Permissible Sources For Funding Overseas Direct Investment

In this blog post, Tanvi Amlani, a student of GGSIP University, who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, writes about the permissible sources for funding overseas direct investment. 

Overseas direct investment: meaning

Overseas Direct Investment in general terms simply means to create investments abroad by way of either contributing to the capital of another nation or by having oneself subscribed to the Memorandum of Association of a foreign entity.

This may also be considered as a method to expand business and create a market outside the home state. Statistical data show that major investments from India are in manufacturing or service sectors. It may ultimately lead to creating brand image overseas and boosting economic ties and financial cooperation between the home state and the host state.

Laws governing Indian overseas direct investments

1. Foreign Exchange Management Act, 1999.
2. Foreign Exchange Management (Transfer or Issue of Security) Regulations, 2000.
3. Master Circulars issued by RBI from time to time relating to dealings in foreign account transactions.

Overseas direct investment takes place through

1. Investing through Stock Exchanges of foreign entities.
2. Private placement in foreign entities.
3. Market Purchase.
4. Investment in a Joint Venture or Wholly owned subsidiary abroad.

Meaning of certain relevant terms

1. Joint Venture: It’s a business arrangement in which two or more entities come together and invest in the same as decided previously by them to accomplish a particular task. However, the identities of parties coming together remain distinct.
2. Wholly Owned Subsidiary: Under this, there are two entities, subsidiary and the parent company. The parent company holds 100% common stock (a security that represents ownership incorporation, it determines the control of such stockholders. They have a right to vote board of directors by the corporate policy) in the subsidiary company.
3. Indian Party: It is a company incorporated in India or a body created under an Act of Parliament or a partnership registered under the Indian Partnership Act, 1932 or a Limited Liability Partnership incorporated under The Limited Liability Partnership Act, 2008 making an investment in a joint venture or a wholly owned subsidiary abroad.

What are the permissible sources for funding overseas direct investment?

Since overseas direct investments define the long-term interests in foreign entities and have a direct blow on the economic growth of a nation, they are highly regulated in India. There are clearly affirmed routes and limits. The sources of such funding have also been specified under the Masters Circulars issued by RBI regarding the same.

A brief discussion on Section 6(3) (a) of FEMA, 1999

The legislative intention of the Act is clearly defined in its preamble which states the purpose of the Act. It has been drafted to regulate foreign exchange by facilitating external trade and payments and promote the orderly development of the foreign exchange market in India.

The definition of Capital Account Transaction as stated means any transaction which alters the assets and liabilities overseas of any person residing in India or of any persons residing outside India but having long-term investments within India. It also includes within its ambit all transactions covered under Sub-section 3 of Section 6 under the same Act.

Section 6 of the Act mentions the requirements for permissible capital account transactions and also the need for an authorized officer for conducting the same. The Reserve Bank of India in consultation with the Central Government of India is authorized to specify the permissible class or classes of the transaction and also the admissible limits for these transactions. The Reserve Bank of India has a right to prohibit, regulate and restrict transfer and issue of foreign securities within and outside India of persons that come under the provisions of the act. It also regulates borrowings, lending, imports and exports, guarantees and securities, and even acquisitions and takeovers.

A brief discussion on Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004

In exercise of powers conferred to RBI by FEMA, 1999, it has made certain regulations directing the Overseas Direct Investment. There are various definitions given under the Act such as ADR (American Depository Receipt), GDR (Global Depository Receipt) which are directly related to the overseas direct investment.

The term direct investment overseas has also been defined in the Regulation; it has been stated that such investments do not include Portfolio Investments (investments made by a person not directly involved in the management of the company).

Part I of the Regulations deal with Direct Investments outside India which says that transactions should be held with prior approval from the RBI. It has also been stated that total financial commitment of the Indian Company must not exceed 100% of its net worth according to the last audited balance sheet. There are much more relevant conditions attached to it which may be referred for more details.

We would now come to the Permissible Sources for going ahead with these overseas direct investment: –

RBI prescribes ceilings for such funding from time to time. The investments abroad are allowed to be funded out of the following resources either alone or in contribution with each other:

1. Drawl of foreign exchange from an Authorized Dealer Bank in India.
2. Capitalization of Exports.
3. A swap of shares according to the valuations specified.
4. Proceeds of External Commercial Borrowings/ Foreign Currency Convertible Funds.
5. In exchange of ADRs and GDRs according to the schemes and guidelines.
6. Balance held in Exchange Earner Foreign Currency Account of the Indian Party.
7. Proceeds of foreign currency fund through ADR/GDR issue

In respect of 6^th and 7^th, the limit of financial commitment would not apply. General Permissions have also been granted to person resident in India for purchase or acquisition of securities in the following manner:

1. Out of funds held in Resident Foreign Currency Accounts.
2. As bonus shares on existing holdings of Foreign Currency Shares.
3. Out of foreign currency resources outside India in the case when the party is not permanently residing in India.

Conclusion

Overseas Direct Investments involve huge amounts of capital account transactions that greatly impact the economic well-being of a place where such financial commitment begins. Therefore, there have been provisions installed in FEMA Act, 1999 to regulate them along with the regulations that prohibit and restrict transactions having an adverse effect on the economy. The Master Circulars issued by the RBI play a great role in providing directions to the mode of investing abroad, procedures and permissible sources for funding along with the routes such as Automatic Route and Approval Route that need to be adopted and kept in mind while planning such direct investments at an international level.

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