Approval Routes for Overseas Direct Investment (ODI) by Indian Party

In today’s date, Indian businesses are stepping out of the country to make substantial investments in the international market. These overseas direct investments or ODIs have presented a very healthy trend, but for one to participate in these transactions certain norms need to be satisfied. 

1. What does “Overseas Direct Investment” transactions mean?

• Overseas Direct Investments are regulated by Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, notified vide Notification No. FEMA.120/RB-2004 dated July 7, 2004.

• Overseas Direct Investment (“ODI”) refers to the investments made by Indian Party in the Joint Ventures (“JV”) and Wholly Owned Subsidiaries (“WOS”) by way of :
  • Subscription to the Memorandum of a foreign entity; or
  • Purchase of existing shares of foreign entities either by market purchase or private placement or through stock exchange.

• ‘Joint Venture (JV)’ means a foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country in which the Indian party makes a direct investment;

• ‘Wholly Owned Subsidiary (WOS)’ means a foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country, whose entire capital is held by the Indian party;

• “Indian Party” means:
  • a company incorporated in India or 
  • a body created under an Act of Parliament or 
  • a partnership firm registered under the Indian Partnership Act, 1932 
  • other entity in India as may be notified by the Reserve Bank

Therefore, Individuals or any other person are not covered under the definition of Indian Party.

2. What are the routes of making an ODI?

• Overseas Direct Investment can be made through following routes:
  • Automatic Route: For ODIs covered under Automatic route, an Indian party does not require any prior approval from the Reserve Bank of India before making any ODI.
  • Approval Route: For investments covered under this route, an Indian party is required to obtain prior approval from the RBI.
  • Prohibited Route: Investments in prohibited sectors are not allowed at all.

3. Which sectors are prohibited from making an ODI?

• An Indian Party can make overseas Direct Investment in any bonafide activity.
• However, any Indian party is completely prohibited from making investment/financial commitment in foreign entities that are engaged in the below mentioned sectors:
  1. Real Estate;
  2. Banking Businesses.

• Real Estate business means the dealing in the real estate or Transferable Development Rights (TDR). However following business activity is not considered as Real Estate:
  1. Development of the Townships;
  2. Construction of the residential/commercial premises, roads and bridges.

• However, Indian banks operating in India can set up JVs/WOSs abroad subject to approval under the Banking Regulation Act, 1949, from the Department of Banking Regulation (DBR), CO, RBI.

4. Which transactions are covered under the Automatic Approval Route by Indian Party?

Automatic approval route is provided for the following sectors subject to fulfillment of ancillary conditions:

1. General Permission for all sectors 
2. Investment in Agricultural Operations Overseas Directly or through Overseas Offices
3. Investment in Equity of a Company Registered Overseas
4. Investment in Financial Services Sector
5. Investment in a foreign security by swap or exchange of shares of an Indian company

4.1 General Permission of ODI for all Sectors (Regulation 6 of  Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004)

• ODI can be made in any sector, except prohibited sector or approval route, subject to fulfilment of conditions mentioned in Regulation 6 of Part I of Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004.

4.1.1 Conditions to be fulfilled for Automatic Approval Route

• An Indian Party may make direct investment in JV or WOS outside India without any requirement of obtaining prior approval of RBI subject to fulfilment of following conditions:

• The total financial commitment* of the Indian party in JV/WOS shall not exceed 100% of the net worth of the Indian Party as on the date of last audited balance sheet.
• Overseas JV or WOS must engage in Bonafide business activity.
• The Indian Party is not on RBI’s Exporters caution list /list of defaulters to the banking system circulated by the RBI or under investigation by any investigation /enforcement agency or regulatory body.
• The Indian party has submitted up to date returns in form APR in respect of all its overseas investments;
• The Indian Party routes all transactions relating to the investment in a JV/WOS through only one branch of an authorised dealer to be designated by it. However, The Indian Party may designate different branches for different JV/WOS.
• The Indian Party submits form ODA to the designated branch of an authorised dealer.

