Demystifying FEMA - The Basics

Let us start with the Fundamentals. FDI in India is guided by the Consolidated FDI Policy Circular of 2015 of Government of India in this regard.

Who can Subscribe to Security: Any entity resicent outside India can invest in securities of Indian entity with some exceptions. Residents of Bangladesh have to take approval from Foreign Investment Promotion Board (FIPB). Residents of Pakistan, apart from taking approval from FIPB, are prohibited from investing in specific sectors. Residents of Nepal and Bhutan can invest only in non-repatriable form.

Types of Instruments that can be issued: Indian companies can issue equity shares, fully and mandatorily convertible debentures, fully and mandatorily convertible preference shares and warrants. From December 30, 2013 optionally convertible instruments have also been permitted. Guiding principle for optionally convertible debentures is that there has to be a lock-in period of 1 year and there should be no assured return. (price not exceeding that arrived at on the basis of Return on Equity (RoE) as per the latest audited balance sheet. This condition has been removed.). The exit price should not be higher than the fair value of shares as determined by a Chartered Accountant or Merchant Banker registered with SEBI based on any Internationally acceptable methodology.

The Issue Price of Security: Under FDI fresh Shares to be issued to Non-residents should not be at a price less than the Fair Value. Fair Value of shares of a listed company is as prescribed by SEBI guidelines. In case of unlisted companies, it is as determined by a SEBI registered Merchant Banker or a Chartered Accountant as per as per any internationally accepted pricing methodology on arm’s length basis. If we see old instructions, earlier it used to be as prescribed under CCI guidelines. This was later modified to Discounted Cash Flow method.

Other Ways of Acquiring Equity: Equity can be subscribed to by converting Debentures and Preference Shares. Non-Convertible Debentures are not treated as FDI. The conversion price of Debenture has to be decided upfront. This can be a predetermined fixed value or it can be based on a formula. The guiding principle of conversion price is that it can not be less than the fair value of equity prevailing on the date of issue of debenture.

Compliance with other Acts: The company has to submit a certificate (format prescribed in FEMA20) from a Company Secretary regarding compliance with the Companies Act and any other conditions that might have been imposed by Government of India.
 

Demystifying FEMA

A business can get long term funds in the form of Equity or Loan or Hybrid instruments.
If a company desires to get these finds from offshore sources, it has to comply with various FEMA requirements. These requirements are spread over numerous FEMA Notifications issued by the Reserve Bank of India.

In this and a series of following posts, I would try to demystify these notifications. A word of disclaimer becomes necessary. The views expressed here are purely personal and the ruling of RBI would be final. The contents of any of my blog should not be taken as professional advice. This is for academic discussion only.

Most common form of long term funds is Equity. Equity can be accessed in Direct or Indirect form. Indirect form of equity means Portfolio Investment by Qualified Institutional Investors.

The relevant instructions regarding Direct participation in equity can be found in a document commonly known as FEMA 20. (Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000 Notification No. FEMA 20 /2000-RB dated 3rd May 2000). In past 15 years this notification has been amended numerous times. Thankfully, RBI consolidates its instructions and publishes them in the form of a Master Circular. These instructions are issued by the name "Master Circular on Foreign Investment in India"

The broad provisions under FEMA for issuance of Equity instruments are that the reporting of receipt of funds from abroad has to be done to RBI within 30 days of receipt of funds through the Authorised Dealer Bank (AD Bank). The shares have to be allotted within 180 days of receipt of funds. The allotment of shares has to be reported to RBI within 30 days of allotment.

In the month of July every year a report has to be submitted to the Department of Statistics and Information Management (DSIM) about the position of Foreign Investment in the Company.

In the following posts, I will discuss about the specific class of investors, instruments and other detailed instructions.