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Investments in foreign companies - FEMA implications

FEMA is the law governing cross-border transactions, including share capital infusions in companies abroad. Casual investments in foreign companies are not fatal and are rectifiable.

Investments in foreign companies - FEMA implications

India has a buzzing startup sector now – thanks to the technocrats and risk-takers who make this sector thrive. It is encouraging to also see how startups (or any company in general) are also exploring setting up companies in other countries (what is called in quasi-legal parlance, as ‘corporate structure’) for commercial, legal, and tax purposes. Frequently, such setting up of companies abroad is done casually and the legal ramifications are not properly considered. For instance, monies are sent abroad without following strictly the procedure laid down under the Foreign Exchange Management Act, 1999 (‘FEMA’) and the applicable Rules, Regulations and other directions or guidelines issued by the Reserve Bank of India (‘RBI’). This write-up explains how such a casual approach is not fatal, is rectifiable, and most importantly, startups need not really lose sleep over it.


Company A was incorporated in Singapore with an initial share capital of SGD 1,000. As per Company A’s books, such amount was given in cash by its shareholder and promoter Mr. X, at the time of incorporation and continued to remain as cash-in-hand with Company A.

Mr. X resides in India permanently and as such is an Indian resident from the purview of tax law as well as under FEMA. He is the 100% shareholder, and also a director, in Company A from incorporation till date.

Mr. X regularly visits Singapore for business purposes and had visited Singapore at the time of incorporation of Company A for the purpose of completing the legal requirements of incorporating such company. During such visit, Mr. X had withdrawn SGD 1000 from an ATM in Singapore from his International Debit Card, issued in India, and used the same for providing the initial share capital.

The issue that arises for our consideration is: whether the investment of SGD 1000 made by Mr. X in Company A as initial share capital is in compliance with the provisions of FEMA and applicable Rules, Regulations and other RBI directions and guidelines?

Relevant provisions of FEMA

The law governing the field of foreign exchange is FEMA, along with applicable Rules, Regulations and other directions or guidelines issued by the RBI from time to time (collectively, ‘FEMA’). In other words, FEMA is the fundamental law in India regarding cross-border transactions involving residents / non-residents, currencies / monies (either in Indian rupees or foreign currencies), and assets (located in India or abroad). Amongst other things, FEMA is the law governing the acquisition of foreign assets (including shares) by an Indian resident, including the payment made for the same in foreign currency (e.g., SGD).

Applying FEMA to the facts of the present query, the following conclusions emerge:

a. Mr. X is a ‘person resident in India’, or simply, an Indian resident.

b. The shares of Company A are ‘foreign securities’, in which Mr. X has invested.

c. The payment for such investment in shares has been made in Singapore Dollars, which is a ‘foreign currency’.

Current and capital account transactions

Under the provisions of FEMA, transactions are broadly classified into (i) capital account transactions, and (ii) current account transactions. Capital account transactions are, inter alia, those transactions which alter the assets or liabilities outside India of persons resident in India. All other transactions are current account transactions. The transaction under consideration, i.e., investment into shares of a foreign company, is thus a capital account transaction since it alters the assets and liabilities outside India of its Indian resident shareholder Mr. X.

The broad rule regarding capital account transactions under FEMA is that such transactions are generally prohibited (i.e., an approval from the RBI is required to undertake them) unless they are specifically permitted (i.e., under FEMA and related laws / provisions it is somewhere written that certain transactions can be undertaken without requiring prior RBI approval). Contrast this with the rule for current account transactions: they are generally permitted (i.e., no RBI approval is required to undertake them) unless they are specifically prohibited (i.e., the nature of the transaction is such that it falls in either a negative list (thus, cannot be undertaken at all) or it requires an RBI approval before it can be undertaken).

Thus, a certain capital account transaction could be said to be permitted only when FEMA and related laws / provisions specifically permit for it to be undertaken. The relevant Regulation here is the Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000 (‘CAT Regulations’). Besides other provisions, the CAT Regulations provide that an Indian resident can undertake investment in foreign securities. Also, the CAT Regulations provide that any person may sell or draw foreign exchange to or from an authorized person (bank) for a capital account transaction specified in the Schedules – the relevant Schedule here is Schedule I, which provides that investment in foreign securities is permissible.

There are certain conditions attached to such provision the relevant ones of which, as applicable to the instant facts, state the following:

  • The investment should not exceed USD 250,000 per financial year. In the instant case, the investment is of SGD 1000, which is much less than the prescribed threshold limit.

  • The payment for investment should be by way of a debit to the account of the investor maintained with an authorized person in India. In the instant case, the payment has apparently been made by way of withdrawal (debit) from an International Debit Card issued by Citibank (authorized person) in India. It is also to be noted that the CAT Regulations provide that ‘drawal’ of foreign exchange for the purpose of investment into foreign securities shall include use of International Debit Card.

