With the spread of the global pandemic coupled with an economic downturn, the government appears to have become concerned at foreign footprints in Indian industries. The growing global antagonism against China heightened concerns over acquisitions by Chinese entities in India. This resulted in the government taking a series of defensive actions, and Press Note 3 that was notified on 17 April 2020, prohibited any FDI from China without government approval. The embargo states that “an entity of a country, which shares [a] land border with India or the beneficial owner of an investment into India who is situated in or is a citizen of any such country, shall invest only with government approval”.
The language of Press Note 3 and the amendment to the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (FEM rules), are worded to prohibit direct investments from any country sharing a land border with India. However, the intent is clear when examined in the light of previous measures including restrictions imposed on bidding in public procurement from countries that share a land border with India, and the successive bans on Chinese mobile applications. They indicate an obvious attempt to minimize the financial and technological foothold that China currently has in India. While their effectiveness can be analysed only in the long run, it is important to understand Press Note 3 and the FEM rules, to help companies walking the tightrope of compliance.
Countries that share land borders
Pakistan, China, Bangladesh, Myanmar, Nepal and Bhutan clearly fall into this category, but there is ambiguity over disputed territories such as Afghanistan and, more importantly, Macau and Hong Kong, both being part of the People’s Republic of China (PRC), and Taiwan. The political and legal status of these regions is contentious. Macau and Hong Kong are Special Administrative Regions of the PRC with separate governing and economic systems. Taiwan has historically operated as an independent country. The FEM Rules, read in line with international law would mean investments from any region forming part of PRC would be considered to be prohibited. Hong Kong would be construed as “sharing a land border with India,” but Taiwan, possibly not.
FEM rules include references to beneficial ownership. This ensures that the restriction on investment imposed by the government will not be bypassed by Chinese entities that attempt to make investments in India indirectly. Given that FEM rules do not define beneficial ownership, reference should be made to related legislation, namely the Companies Act, 2013, which prescribes a threshold of 10% ownership for determining beneficial holding, and the Prevention of Money Laundering Act, 2002 (PMLA), which prescribes a threshold of 25% ownership for determining the beneficial holding for companies and a threshold of 15% for other unincorporated entities.
FEM rules do not prescribe any threshold for determining beneficial ownership and, as a result it could be argued that a nominal or miniscule ownership held beneficially by a person resident in, or a citizen of a country that shares a land border with India, could potentially render the entire body of funds being precluded from investment in India under the automatic route. While the government has clarified that beneficial ownership is to be interpreted in line with the PMLA in the context of public procurement, clarity in respect of Press Note 3, is still awaited.
These ambiguities are a particular source of concern for pooled investment vehicles that raise funds from across the world. Given the commercial relevance of China in general, and regions such as Hong Kong in particular, it is likely that most pooled investment vehicles have stakeholders, such as limited partners, managers, or contributors based in China, particularly in Hong Kong. China in the recent past has been a major participant in the private equity market in India, backing several notable startups and unicorns in the country. A number of startups are already struggling to stay afloat during the pandemic and regulatory restrictions on raising money even from existing investors based in China could pose a significant challenge for them.
Full of ambiguities as set out above, Press Note 3 may result in cutting off cash flow to the already cash-strapped startup ecosystem in the country. However, it may also be viewed by the government as an opportunity to create and support a sustainable domestic financial environment, where start-ups can survive without having to rely on foreign investments, particularly from China. While the government attempts to institute a self-sufficiency movement, backed by an economic stimulus package, clarity is awaited on the permissibility of investments from China.
Ashwini Vittalachar is a partner and MV Abhinaya is an associate at Samvad Partners.
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