Companies Act 2013: In times of COVID-19, the rules for national protection against opportunist investment needs greater clarity

By Hiren Bhatt and Vikas Pareek

In the current unprecedented times before the world, countries are ring fencing their national interest by setting oversight over the foreign investment in order to avoid opportunistic takeovers. Following the similar announcement by other jurisdictions like Australia, Spain, Germany; the Government of India (GOI) vide Press Note 3 (PN3) of 2020, has made all Foreign Direct Investment (FDI) from countries sharing a ‘land border’ with India (Bordering Countries) subject to prior government approval.

This PN3 was subsequently made effective through a notification dated 22 April 2020 introducing rules issued under the Foreign Exchange Management Act (FEMA) (Non-debt Instruments) Amendment Rules, 2020. The countries which share a land border with India are Afghanistan, Bangladesh, Bhutan, China, Myanmar, Nepal and Pakistan.

As per the PN3, (a) investments by entities incorporated in a ‘country which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country’ will require prior approval of the Government of India. It also states that in the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction/purview of (a) above, such subsequent change in beneficial ownership will also require prior government approval. Prior to introduction of PN3, the investment from Pakistan and Bangladesh were under approval route and in case of Nepal and Bhutan prior approval was required in certain specific cases such as acquisition of immovable property.

In relation to FDI, the PN3 (i) increases the list of countries whose investors are prohibited to invest in India under automatic route and (ii) makes an investment which otherwise would have been under automatic route, subject to prior approval if made by an entity whose beneficial owner is a citizen of a Bordering Country.

Though the intent of the GOI was to prevent ‘opportunistic’ investments into the Indian businesses which has suffered sharp fall in value due to Covid-19 pandemic, the GOI’s move has raised a lot of questions from the investor community, answers of which could pave way for additional foreign investment into India.

Amongst others, the PN3 does not lay down the criteria for application of beneficial ownership test. The term “beneficial owner” has been discussed under various laws in India which are two fold in terms of shareholding and control and covers:

(i) an individual holding prescribed shareholding or voting rights or right to participate in dividends or right to exercise control or significant influence over the company (Companies Act, 2013) or

(ii) has ownership or entitlement or has control over the investee company (Prevention of Money-laundering Act, 2002).

The prescribed shareholding level under these laws for determining beneficial ownership ranges between ten percent to twenty five percent and the control specific criteria to be looked at from appointment of majority director, controlling the management or policy decision perspective.

Thus, till the time, the term “beneficial owner” is not defined, the ambiguity may impact the foreign investments into India from across the globe as investors in Bordering Countries have stakes in lot of companies around the world. Clarity with respect to beneficial ownership test would help various private equity funds with investors from Bordering Countries, though not controlled, which otherwise may face regulatory hurdles and in turn impact the foreign investments in India.

Further, clarity regarding whether the restrictions under the PN3 are also intended to be applicable for investors coming from Hong Kong, Taiwan and Macau would also be greatly appreciated. Furthermore, clarity regarding applicability of the PN3 to share issuance in the form of Bonus and Rights issue to the existing shareholders from the Bordering Countries would relax the larger investor community.

While the PN3 is a timely move by GOI in the national interest, addressing above concerns would set the tone right in the investor community. Further, it remains to be seen that if the Covid-19 pandemic extends to the major part of the current financial year, how India Inc. moves into self-dependency mode to triumph over the slowed down foreign financial investments, if any, due to this bold move.

Hiren Bhatt is Partner, Deal Advisory, M&A Tax and PE, KPMG in India and Vikas Pareek is Associate Director, Deal Advisory, M&A Tax & PE, KPMG in India.

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