The key to making acquisitions is being ready because you really never know when the right big one is going to come along. – James McNerney

Governments, regulators, citizens all over the globe are trying hard to coupe up with the effects caused by the deadly virus – COVID – 19, on the health of both individuals as well as the economy. Government of each and every country is trying hard to strike the right balance between the deflating economy as well the lives of people. In the recent times, various countries have expressed (subtly or otherwise) concerns about being vulnerable to takeover or acquisition by one of the world’s fastest growing economy – China.

As per media reports China already has foreign exchange reserves of more than 3 trillion dollars- equal to the GDP of India for 2019. Accordingly, cash rich countries with huge foreign exchange reserves may be perceived to be in a position to make huge investments, in the nature of ‘opportunistic takeovers / acquisitions’ and derive the benefits of low valuations across corporate sector, as rightly advised in the above quote by Mr. James McNerney, former President and CEO of The Boeing Company.

In order to avoid hostile takeover from any foreigner, various countries such as Spain, Italy and Germany are in the process of or have already strengthened the foreign inflow investment laws to make foreign takeover harder.

The Government of India through the Department for Promotion of Industry and Internal Trade (“DIPP“) has issued Press Note No. 3(2020 Series) dated April 17, 2020 (“Press Note“) which has amended the Consolidated Foreign Direct Investment Policy, 2017 (“FDI Policy“) and the Ministry of Finance with a view of aligning the Press Note with the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“Non-Debt Rules“) through Notification dated April 22, 2020 (“Notification“) has amended the Non-Debt Rules.

The amendments in the FDI Policy and the Non-Debt Rules are effective from April 22, 2020. The said amendments have been introduced with a view of ‘curbing opportunistic takeovers/ acquisitions of Indian companies due to COVID – 19 pandemic’.

A relook at the FDI Policy and the Non-Debt Rules in the times such as the current scenario becomes important, moreover because of the fact that several sectors and industries were open to 100% foreign ownership under the FDI Policy and the Non-Debt Rules without the need for any prior scrutiny or regulatory approval.

LEGAL FRAMEWORK UNDER THE FDI POLICY AND NON-DEBT RULES

Prior to the amendment brought in the FDI Policy and the Non-Debt Rules, the FDI Policy and the Non-Debt Rules required government approval only for investments sought to be made by a citizen or entity from Bangladesh and Pakistan.

However, the FDI Policy and the Non-Debt Rules have been revised as under:

Primary investments – The amended FDI Policy and the Non-Debt Rules provides that any investments by an entity or a beneficial owner of an investment into India is situated in or is a citizen of any country which shares land border with India shall require prior government approval.

Secondary investments – Transfer of ownership in any existing or future FDI in an Indian entity, whether directly or indirectly, which results in the beneficial ownership falling in the hands of entities / citizens of the neighbor countries shall also require prior government approval.

ASPECTS REQUIRING FURTHER CLARITY

While the prompt response of the Government of India is applaudable, the Press Note and the Notification leaves certain areas unclear, for which a better clarity, which may be through further amendments in the Non-Debt Rules being the relevant rules applicable to foreign investments into India under the Foreign Exchange Management Act, 1999 (“FEMA“) is awaited:

1. Land Border Countries

The Press Note and the Notification has laid down the restrictions in respect of countries that share land border with India. No specific countries have been mentioned in this regard. It is pertinent to note that India shares land border with Pakistan, Bangladesh, China, Nepal, Myanmar, Bhutan and Afghanistan. Accordingly, the restrictions may be well applied to investments from the said countries.

Hong Kong is a special administrative region under China. However, it is treated as a separate jurisdiction for transaction and tax purposes. India has an independent tax treaty with Hong Kong and investments coming from the region are recorded separately from that of China.

However, since the Press Note and the Notification are not detailed ones, it is ambiguous if the restrictions brought in shall be applied to investments from Hong Kong as well, moreover when the Securities and Exchange Board of India has asked the custodian banks to disclose details of ultimate beneficial owners of Foreign Portfolio Investors (“FPIs“) based in China and Hong Kong.

2. Meaning of beneficial owner

The term ‘beneficial owner’ has not been defined in the FDI Policy nor in the Non-Debt Rules and not even in FEMA. However, the said term has been defined in the Prevention of Money Laundering Act, 2002, as the natural person who ultimately owns or controls a client and/or the person on whose behalf the transaction is being conducted, and includes a person who exercises ultimate effective control over a juridical person.

The threshold limit for different kinds of entities have been stated under the Prevention of Money-Laundering (Maintenance of Records) Rules, 2005, in order to determine controlling ownership interest. The said limits are ownership / entitlement to:

• more than 25 percent of shares or capital or profits in case of a company;
• more than 15% of the capital or profits in case of a partnership; or,
• more than 15% of the property or capital or profits in case of an unincorporated association or body of individuals.

The Reserve Bank of India applies the aforementioned thresholds for the purpose of determining beneficial ownership of entities in its ambit.

In absence of any thresholds in the FDI Policy and the Non-Debt Rules, it seems that funds / companies in which even a single beneficiary holding a single share is an entity / individual to whom the said restriction apply, such entities shall be required to seek prior government approval, which may not be the intent. Accordingly, a clarity regarding the threshold of beneficial ownership, beyond which government approval shall trigger is required.

CONCLUSION

While the amendments made in the FDI Policy and the Non-Debt Rules are welcome, it shall be interesting to see how will the same be applied in practical scenarios, in order to achieve the intent of such regulatory amendments in true letter and spirit, which will help India tide over the spill-over effects on account of the COVID – 19 pandemic.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.