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  • Anirudh Agrawal

Changes to FDI Policy: A Knee Jerk Reaction or a Well-Planned Strategy?

[Anirudh Agrawal is a student at NALSAR University of Law.]

The government has revised the Consolidated Foreign Direct Investment (FDI) Policy through Press Note 3 (Press Note 3) with the primary intention of curbing hostile or opportunistic takeovers of distressed Indian companies. The Press Note 3 has introduced restrictions on FDI from the countries sharing land borders with India by mandating prior approval of the government. The prior approval will also be required for transactions where the beneficial owner of the investment, is directly or indirectly from the country sharing land border with India.

The route adopted by the government has been inspired from developed countries including USA, Spain, Germany, and Italy who have restricted FDI from certain jurisdictions or have expanded the list of sectors in which prior approval of government will be required for FDI. The government was provoked after the Peoples Bank of China increased its shareholding in India’s largest non-banking mortgage provider, HDFC Ltd., especially when the prices of most of the Indian stocks have plunged dramatically.

Some of the key considerations and implications are enumerated below:

Beneficial ownership

Press Note 3 states that any transfer of ownership that results in “beneficial ownership” changing will require prior approval of the government. But the notification failed to elaborate upon the criteria to be used to ascertain such 'beneficial ownership' of the investment. The term 'beneficial ownership' has different meanings under different statutory provisions in India.

Rule 9(1A) of the Prevention of Money Laundering Act 2005 (PMLA) defines a “beneficial owner” as any natural person who has the ultimate control over the client or a person on behalf of whom the entire transaction has been conducted and includes a person who exercises ultimate control over the juridical entity. According to Rule 9 of the Companies (Management and Administration) Amendment Rules 2018, any person who has acquired or holds a beneficial interest in shares of the company will be referred to as a beneficial owner. Similarly, Section 89(10) of the Companies Act 2013 defines that a person is said to have acquired a “beneficial interest” in shares if he is entitled to exercise any right over the shares or has right to participate and receive dividend on the share. RBI’s master direction on Know Your Customer (KYC) defines a beneficial owner as a person having controlling ownership interest or exercising control through other means wherein “controlling interest” is defined as having more than 25% share in capital or profits of the firm. In light of the ambiguity in the definition to be used, the government must use a definition which provides a definite threshold to define ultimate beneficial owner since, in the absence of any threshold, the requirement of prior government approval will be needed even if a single share is transferred by the investing entity.

Discouraging investors

Most of the startups and MSMEs in the country are funded by Chinese investors. Chinese companies have investments worth more than $6 billion in the country including in start-ups like PayTM, Swiggy, Big Basket, and OLA among several other entities. Chinese companies have approximately invested $4.4 billion in greenfield and brownfield investments. Subjecting every Chinese investment in the country to the approval route will create a roadblock in bringing the economy back on track and these start-ups will suffer collateral damage owing to such move.

Amidst the COVID-19 crisis, one of the biggest challenges to the market would be to inspire confidence among the investors to invest capital in the market. The pandemic has unsettled the supply chain globally and the companies have started looking at importing the products from other destinations. This is a great opportunity for India especially the MSMEs and start-ups to capitalize upon, but in the absence of availability of capital, it would be impossible for India to leverage upon the golden opportunity. The Press Note 3 has put a blanket restriction on investments and fails to make any distinction between investments which are purely financial in nature, as against those which are strategic in nature intended to acquire a majority stake in the entity. Since the route through government approval is cumbersome and time-consuming, it may dissuade companies from investing in Indian companies.

Applicability on investments from Hong Kong

The Press Note 3 states that all those investments coming from the “border” countries would be subjected to government approval. According to statistics from the Department for Promotion of Industry and Internal Trade (DPIIT), while the inflow of capital from China stood at $2.3 billion, the capital inflow from Hong Kong amounts to $4.2 billion. Therefore many market participants have argued that since Hong Kong based investors too exercise huge power over the Indian market, the broader purpose of the amendment will be defeated if investments from Hong Kong are excluded. Also, since most of the Chinese investments in India are routed through multiple tax-friendly jurisdictions including Hong Kong, it is unlikely that the government will exclude Hong Kong from the ambit of the Press Note 3.

On the other hand, whilst Hong Kong has been declared as a reciprocating territory under Section 44A of the Code of Civil Procedure 1908, such status has not been provided to China. Even the World Trade Organization has granted separate membership to both China and Hong Kong. Also, the DPIIT tracks the data of investments from both countries differently. Therefore, the possibility of excluding investments from Hong Kong from the ambit of the Press Note 3 cannot be ruled out completely though it still remains a contentious issue.

Applicability on foreign portfolio investment

Foreign Exchange Management (Non-Debt Instrument) Rules 2019 define Foreign Portfolio Investments (FPIs) as those investments which constitute less than 10 percent of the post issue paid-up equity capital in a listed company. The Press Note 3 does not impose any restriction on FPIs from border countries and imposes restrictions only on FDIs coming from the neighboring countries. But not including FPIs will be against the very purpose of the Press Note 3 as several FPIs by colluding or a single FPI holder by investing through different jurisdictions or by investing through shell companies can affect the 'beneficial ownership' in the Indian entity and therefore even the government officials have stressed upon interpreting the policy in the “widest possible way”.

Also, considering that the primary intention of the Press Note 3 was to prevent hostile takeover or acquisition of Indian companies, it can be expected that the Securities and Exchange Board of India (SEBI) might come up with a notification to restrict even FPIs from border countries. SEBI recently has also asked the custodian banks to divulge the details of the 'beneficial owners' of FPIs primarily based in China and Hong Kong.

One size fits all approach

The Press Note 3 does not exempt any particular sector from its ambit. Furthermore, since the clearance process with the government can take anywhere between 6-12 months, many entities would find it increasingly difficult to stick with investment plans for India. Instead, the government should have provided exemptions or greater discretion to itself while scrutinizing the investment in certain sectors. For example, if the investment is in a sensitive sector like banking or defense manufacturing or telecom, then the government could stay with an additional layer of scrutiny, but if the investment is in a sector which has great job creation potential like automobiles manufacturing or in MSMEs, such investments should ideally be allowed to operate through automatic route.


The government in an attempt to prevent predatory acquisitions of the Indian companies has adopted a one size fits all approach wherein no exemption has been carved out for certain entities or specific types of investment. Considering that substantial capital will be required for recovery of the economy post the pandemic, the government must offer necessary relaxations in investments in certain sectors specifically to non-sensitive sectors and those sectors which are primary employment creators.

The government may restrict the acquisition of an entity citing national security concerns (as done by US) or public order (as done by European Commission). Another possible route available with the government is to subject entities from certain jurisdictions to increased KYC requirements by requiring an authorized bank dealer to divulge greater information to find out the beneficial interest of entities seeking to invest indirectly through tax heavens.

It is hoped that the government will come out with clarifications on the scope of 'beneficial ownership' especially when the investment is in multi-layered structure and spread across multiple jurisdictions. The government must endeavor to build a comprehensive framework where accommodations are made for those minority investments which do not result in transfer of ownership or investment by foreign entities in their wholly-owned subsidiaries. The government would have done well had it devised a method through which investment through shell companies can be monitored as most of the Chinese investments are routed through tax-friendly jurisdictions like Singapore or Hong Kong which do not share boundaries with India.


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