  • The investor shall furnish to the RBI a declaration in the manner prescribed in the regulations relevant to the transaction. The RBI declaration needs to be made as applicable to the factum of investment into shares of a foreign company in the prescribed regulations.

In view of the above, on the question whether the transaction under question is permissible in substance under FEMA or not, the answer is in the affirmative. It is pertinent now to consider the procedure and modalities under which the transaction would be covered.

Liberalized Remittance Scheme (LRS)

The Liberalized Remittance Scheme (‘LRS’), introduced in 2004, provides a liberalization measure to facilitate Indian residents to remit funds abroad for permitted current or capital account transactions or combination of both. The LRS has been amended from time to time, while the substance and concept behind the scheme has remained the same.

The LRS provides for a remittance of up to USD 250,000 per financial year to be allowed to be made by Indian residents for certain transactions. Investment into shares of a company or setting up a company in the form of a joint venture or wholly owned subsidiary are allowed under LRS.

The following points are noteworthy in this regard:

  • The LRS provides that remittance could be made for making investments abroad by way of acquisition and holding shares of both listed and unlisted overseas companies. This route has in common parlance been known as the portfolio route of investment, with the term ‘portfolio’ not been defined in the legal provisions. There had been a doubt as to whether this route can be used for ‘setting up’ a company, or in other words, whether an Indian resident can use this route to set up a company where s/he is the sole or substantial shareholder (and, maybe the promoter). Although since the term ‘portfolio’ or the term ‘investment’ have not been defined, a view may be aptly taken that the LRS covers even scenarios where the investment amounts to setting up of a company.

  • From 05.08.2013, however, the above doubt has been eliminated with the RBI notifying that an Indian resident can set up a company (wholly owned subsidiary or joint venture) also through the LRS route, subject to certain conditions similar to overseas direct investment route.

Thus, investment into shares of a foreign company, either as a simple (portfolio) investment or for the purpose of setting up a company as a promoter shareholder, is allowed under the LRS. Without going into the details of the ‘overseas direct investment’ scheme which is statutorily laid down in the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004, and the RBI Master Direction on the subject matter, it is noteworthy that the LRS is an alternative scheme compared to the ODI route and is much less complicated in terms of compliance requirements.

For the purpose of making the remittance under LRS, the scheme prescribes that a Form A2 is required to be filled up and submitted to the bank. Upon submission of such Form, the investor may ask for a debit to his bank account and in return ask for: (i) a draft or (ii) direct remittance to the foreign party or (iii) travelers’ cheques or (iv) foreign currency notes. The Form also requires the investor to undertake that his request is within the overall limit of USD 250,000 in that financial year. Once the Form is processed by the bank, any of the above, e.g., foreign currency notes, may be taken by the investor abroad and used towards the investment. As an alternative, an International Debit Card may also be used for the debit to the investor’s bank account and obtaining foreign currency notes by him for the purpose of the investment (recall as explained above the provisions of the CAT Regulations).

The Form A2 thus serves the limited purpose of making sure that the reporting is properly carried out and the bank is aware of foreign currency amounts being used towards LRS transactions. Since the transaction is substantively within the provisions of the LRS, along with the CAT Regulations, in case any person does not file Form A2, this would amount to a technical non-compliance, which can be compounded as per FEMA provisions. In any case, such non-compliance would not affect the nature or substance of the investment at all.

Retention and reinvestment of income

It is also to be noted that the LRS provides that an investor, who has remitted funds under LRS can retain and reinvest the income earned on the investments and is not required to repatriate the funds or income generated out of the investments made under the scheme. Thus, in case Mr. X sells the shares of Company A in the future, the above provision would allow him to retain and reinvest the gains / income arising from such sale proceeds outside India without requiring a repatriation of the same. Even if the investment is considered to have been allowed (for ‘setting up’ the company, rather than as a portfolio investment) as referred to in Paragraph 13(b) above, the same provisions would apply for the activity of investment by Company A into other startup companies, with some additional conditions similar to the overseas direct investment route.


The illustration explained above and the queries that arise with respect to FEMA implications, thus may be answered as follows:

  • The transaction of investment in Company A shares is a permissible capital account transaction as per FEMA and the CAT Regulations. The transaction of withdrawal from an International Debit Card for the purpose of investment into foreign securities is also a permissible capital account transaction.

  • The investment is permissible under the LRS being under the prescribed threshold limit of USD 250,000.

  • Reporting requirement of furnishing Form A2 for the purpose of availing LRS is to be satisfied. In case the same has not been done, the investor may approach the appropriate authority for compounding.

  • Repatriation of proceeds earned from the investments made under the LRS is not required, and the investor may retain and reinvest the same outside India.

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