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15 Dec 2015

Liberalisation of FDI regime- Booster Dose 2

This article is the second part of the earlier published article on the liberalization in the Foreign Direct Investment (“FDI”) regime. It contains additional information and clarifications relating to amendments made to the Consolidated FDI Circular of 2015 through Press Note 12 (2015 Series) that was issued on November 24, 2015, subsequent to the Press Note issued on Nov. 10, 2015.  

This article also contains a brief analysis of the liberalized norms for sectors that were not covered in the earlier article.

A. Definition of “Manufacture”:

 The term “Manufacture” has now been defined in the Policy. The definition is the same definition of “Manufacture” under the Income Tax Act, 1961.

 It needs to be noted that the event of “manufacture” is the basis of charging of excise duty under Central Excise Act and there could be scenarios wherein an activity is considered as “manufacture” under Excise laws but fails to qualify for the definition under Income Tax Act. Since the “Make in India” mission is intended to position/showcase India as the world’s manufacturing hub, alignment of the term “manufacture” with the Central Excise Act could potentially avoid litigation regarding the term “manufacture”.

B. FDI in Limited Liability Partnerships (“LLP”):

 Finally, FDI is permitted in LLPs operating in sectors where 100% FDI is allowed under the automatic route. However, FDI in LLPs seeking to operate in sectors where FDI-linked performance conditions are prescribed (e.g. Construction Development, Non-Banking Finance Companies etc.) still require FIPB approval. 

 Downstream investment by LLPs (that have received FDI) is also permitted in Indian Companies/LLP’s, provided the requisite funds for such downward investment is brought from abroad not from Indian markets. However, such downward investments are permitted from internal accruals.

C. Investment by swap of shares:

 Investment by swap of shares has been permitted (irrespective of the amount) in the sectors where 100% FDI is permitted under the automatic route. The valuation of shares in such matters will need to be carried out by a merchant banker registered with SEBI or an Investment Banker outside India registered with the appropriate regulatory authority in the relevant host country. Thus far, swap of shares through government approval route was a hindrance; it is expected that the permission to invest by swap of shares will facilitate Indian companies partnering with companies abroad.

D. Liberalization of FDI norms in the Defense sector:

 In a major boost to the defense sector, FDI upto 49% is now permitted under the automatic route (earlier, this was possible only via – government approval route) in defense industry subject to industrial licensing. This would allow defense sector to attract FDI more freely and would give a fillip to the domestic defense industry. 

 However, considering the strategic importance and sensitivity of this sector, FDI in defense sector is subject to security clearance and guidelines of the Ministry of Defence. It is also mandated that the investee company should be structured to be self-sufficient in the areas of product design and development and should have maintenance and life cycle support of the product being manufactured in India. 

 This suggests that FDI of up to 49% through the automatic route would require companies in the defense sector to set up their design/development/maintenance facility in India along with their manufacturing facility

E. Construction Development Sector

 The amendments in the FDI norms for the Construction Development Sector are significant and would go a long way in attracting FDI in this capital intensive sector.

 The significant changes are:

  1. A foreign investor is now permitted to exit and repatriate investments any time after the expiry of a lock-in period of 3 years irrespective of the project’s completion stage or the status of the trunk infrastructure.
  2. The lock-in period of 3 years would not be applicable in cases where the project is completed before the lock-in period or the trunk infrastructure is completed; in such cases, the foreign investor can exit even ahead of 3 years.
  3. Earning of rent/income from leasing of property (not amounting to transfer) will not amount to real estate business which is otherwise prohibited for any FDI.

 These changes have removed the major impediment that existed in the form of the double whammy of completion of the project/trunk infrastructure and expiry of lock-in period. This was seen as a hurdle to attracting foreign capital. Additionally, opening up of the rental business for FDI would allow REITs and other specially-structured investment vehicles to take exposure in this sector.

 This set of liberalized FDI norms is definitely a welcome sign that signals the government’s desire to bring in more fundamental changes in the way it approaches FDI. Although the changes may not immediately result in dramatic inflows of FDI into the country, they certainly help India strengthen its position as one of the hottest FDI destinations globally at the current time.

 Disclaimer:

 This write-up is meant for general informational purposes only. The views expressed are the author’s personal views and as such, they should not be considered as the firm’s view on the subject.

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