This Article is submitted by –
- Atif Ahmed is a practicing Advocate
Seeking a foreign investment is the dream of many Indian businesses, especially startups. In fact, Indian businesses are becoming globally competitive, and are continuously drawing the attention of foreign investors. Recently, the likes of Facebook, Intel Capital, General Atlantic, among 9 other foreign investors have invested an amount of INR 117,588.45 Crore in Reliance Jio, in exchange for 25.09% stake. The benefits of drawing foreign investment for a business are many, for example, a foreign investor would buy the shares of an Indian Company at significantly better prices by valuing the business much more than what a domestic investor would.
There are plenty of ways in which you can structure your business. You have the liberty to structure it in the simple form of Sole Proprietorship, or you may run the business along with a partner and may go for Partnership Firm, or if you want to limit your liability, you can structure the business as LLP or as a Company, among many other structures. Each structure comes with its own set of advantages and disadvantages in terms of cost, tax, complexity, compliances etc.
Whether you are already running a business, or you are planning to start one in India, especially a startup, you must have pondered upon the possibility or desire of drawing foreign investment to your business at some point of time. In such a case, it becomes imperative to know whether or not your business can receive foreign investment in India, if so, under conditions?
The rules governing Foreign Direct Investment (“FDI”) in India depend upon the structure of the business and the sector that it operates in. These FDI norms are governed by FDI Policy issued by Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India. The latest policy was issued back in 2017 i.e. Consolidated FDI Policy 2017. The changes to the FDI Policy are made in forms of Press Notes.
Let us now understand, what are the rules for FDI for each business structure and how does the FDI in different sectors take place.
Indian Company
According to FDI Policy 2017, ‘Indian Company ’means a company incorporated in India under the Companies Act, as applicable.
Conditions for receiving FDI in Indian Company
The investment into an Indian Company can be made under one of the following three categories:
Automatic Route
Under the Automatic Route, the non-resident investor or the Indian company does not require any approval from the Government of India for the investment. For example, FDI in the ‘Agriculture & Animal Husbandry’ sector is allowed under 100% automatic route.
Government Route
FDI in activities not covered under the automatic route, requires prior approval of the Government. Such applications are considered by the Foreign Investment Promotion Board (FIPB). For example, FDI into the Print Media sector (having a sector cap of 26%) can only be made under the Government Route.
Applications can be made in Form FC-IL, which can be downloaded from the website of DIPP.Click here to visit the website.
Prohibited Sectors:
According to the FDI Policy 2017, FDI is completely prohibited under eight sectors in India. These are:
- Lottery Business including Government/private lottery, online lotteries, etc;
- Gambling and Betting including casinos etc.;
- Chit funds;
- Nidhi company (borrowing from members and lending to members only);
- Trading in Transferable Development Rights (TDRs);
- Real Estate Business or Construction of Farm Houses;
- Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes;
- Activities or sectors that are not open to private sector investment (e.g. Atomic Energy);
- Legal, accounting and architecture services;
- B2C e-commerce
Note: Indian companies receiving FDI, either under the Automatic route or the Government route, are required to comply with provisions of the FDI policy, including reporting the FDI to the Reserve Bank of India.
Following table shows the different ways in which a foreign investor can invest in an Indian Company.
The ways in which Foreign Investor could contribute in a company
| Method | Meaning |
| Cash or Cash Equivalents | It refers to banking channels. This is the most common way that foeign investment is brought in. |
| Share Swap | Investor exchanges the shares of his company with the shares of the company that he invests in. |
| Tangible Assets | The investor can also contribute in terms of capital goods. |
| Intangible Assets | The investor can bring in technology, trademark, patent, know-how etc. |
| Conversion of Loans into Shares | The loans taken by the investee company can sometimes be converted into shares. |
Limited Liability Partnership
Meaning
Under limited liability partnership (LLP), some or all the partners have limited liabilities. LLP exhibits elements of both, partnership and corporation. In LLP, partners are not liable misconduct or negligence of one another. This is an important difference from the traditional partnership firm.
Unlike the traditional partnership business in India, LLP is a body corporate and has a legal entity that is separate from its partners, and it has perpetual succession. Further, any change in the partners of a LLP (i.e. retirement of a partner or admission of a new partner) shall not affect the existence, rights or liabilities of the LLP.
In India, LLP is constituted and governed by Limited Liability Partnership Act, 2008.
