On 16 August 2024, the Ministry of Finance, notified the Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024 (Amendment Rules) to further amend the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules). The Amendment Rules inter alia relax cross-border share swaps, clarify downstream investments made entities owned by Overseas Citizens of India (OCIs) on a non-repatriation basis, standardize the definition of ‘control’ and so on.

Share Swaps for Secondary Transfers

Previously, the NDI Rules permitted Indian companies to issue equity instruments to a person resident outside India (PROI) against swap of equity instruments without prior Government approval – provided the issuer company was engaged in a sector under automatic route. Until the notification of the Amendment Rules, the NDI Rules conferred express permission for the issuance of equity instruments in consideration for a share swap. The NDI Rules were silent regarding secondary swaps of equity instruments.

Under the Foreign Exchange Management Act, 1999 (FEMA), capital account transactions – i.e. those which alter the assets or liabilities (including contingent liabilities) held outside India by persons resident in India – may only be undertaken if expressly permitted. As per FEMA, any cross-border financial transaction which is not expressly permitted may be undertaken only with the prior approval of the Reserve Bank of India (RBI). Therefore, in the absence of express permission under the NDI Rules, secondary shares swaps required prior approval of the RBI.

The Amendment Rules now permit the transfer of equity instruments of an Indian company between a person resident in India and a PROI by swap of equity instruments of the Indian Company swap of equity capital of a foreign company in compliance with Foreign Exchange Management (Overseas Investment) Rules, 2022 (OI Rules). Government approval for such transfers will be required wherever the sectoral caps or other requirements under FEMA apply. As a consequence of the Amendment Rules, secondary share swaps for companies operating in automatic route sectors can now be undertaken more swiftly.

Clarification on Downstream Investments by OCIs

The NDI Rules do not consider investments made by Indian entities owned and controlled by non-resident Indians (NRIs) on a non-repatriation basis when calculating indirect foreign investment. However, such investments made by Indian entities owned and controlled by OCIs was considered indirect foreign investment.

The Amendment Rules have now brought OCIs on par with NRIs by clarifying that investments made by an Indian entity which is owned and controlled by an NRI or OCI on a non-repatriation basis shall not be considered for calculation of indirect foreign investment for identifying downstream investments.

Government Approval for Foreign Portfolio Investment

The Amendment Rules provide that aggregate foreign portfolio investment (FPI) up to the sectoral cap will not require government approval or compliance with sectoral conditions, given that such investment does not result in transfer of ownership or control. Previously, government approval was required, and sectoral conditions applied if the aggregate FPI was up to 49% of the paid-up capital or the sectoral cap, whichever was lower.

Sectoral Cap for White Label ATMs

The Amendment Rules have aligned the NDI Rules for White Label ATM Operations (WLAO) with the Consolidated FDI Policy of 2020 (FDI Policy). The NDI Rules now mirror the requirements under FDI Policy allowing 100% FDI in WLAO through the automatic route.

Definition of ‘Control’

Previously, ‘control’ under the NDI Rules was defined under specific provisions relating to downstream investments, investments by PROI in an investment vehicle and purchase and sale of equity instrument by FPIs. Prior to the Amendment Rules, the NDI Rules defined ‘control’ as:

  1. In the case of a company, the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreement or voting agreement;
  2. In the case of a limited liability partnership (LLP), the right to appoint majority of the designated partners, where such designated partners, with specific exclusion to others, have control over all the policies of an LLP; and
  3. In the case of an alternative investment fund (AIF), control of such AIF in hands of sponsors and managers or investment managers with general exclusion to others.

The Amendment Rules have revised the definition of ‘control’ vis-à-vis companies and LLPs:

  1. In the case of a company, control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner. This is the definition presently prescribed by the Companies Act, 2013; and
  2. In the case of an LLP, control means the right to appoint majority of the designated partners, where such designated partners, with specific exclusion to others, have control over all the policies of an LLP.

Definition of ‘Startup’

In 2016, the Department for Promotion of Industry and Internal Trade (DPIIT) had introduced the following criteria for identifying ‘startup’ as an entity: (i) which has been incorporated for no longer than 5 years; (ii) with turnover not exceeding INR 25,00,00,000 in any of the financial years; and (iii) which is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.

While the DPIIT amended the definition in 2019 to modify parameters of turnover and date of incorporation, the NDI Rules had not been amended to reflect the new definition. The Amendment Rules have now updated the definition of ‘startup’ to read as the DPIIT’s 2019 definition, i.e., a startup will be an entity: (i) which has been incorporated for no longer than 10 years; (ii) with turnover not exceeding INR 100,00,00,000 in any of the financial years; and (iii) which is working towards innovation, development, or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

Concluding Comments

The Amendment Rules work towards clarifying the NDI Rules, rationalising provisions, and simplifying investments. Importantly, the amendments in respect of secondary share swaps will enable companies to enter into variety of swap structures without requiring RBI approval. Further liberalisation may however be necessary as the OI Rules permit investment by resident individuals in foreign entities through secondary share swaps in the event of mergers, demergers, amalgamations and liquidation.

We hope that the Indian regulators take a consistent view, and the amendment will help in moving the transaction swiftly and with lower regulatory compliance costs. This is specifically a promising change in higher interest rate scenario, where companies will have additional options to structure mergers, acquisitions, and the like through a combination of cash and non-cash consideration. 

Bharucha & Partners – Parag Bhide , Mitali Kshatriya and Shaam Thelapilly