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  • Reetika Gupta

Overseas Direct Investment (ODI) – Key changes implemented by New Rules and Regulations

There is a growing trend of Indian entrepreneurs making their way into the overseas market to expand their footprint and develop a multinational presence to attract more investment. Even Indian Individuals have shown a willingness to invest in start-ups and strategic sectors abroad. The trend of incentivizing the workforce with employee stock options and sweat equity of foreign companies is also on a rise. The Ministry of Finance and the Reserve Bank of India notified the new overseas investment regime (“Revised ODI Framework”) on August 22, 2022, to create a more comprehensive and robust framework that is more aligned to the recent trends of the Indian offshore market. The Revised ODI Framework inter alia comprises of:

  • the Foreign Exchange Management (Overseas Investment) Rules, 2022 mainly governing overseas non-debt investment framework (“OI Rules”).

  • the Foreign Exchange Management (Overseas Investment) Regulations, 2022 mainly governing overseas debt investment framework (“OI Regulations”); and

  • the Foreign Exchange Management (Overseas Investment) Directions, 2022 issued by the RBI to authorised persons (“OI Master Directions”).

It supersedes the overseas direct investment regime governed under the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004, Master Direction – Direct Investment by Residents in Joint Venture (JV) / Wholly Owned Subsidiary (WOS) Abroad and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India), Regulations 2015 (“Old Regime”).

In today’s article, we will share the key changes brought about by the Revised ODI Framework, which are as follows:


1- Introducing new 10% voting rights test in the definition of ‘Control’:

The Revised ODI Framework has now clarified the qualitative and quantitative test of the term ‘control’. The definition of ‘Control’ means (i) the right to appoint a majority of the directors; or (ii) to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders’ agreements or voting agreements that entitle them to 10% or more of voting rights or in any other manner in the entity. In other words, even 10% shareholding is sufficient to satisfy the control test, irrespective of whether an investor actually has the right to appoint a majority of directors or participate in management/policy decisions.


Impact: Under the OI Rules, a subsidiary would be regarded as an entity, over which a foreign entity has control. By virtue of the reduced threshold of 10% for control, a Foreign Entity may be regarded as a subsidiary or a ‘step-down subsidiary’ even when it does not meet the ‘subsidiary test’ under Section 2(87) of the Companies Act.


2- Clear segregation between an overseas direct investment (ODI) and an Overseas Portfolio Investment (OPI):

The OI Rules have revamped the meaning of ODI and have removed the concept of investment in a WOS / JV to investment in the foreign entity. A definition of OPI has been included to cover investments in foreign securities which do not qualify as ODI. Further, OPI does not include investment in any unlisted debt instruments, or any security issued by a person resident in India who is not in an International Financial Service Centre (“IFSC”).


An ODI inter alia includes

  • Acquisition of unlisted equity capital of a foreign entity; or

  • Subscription as a part of MoA of a foreign entity; or

  • Investment in 10% or more of the paid-up equity capital of a listed foreign entity; or

  • Investment with control where investment is less than 10% of paid-up equity capital of the listed foreign entity.

Impact: Investment in even a single share of an unlisted foreign entity would now qualify to be ODI and if one intends to enjoy the benefits of OPI then a non-controlling investment of less than 10% in a listed foreign entity should be maintained. It is pertinent to highlight that once classified as an ODI or OPI, the investment continues to be treated as an ODI or OPI even if does not fulfil the ‘ten percent’ or ‘control’ or listing threshold at any subsequent point in time.


3- Change in the calculation of Total Financial Commitment Limit (“TFC Limit”):

Whilst the erstwhile TFC Limit has been retained at 400% of net worth, the definition of ‘net worth’ has been aligned with Section 2(57) of the Companies Act and now includes security premium account. However, the Indian Entity can no longer utilise the net worth of its subsidiary/ holding company. Further, the OI Rules have clarified that the TFC Limit should be determined at the time of undertaking the financial commitment. It is also pertinent to note that the TFC Limit only includes ODIs, and a separate limit of 50% of net worth has been provided for OPIs.


Impact: As highlighted the OI Master Directions have done away with utilising net worth of the subsidiary / holding company which will impact large conglomerates where subsidiaries are used to structure overseas Investment.