Conditions for receiving FDI in LLP
Although FDI in LLP is permitted, however, the conditions under which it is allowed are restrictive as compared to the conditions for FDI in an Indian Company as discussed above. Usually LLPs require regulatory approval for receipt of FDI, plus they cannot ordinarily make downstream investments into
other entities, and also cannot avail foreign loans.
Following are the conditions that govern FDI in LLP:
- FDI is allowed in LLP mostly through government approval route, however FDI under Automatic Route is also permitted under certain conditions:
- 100% FDI must be allowed in that sector for a company through 100% automatic route under the FDI Policy, and
- There should not be any ‘performance related’ conditions stipulated in the FDI policy for that sector. ‘Performance related’ conditions include minimum amount of investment, lock-in period etc.
- Further, FDI in LLP is also subject to the compliance of conditions of LLP Act, 2008.
- LLP having foreign investment can make downstream investments into a company or another LLP, only if that company or LLP belongs to a sector in which 100% FDI is allowed under automatic route and where there are no FDI related performance conditions.
- FDI is only allowed to be made by the way of cash consideration. This effectively means that the investor cannot contribute in terms of technology, trademark, or other capital goods (which is allowed for a company structure).
- The LLP having foreign investment and operating in the sectors where 100% FDI is allowed through automatic route and where there are no FDI linked performance conditions is permitted to be converted into a company under the automatic route.
- LLPs are also not eligible to avail ECB i.e. External Commercial Borrowings (i.e. they are not eligible to raise any overseas debt).
Partnership Firm and Sole Proprietorship
Partnership Firm:
A partnership firm is an organization which is constituted by two or more persons to run a business with a goal of earning profit. Each member of such firm is known as a partner and collectively the firm is known as a partnership firm. Partnership firm in India, is governed by the Indian Partnership Act, 1932.
Sole Proprietorship:
The sole proprietorship is the simplest business structure under which one can operate a business. Under sole proprietorship, only one person owns the business and he/she is personally responsible for its debts.
What are conditions for receiving FDI in a Partnership Firm and Sole Proprietorship?
FDI by NRI/PIO
A Non-Resident Indian (NRI) or a Person of Indian Origin (PIO) resident outside India can invest in the Partnership Firm or a Sole Proprietorship in India, subject to the following conditions:
- Amount is invested by inward remittance or out of NRE/NRO/FCNR(B) account maintained with authorized dealers or banks.
- Such partnership Firm or a sole proprietorship should not be engaged in the agriculture, plantation, real-estate, or print media sectors.
- The investment must be on non-repatriation basis i.e. amount invested shall not be eligible for repatriation outside India.
Note: In case the NRI/PIO wants to invest and repatriate the amount, then they have to seek prior permission from RBI.
FDI by other Non-Residents
If a person other than NRI/PIO wants to invest in a Partnership Firm or a Sole Proprietorship in India, then they may make an application and seek the prior nod of RBI for making such investment. The application will be decided by RBI, in consultation with the Government of India.
Trust
A trust is a structure where one person, referred to as trustee, carries out the business on behalf of the members or beneficiaries of the trust. The trustee is liable for the debts of the trust and may use its assets to pay off such debts. However, if there is a shortfall, the trustee will be held responsible for the difference.
- A trust is not a separate legal entity.
- A trustee may be an individual or a company.
In India trusts are governed by Indian Trusts Act, 1882.
What are the conditions for receiving FDI in a Trust?
Normal rule is that FDI is not permitted in Trusts. But the only exception to this rule is that in case the Venture Capital (VC) Funds are structured as trust, then in such case, FDI is permitted, subject to the following conditions:
- The Venture Capital (VC) Fund must be registered with Security and Exchange Board of India (SEBI) and Investment Vehicle.
- The investment further requires approval of the appropriate administration or department identified by the Department of Industrial Policy and Promotions (DIPP).
Note: The investment into a VC Fund structured as a company is permitted under the automatic route.
Non-Banking Financial Companies (NBFCs) and Core Investment Companies (CICs)
Non-Banking Financial Company (NBFC)
A Non-Banking Financial Company (NBFC) in most simple terms can be defined as the companies that are engaged in the business of providing various banking services, but not actually having a banking license from Reserve Bank of India. NBFC is also known as Non-Banking Financial Institution and it is registered under the Companies Act, 2013. For more information about NBFC, click here.
Core Investment Company (CIC)
A Core Investment Company (CIC) is a special form of NBFC, registered with RBI, and having asset size of more than INR 100 Crore. CIC carries on the business of acquisition of shares & securities and holds not less than 90% of its net assets in the form of investment.
