Insights

The Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules, 2024 was introduced on August 16, 2024. It brings significant updates to the regulatory framework governing foreign investments in India. This amendment is part of the government’s broader efforts to simplify the rules surrounding foreign direct investment. The main aim is to facilitate global expansion of Indian companies through mergers, acquisitions, and strategic ventures. The following article provides an in-depth analysis of the key changes. It highlights the deficiencies in the previous rules and how the new amendments address these gaps.

Revised Definition of Control
One of the most significant changes introduced by the Amendment Rules is the alignment of the definition of “control” with the Companies Act, 2013. Previously, the definition was found under Explanation (d) of Rule 23 of the 2019 Rules. This provided a specific explanation of control in relation to downstream investments. The revised rule defines control in terms of the ability to appoint the majority of directors or partners in a company or LLP, as outlined in the Companies Act.

Under the earlier framework, the term “control” varied across different regulations. Such irregularity naturally leads to ambiguity in its application. The inconsistent definitions created complications, particularly for foreign investors trying to navigate downstream investment requirements.

Now, a new definition for the term “control” has been inserted under Rule 2 of the NDI Rules. This directly references the definition provided under the Companies Act, 2013. Control is defined under clause (da) under Rule 2. 

By standardising the definition with the Companies Act, this amendment brings clarity and consistency. Such standardisation makes it easier for businesses to understand and comply with the law. It ensures that the term “control” is uniformly applied across different corporate structures extending even to LLPs. Such changes are likely to minimise disputes related to the interpretation of control in foreign investments. Although there is no significant change for LLPs, this amendment ensures that policies are controlled by designated partners.

Updated Definition of Startup Company
The definition of a startup company has been aligned with the February 19, 2019, notification issued by the Department for Promotion of Industry and Internal Trade. The new definition includes companies recognized under the G.S.R. 127(E) notification. The new threshold for startups-

1.  Raises the turnover limit from 25 crore rupees to one hundred crore rupees.
2. Extends the recognition period from 5 to 10 years from the date of incorporation or registration.

The old definition was found in a 2016 notification. The problem or deficiency in it was that it  did not reflect the evolving nature of the startup ecosystem. This deficiency was especially regarding eligibility criteria like turnover thresholds and recognition periods. The outdated framework limited the potential for many companies to qualify as startups, Hence, it resulted in them missing out on foreign investment benefits. 

The updated definition found under the newly substituted clause (an) under Rule 2 expands the eligibility for startup recognition by firstly increasing the turnover to one hundred crore rupees and also extending the period of recognition to ten years. This change encourages foreign investments in India’s thriving startup sector, particularly those in the technology and innovation-driven fields. Due to these new Rules, companies are now more likely to qualify for the benefits available to startups.

Simplification of Government Approval Requirements
Another significant change the Amendment Rules have introduced is the revised language surrounding government approvals under clause (1) of Rule 9. It clarifies that prior government approval is required for all transfers of equity instruments where such approval is necessary, regardless of the sector involved.

The earlier provisions lacked clarity regarding the circumstances under which government approval was needed. The earlier provision- “prior government approval shall be obtained for any transfer in case the company is engaged in a sector which requires government approval” was more sector specific. Hence, it created ambiguity as it left room for interpretation in cases where companies were not clearly engaged in a specific sector.

The revised rule simplifies compliance by clearly stating that government approval is required in all applicable cases. Such clarification was long overdue as it is now easier for investors and companies to navigate regulatory processes. The Amendment also ensures transparency and consistency in the application of foreign investment laws while still maintaining necessary safeguards for sensitive sectors.

Introduction of Rule 9A- Swap of Equity Instruments and Capital
The introduction of Rule 9A allows for the swap of equity instruments and capital between an Indian company and a foreign company. The new Rule 9A permits the swap of equity instruments between-

(a)  a person resident in India and a person resident outside India, or
(b)  the swap of equity capital of a foreign company.

However, the new rule also specifies that transactions must comply with rules established by the Central Government and the Reserve Bank of India.

Under the earlier rules, while share swaps between Indian entities were allowed, such cross-border share swaps were heavily regulated and often required RBI approval. The extensive regulation complicated global mergers and acquisitions involving Indian companies. The complicated regulations regarding cross-border swaps created a regulatory bottleneck that impeded the growth of Indian businesses looking to expand internationally.

