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Brief Overview of Foreign Direct Investment in India

Foreign Direct Investment (FDI) has played a crucial role in shaping the economic landscape of India, positioning it as one of the most attractive destinations for global investors. With its vast market potential, skilled workforce, and ongoing economic reforms, India has emerged as a powerhouse in attracting foreign capital. FDI in India not only fosters technological advancements and infrastructure development but also contributes significantly to job creation and overall economic growth. This article aims to delve into a brief legal overview of the law on such foreign direct investments, including the FEMA and FDI Policy.

I. Introduction

Foreign Direct Investment (‘FDI’) is defined by the World Trade Organization as “the investment made to acquire lasting interest in an enterprise operating in an economy other than that of the investor.” The purpose of making FDI, or allowing it, is to add foreign capital, advanced technology, and improved managerial skills, which can drive economic growth of the nation and increase financial globalization.

The Indian government aims to attract and encourage FDI in the country to supplement domestic capital, technology, and skills for faster economic growth and development. FDI is different from foreign portfolio investment (‘FPI’). While FPI involves a lasting interest in an enterprise in the host country through modes such as investment in securities, without any management involvement, FDI typically involves a foreign investor taking a significant stake in an Indian company, possibly even controlling it.

II. Summary of legal provisions

The inflow of FDI into India is governed by the provisions of the Foreign Exchange Management Act, 1999 (‘FEMA’) and the FDI policy of India. FEMA is the fundamental law governing the inflow and outflow of foreign exchange into and out of India respectively. As per FEMA, capital account transactions (affecting the assets and liabilities of an enterprise) are generally prohibited unless specifically permitted. On the other hand, current account transactions are generally permitted unless specifically prohibited.

An investment into an enterprise in India, i.e., an FDI, would be in the nature of a capital account transaction. Thus, it needs to be specifically allowed and permitted to overcome the general restriction under FEMA. Such specific permission is granted and governed by the FDI policy, which is periodically updated and modified to reflect the present appetite of the country.

More specifically referring to the legal provisions under FEMA, s. 6 of FEMA specifies that any person resident outside India can invest in the capital of an Indian company under the FDI route and s. 7 of FEMA specifies the modes of investment that are allowed under the FDI route, including equity shares, compulsorily convertible preference shares and convertible debentures. Further, s. 8 stipulates the sectors in which FDI is prohibited or restricted and also provides for the formation of the Foreign Investment Promotion Board to consider and approve proposals for FDI in sectors where it is restricted. S. 9 of FEMA then specifies the conditions for the transfer of capital instruments from a person resident outside India to an Indian resident or vice versa. There are certain reporting requirements also provided for under FEMA and its Rules and Regulations to ensure that the provisions are followed in letter and spirit.

III. Routes of investment

Automatic Route: As per the definition clause 2.1.4 of the FDI policy, the automatic route can be defined as “the entry route through which investment by a person resident outside India does not require the prior approval of the Reserve Bank of India or the Central Government.” Under the Automatic Route of investment, Foreign Direct Investment of up to 100% is allowed in all the specified sectors as notified by the RBI.

Approval Route: Under the approval route, which is quite contrary to the automatic route, prior approval of the government is required. The process of obtaining such government approval involves various steps including:

  1. Identify the Sector: Determine if the intended investment falls under a sector that requires government approval for FDI. The RBI and the Department for Promotion of Industry and Internal Trade (DPIIT) maintain updated lists of sectors that are under the government route for FDI.

  2. Obtain Necessary Clearances: Once the sector is identified, obtain any necessary clearances or approvals from relevant ministries or departments, as per the sector-specific regulations. For example, if the investment is in a defence or telecom sector, approvals from the Ministry of Defence or the Department of Telecommunications may be required, respectively.

  3. Submit Proposal to Foreign Investment Facilitation Portal (‘FIFP’): Prepare and submit the proposal for FDI to the relevant ministry or department through the FIFP or any other designated portal as per the guidelines issued by the government.

  4. Review and Approval: The proposal will be reviewed by the concerned ministry or department, and they may seek additional information or clarifications if required. Once the proposal is deemed complete and satisfactory, the ministry or department will issue an approval letter or an intimation letter, as applicable.

  5. Reporting to RBI: After obtaining the approval, the Indian company receiving the FDI needs to report the investment details to the RBI through the designated Authorized Dealer Bank within 30 days of receiving the funds.

