the transfer handling bank (i.e. the
bank that ultimately receives that funds) be made liable to process the application forprocuring the KYC certificate from the remitter’s overseas bank, as the banks alone
possess the relevant details of remittance and fund transfer instructions, which are
invariably required to coordinate the KYC generation process.
5. Valuation for the downstream investment by an Indian Company
5.3 Paragraph 4.6.6(iii) of the Circular provides that for operating-cum-investing
companies and investing companies, the downstream investments can be made
subject to the applicable SEBI/RBI guidelines issued forissue/transfer/pricing/valuation of shares.
5.4 It may be noted that the SEBI/RBI guidelines for transfer/issue of shares of a listed
and an unlisted company under Chapter 3 of the Circular are those applicable to
transactions between a person resident outside India and person resident in India.
Since downstream investment envisages transaction between two companies resident
in India, the said guidelines will not have any application as such. In addition, since
the transaction does not involve in inflow or outflow of foreign exchange, even if
such guidelines were to be applied, it is too onerous a condition, without any
corresponding benefits to Indian foreign exchange balance.
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5.5 Accordingly, we recommend removal of Paragraph 4.6.6(iii) of the Circular.
6. Reconsideration of the Letter of Approval
6.3 Paragraph 4.7.10 of the Circular provides that no condition specific to the letter of approval issued to a non-resident investor would be changed or additional condition
imposed subsequent to the issue of a letter of approval.
6.4 Please clarify if Foreign Investment Promotion Board (“FIPB”) will not entertain any
further application/letter filed for, inter alia, any of the following purposes:
6.4.3 clarifying any of the submission made by non-resident investor, which may have
been misunderstood by FIPB, or
6.2.2 seeking expansion of the scope of the approval granted by FIPB, or
reconsideration of the approval terms or rejection of the application.
7. Investor’s obligation to obtain necessary approvals for the Project
7.2 Point 4 of Paragraph 5.2.13.2 of the Circular requires that at least 50% of the project
to be developed within a period of 5 years from the date of obtaining all statutory
clearances. For this purpose, it further requires the investor to provide for the
infrastructure and mandates the investor to obtain the completion certificate from the
concerned local body/service agency, before investor disposes of serviced housing
plots. Further, point 6 of the same paragraph provides for the investor/investee
company to obtain all necessary approvals for the project.
7.3 We submit that an investor in equity share capital is distinct from the company that it
invests in. Investor is the supplier of the capital, whereas the execution of the project
is the responsibility of the project company. Most local authorities require the Indianproject company to be the applicant. Therefore, the project company is usually not
only responsible for making application for approvals but also the primary person in
control of the development of the project vis-à-vis the authorities, with no control or
supervision available with the investor.
7.4 Therefore, we believe that obtaining approvals/permission/licenses for the execution
of the project and complying with them should be the responsibility of the project
company and not the investor. Accordingly, in case of breach of any of the conditions
imposed by the law or under any of the approvals/permission/licenses, the investor
should not be held liable for the same, unless it can be demonstrated that the
approvals/ permissions/ licenses could not be obtained due to any act or omission of the investor.
7.5 In view of the above, we request you to clarify the Investor shall be liable only if
approvals/ permissions/ licenses could not be obtained due to any act or omission of
the investor.
8. FDI in Non-Banking Finance Companies
8.2 Paragraph 5.2.18 of the Circular list out 18 categories of the Non-Banking Finance
Companies (“NBFCs”) in which FDI is permitted under the automatic route. Further,the general permission for transfer of shares from persons resident in India to persons
resident outside India is not available in case of NBFCs.
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8.3 NBFC has been defined under Section 45I(f) of the Reserve Bank of India Act, 1934as
“(i) a financial institution which is a company;
(ii) a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other
manner, or lending in any manner;
(iii) such other non-banking institution or class of such institutions, as the Bank may,
with the previous approval of the Central Government and by notification in the
Official Gazette, specify.”
8.4 Some categories of the NBFCs listed out in para 5.2.18 do not satisfy the test of being
the NBFCs under the RBI Act. While there are clear guidelines for determination of
an NBFC under the RBI Act, it is difficult to decipher a definition or clear guidelines
on what would constitute an NBFC under the Circular. We understand that automatic
route of foreign investment is available only in the specified 18 NBFCs, and no other.Further, it is unclear as to which category of NBFCs does the general permission for
transfer of shares from resident to non-residents apply to: those falling under thedefinition of NBFC under the RBI Act, or the 18 categories specified in para 5.2.18.
8.5 In view of the above, please clarify the following in the forthcoming consolidated FDI
policy:
8.5.2 Whether the NBFC as defined in paragraph 5.2.18 is the same as the NBFCdefined under Reserve Bank of India Act, 1934? Or
8.5.3 Whether the NBFCs as understood under FDI Policy is a category distinct from
the one defined under the RBI Act? If yes, then please provide a suitable
definition for the same.
