Can a Foreign Company Invest in an Indian Co. without Consideration?

India today is a part of the top 100 clubs on Ease of Doing Business. According to Press Bureau of India, it is rapidly emerging as a preferred investment destination where Foreign Direct Investment (FDI) inflows have increased 20-fold in last 20 years. In light of these developments, the FDI Policy of India has highlighted some methods and procedures to ease investments in India, without transfer of funds.

Eligibility for Investment in India

According to Reserve Bank of India’s (RBI) Master Circular, a person resident outside India or an entity incorporated outside India, (other than a citizen of or entity incorporated in Pakistan) can invest in India, subject to the FDI Policy of the Government of India. A citizen of Bangladesh or an entity incorporated in Bangladesh can invest in India under the FDI Scheme, with the prior approval of the FIPB.

Companies registered under the Companies Act 2013 can issue the shares to their foreign investors or partners without the consideration or physical transfer of funds in India. Some of the scenarios in which the company normally issues the shares without consideration are:

1.    Conversation of External Commercial Borrowings (ECB), i.e., foreign loan, into the Equity

2.    Swap of Shares

3.    Issue of equity shares against Pre-operative / pre – incorporation expenses

4.    Issue shares against the import of goods

5.    Issue of shares against Provider of technology/Technical Know How.

Conversion of ECB to shares

ECB refers to borrowings by Indian firms to raise funds from outside India in foreign or Indian currency. Indian corporates are permitted by the Indian government to raise funds using External Commercial Borrowing to help the companies expand their business, acquire assets, and repay existing debt.

Indian companies have been granted general permission for conversion of ECB into shares / convertible debentures, subject to the following conditions and reporting requirements:

a)    Whether the activity of the company is covered under the Automatic Route for FDI. Else, the company has obtained Government's approval for foreign equity in the company, if required;

b)    The foreign equity after conversion of ECB into equity is within the sectoral cap, if any;

c)    Pricing of shares is determined as per SEBI regulations for listed company or DCF method for unlisted company;

d)    Compliance with the requirements prescribed under any other statute and regulation in force;

e)    The conversion facility is available for ECBs availed under the Automatic or Approval Route and is applicable to ECBs, due for payment or not, as well as secured / unsecured loans availed from non-resident collaborators.

Full conversion of ECB

• The company shall report the conversion in Form FC-GPR to the Regional Office concerned of the Reserve Bank as well as in Form ECB-2 to the Department of Statistics and Information Management (DSIM), Reserve Bank of India, Bandra-Kurla Complex, Mumbai – 400 051, within seven working days from the close of month to which it relates.
• The words "ECB wholly converted to equity" shall be clearly indicated on top of the Form ECB-2. Once reported, filing of Form ECB-2 in the subsequent months is not necessary.

Partial conversion of ECB

• The company shall report the converted portion in Form FC-GPR to the Regional Office concerned as well as in Form ECB-2 clearly differentiating the converted portion from the non-converted portion.
• The words "ECB partially converted to equity" shall be indicated on top of the Form ECB-2. In the subsequent months, the outstanding balance of ECB shall be reported in Form ECB-2 to DSIM.

List of documents for conversion of ECB to Shares

• Approval from lender for conversion of ECB into Equity.
• Board Resolution for taking Boards approval for conversion of ECB to shares.
• Special Resolution for taking members approval for conversion of ECB to shares.
• MGT-14 for filing of special resolution.
• Agreement between lender and Company for conversion of ECB to Equity.
• Last ECB-2 Return.
• Loan Registration Number obtained from RBI.
• List of allottee.
• Valuation Report.
• Issuance of share certificate.
• Form PAS-3.
• CS certificate for FC-GPR.

Swap of shares

A share swap transaction is self-explanatory. Shares of the Indian company are issued by consideration paid through shares of the acquiring entity. Cash circulation can be avoided. Mature companies typically use this structure in combination with cash payments to minimize immediate and significant cash outflows.

The Authorised Dealer banks in India, who are the watchdogs of RBI tasked with overseeing compliance with Foreign Exchange Management Act, 1999 (FEMA) and its attendant regulations, require details of the transactions such as number of shares received / allotted, premium paid / received, brokerage paid / received, etc., and also give a confirmation to the effect that the inward leg of transaction has been approved by Department for Promotion of Industry and Internal Trade (DPIIT) (if applicable) and the valuation has been done as per the laid-down procedure and that the overseas company’s shares are issued / transferred in the name of the Indian investing company.

To the extent that such swaps involve persons who are resident outside India, both FEMA Regulations and the Companies Act, 2013 play a substantial role in determining the valuation of the target company and the resultant swap ratio.

Documents required for share swap:

• Scheme of merger and acquisition.
• Board Resolution confirming Boards approval.
• Special Resolution confirming members approval.
• MGT-14 for filing of special resolution.
• Valuation Report (Merchant Banker registered with SEBI).
• Issuance of share certificate.

