The Department of Economic Affairs on 16 August 2024 had issued a notification amending the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019. The Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules, 2024 mark a significant step in simplifying and modernizing the regulatory framework governing non-debt investments. The article details key changes under the 2024 Rules which include:
A. Standardization of Definitions
1. Control: The 2024 Rules have amended the definition of ‘Control’ to align it with the definition provided under the Companies Act, 2013. However, the existing definition continues to apply insofar as the limited liability partnerships are concerned. Also, earlier the term ‘Control’ as it was previously defined was limited to Rule 23 of the Rules (governing downstream investments), the 2024 Rules has extended its applicability to all the Rules, thereby bringing uniformity to the Rules.
2. Startup Company: The existing definition of ‘startup company’ referred to the erstwhile notification of the Ministry of Commerce and Industry dated 17 February 2016. The 2024 Rules has aligned the definition of ‘startup company’ with the latest notification of 19 February 2019. Accordingly, a company shall be considered as a startup if:
a) it has been incorporated or registered in India for less than 10 years, instead of 5 years; and
b) its turnover has not exceeded INR 100 crores, as opposed to INR 25 crores.
B. Enabling Seamless Equity Swaps and Capital Transfers
The new Rule 9A has enabled swap arrangements for equity instruments transfer between residents and non-residents. Specifically, this rule allows for:
a. Swap of Equity Instruments in line with the rules framed by the Central Government and regulations issued by Reserve Bank of India (“RBI”);
b. Equity swap for Foreign Direct Investment (FDI) in the form of shares of a foreign company, subject to the provisions under the Central Government regulations, including Foreign Exchange Management (Overseas Investment) Rules, 2022, and related guidelines of RBI.
Earlier, Rule 21 (Pricing Guidelines) read with Schedule I of the NDI Rules allowed for the issuance of equity instruments by an Indian company to a non-resident in exchange for the swap of equity instruments of another Indian company. Pursuant to this amendment, an Indian entity is now permitted to issue securities to a non-resident in exchange for equity instruments or equity capital from either an Indian or foreign company, thereby facilitating easier cross-border equity swaps. For the purposes of the new Rule 9A, the definition of ‘equity capital’ is as per the OI Rules.
C. Downstream Investments by OCI-Owned Entities
The Rules excluded investments made by entities owned and controlled by non-resident Indians (NRIs) on a non-repatriation basis from being calculated under indirect foreign investment. The 2024 Rules have brought the Overseas Citizens of India (OCIs) on par with the NRI owned entities. Accordingly, an investment made by any entity which is owned and controlled by an NRI or an OCI on a non-repatriation basis has been excluded from being considered as an ‘indirect foreign investment’.
D. Removal of 49% Threshold in Foreign Portfolio Investment Regulations
Prior to the 2024 Rules, government approval was necessary if foreign portfolio investment exceeded 49% of the paid-up capital or the applicable statutory limit, whichever was lower. This requirement was especially important if such investments led to an ownership change or change in control from Indian citizens to foreign residents. The recent amendment has eliminated this 49% threshold by stating that if total foreign portfolio investment remains within the sectoral or statutory cap and does not result in a shift in ownership or control from Indian citizens to foreign residents, no government approval is needed.
E. Facilitation of Foreign Direct Investment in White Label ATMs
The 2024 amendment has aligned the Rules with the Consolidated FDI Policy 2020 by allowing 100% FDI in White Label ATM Operations (“WLAO”) under the automatic route. However, to qualify for this 100% FDI under the automatic route, the following conditions must be met:
a. The non-bank entity setting up WLAOs must maintain a minimum net worth of INR 100 crore as per the latest audited financial statements.
b. If the entity is also involved in providing ‘Other Financial Services’ as defined in Schedule I of the NDI Rules, the foreign investment in the WLA entity shall also comply with any applicable minimum capitalization requirements for such services.
c. All foreign investments must adhere to the specific criteria and guidelines issued by the RBI under the Payment and Settlement Systems Act, 2007.
These provisions ensure that while 100% FDI in WLAO is permitted, it is subject to regulatory safeguards to maintain financial stability and compliance with established guidelines.
Conclusion
While the Rules allowed Indian companies to issue equity securities to non-residents through the mechanism of share swaps with other Indian companies, there existed a vacuum in the regulations for cross-border share swaps.
The recent amendments to the Rules fill that gap, so Indian companies can now issue or transfer directly equity instruments against shares received by it from foreign companies. Cross-border share transfers have been made easier by this amendment and, therefore, it improves the possibility of international growth, mergers, acquisitions, and other important strategies by Indian companies, and that makes the country even more attractive for incoming foreign investments. The investment process is also becoming more efficient, promoting greater uniformity in the regulatory landscape.
Authors: Abhishek Kale, Manish Parmar, Niyati Shroff & Shikha Modi