• For the purpose of calculation of Limit of 100% of net worth, following shall be considered:
  • cash remittance by market purchase and /or equivalent rupee investments in case of Nepal and Bhutan
  • capitalisation of export proceeds and other dues and entitlements;
  • 50% of the value of guarantees issued by the Indian party to or on behalf of the joint venture company or wholly owned subsidiary.
  • investment in agricultural operations through overseas offices or directly
  • External Commercial Borrowing in conformity with other parameters of the ECB guidelines
  • However, despite the conditions mentioned above, investment in Pakistan shall not be permitted.

* Financial Commitment means:

• amount of direct investment by way of contribution to equity and loan and 
• 50 per cent of the amount of guarantees issued by an Indian party to or on behalf of its overseas Joint Venture Company or Wholly Owned Subsidiary

4.1.2 Source of Funding of ODI

• For Automatic Approval, investment in ODI must be funded out of one or more of following routes:
  • out of the funds held in the Exchange Earners’s Foreign Currency Account (“EEFC”) maintained by the Indian party.
  • drawal of foreign exchange from an authorised dealer in India does not exceed 100 % of the net worth of the Indian Party as on the date of last audited balance sheet. Factors considered above for calculation of limit of 100% shall again be considered here.
• An Indian Party may make ODI without any limit in any foreign security out of the proceeds of its international offering of shares through the mechanism of ADR and/or GDR. However, 
  • the ADR/GDR issue has been made in accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme 1993 and the guidelines issued thereunder from time to time by the Central Government;
  • The Indian Party files complete details of investment proposed in Form ODA.

4.1.3 Other Points to be considered

• An Indian Party may extend a loan or guarantee to and on behalf of JV/WOS within the permissible financial commitment. However, loan or guarantee shall be permitted only if the Indian Party has made investment by way of contribution to the equity capital of the Joint Venture.
• If investment is made in any existing company outside India, the valuation of shares of the company shall be made in following manner:
  • investment is more than USD 5 million: Valuation of shares shall be made made by a Category I Merchant Banker Registered with SEBI or an Investment Banker/Merchant Banker outside India registered with the appropriate regulatory authority in the host country; 
  • Consideration is paid fully or partly by  issue of the Indian party’s shares: Valuation of shares shall be made made by a Category I Merchant Banker Registered with SEBI or an Investment Banker/Merchant Banker outside India registered with the appropriate regulatory authority in the host country; 
  • In all other cases: Valuation shall be made by a Chartered Accountant or a Certified Public Accountant.

4.2 General Permission for  Investment in Agricultural Operations Overseas Directly or through Overseas Offices (Regulation 6A)

• A company incorporated in India or a partnership firm registered under Indian Partnership Act, 1932, may undertake agricultural operations either directly or through their overseas offices subject to following conditions:
  • the Indian party is otherwise eligible to make investment under Regulation 6 and that such investment is within the overall limits as specified in Regulation 6.
  • In case of acquisition of land overseas, the valuation of the land is certified by a certified valuer registered with the appropriate valuation authority in the host country.

4.3 General Permission for Investment in Equity of a Company Registered Overseas (Regulation 6B)

• A Resident individual or a listed Indian company or a mutual fund registered in India, may invest in
  • shares of an overseas company which is listed on a recognised stock exchange and has in its name share holding of not less than 10% in any listed Indian company as on 1st January of the year of investment; or
  • the rated bonds/ fixed income securities issued by companies at (a) above:
• However, investment shall be made subject to following conditions:
  • in the case of investment by a listed Indian company, the investment shall not exceed 25% of listed Indian Company as on the date of its last audited balance sheet;
  • in the case of investment by a Mutual Fund, the investment shall not exceed the ceiling stipulated by SEBI from time to time;
  • every transaction relating to purchase and sale of shares of the overseas company or bonds/ securities shall be routed through the designated branch of an authorised dealer in India.

