Globalization and liberation has considerably enhanced the business between India and other countries across the globe. Considering the availability of resources in India, Foreign Companies and other foreign entities are eager to invest their funds in Indian Entities through different routes.
Investment in Indian is highly regulatory and every Investment comes under supervision and regulation of Reserve Bank of India (RBI). A NRI has various options of vesting funds in India entities such as Investment through Equity Instruments, Preferential shares, Debentures, Loans etc. Every route has its own pros and cons. An investor is required to analyze every route very minutely to avoid any repercussions.
Foreign companies sets up wholly owned subsidiaries in India for different purposes such as providing back end services to Holding Company or Group Company, carrying out Liaising activity in Indian Market, Carrying out marketing in Indian market etc. Funding requirement of Wholly owned subsidiary is met by the Parent Company only. However, a question arises is what possible options are available to the parent company for providing funds to the Indian Subsidiary.
This article envisages different options available to a Parent company to fund its Wholly owned subsidiary based out in India.
1.Options of Funding of Indian WOS by Parent Company
a. Investment through Equity Instruments
- A parent company can invest funds in its Indian wholly owned subsidiary through equity shares. Since, the parent company already holds all the stake in the Indian Subsidiary company, this funding can be done by issuing additional shares only.
- Foreign Direct Investment can be done in India through following route:
- Automatic Approval Route;
- Approval Route
- Under Automatic Approval Route, no prior approval is required from the Reserve Bank of India for making Investment in Indian Entities. There are certain sectors wherein 100% FDI is allowed under automatic approval route such as Ports and Shipping, Renewable energy etc. If the Indian Entity is dealing in a sector wherein 100% FDI is allowed under Automatic Approval Route, Parent company may invest funds through issuance of equity shares.
- Under the Approval route, prior approval of RBI is required for investing funds in India. There are certain sectors where FDI upto specified % is permitted under automatic approval route. However, Investment beyond such % can be made with prior approval of RBI. If an Indian Entity is dealing in sectors wherein prior approval of RBI is required, parent entity is required to obtain the prior approval of RBI.
b. Preference Shares
- After Equity shares, another option available to the Foreign Holding Company to push funds to Indian WOS is issuance of preference shares. Investment through Preference shares is considered as Foreign Direct Investment only and the same can be done through Automatic Approval Route or Approval Route, as applicable. This route contains the benefit of both ownership and returns.
- An Indian company can issue only Compulsorily convertible preference shares to the foreign Investors and such shares shall be issued as per pricing guidelines issued and valuation norms given under FEMA. Other types of preference shares such as, non-convertible, optionally convertible or partially convertible, have to be in accordance with the guidelines applicable for External Commercial Borrowings (ECBs).
- Only preference shares that are compulsorily convertible can be issued to the Foreign investor.
c. External Commercial Borrowings
- In common parlance, External Commercial borrowings means commercial loans granted by non-resident entities to Indian Resident entities. ECBs are raised for business purposes only.
- As per ECB Master Circular, External Commercial Borrowings,, are commercial loans raised by eligible resident entities from recognised non-resident entities and should conform to parameters such as minimum maturity, permitted and non-permitted end-uses, maximum all-in-cost ceiling, etc. The parameters given below apply in totality and not on a standalone basis.
- Therefore, External Commercial Borrowings (ECB) is also one of the route for funding Indian Subsidiaries. This route is opted when money is required to be returned within a specified period and Parent company wants to earn some interest income.
- For the purpose of raising funds through External commercial Borrowing, the Indian Subsidiary and parent company is required to comply with provisions of FEMA law such as purpose for which such loans can be used, who are eligible borrowers, who are eligible lenders, whether prior approval of RBI is required or not etc.
- Debenture is one of the most common forms of investment. Debentures are resorted when the lender wants to earn fixed interest income and wants to get funds returned within specified time.
- Indian companies are allowed to issue both Compulsory Convertible Debentures, i.e., Debentures required to be converted into equity shares at specified date, and Non-convertible Debentures.
- Foreign investors are permitted to invest into compulsorily convertible debentures (CCD) issued by Indian companies under the foreign direct investment (FDI) route. This investment is to be done on a non-repatriable basis, i.e, investors are not permitted to repatriate funds back from India. Also, these CCDs must mandatorily be converted into equity shares and the pricing norms shall apply. The equity shares issued subsequently after the conversion, can be transferred by the investor.
- The Reserve Bank of India permits investment through Non-convertible Debenture route. NRIs can invest in NCDs on a repatriation and non-repatriation basis. Persons of Indian origin and NRIs can make NCD Investment in companies offering the same if the rules of the issuing company allow them. In India, rarely a company allows an NRI to invest in a public issue NCD.
e. Rupee denominated bonds (Masala bonds)
- A Masala bond is a rupee (INR) denominated bond issued by Indian entities to international investors for raising funds in the international market. These Masala bonds are offered to foreign investors willing to invest in India. It must be noted that in the case of these bonds, all transactions including buying of bonds, interest payments, and repayment, are done in the Indian currency, that is, the Indian rupee.
- For the foreign investor, these bonds are attractive as they offer approximately two to three percent higher rate of interest as compared to the standard LIBOR (London Interbank Offer Rate).
f. Through business arrangements
Many Indian subsidiaries provide services to the Parent company only or the other group companies. In such cases, funds are provided to the Indian Subsidiary in the form of business receipts for providing such services. In some modes, funds are provided in the form of reimbursement also. Wherein, Parent company reimburses the Indian company for the expenses incurred by the Indian Subsidiary. These transactions do not require prior approval of RBI. However, Compliance under Income Tax, Goods and Service Tax etc. may need to check for this form of business arrangement.
For this purposes, Indian Subsidiary Company and Holding Company are required to enter into detailed agreement.
2. Factors to be considered while selecting route of Investment
Foreign Company is available with multiple routes to invest funds in Wholly owned subsidiary. Every route has its own pros and cons and Parent company is required to consider following factors while selecting route of investment:
- Purpose of Investment: Holding company is required to check the purpose of Investment. E.g. If funds are required for a limited period and no permanent funding is required then the parent company should opt for the method where repatriation of the funds are allowed and least approvals are required.
- Intention of holding Company: Parent company needs to decide the intention of investment, i.e., Whether Parent company wants to increase its share capital investment in the holding company or its wants to invest as debenture holders. Equity investment involves risk and does not ensure regular dividend income. Whereas, Investment in debentures ensures regular interest and repayment of principal amount after specified period.
- Approval Routes: Some forms of investment require approval from RBI and such approvals process may take considerable time. Therefore, immediate funds requirement can’t be met through sources where approval is a time taking process.
Parent Foreign Companies are available with various options for funding of Indian Subsidiary. However, each option has its own pros and cons. Parent Company may seek professional options to decide on which method is suitable for funding purposes considering provisions of FEMA, Income Tax Act, Company Law and facts of each case.