Foreign Direct Investment


Foreign Direct Investment (“FDI”) is permitted in all sectors except for those contained in the prohibited list including atomic energy, betting and gambling, lottery business etc. It may or may not require prior regulatory approval depending on the government policy in the relevant sector in which investment is proposed to be made. Proposals, where no such permission is required fall under the “automatic” route, while for others, an application has to be made to the Foreign Investment Promotion Board (“FIPB”) and fall under the “government” route.

Before the year 2000, FDI was allowed up to percentages (50 per cent, 51 per cent and 74 per cent) in very few selective sectors. In the year 2000 with a view to promote foreign investment and provide much need impetus to the Indian economy, the FDI policy was inversed to permit FDI in all sectors with the exception of few sectors in which FDI is either prohibited or restricted.

Automatic route

FDI in certain sectors is permitted under the “automatic” route. However, even for sectors falling under the automatic route, there may be a cap for FDI; any FDI beyond the specified percentage may be made with prior permission of the government depending on the government policy in that sector. For instance, for existing projects, FDI in airports is allowed upto 100 percent but beyond 74 percent requires government approval. Or, in other words, till 74 percent investment qualifies under the automatic route. For Greenfield projects for airports, FDI is permissible upto 100 percent under the automatic route. For most manufacturing activities, FDI upto 100 percent may be made under the automatic route.

The government liberalized FDI by opening up more sectors like permitting FDI upto 100 percent in retail trade of “single-brand” products, with its prior approval, subject to specified conditions. It also brought under automatic route upto 100 percent certain activities like manufacture of industrial explosives and hazardous chemicals, setting up greenfield airport projects and cash and carry wholesale trading and export trading.

Investment in certain specified units viz. Export Processing Zones (“EPZ”)/Electronic Hardware Technology Park (EHTP)/Software Technology Park (STP) /Industrial Parks also qualify under the automatic route.

Post investment under this route, the Reserve Bank of India (“RBI) must be informed of the inward remittance within 30 days of receipt of funds towards such an investment. Further, prescribed documentation is required to be filed with the RBI through the designated AD Bank within 30 days of issue of shares to the foreign investor and within 60 days for transfer of shares to the foreign investor.

No prior approval of the FIPB is required in respect of transfer of shares/convertible debentures, by way of sale, of the Indian company, from resident to non-resident or vice-versa. This is subject to certain conditions like sectoral caps, pricing norms, etc. Indian Party is required submit the required documents along with Form FC-TRS with the AD Bank. However, the financial service sector (i.e. banks, Non Banking Financial Companies and insurance) are excluded and require prior regulatory approval.

FIPB approval

The Government of India, through the FIPB, is the regulatory body for FDI into India. For activities, which do not qualify under the automatic route, FIPB has formulated sector-specific guidelines which are amended from time to time. FIPB considers each proposal on a case-to case-basis, and normally, takes at least 4-6 weeks to grant approval after submission of the application. While earlier, proposals with a total investment exceeding INR 6.00 billion were submitted to the Cabinet Committee on Economic Affairs (“CCEA”) for decision by FIPB, now the Ministry of Finance (in-charge of FIPB) can consider the proposals with a total foreign equity inflow of and below INR. 12.00 billion. Where the total foreign equity inflow exceeds INR. 12.00 billion, FIPB’s recommendations on the proposal are placed before the CCEA and the FIPB Secretariat in the Department of Economic Affairs process the recommendations of the FIPB to obtain the approval of the Minister of Finance. In addition, the CCEA can also consider the proposals that are referred to it by the FIPB or the Ministry of Finance (in-charge of FIPB).

Proposals where government approval is required may be discussed with the government officials in person by the foreign investor himself or through his representatives (Company Secretaries / lawyers) in India.

After issue of shares to the foreign investor, the Indian company (in which investment has been made) is required to file the prescribed documents with the RBI through its designated AD Bank within 30 days.