  6. Compliance and Record Keeping: The Indian company is required to comply with the conditions and regulations associated with the approved FDI, maintain records, and submit necessary reports to the RBI and other government agencies as per the prescribed timelines.

Further, it is pertinent to note that the process and requirements for obtaining government approval for FDI under the government route may vary depending on the sectors, the amount of investment and other factors.

IV. Sectoral conditions and prohibitions

The FDI policy imposes certain sectoral conditions on various sectors. Such conditions are tabulated in Chapter 5.2 of the FDI Policy, 2020. For each sector listed in such table, the conditions are two-pronged: (i) what is the percentage till which FDI is permitted in such sector, and (ii) whether the entry route for such sector is ‘automatic’ or through ‘government approval’. For certain sectors, for instance, 100% FDI is permitted through the automatic route. For certain other sectors, only a limited investment is permitted and that also through the government (approval) route (e.g., for print media, only 26% investment is permitted through FDI, through the government route). The sectoral conditions are to be adhered with, and any contravention of the same shall be treated as a violation of the FDI policy.

In certain sectors, FDI is completely prohibited (such prohibitions are contained in Chapter 5 of the FDI policy) - viz., chit funds, lottery business, Nidhi companies, trading in transferable development rights (TDRs), gambling and betting including casinos etc.

Thus, basis the above, it could be concluded that there are three types of investments under FEMA read with the FDI policy: (i) permitted under the automatic route, (ii) permitted through the government (approval) route, and (iii) completely prohibited.

V. Reporting requirements

Being a law, the success and enforceability of which depends heavily on regulating the end-use of the funds that come into the country, FEMA and the FDI Policy cast reporting obligations in connection with the incoming FDI. To illustrate, the following forms are to be filed in compliance with the law:

  • FC-GPR (Foreign Currency-Gross Provisional Return) Form: An Indian company issuing equity instruments to a person resident outside India should file an FCGPR Form, within 30 days from the date of issuance of the equity instruments.

  • FC-TRS (Foreign Currency-Transfer of Shares) Form: The resident transferor/transferee or the person resident outside India holding equity instruments on a non-repatriable basis, as the case may be, should file the FCTRS Form, within 60 days of the transfer of equity instruments or receipt/remittance of funds, whichever is earlier.  

  • LLP(I) Form: A limited liability partnership (LLP) receiving the amount of consideration for the capital contribution should file the LLP(I) Form, within 30 days from the date of receipt of the amount of consideration.

  • CN Form: The Indian start-up company issuing convertible notes to a person resident outside India should file a CN Form, within 30 days from the date of issuance of the convertible notes. Further, the resident transferor/transferee should file CN Form, within 30 days of the transfer of the convertible notes issued by an Indian start-up company, from a resident to a non-resident (or vice-versa). [This is applicable only to start-up companies registered under the Startup India scheme, since only such companies can issue convertible notes.]

  • DRR Form: The domestic custodian issuing/transferring the depository receipts, in accordance with the Depository Receipt Scheme, 2014 should report in DRR Form, within 30 days of issuance/transfer of depository receipts.

  • ESOP Form: An Indian company issuing employees’ stock options to persons resident outside India who are its employees/directors or employees/directors of its holding company/joint venture/wholly owned overseas subsidiary/subsidiaries should file an ESOP Form, within 30 days from the date of issuance of employees’ stock option.

  • DI Form: where an investment is being made to a downstream investment entity which shall be, and which is considered as indirect foreign investment for the investee Indian entity should file a DI form.

  • INVI Form: Under the INVI form where an investment vehicle which has issued its unit to a person outside should file this form.

VI. Conclusion

FDI plays a pivotal role in developing the national economy and under such prospect the FDI Policy is notified from time to time. The FDI Policy, 2020, has made significant changes in sectors such as defense, financial, and insurance, allowing more foreign investment in these areas. The present policy aims to promote foreign investment in India while ensuring that it aligns with the country's overall economic goals. The policy also removes restrictions on investment from neighboring countries, which was previously subjected to government approval. Overall, it is to be appreciated that while the FDI Policy and the larger FEMA law are legal documents, they serve a larger economic and social interest of the country. While permitting foreign investment for growth, development, and global inclusion of Indian businesses, they should also ensure that foreign investment does not harm the interests of local businesses.

Authored by Pranav Dabas, Advocate, at Metalegal Advocates. The views are personal and do not constitute legal opinion.


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