Investments From Hongkong, Taiwan, Beneficial Owner In Press Note 3 Need Amplification

The Government of India (“GoI”) has reviewed and amended the Foreign Direct Investment (FDI) policy to curb opportunistic takeovers/acquisitions of Indian companies, consequent to Covid-19 pandemic, and the GoI has vide Press Note No. 3 (2020 series) dated 17^th April 2020 (hereinafter “PN3”) and has revised the FDI policy to this effect.

In this article, we examine the FDI policy amendment, and the areas that are desired to be addressed either by the GoI and/or Reserve Bank of India.

Present Position in FDI Policy

The FDI policy in India is structured in such a way that certain foreign investments are covered either under automatic route or under the approval route (i.e. prior approval of GoI is required before the foreign investment is made). The factor to determine whether a foreign investment is covered under automatic route or government route (“Entry Route”) is based on either the geographical origin of the investment, or on the sector in which the foreign investment is being made. 

Prior to PN3, investments that had the following geographical origins were covered under the government route:

• By a citizen of Bangladesh or an entity incorporated in Bangladesh;
• By a citizen of Pakistan or an entity incorporated in Pakistan. (It is to be noted that investment from Pakistan in defence, space, atomic energy and sectors prohibited for foreign investment is not allowed even under approval route)

PN3 modification to FDI Policy

With PN 3, the GoI has increased the coverage of the investment from geographical origin, which was earlier limited to Bangladesh and Pakistan, to cover all countries that share land border with India. While the Press Note does not specify the countries that share a land border with India, as per the information made available by Department of Border Management, Ministry of Home Affairs, GoI, the following are the seven countries with whom India shares its land borders, viz: China, Pakistan, Bangladesh, Nepal, Myanmar, Bhutan and Afghanistan. .

Instances when prior permission will be required under PN3

a) Direct investments into an Indian company, either from citizens or entities from the aforementioned countries, require prior approval of GoI.

b) The need for prior approval of GoI, under the press note, would extend to investments from entities from other geographical locations too, if the beneficial owner of such entity is a citizen of any of the abovementioned seven countries.

c) The present language of PN 3 indicates, that if the beneficial owner, even though not a citizen of the seven countries that share land border with India, but is a resident (situated) in any of those countries would also require prior permission from GoI.

d) When there is a share transfer from an existing shareholder to an entity/individual to another, which will result in the shares getting transferred to those covered under (a) to (c) above.

Effective Date

The changes made in PN 3 was made effective from the date of amendment to the relevant regulations under Foreign Exchange Management Act, 1999 by the RBI.

RBI has since made amendment to Foreign Exchange Management (Non-debt Instrument) Rules, 2019 by way notification no. S.O. 1278(E) dated 22^nd April 2020 (“RBI Notification”).

Issues that need to be addressed

1. Neither PN 3, nor the RBI Notification list out countries, and for this one would have to refer to information made available by Department of Border Management Ministry of Home Affairs. Two geographies that have a China connect, viz: Hongkong and Taiwan, fall into a unique category. Hongkong falls under the category of “One Country, Two Systems”, and is a “Special administrative region” of “People’s Republic of China”, which is recognised by GoI. So, it appears that investments from Hongkong will also be covered by PN 3 and RBI Notification.

2. However, Taiwan, which is also known as Republic of China, may stand in a different footing, given the relationship between India and Taiwan, and investments from Taiwan may not be restricted by PN 3 and RBI Notification.

3. The terms “Beneficial Owner”, “Beneficial Ownership” used under this PN3 are not defined nor they are defined under the Foreign Exchange Management Act, 1999 read with the RBI Notification. There are other enactments that define the term “Beneficial Owner”.

a. Prevention of Money Laundering Act, 2002:

Rule 9 of the Prevention of Money Laundering (Maintenance of Records) Rules, 2005 read with the Master Direction – Know Your Customer (KYC) Direction, 2016 as on 1^st April 2020, defines “Beneficial Owner” to identify an individual behind an entity opening an account with a bank.  

As per this, a “Beneficial Owner” is a natural person(s) who act(s) on his/her own or together or along with any juridical person, and lays down two criteria for determining the beneficial owner:

• Based on certain rights in the investing entity; or
• Based on threshold on stakes held in the investing entity.

An individual will be considered as beneficial owner of an entity investing in the Indian Company,

• if such Individual has the right to appoint majority of the directors or to control the management or policy decisions, whether by way of
• shareholding;
• management rights;
• shareholders agreements; or
• voting agreements.

  or

• If such individual owns 25% of shares or capital or profits of the body corporate investing in the Indian Company or in case, the entity investing is a non-body corporate (i.e., partnership firm, unincorporated association, body of individuals, Trust), the individual should own 15% of the non-body corporate.

b. Companies Act, 2013:

The other law which uses the term beneficial owner is Companies Act, 2013 and it defines the term “Significant Beneficial Owner (SBO)”. This term is used in the context of identifying an individual holding significant interest indirectly, in an Indian Company.

Under the Companies Act, for an individual to be considered as a Significant Beneficial Owner amongst other criterions, two conditions have to be satisfied:

• The individual should hold more than 50% stake in the entity registered outside India, that is proposing to invest, or 50% stake in the ultimate holding company of that investing entity; and the other is
• The investing entity should hold in the Indian Company more than 10% of the share capital, or voting rights, or right to dividend or significant influence.

CONCLUSION

Although it seems the definition of the beneficial owner under Prevention of Money Laundering (Maintenance of Records) Rules, 2005, can be taken to identify the beneficial owner of an investment in an Indian Company, it is still left to different interpretations as the same is not explicitly defined in the PN3.   Hence the Government of India/RBI should clarify the term beneficial owner/ beneficial ownership.

With the Government of India giving a thrust on ease of doing business, it is only important that it clarifies on the matters relating to the threshold of beneficial ownership, threshold investment from the land border countries that require prior approval of GoI, and also the position of investment from Taiwan and Hongkong, so as to avoid delays in investment in the Indian companies that receive the investment.

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Contributing Advisors