Downstream Investments and Applicability of Deferred Payment Conditions in India

A foreign investor can invest in India either directly or indirectly through another Indian entity. Direct investment by a foreign investor will be termed asforeign direct investment. A subset of foreign investment is an investment by a foreign investor through an entity/LLP incorporated under Indian Laws. This is known as downstream investment.

In other words, Indian companies that have foreign investment, and which are used for further investment into underlying target Indian companies, can be considered as FOCCs(ie, foreign owned and/or controlled company): that is, the Indian entity has received foreign investment in the past and is being controlled and owned by the foreign investor/non-resident person.

Downstream investments are governed under the Foreign Exchange Management Act, 1999 (FEMA), and rules and regulations made thereunder, more particularly Rule 23 of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (the “FEMA NDI Rules”), which provides that an Indian entity that has received indirect foreign investment has to comply with the entry route, sectoral caps, pricing guidelines and other attendant conditions as applicable for foreign investment.

Reporting requirements for downstream investments are provided under the FEMA (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019. The Indian entity making downstream investment into another Indian entity has to report as follows:

As discussed above, downstream investment needs to comply with the entry route, sectoral caps, pricing guidelines and other attendant conditions as applicable for foreign investment. The term “other attendant conditions as applicable for foreign investment” is broader and has not been defined in the FEMA NDI Rules.

One may take this view and include the deferral payment conditions of Rule 9(6) of the FEMA NDI Rules as applicable for foreign investments in other attendant conditions. Said Rule deals with deferred consideration and indemnity payable by FOCCs, ie, deferred consideration shall not exceed 25% of the total sale consideration and the period of deferred consideration shall not exceed 18 months from the date of transfer agreement.

It is important to note that Rule 9(6) deals with the transfer of equity instruments (which includes equity shares) of an Indian company between a person resident in India and a person resident outside India. Further, as per Section 2(v) of FEMA, a “person resident in India” includes any person or body corporate registered or incorporated in India and, as per Section 2(w) of FEMA, a “person resident outside India” means a person who is not resident in India.

The government of India has recently amended the FEMA NDI Rules and these have revised the definition of an Indian company. The amended rules define the term “Indian company” as follows: “‘Indian Company’ means a company as defined in the Companies Act, 2013 or a body corporate established or constituted by or under any Central or State Act, which is incorporated in India.”

Further, the extant norms have defined the term “Indian company” as: “‘Indian Company’ means a company incorporated in India.” Based on that, one can conclude that an Indian company incorporated in India is considered to be an Indian entity under FEMA NDI Rules.

In view of the above provisions, Rule 9(6) of the FEMA NDI Rules, which deals with deferral payment consideration, could be said to be applicable only in the case of the transfer of equity shares of an Indian company between a person resident in India and a person resident outside India and not for a transaction to be entered into between two persons resident in India. Further, an Indian entity (even though FOCC) is considered to be a “person resident in India” under the FEMA NDI Rules as it is a body corporate incorporated in India.

Hence, FOCC, being an Indian entity, would be considered as a person resident in India and, as such, Rule 9(6) of FEMA NDI Rules, which deals with deferral payment consideration, may not apply on transfer of equity shares between resident sellers and FOCC.

As per Rule 4(3) of the FEMA NDI Reporting Regulations, where equity instruments are transferred between a person resident in India and a person resident outside India, reporting shall be made with RBI in Form FC-TRS within 60 days of the transfer of equity instruments or receipt/remittance of funds, whichever is earlier. Further, transfer of equity instruments prescribed in Rule 9(6) of the FEMA NDI Rules shall be reported in Form FC-TRS on receipt of every tranche of payment – this reporting is not applicable for a transfer of shares between an Indian entity (even though FOCC) and a resident seller, ie, a transaction between two residents in India.

Hence, in view of the harmonious reading of the above provisions under FEMA, one could argue that Rule 9(6) of FEMA NDI Rules, which deals with deferred payment consideration, may not be applicable in the case of a transfer of equity shares of a resident seller to a person resident in India (though FOCC), since it is a transfer between two persons resident in India.

It is therefore arguable that there are no specific regulations/provisions under Rule 23 of the FEMA NDI Rules that deal with downstream investments and provide for deferred consideration conditions applicability in respect of downstream investments made in circumstances similar to those prescribed under Rule 9(6) of the FEMA NDI Rules.

This article specifically focuses on deferred payment conditions being applicable to FOCC investments; however, conservative views recommending the seeking of clarification from the regulators are also prevalent in the arena.