February 2009 press notes
On February 13, 2009, radical changes were made to the FDI norms in anticipation of greater foreign investments. The Department of Industrial Policy and Promotion issued Press Notes 2 and 3 of 2009 and issued further clarifications on February 25, 2009 through Press Note 4 of 2009 which clarify, expand upon and modify the various previous policies and the method of calculation of direct and indirect foreign investment. Briefly, under the February Press Notes, the dual criteria to determine whether or not foreign holding is to be treated as FDI are management as well as economic control. This has had a considerable impact on calculating indirect foreign investment in a company, especially with regard to downstream foreign investment.

Calculation of Foreign Investment

In terms of Press Note No. 9 of 1999 issued by DIPP certain guidelines were laid down for the downstream investment made by foreign owned Indian holding companies that required prior FIPB/Government approval. The Government has come out with a fresh set of guidelines/press notes on the subjects of indirect investment and downstream investment. Press Note No. 2 of 2009 was issued, wherein guidelines for calculation of total foreign investment were detailed.

There are different ways in which investment can be made in Indian Companies.

Direct Method

In this method, Investment is directly routed to the Indian Company from Foreign Company.  Pictorial presentation is represented below:

Indirect Method
Foreign Company can also resort an indirect way to Invest in Indian Companies.

In the above method Indian Company (I Co1) is the shareholder in I Co2. In other words, Foreign Company owns shares in I Co2 through I Co1.  In the Indirect Method herein above referred, total foreign investment is total of Foreign Direct Investment + Indirect Investment.

Press Note 4 of 2009 (Press Note 4) seeks to clarify compliance with foreign investment norms compared with downstream investments. Although the language in the operating part of the press note is not very clear, the introductory paragraph suggests that it is restricted to downstream investments by an ICo1 if the ICo1 is owned or controlled by non-resident entities. It categorizes ICo2 into three baskets:

  1. Operating companies: Sectoral caps and conditionalities of FEMA have to be complied with.
  2. Operating-cum-investment companies: Sectoral caps and conditionalities of FEMA have to be complied by ICo2 as well by the ICo3 (Domestic Company) in which the investment is proposed by the ICo2.
  3. Investment companies: If the ICo2 is an investment company (i.e. neither an operating company nor an operating-cum-investment company), FIPB approval is required regardless of the amount or extent of foreign investment. Further, the Domestic Company will have to comply with conditionalities and sectoral caps.

If the ICo2 is an operating-cum-investing company, or an investment company, additional conditions are prescribed in relation to downstream investment by an ICo2 in Domestic Companies.

  • Two conditions are procedural and require certain intimations of downstream investment within 30 days of investment and certain board resolutions to be submitted to FIPB, SIA & DIPP.
  • Other conditions are substantive and require compliance with certain pricing guidelines.

The key principle emerging from Press Note 2 is that as long as an Indian company is owned and controlled ultimately by resident Indians, foreign investment in the Indian company would be ignored in relation to downstream investments made by the Indian company.

Two Tests” to be satisfied for deciding the applicability of Press Note 2 and 4 are as under:

  1. Control and Ownership of the Indian Investing Company
  2. The pattern of ‘Downstream Investment’ in the Sector in which the Investment is being made for being able to.

First Test:  Control and Ownership of the Indian Investing Companies.
“Owned” by resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens, if more than 50% of the equity interest in it is beneficially owned by resident Indian citizens and Indian companies, which are owned and controlled ultimately by resident Indian citizens.

“Controlled” by resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens, if the resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens, have the power to appoint a majority of its directors.

Conversely, an Indian company may be taken as being “owned” by ‘non resident entities’, if more than 50 percent of  the equity interest in it is beneficially owned by non-residents “controlled” by ‘non resident entities’, if non-residents have the power to appoint a majority of its directors. Thus in the instant case, CFPL is owned and controlled by resident Indian Citizens.

Second Test: Downstream Investment
Please note that Press Note 4 is applicable only to downstream investment by investing Indian companies owned or controlled by non-residents. In other words, if the investing Indian companies are not foreign owned or controlled, Press Note 4 does not apply.

Disclaimer: The entire contents of this document have been developed on the basis of relevant provisions and are purely the views of the authors. Though the author has made utmost efforts to provide authentic information however, the authors and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.


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