ISSUE XIII : DIPP’s new outlook: No stop signs, speed limit

DIPP’s New Outlook: No stop signs, speed limit


Prior to April 1, 2010, the Foreign Direct Investment (“FDI”) policy was renewed on a continual basis through Press Notes notified by the Department of Industrial Policy and Promotion (“DIPP”). However, as an investor-friendly measure, based on the precedent set last year, the DIPP has introduced the bi-annual consolidated FDI policy to bring about certain changes in order to further liberalize foreign investment in India.

The DIPP, with the objective to promote FDI through a simple, rationalized and transparent policy framework, has issued the current consolidated FDI policy, effective from April 1, 2011 which sets forth certain changes from the last Circular 2 of 2010 issued in October 2010. This bulletin highlights the changes introduced by the latest policy in the foreign investment regime in India and analyses the implications of such changes.

1. Deletion of the Press Note 1 of 2005

Press Note 18 of 1998 had initially introduced a restriction on a foreign investor to make any further investment, technology transfer or trademark agreement in the “same” or “allied” field as the existing ventures, without the prior consent of the Foreign Investment Promotion Board (“FIPB”). However, this condition was narrowed down vide Press Note 1 of 2005 wherein it was stipulated that a No-objection certificate (“NOC”) would be required from the Indian partner to consider new ventures by the foreign investor solely in case of joint-ventures prior to January 12, 2005 in the “same” field.1 This restrictive condition was not applicable to ventures entered into after the stipulated date and moreover if they were in any “allied” field.

The abovementioned provision does not find any mention in the current FDI policy. Effectively, a foreign investor with an existing joint-venture, technology transfer or trademark agreement even entered prior to January 12, 2005, would no longer require prior consent of the FIPB to make fresh investment in the “same” field as the existing venture and agreement.

The deletion of the above condition is a welcome change for foreign investors since the provision had been abused by Indian companies to block foreign investors from investing in the Indian market through other vehicles. Despite the changes brought about by Press Note 1 of 2005, the foreign investors still had to necessarily seek a NOC from the Indian partner at the outset to avoid any dispute at a later stage. This change would be a positive sign for foreign investors and attract FDI inflows in the Indian market.

2. Inclusion    of    fresh   categories   for   issue    of   shares   against   non-cash consideration

Previously, equity and preference shares could be issued only for cash consideration apart from conversion of external commercial borrowings and against lump sum technical know-how fees and royalty. Issue of shares against any other non-cash consideration was subject to prior FIPB approval.

However, the current FDI policy has also provided for issuance for equity shares against import of capital goods, machinery and equipment (including second-hand machinery) and for payment of pre-operative and pre-incorporation expenses (including payment of rent etc.), with prior FIPB approval. However, the FIPB approval would be granted subject to certain conditions being met such as import of capital being in accordance with the Exim policy, independent valuation of the goods2, production of customs documents and certificates assessing fair value of import, clear indication of the beneficial ownership and identity of the importer company as well as the overseas entity, in case of issuance of equity shares for capital goods. Similarly, for issuance of shares against payment of expenses is subject to verification of expenses by the Statutory Auditor, direct payments by the foreign investor etc. In each case, the conversion would need to be mandatorily done within 180 days of shipment of goods and receipt of remittance respectively.

These changes were extensively lobbied by the industry and have been introduced pursuant to stakeholder suggestions and consultations under the Discussion Paper released by the DIPP on the same subject in September 2010. It is pertinent to note that while there is a general permission to convert ECBs, lumpsum fee and royalty into preference shares as well as equity shares, the abovementioned categories permit solely issue of equity shares for consideration other than cash.

3. Amendments to downstream investment

Guidelines for downstream investment or indirect foreign investment were introduced under the controversial Press Notes 2, 3 and 4 of 2009 and which brought about the concept of “control” and “ownership” of Indian and foreign companies along with the method of calculation of direct and indirect foreign investment. The latest FDI policy has done away with the categorization of companies into “operating companies”, “operating- cum-investing companies” and “investing companies” and has replaced it with “companies owned or controlled by non-resident entities” and “companies owned and controlled by Indian residents”.