Issue of Equity Shares Against Pre-Operative/Pre-Incorporation Expenses

As per RBI Master Directions – Foreign Investment in India, pre-incorporation / pre-operative expenses include the amounts remitted to the investee Company’s account or to the investor’s account in India (if any) or to any consultant or attorney or to any other material/service provider for expenditure relating to incorporation or necessary for commencement of operations.

A wholly owned subsidiary set up in India, the Indian company can issue shares against pre-operative/pre-incorporation expenses subject to a limit of 5% of its capital or USD 5,00,000 whichever is less. This is subject to the condition that it occurs within 30 days from the date of issue of equity instruments. However, it may not be later than one year from the date of incorporation or such time as the Reserve Bank permits. The Indian company shall report the transaction to the Reserve Bank as per the reporting requirements specified by RBI:

a)    Submission of Foreign Inward Remittance Certificate (FIRC) for remittance of funds by the overseas promoters for the expenditure incurred.

b)    Verification and certification of the pre-incorporation/pre-operative expenses by the statutory auditor.

c)    Payments should be made by the foreign investor to the company directly or through the bank account opened by the foreign investor as provided under FEMA Regulations.

d)    The applications, complete in all respects, for capitalization being made within the period of 180 days from the date of incorporation of the company.

Shares Import of Capital Goods

RBI Circular No. 74 dated 30 June 2011 states that import of capital goods/ machinery/ equipment (excluding second-hand machinery), must be subject to compliance with the following conditions:

a)    Any import of capital goods/machinery etc., made by a resident in India, must be in accordance with the Export/Import Policy issued by Government of India/as defined by Directorate General for Foreign Trade (DGFT) /FEMA provisions relating to imports.

b)    The application clearly indicating the beneficial ownership and identity of the Importer Company as well as overseas entity.

c)    Applications complete in all respects, for conversions of import payables for capital goods into FDI being made within 180 days from the date of shipment of goods.

Provider of Technology/Technical Know How

General permission is also available for issue of shares/preference shares against lump sum technical know-how fee, royalty due for payment - subject to entry route, sectoral cap and pricing guidelines and compliance with applicable tax laws.

Issue of equity shares against any other funds payable by the investee company, remittance of which does not require prior permission of the Government of India or Reserve Bank of India under FEMA, 1999 or any rules/ regulations framed, or directions issued thereunder, or has been permitted by the Reserve Bank under the Act or the rules and regulations framed, or directions issued thereunder is permitted, provided that:

(I)    The equity shares shall be issued in accordance with the existing FDI guidelines on sectoral caps, pricing guidelines etc. as amended by Reserve bank of India, from time to time;

Explanation: Issue of shares/convertible debentures that require Government approval in terms of paragraph 3 of Schedule I of Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 or import dues deemed as ECB or trade credit or payable against import of second-hand machinery shall continue to be dealt in accordance with extant guidelines;

(II)    The issue of equity shares under this provision shall be subject to tax laws as applicable to the funds payable and the conversion to equity should be net of applicable taxes.

Process & list of documents for filing application for conversion of import of capital goods/pre-operative expenses & into FDI

For import of capital goods as FDI, foreign investors must pick the government route, approval for which are obtained through National Single Window System on Foreign Investment Facilitation Portal (FIF Portal) - https://fifp.gov.in/Default.aspx

Based on the application received on NSWS, DPIIT, under Ministry of Commerce & Industry, will identify the concerned Administrative Ministry/Department and assign the proposal within prescribed timeline to the concerned Administrative Ministry/Department (Competent Authority) for processing and disposal of the proposal.

Process time: 8-12 weeks

List of documents

• Letter of authorisation
• Summary proposal of FDI
• Shareholding pattern of Investee
• Details of beneficial owner
• Investee Documents- MOA, AOA, COI, Board Resolution for proposed investment, last 3 years audited financial statements
• Investor Documents- MOA, AOA, COI, Board Resolution for proposed investment, last 3 years audited financial statements, copy of past approvals (if applicable)
• Investment Agreement between Investor and Investee
• Valuation certificate as required in the FDI Policy
• Declaration for proposals not falling under purview of Press Note 3 (2020)
• Duly notarized Affidavit on stamp paper of INR 100/- only
• Any other approval / consent / NoC required by Investee or Investor(s) from any shareholder, third party or any other entity in respect of the proposed activity(s)/ investment(s)/transaction(s).

General conditions for FDI in India in consideration other than cash

1.    All requests for conversion should be accompanied by a special resolution of the company.

2.    Government’s approval would be subject to applicable pricing guidelines under FEMA and appropriate tax clearance.

3.    For sectors under automatic route, issue of equity shares against import of capital goods/ machinery/ equipment (excluding second-hand machinery) and preoperative/pre-incorporation expenses (including payments of rent etc.) is permitted under automatic route subject to compliance with respective conditions mentioned above and reporting to RBI in form FC-GPR as per procedure prescribed under the FDI policy.

Conclusion

India has recorded highest ever annual FDI inflow of USD 83.57 billion in the Financial Year 2021-22. While details with respect to foreign investment without consideration are not available for open perusal, it could be an interesting perspective to hold in light of the increasing FDI inflow and whether more options or ease in current options of investment without transfer of funds must be introduced.