8.5.4 Whether foreign investment in an NBFC which does not find place in one of the
categories mentioned in paragraph 5.2.18 is allowed or prohibited?
9. Minimum Capitalization by payment of share premium
9.2 The note to paragraph 5.2 of the Circular provides that the minimum capitalization
includes share premium received along-with the face value of the share, only when it
is received by the company upon issue of the shares to the non-resident investor. It
further provides that any amount paid by the transferee during post-issue transfer of
shares beyond the issue price of the share, cannot be taken into account while
calculating minimum capitalization requirement.
9.3 It is unclear, however, if in the event the shares are sold to a non-resident at a price
which is lower than the issue price of shares to the Indian promoter, would the issueprice paid by the Indian promoter or the lower price paid by the non-resident
purchaser to the Indian promoter be considered for calculating the minimum
capitalization. Please clarify this position in the forthcoming FDI Policy.
10. FDI in Trust
10.2 Para 3.3.3, prescribes that ‘FDI in Trusts other than VCF is not permitted .’ FDI has
been defined in Paragraph 2.1.12 to mean an ‘ investment by non-resident
entity/person resident outside India in the capital of an Indian company under
Schedule I of FEM (Transfer or Issue of Security by a Person Resident Outside India)
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Regulations, 2000’. Therefore, the definition of FDI in the Circular itself contemplates investments in companies alone, and not in trusts, societies or other
similar entities.
10.3 Interestingly, the definition of ‘security’ under FEMA has merely incorporated mutual
fund units or units of UTI as securities. Units of any other trusts should not fall within
the meaning of ‘security’ under FEMA. In fact, ‘units of a trust’ simpliciter do not
find mention in the definition of ‘security’ under FEMA.
10.4 Further, contributions to charitable trusts is regulated under a distinct regulatory
regime envisaged under the Foreign Contribution Regulation Act. 1976. Therefore,
the regulations set out under the FDI Policy should, ideally, not apply to such
contributions to trusts.
10.5 At best, the FDI Policy should regulate only such investments in trusts, which confer
some proprietary benefits on the investor into the trust units. Therefore, we stronglyrecommend that only proprietary investments in trusts should be regulated under the
FDI Policy. Contributions of non-proprietary nature should continue to remain
regulated under the Foreign Contribution Regulation Act, 1976 and not under FEMA
as such.
11. Repatriation of amount invested in Partnership Firm
11.2 Paragraph 3.3.2 (c) and also Regulation 4 (c) of the Foreign Exchange Management
(Investment in Firm or Proprietary Concern in India) Regulations, 2000 provides thatthe amount invested by a non-resident Indian or a person of Indian origin by way of
contribution to the capital of a firm cannot be repatriated outside India.
Further, Regulation 5 of the above regulations provides that a firm in India may makethe payment to or for the credit of a non-resident Indian or a person of Indian origin,
the sum invested by such person or the income accruing to such person by way of
profit on such investment. For the sake of convenience, the Regulation 5 of Foreign
Exchange Management (Investment in Firm or Proprietary Concern in India)
Regulations, 2000 is reproduced below:
“ 5. Permission to a firm or a proprietary concern to make payment to a non-
resident Indian or a person of Indian origin who has made investment
A firm or a proprietary concern in India may make payment to or for the credit of a
nonresident Indian or a person of Indian origin the sum invested by such person inthat firm or the proprietary concern or the income accruing to such person by way of
profit on such investment.”
11.3 A reading of the above Regulation 5 suggests that both the amount invested and the
income accrued by way of profit on investment to a non-resident Indian, can be
repatriated. On the contrary, Regulation 4 that allows investment by a non-residentIndian by way of contribution to the capital of a firm, under sub-regulation
(c) prohibits repatriation of such invested amount.
11.4 While this issue has not been specifically dealt with in Circular 2, since the FDI
Policy seeks to consolidate the entire regulatory regime on foreign investment, kindly
confirm in the forthcoming consolidated FDI policy document, which one of thefollowing understandings is correct:
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11.4.2 A non-resident Indian, who has contributed to the capital of firm is allowed torepatriate only the income accrued to such person by way of profit on investment;
or
11.4.3 A non-resident Indian, who has contributed to the capital of firm is allowed to
repatriate both the amount invested and the income accrued to such person by
way of profit on investment.
Please feel free to contact any of the following counsels for any clarifications:
Abhishek Tripathi – [email protected]
Shivendra Singh – [email protected]
Yours Sincerely,
Abhishek Nath Tripathi
On behalf of
Sarthak- Advocates & Solicitors
New Delhi