Although, provisions relating to downstream investment by an Indian company that is owned or controlled by a non-resident entity are essentially the same and continue to not require any FIPB approval subject to sectoral caps/conditions being met, the policy has essentially excluded operating companies from the ambit of downstream guidelines and provided guidelines only for investing companies. As such, as provided in Press Note 4 of 2009, foreign investment into an Indian company engaged only in the activity of investing in the capital of another Indian company i.e. holding companies, and into companies which do not have any operations and also do not have any downstream investments will, continue to require prior FIPB approval, regardless of the amount/extent of foreign investment. Further, as and when such company commences business(s) or makes downstream investment it will have to comply with the relevant sectoral conditions and caps. Core investment companies must additionally comply with the Reserve Bank of India (“RBI”) regulatory framework designed specifically for them.3

The FDI policy has also laid down certain activities in which foreign investment into Non-Banking Finance Companies, carrying on the activities approved for FDI, will be allowed under automatic route.4

While, the changes introduced do not have far-reaching consequences, these changes will assist in streamlining the process of downstream investment in India and is expected to significantly ease the conduct of business.

4. Pricing of convertible instruments

The latest FDI policy has given flexibility to an issuer to determine the conversion price of convertible capital instruments at the time of issue of such instruments or at the time of actual conversion provided the conversion formula is specified at the outset. This is as opposed to mandatorily determining the pricing upfront at the time of issue itself provided in the erstwhile FDI policy. However, in case of providing the conversion formula, the price cannot be lower than the fair value determined at the time of issuance of the instrument. The valuation of convertible instruments may be determined via the discounted cash flow method for unlisted companies and SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 for listed companies.

This amendment would enable the recipient to obtain the valuation of the convertible instrument based upon their performance and consequently, allow for upside benefits on improved performance of business to accrue to shareholders.

5. Other changes in the FDI policy

There have been certain other changes in the FDI policy as well. These include:

5.1 FDI in Venture Capital Funds (“VCFs”) – FDI is now allowed in Indian Venture Capital Undertakings /VCFs /other companies as well under the automatic route.5 SEBI registered Foreign venture capital investors may invest in a domestic VCF after seeking FIPB approval in cases where the VCF is a trust. No approval is required if the domestic VCF is a company incorporated under the Companies Act, 1956. Bearing in mind, the tax advantage for VCFs constituted as trusts in relation to companies, the implication of the amendment would be limited.

5.1 Reporting upon issue of shares – Instead of filing Part B of Form FC-GPR, DIPP has formulated another form called Annual Return on Foreign Liabilities and Assets in Annexure 1-B of the policy.

5.2 Trading – Wholesale trading of items sourced from medium and small enterprises has been placed under 100% automatic route and the requirement to seek FIPB approval has been removed.

5.3 Warrants – The FDI policy has clarified that FIPB approval is required only for issue of warrants and party-paid shares to persons resident outside India. The policy does not specifically state that warrants are not considered under the definition of “capital; yet it does affirm that the policy is under review, and so further changes are anticipated.

5.4 Portfolio Investment Scheme – DIPP has sought to increase the aggregate limit of investment by a Foreign Institutional Investor in an Indian company under the Portfolio Investment Scheme to higher than 24% of the capital of the company to the sectoral cap upon passing a resolution by the Board and Shareholders.


India’s new foreign investment policy is certainly a work-in progress given the steps taken to rectify the faults and drawbacks that exist as well as to further streamline and simplify the process of investment in India. The abolition of the Press Note 1 of 2005 is a significant feature to address a matter that has been a road block for investors for a length of time. All the same, there are numerous other reforms that were being sought by the industry and which have not been addressed in the latest FDI policy. Until the next FDI policy in 6 months, these changes will received well by foreign investors.

This bulletin is prepared by Shaista Arora (under the supervision of Pooja Yadava, Sr. Associate), a final year law student at Amity Law School, Delhi who interned at PSA.

1 “Same” field being determined by the NIC Code
2 Preferably by independent valuer from the country of import
3 RBI Circular No. DNBS (PD) CC No. 206/03.10.001/2010-11
4 The activities are merchant banking, under writing, portfolio management services, investment advisory services, financial consultancy, stock broking, asset management, venture capital, custodian services, factoring, credit rating agencies, leasing and finance, housing finance, forex broking, credit card business, money changing business and micro credit.
5 Schedule 6 to Notification No. FEMA 20


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