4.4 Investment in Financial Services Sector (Regulation 7)

• An Indian party may make investment in an entity outside India engaged in financial services activities provided that the Indian party:
  • has earned net profit during the preceding 3 financial years from the financial services activities;
  • is registered with the regulatory authority in India for conducting the financial services activities;
  • has obtained approval from the concerned regulatory authorities both in India and abroad, for venturing into such financial sector activity;
  • has fulfilled the prudential norms relating to capital adequacy as prescribed by the concerned regulatory authority in India.

(2) any additional investment by an existing JV/WOS or its step down company in the Financial Services Sector shall be made only after complying above mentioned conditions.

4.5 Investment in a foreign security by swap or exchange of shares of an Indian company (Regulation 8)

• An Indian Party may acquire shares of a foreign company which is engaged in bonafide business in exchange of ADRs/GDRs issued to the Foreign Company in accordance with the scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993, and the guidelines issued thereunder from time to time by the Central Government subject to following conditions:
  • the Indian Party has already made an ADR and / or GDR issue and that such ADRs/GDRs are currently listed on any stock exchange outside India; 
  • such ODI by the Indian Party does not exceed an amount equivalent to 10 times the export earnings of the Indian Party during the preceding financial year as reflected in its audited balance-sheet, inclusive of all investments made under Regulations in Part I.
  • the ADR and/or GDR issue for the purpose of acquisition is backed by underlying fresh equity shares issued by the Indian Party;
  • the total holding in the Indian Party by persons resident outside India in the expanded capital base, after the new ADR and/or GDR issue, does not exceed the sectoral cap prescribed under the relevant regulations for such investment;
  • the valuation of the shares of the foreign company is made, 
    • as per the recommendations of the Investment Banker if the shares are not listed on any stock exchange; or
    • based on the current market capitalization of the foreign company arrived at on the basis of monthly average price on any stock exchange abroad for the three months preceding the month in which the acquisition is committed and over and above, the premium, if any, as recommended by the Investment Banker in its due diligence report in other cases.
• Within 30 days from the date of issue of ADRs and/or GDRs in exchange for acquisition of shares of the foreign company under sub-regulation (1), the Indian Party shall submit a report in form ODG to the Reserve Bank.

5. For which ODI approval of RBI is required?

For following ODI, prior approval of RBI is required

i) Overseas Investments in the energy and natural resources sector exceeding the prescribed limit of the net worth of the Indian companies as on the date of the last audited balance sheet;

ii) Investments in Overseas Unincorporated entities in the oil sector by resident corporates exceeding the prescribed limit of their net worth as on the date of the last audited balance sheet, provided the proposal has been approved by the competent authority and is duly supported by a certified copy of the Board Resolution approving such investment. However, Navaratna Public Sector Undertakings, ONGC Videsh Ltd and Oil India Ltd are allowed to invest in overseas unincorporated / incorporated entities in oil sector (i.e. for exploration and drilling for oil and natural gas, etc.), which are duly approved by the Government of India, without any limits, under the automatic route;

iii) Overseas Investments by proprietorship concerns and unregistered partnership firms satisfying certain eligibility criteria;

iv) Investments by Registered Trusts / Societies (satisfying certain eligibility criteria) engaged in the manufacturing / educational / hospital sector in the same sector in a JV / WOS outside India;

v) Corporate guarantee by the Indian Party to second and subsequent level of Step Down Subsidiary (SDS);

vi) All other forms of guarantee which is offered by the Indian Party to its first and subsequent level of SDS;

vii) Restructuring of the balance sheet of JV/WOS involving write-off of capital and receivables in the books of listed/ unlisted Indian Company satisfying certain eligibility criteria mentioned under Regulation 16A of notification ibid;

viii) Capitalization of export proceeds remaining unrealized beyond the prescribed period of realization will require the prior approval of the Reserve Bank; and

ix) Proposals from the Indian party for undertaking financial commitment without equity contribution in JV / WOS may be considered by the Reserve Bank under the approval route based on the business requirement of the Indian Party and legal requirement of the host country in which JV/WOS is located.