Downstream investments by NRIs are not foreign investments

Investments by non-resident Indians (NRI) in Indian entities, that is companies or LLPs, on a non-repatriation basis are deemed to be domestic investments and treated equally with investments by residents. However, the Foreign Direct Investment Policy 2020 (FDI policy) was unclear whether downstream investments by an Indian entity owned and controlled by NRIs would be treated as a foreign direct investment or a domestic investment.

A downstream investment means an indirect foreign investment by an Indian entity in another Indian company or LLP by subscription or acquisition of its equity. An entity is considered owned and controlled by NRIs if more than 50% of its equity is beneficially owned by NRIs or Indian companies ultimately owned and controlled by NRIs, and the right to appoint a majority of the directors or to control its management or policy decisions, either through shareholding, contractual arrangements, or otherwise is exercisable individually or collectively, directly or indirectly by NRIs. Both conditions have to be satisfied for an Indian entity to be considered NRI owned and controlled.

Press Note 1 of 2021 dated 19 March 2021 issued by the Department for Promotion of Industry and Internal Trade (PN 1) has clarified that downstream investment by an entity owned and controlled by NRIs shall be treated as domestic investment and not indirect foreign investment. Further, any downstream investments made by such an Indian entity owned and controlled by NRIs, on a non-repatriation basis will be excluded from the calculation of indirect foreign investment in the invested entity. This allows an Indian entity owned and controlled by NRIs to make investments in other Indian companies as if a resident were making such investments.

Some have welcomed the clarification as opening greater opportunities for foreign investors that are interested in higher equity stakes, and control, in sectors such as multi-brand retail, banking and digital media, that have foreign direct investment (FDI) limits of 51%, 74% and 26%, respectively. PN 1 may free them from FDI investment caps in these sectors by using an intermediate NRI owned and controlled Indian entity. Once it is deemed to be outside the FDI caps, an entity will not have to comply with such rules in relation to entry routes, sectoral caps and pricing guidelines that normally apply to FDI.

Other stakeholders consider that the position of downstream investments by Indian companies owned and controlled by NRIs on a non-repatriation basis was always that such investments were treated as investments by residents, and the amendment in PN 1 is merely a clarification of the existing rule. However, the text of the FDI policy does not definitively support this view. It categorically states that in calculating indirect foreign investment in cases of downstream investments, any foreign investments through an Indian entity owned and controlled by resident Indians or by Indian entities ultimately controlled by resident Indians are excluded. But it is silent on calculating indirect foreign investment in cases of downstream investments, when such foreign investments are made through an Indian entity owned and controlled by NRIs.

The amendment in PN 1, although expressed as a clarification, is welcome. It will allow investments by NRIs to be treated equally with investment by residents, not only through direct investments in Indian entities, but also by downstream investments.

The timeline for implementing PN 1 is crucial for various stakeholders. PN 1 provides that it shall come into effect, in accordance with usual practice, from the date of inclusion in the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019. However, since PN 1 has reviewed and clarified the FDI policy on downstream investments by NRIs, it would have been a better step if PN 1 had grandfathered all downstream investments by Indian entities owned and controlled by NRIs and treated them as resident investments. PN 1 is relatively new, and it therefore remains to be seen whether authorities will adopt this favourable view and treat all non-repatriable downstream investments made by entities owned and controlled by NRIs prior to issue of PN 1 as domestic investments and not as indirect foreign investments.

Shinoj Koshy is a partner and Purvi Khanna is an associate at L&L Partners