The flip-flops in the latest Foreign Direct Investment (FDI) guidelines, and the confusions created by the Press Notes which followed, display the discomfort of Indian regulators in dealing with offshore multi-layered investments, with demons of drug money, tax evasion and round tripping lurking in all corners. Multi-layered tax effective investment structuring is commonly resorted to by transnational corporations, leveraging favourable tax rates, no different from other advantages any destination has to offer by reason of location or resources.
The announcement of February 11 was expected to open all doors wide for FDI, even in the sensitive sectors of media, defence, insurance and retail, and the rider of ownership and control did not pose much concern. As on date, it is not clear which way the policy will swing.
Press Notes 2 and 3 of 2009 followed a week later. Press Note 2 (PN2) clarified the distinction between non-resident direct and indirect investments. The determination criteria already provided for three different calculations — proportionate method in telecom and broadcasting sectors, insurance, according to Insurance Regulatory and Development Authority (IRDA) Regulations. In infrastructure/service sectors, policy positions already provided for indirect investment not being set off against the sectoral cap, provided the foreign investment did not exceed 49 per cent of the equity capital, and management rested with Indian owners.
For foreign owned holding cum operating companies in infrastructure, for any downstream investment, Foreign Investment Promotion Board (FIPB) approval had continued to be required under Press Note 9/99. The recent spurt in such applications before the FIPB, was because companies were being compelled to obtain post-facto approval. This appeared to be liberalised in PN2 as only being prospective. The absence of clarity in the existing regimes and trigger points had to be addressed — and a policy position to be taken whether to liberalise further.
PN2’s purpose is to lay down guidelines for foreign investors routing investments through investing companies, Indian by ownership or control, and provide clarity for situations in which such investment would not count towards calculating the sectoral cap, and for the control tests to be satisfied.
PN2 defines an Investing Company to mean an Indian Company, i.e., registered as per the Indian Companies Act (“Act”) making equity/preference/CCD investment in another company. This itself is confusing because an Investing Company can be located anywhere. Indian Ownership in the Investing Company is determined as conclusive if more than 50 per cent of the equity is beneficially owned or controlled ultimately by Resident Indian Citizens. Therefore, there could be a chain of relationships originating or culminating in India, provided the beneficial interest is established.
This is a grey area, as beneficial interest is not defined. Section 187-C of the Act provides for treatment of “beneficial interest”, but does not define it, though it has been interpreted as the right to receive dividends and other benefits accruing from shares. PN2 should have laid down the benchmarks of what constitutes beneficial interest as that would facilitated determining the disclosures the parties would have to make. “Control” has been defined to mean the power to appoint majority of the directors, which should be provided in the Articles of Association. Rightly this has raised a concern about the sanctity of Shareholder Agreements, hitherto respected as the parties’ private arrangements.
PN2 provides that all inter-se agreements have to be disclosed. Does this mean affirmative and veto rights will not work in these situations; and will joint ventures structured as quasi partnership become policy non-compliant? How stringent would the scrutiny levels be, and would the number of side letters executed offshore increase incrementally? Finally, what is worrying is that the Regulator will don a quasi-judicial mantle, and conflicts in interpretations will multiply.
The illustration of the various scenarios goes to establish that if a company wants financial returns on its investment, but willing to cede control - it would make good money sense to invest 49 per cent in the offshore or onshore Indian Investing Company. PN2 also makes clarifications for sectors having cap, and providing for beneficial ownership if it exceeds the threshold limits.
But Press Note 3 (PN3) has made FIPB approval mandatory in all sectors having caps, even where automatic route limits exist, and till now only the sectoral regulator’s consent was required. It is also not clear whether Indian shareholding in listed companies of non promoters and Indian independent directors would be taken into account for determining control limits. The language of PN3 indicates that its contents are applicable retrospectively which is inconsistent with PN2. And with another Press Note on the cards, one has to wait to pop the champagne cork.
Kumkum Sen is a Partner in Rajinder Narain & Co. and can be reached at kumkumsen@rnclegal.com
