INTRODUCTION

The Department for Promotion of Industry and Internal Trade, Government of India (“DPIIT”) had vide press note 3 of 2020 dated April 17, 2020 (“Press Note 3”) amended the extant foreign direct investment (FDI) policy dated August 28, 2017. As per Press Note 3, the amendment was introduced with an aim to curb opportunistic takeovers of Indian companies by persons or entities (directly or indirectly) of any country which shares a land border with India (“Bordering Country”) during difficult times on account of COVID-19

Press Note 3 provided that the amendment would come into effect upon issuance of a notification under the Foreign Exchange Management Act, 1999 (“FEMA”).

The revised FDI framework for investments originating from a Bordering Country as contained in Press Note 3 (“Revised FDI Framework”) has now been implemented vide notification number 1278(E) dated April 22, 2020 issued by the Department of Economic Affairs, Ministry of Finance, Government of India (“Implementation Notification”). Vide the Implementation Notification, the Foreign Exchange Management (Non-Debt Instrument) Rules 2019 (“NDI Rules”) have been amended to enforce the Revised FDI Framework.

SCOPE OF THE REVISED FRAMEWORK

In order to understand the exact scope of the Revised FDI Framework, a reference can be made to the text of the amended provision as contained in the Implementation Notification which reads as under:

• “Provided that an entity of a country, which shares land border with India or the beneficial owner of an investment into India who is situated in or is a citizen of any such country, shall invest only with the Government approval:
• Provided further that, a citizen of Pakistan or an entity incorporated in Pakistan shall invest only under the Government route, in sectors or activities other than defence, space, atomic energy and such other sectors or activities prohibited for foreign investment:
• Provided also that in the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction or purview of the above provisos, such subsequent change in beneficial ownership shall also require government approval.”

The usage of the term ‘citizen’ in the context of beneficial owners and the fact that the term ‘beneficial owner’ is being used as a distinct category from the term ‘entities’ indicates that the term ‘beneficial owner’ is likely being used in the context of natural persons or individuals.

Investments from citizens or entities of Pakistan in sectors like defence, space, atomic energy and other non-permitted activities for FDI remain prohibited as earlier.

Additionally, transfer of existing or future investments which may result in the beneficial ownership of an investment in India falling in the hands of individuals who are residents or citizens of any Bordering Country, will also require a prior government approval. This basically means that the following transactions which are otherwise outside the purview of FEMA/ FDI regulations will also require a prior government approval:

• Transfer of equity instruments from a resident to another resident; and
• Transfer of equity instruments from a non-resident to another non-resident,

so long as any such transaction has the effect of a resident or citizen of a Bordering Country acquiring beneficial ownership in an Indian entity.

Consequently, in terms of the Revised FDI Framework, investments by the following persons into Indian entities will require a prior approval from the Government of India:

• Entities situated in any Bordering Country; and
• Beneficial owners of any investment who reside in, or are citizens of, any Bordering Country.

DETERMINATION OF ‘BENEFICIAL OWNER’

In terms of the Revised FDI Framework, the term ‘beneficial owner’ is a determining factor for ascertaining whether a transaction will require a prior government approval or not. After the issuance of the Press Note 3, there were expectations that the Government of India will, through the Implementation Notification or otherwise, clarify the scope of the term ‘beneficial owner’ for the purposes of the Revised FDI Framework. However, the Implementation Notification provided nothing further than what was contained in the Press Note 3. In the present circumstances, it has become imperative to understand the import of the term ‘beneficial owner’ in the context of investment in shares of an Indian entity in order to understand the ambit of the Revised FDI Framework.

While, the concept of beneficial ownership has been dealt with differently under multiple laws in India, in the present context, since the Reserve Bank of India (“RBI”) is the primary regulator under the FEMA, it is critical to analyse the methodology prescribed by the RBI for ascertaining the ‘beneficial ownership’ in order to understand regulatory intent and thought process related to it.

The RBI in its master direction titled “Know Your Customer (KYC) Direction, 2016” issued on February 25, 2016 (“KYC Master Direction”) to establish a mechanism for customer identification procedure in line with the provisions of Prevention of Money Laundering Act, 2002, has prescribed the definition of the term ‘beneficial owner’.

As per the KYC Master Direction, the term ‘beneficial owner’ with respect to a juridical person means the natural person who:

From the reading of the aforesaid, it seems that KYC Master Direction traces the ownership interest of the ultimate natural person for ascertaining beneficial ownership irrespective of the number of layers of juridical persons through which such a beneficial ownership is held.

It is pertinent to note here that both KYC Master Direction and the Revised FDI Framework seek to trace the ultimate natural person for the determination of a ‘beneficial owner’. The reference to beneficial interest as ultimate beneficial interest held by a natural person meets the intent of the Revised FDI Framework and is likely introduced to ensure that the restriction cannot be bypassed by citizens or persons situated in a Bordering Country by investing through entities situated outside the Bordering Countries. Therefore, the definition prescribed in the KYC Master Direction may be considered by the Government of India for guidance on the applicability of the Revised FDI Framework for investments into Indian entities.

INCIDENTAL IMPLICATIONS

Owing to the broad nature of the restrictions contained in the Revised FDI Framework, several issues have continued to baffle investors vis-à-vis investments which, going by the intent stated in the Press Note 3, should not be within the ambit of the Revised FDI Framework.

Applicability to future investments in existing ventures (including wholly owned subsidiaries) and investments by financial investors such as venture capital and private equity funds are the most pertinent amongst such issues.

While on a plain reading of the Revised FDI Framework, it may seem that such transactions were not intended to be subjected to a prior government approval, the government may have purposely kept the ambit of the provisions broad enough to cover such transactions with an apprehension that general exceptions for such investments may be exploited to defeat the intent behind the Revised FDI Framework by making downstream investments or structuring investments through investment funds, etc.

PRESENT POSITION

As per the Revised FDI Framework, all investments from entities or natural persons (residents or citizens) of any Bordering Country into Indian entities engaged in permitted sectors will require governmental approval. This will cover investments from Pakistan, Bangladesh, Afghanistan, Nepal, Bhutan, Myanmar and China.

The approval will also be required for investments made by residents or citizens of any Bordering Country indirectly through entities or juridical persons situated in other countries but beneficially owned by them..

Further any transaction which, while not involving any fresh investment in India, has the effect of resulting in the beneficial ownership of any existing or future FDI in India falling in the hands of an entity or natural person situated in any Bordering Country, will also entail a government approval..

In the absence of specific parameters for determination of beneficial ownership, currently there is uncertainty as to the ambit of the Revised FDI Framework. It is hoped that the Government of India will prescribe specific parameters to determine beneficial ownership, to ensure that investors have clarity vis-à-vis their investments in India. This is also required for procedural purposes i.e. to ensure that authorised dealer banks may identify cases falling within the purview of Revised FDI Framework, so they can be referred to the Government of India for scrutiny and approval..

[The authors are Joint Partner and Associate, respectively, in Corporate practice of Lakshmikumaran and Sridharan, New Delhi]