What are the conditions for receiving FDI in a NBFC and CIC?
NBFC
According to Press Note No.1 (2018 Series) issued by Department of Industrial Policy and Promotion (DIPP), investment in any NBFC shall be under 100% automatic route.
CIC
Foreign Direct Investment in CICs is not automatic and can be made only through the Government approval route. Further, the CICs are also required to additionally adhere to the ‘RBI’s regulatory framework for CICs’.
Startup Companies
Introduction and Meaning
A startup company is initiated by a person to seek, develop, and validate a scalable business model. Startups face high level of uncertainty and have risks of failure. Despite such risks, the ones which succeed become formidable and influential. Some startups even become unicorns, i.e. privately held startup companies valued at over US$1 billion, for e.g. Oyo, Paytm, Ola, Swiggy etc.
Startup Company is a private limited company and is incorporated either under the Companies Act, 1956 or under Companies Act, 2013.
An entity shall be considered as a ‘Startup’, only if it fulfills the following conditions-
- It shall not have completed 7 years from the date of its incorporation/registration (or 10 years in case of Startups in Biotechnology sector), and
- Its turnover shall not have exceeded INR 25 Crore, and
- It shall be working towards innovation or development or deployment or commercialization of new products, processes or services, which is being driven by technology or intellectual property (IP).
What are the conditions for receiving FDI in a Startup Company?
- According to FDI policy 2017, startups are allowed to raise 100% funds from SEBI (Securities and Exchange Board of India) registered Foreign Venture Capital Investors (“FVCI”) under the automatic route. Start-ups can issue equity or equity linked instruments or debt instruments to FVCI against receipt of foreign remittance, as per the Foreign Exchange Management Act (FEMA) Regulations.
- In addition, start-ups can issue convertible notes to person resident outside India, subject to the following conditions:
(i) A person resident outside India (except Pakistan or Bangladesh citizen or an entity which is registered or incorporated in Pakistan or Bangladesh), may purchase convertible notes issued by an Indian startup company for an amount of INR 25 Lacs or more, in a single transaction.
(ii) A startup company which is engaged in a sector where foreign investment requires prior approval of the Government, can issue convertible notes to a non-resident, only with the consent of the Government.
(iii) A startup company issuing convertible notes to a person resident outside India, shall receive the amount of consideration by inward remittance through banking channels or by debit to the NRE/FCNR(B)/Escrow account. Such account shall be maintained by the only in accordance with the FEMA (Deposit) Regulations, 2016.
Note: However, the above mentioned escrow account shall not be permitted to continue beyond a period of six months.
(iv) Non-Resident Indian (NRI) may acquire the convertible notes. However it shall be on non-repatriation basis.
(v) A person resident outside India may acquire or transfer, by way of sale, convertible notes, from or to a person resident in or outside India. However, such transfer shall take be effected according to the pricing guidelines prescribed by the RBI.
Note: Prior approval from the Government shall be obtained for such transfers in case the startup company is engaged in a sector where Government approval is required.
(vi) The startup company issuing convertible notes is also required to furnish reports as prescribed by Reserve Bank of India (RBI).
| What is a convertible note? Convertible Note means an instrument that can later be converted into a different security. For example, compulsorily convertible debenture (CCD). |
Conclusion
From the reading of the above article, we understood how the FDI norms are different for different structures of the business, depending upon the sector that the business operates in. So, the optimal structure would be different for different businessmen depending upon a variety of factors, like cost, tax, compliances, complexity, investment goals, etc. For example, for someone who wants to operate on a limited capital, would go for sole proprietorship or partnership firm; someone who does not want an unlimited liability and only wants a limited amount of foreign investment (by way of cash), would want to choose LLP if the sector he operates in could receive 100% automatic investment, because his compliances would be lesser than a company and the structure still suits his goals. Having said that, if however your goal is to receive foreign investment, Company would be your most optimal structure, as it gives you the maximum amount of freedom to raise foreign funding in form of not only cash/cash equivalents, but also in other ways such as capital goods, technology, IP, knowhow, share swap, conversion of loan, etc.
“The views of the authors are personal“
References
- Consolidated FDI Policy, 2017 – Issued by DIPP
- Press Note No.1 (2018 series) -Issued by DIPP
- https://www.smallbusiness.wa.gov.au/business-advice/business-structure/trust
- https://studycafe.in/2019/03/foreign-direct-investment-in-startup-companies.html