4- Investment in strategic sectors:

The term “strategic sector” as per the Revised ODI Framework includes energy and natural resources sectors such as oil, gas, coal, mineral ores, submarine cable system and start-ups and any other sector or sub-sector as deemed fit by the Central Government. It is pertinent to note that where the foreign entity’s core activity lies in any strategic sector, the restriction of limited liability structure of foreign entity shall not be mandatory. Accordingly, ODI in unincorporated companies operating in such strategic sectors has been permitted.


Impact: The concept of ‘strategic sector’ has been introduced to enable greater Indian investment in such sectors abroad. Given neither the OI Rules nor the OI Master Directions provide the meaning of ‘startups’ for the purpose of strategic sector and the Strategic sector has been defined in an inclusive manner, the government has retained the power to allow investments in foreign entities beyond the stipulated limits in the future.


5- Gifts of foreign securities by non-residents to Indian resident Individuals:

Under the Previous ODI Regime, gifting of foreign securities by non-residents to an Indian resident individual was permitted freely. However, the New ODI Regime states that Individuals can now acquire shares through gifts only from persons outside India, subject to compliance with the Foreign Contribution (Regulation) Act, 2010 (FCRA). FCRA is a law that regulates foreign contributions to NGOs and other establishments. It mandates registration or approval for receiving foreign contributions by certain person and prohibits certain category of persons from accepting foreign contribution. It is pertinent to highlight that the recent amendment in the FCRA rules allows Indians to receive up to INR 10,00,000 (Rupees Ten Lakhs only) in a year from relatives staying abroad without informing the authorities.


Impact: This new rule has helped plug the loophole that existed for long as the erstwhile RBI regulation which permitted any Indian resident individual to acquire foreign securities by way of gift from non-residents without taking into consideration FCRA compliance.


6- Pricing Guidelines:

The pricing for overseas investment should be arrived on an arm’s length basis as per any internationally accepted pricing methodology and such valuation report can be issued by any recognized valuer. The AD banks are now made responsible for ensuring compliance with such arm’s length pricing requirements.


Impact: Given RBI has not specified any guiding principles for 'arm’s length pricing' determination, it could result in divergent practices amongst the AD banks.


7- Round Tripping (ODI-FDI Structures):

One of the most substantive changes brought by way of this New Framework is clarity on restrictive and permitted round tripping as the Old Regime did not explicitly mention round-tripping in the text of the law. It was only through FAQ No.64 of RBI’s ODI FAQs that enacted substantive law by mandating prior RBI approval for round-tripping transactions. In simple words, Round Tripping means an ODI-FDI structure i.e., a transaction that involves capital belonging to a country (e.g., India) leaving the country (e.g., Mauritius) and then getting reinvested in the form of FDI.


Under the New Regime, ODI-FDI structures shall be permitted subject to compliance with the layering restrictions set out under Rule 19(3), which provides that resident Indians can make financial commitments in a foreign entity that has invested or invests into India without prior RBI approval provided the entire structure does not have more than two layers of subsidiaries, either directly or indirectly.


Impact: It is important to keep in mind that the round tripping is applicable only in the ODI transaction and not in the OPI. Also, regulatory clarity is awaited on how to compute the number of layers and the test of ‘subsidiaries’ for correct interpretation of restriction of the OI Rules.


8- Acquisition of shares under ESOP or employee benefits scheme or sweat equity shares:

The Erstwhile Regime also permitted resident individuals to acquire foreign securities under ESOP. However, under the New Regime the employees and directors who receive shares under an ESOP offered by a foreign company shall be considered to have received an Overseas Portfolio Investment (OPI). Consequently, the value of such shares / interest will count towards such individual’s Liberalized Remittance Scheme (LRS) limit of USD 250,000.


The repatriation requirements are also modified such that, if an individual acquires securities that represent (in the aggregate) less than 10% of the company's share capital, the individual will be required to repatriate any proceeds related to the securities within 180 days of receipt (unless the amounts are reinvested by the individual in compliance with the OI Regulations within the 180-day period). While in the event the individual acquires securities that represent (in the aggregate) 10% or more of the company's share capital, the individual will be required to repatriate the proceeds within 90 days of receipt.


Impact: Given the LRS limit of USD 250,000 shall apply on the ESOP, if an individual is required to send USD 100,000 as grant price on exercise of the ESOPs in a financial year then he/ she will only be permitted to remit USD 150,000 outside India under LRS.


This content is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. In case you have any specific query, please email at reetika@aristolegal.co.in


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Reetika Gupta

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Email: reetika@aristolegal.co.in

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