Despite the apparent safeguards, there is enough scope for abuse, says Arun Kumar.
Thanks to the constant lobbying by various cash-strapped Indian promoters who are looking for foreign funds beyond the current FDI caps to bail them out, the country now has two types of foreign investors. Those that invest upto the sectoral caps — of 26 per cent in the case of insurance, 49 per cent in the DTH business and 74 per cent in the case of telecom — in each industry, and those that can go up to 90 per cent and more through a series of holding companies. The second type, made possible through new FDI rules, takes India’s FDI rules back to the pre-2006 era when, though control was ostensibly in the hands of Indian promoters who under the law were supposed to own at least 51 per cent of their firms, foreigners were the main beneficial owners of the company. There are some safeguards to make sure Indians ‘control’ these companies, but these are not foolproof (more on this later).
Under the law, as it stood before the recent change, all foreign holdings, whether through FDI or FII, whether directly or indirectly, had to conform to the sectoral caps. An example should make this clear. Take the case of Arun Kumar Ltd (AKL), a company with a Rs 100 crore equity owned by an Indian citizen called, say, Arun Kumar. Now, let’s say 49 per cent of this company is sold to a foreigner, ABC, at a premium, for Rs 100 crore. So, AKL is now an Indian-owned and -controlled firm with an equity base of Rs 200 crore, especially since Arun Kumar will have more directors than ABC. Now, say AKL buys 74 per cent into BLM (the next set of initials!) and ABC buys the remaining 26 per cent. Under the old rules, ABC’s equity holdings in BLM would be considered to be 62.3 per cent (26 per cent direct plus 49 per cent of AKL’s 74 per cent). Under the new rules, however, since AKL is an Indian-owned and -controlled company, the 26 per cent holding of ABC in BLM is considered as being that owned by an Indian!
In other words, a foreigner can bankroll an Indian venture to any extent, even upwards of 90 per cent by extending the AKL-BLM chain to, say, CMN and DNO while the law puts an FDI ceiling of 26, 49 or even 74 per cent. So what, ask those who got it done. As long as the company is controlled by Indians, how does it matter who funds it? And before rushing to conclusions, why not wait to see the actual instances of abuse and weigh these against the FDI inflows. It is a valid question, and there is nothing wrong if the foreign investor in the holding company is different from that in the subsidiary—but the government has not specified that. And in any case, identities are often not known when investments are routed through front companies in tax havens.
And what if the foreign investor is the same in the holding and subsidiary company? In such situations, the argument is made, few international firms are going to fund the bulk of a company unless there is significant control. A common method for such control is for the foreign and Indian partners to have side agreements spelling out specific shareholder rights; these agreements may or may not be disclosed to the authorities. There is also the other method, whereby many Indian promoters continue to control their companies through a series of investment firms where they have neither ownership nor board seats, or through trusts.
Those in favour of the new rules argue that such scenarios on pyramiding shareholdings are fanciful. Do you really think, they ask, an international investor will bankroll 90 per cent of a venture in this indirect fashion if the company’s sales/profits cannot be added to that of the parent company (which, under the structure laid out by the government, it cannot)? The argument has some merit, so there is a natural safeguard.
But clever lawyers can always do some fancy drafting. In March 2006, telecom firm Hutchison Telecommunications International Ltd (HTIL) reorganised its holdings in Hutchison Essar since the FDI cap in telecom was 49 per cent and the government seemed intent on enforcing it. At that time, HTIL’s disclosure to the SEC in the US said that HTIL had ‘an aggregate direct equity of 42.34 per cent of Hutchison Essar’, that the ‘HTIL Group will also continue to hold an indirect interest in Hutchison Essar … of 19.54 per cent …’ If this wasn’t enough, the clincher was ‘The Board has been advised and has concluded that ... Hutchison Essar will continue to be consolidated as subsidiaries of HTIL under both Hong Kong GAAP and US GAAP following the Reorganisation.’ In other words, a foreigner can consolidate an Indian company’s accounts even without owning the majority of shares.
In February 2007, when Vodafone took over Hutchison Essar, its news release said it had ‘agreed to acquire companies that control a 67 per cent interest in Hutch Essar from HTIL’. The problem was that 12 percentage points of this 67 per cent was owned by Analjit Singh and Asim Ghosh, so how did Vodafone say it had bought that stake from HTIL? Both Singh and Ghosh said they were independent owners, and not proxies for anyone — a position that was finally accepted by the authorities.
What of the possibility of using the new FDI guidelines to enter into sectors where foreigners are not permitted like, say, multi-brand retailing of the type Wal-Mart does? Let’s go back to AKL with its Rs 100 crore equity. Assume it now sells 49 per cent of this to ABC at a huge premium adding up to, say, a total price of Rs 1,000 crore — assume the proportion of directors is, as earlier, three nominated by Arun Kumar and two by ABC. Now let AKL buy 95 per cent of a company called MBR (Multi-Brand Retail) for Rs 900 crore —for this to work, MBR cannot be a fully-owned subsidiary of AKL. So, the other 5 per cent can be owned by anyone else, but this person has to be an Indian. MBR is now a rich, fully-Indian-owned and -controlled company, well within its rights to do multi-brand retail. But, in fact, the bulk of the money has come from ABC (who, through his 49 per cent stake in AKL controls 46.6 per cent of MBR). ABC, it is true, does not nominate the majority of directors, but getting around this is relatively easy since he controls the purse-strings. And there are the side agreements.
It can be no one’s case that it should not be easier for Indian firms to access foreign capital, or that foreign investment norms should not be eased. But why not open up directly instead of doing it in this roundabout manner?