The new rule addresses this issue by making it easier for Indian companies to engage in share swaps with foreign entities. This amendment is expected to reduce procedural delays and enhance the global competitiveness of Indian companies as they now have easier access to international markets. Moreover, the provision to require government approval only in specific cases ensures that sensitive transactions continue to be monitored.

Clarification on Downstream Investments by NRIs and OCIs
As per a newly added Explanation under Rule 23, investments made by entities owned and controlled by Non-Resident Indians (NRIs) or Overseas Citizens of India (OCIs) on a non-repatriation basis will not be considered for the calculation of indirect foreign investments. 

The previous rules excluded only NRI-controlled entities from being counted as indirect foreign investments. This exclusion did not apply to OCI-controlled entities which created a gap that discouraged OCIs from making non-repatriation investments in Indian companies.

By extending the exclusion to OCI-controlled entities, this amendment levels the playing field and encourages more OCIs to invest in India. It aligns the treatment of OCI and NRI investments. Hence, the rules are expected to attract additional foreign capital from the Indian diaspora and increase the overall foreign participation in Indian businesses.

OCIs now have more incentives to invest in Indian enterprises without the complexity of being counted as foreign investors.

Removal of the 49% Cap on Foreign Portfolio Investment
The Amendment Rules have removed the previous requirement that foreign portfolio investments (FPI) exceeding 49% of the paid-up capital of an Indian company must obtain government approval. However, this is provided that such investments do not lead to a transfer of ownership or control to persons resident outside India. 

Prior to the amendment, any foreign portfolio investment exceeding 49% of the paid-up capital of a company triggered the need for government approval as seen under the entry routes for total foreign investment in Schedule I. This was the case even if the transaction did not result in a change of ownership or control. Such rules created bureaucratic hurdles and slowed down the investment process as the cap limited the amount of foreign investment that could be made in Indian companies without regulatory intervention. Furthermore, this 49% cap was inconsistent with the sectoral limits in several industries. Essentially, growth was stifled as the sectors themselves may have allowed for higher levels of foreign investment. However, they were limited by the 49% cap imposed by the rules. 

Under the revised rule, FPIs can now invest up to the sectoral or statutory cap without needing prior government approval as long as the control of the company remains with Indian citizens.

This change is likely to result in an increased flow of foreign capital where foreign investors often seek to acquire significant stakes. This could particularly benefit sectors like technology, pharmaceuticals, and financial services. The reduced need for government approval will enhance the attractiveness of Indian companies as investment targets as it improves the ease of doing business for foreign entities. Moreover, this amendment will enable Indian companies to raise more capital through FPIs without undergoing lengthy approval processes- fuelling greater growth and expansion.

100% FDI in White Label ATM Operations
The Amendment Rules permit 100% FDI under the automatic route in White Label ATM Operations (WLAO) which is subject to specific conditions. Non-banking entities intending to set up White Label ATMs must have a minimum net worth of one hundred crore rupees (as per the latest financial year’s audited balance sheet). 

The earlier rules restricted foreign investments in the financial services sector particularly in ATM operations. This limited the potential for expanding financial inclusion in underserved regions.

By allowing 100% FDI in WLAO, the Amendment Rules encourage greater participation of foreign investors in expanding ATM infrastructure in India. Such change is particularly crucial for promoting and boosting financial inclusion in underserved areas as it allows for the deployment of ATMs in rural and semi-urban areas. This increases access to banking services for those living in such areas.

Conclusion
The Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules, 2024 are a welcome step towards simplifying the regulatory framework governing foreign investments in India. It brings critical reforms that promote foreign investment while safeguarding national interests. The changes introduced offer greater clarity and flexibility for businesses and investors. Special emphasis are placed on cross-border transactions and startup investments. The inclusion of updated definitions in the new rules, the attempt to streamline government approvals and enhanced investment opportunities in sectors like startup companies and White Label ATM Operations are expected to attract significant foreign capital. Such policies are likely to boost India’s standing as a global investment destination. By removing previous restrictions and aligning policies with modern and evolving business needs, these amendments will likely result in an increased influx of foreign capital and enhanced opportunities for Indian companies in the global market. These changes not only promote ease of doing business but also position Indian companies to better compete on the world stage.