FEMA : Non-Debt Instrumental Rules

[Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments]

Notification date: 17th October 2019

The said notification has repealed the already existing Foreign exchange Management
(Transfer or Issue of Security by a person resident outside India) Regulations, 2017 and
Foreign Exchange Management (Acquisition and Transfer of Immovable property in India)
Regulation, 2018. Foreign exchange management (Non-debt instruments) Rules, 2019 came
in substitute and necessary changes.

Newly Introduced terms:

Non-Debt Instruments: The Non-Debt Instruments Rules has introduced a couple of key
definitions. The expression "non-debt instruments" means:

1. all investments in equity in incorporated entities (public, private, listed and unlisted);
2. capital participation in Limited Liability Partnerships ("LLP");
3. all instruments of investment as recognized in the foreign direct investment ("FDI")
policy as notified from time to time;
4. investment in units of Alternative Investment Funds, Real Estate Investment Trust and
Infrastructure Investment Trusts;
5. investment in units of mutual funds and Exchange-Traded Fund which invest more
than fifty per cent in equity;
6. the junior-most layer (i.e. equity tranche) of securitization structure;
7. acquisition, sale or dealing directly in immovable property;
8. contribution to trusts;
9. Depository receipts issued against equity instruments.

Debt instruments:

1. Government bonds;
2. corporate bonds;
3. all tranches of securitization structure which are not equity tranche;
4. borrowings by Indian firms through loans;
5. Depository receipts whose underlying securities are debt securities.
 ** The Relevant Notification contains a catch all provision which provides that any
instrument that does not fall under any of the above definitions would be deemed to be "debt
instruments".

Equity Instruments: All the equity shares, convertible debentures. Preference shares and share
warrants issues by an Indian company are called equity instruments.

Hybrid Securities: Hybrid instruments such as optionally or partially convertible preference

shares or debentures are called hybrid secutities.

** The term “hybrid instruments” is not yet has been used in the Non-Debt Instrumental
Rules.

Investment Vehicle: The Non-Debt Instruments Rules has expanded the ambit of the term
"investment vehicle". It now includes mutual funds that invest more than 50% of its corpus in
equity instruments of an Indian company and is regulated by the SEBI (Mutual Funds
Regulations), 1996.

Key Aspects:-

1. Dilution of Authority of the RBI: Earlier, the RBI was entrusted with powers to approve
transactions which were not covered under general permission. The Rules have
introduced additional language which mandates that the applications for the approval of
the transactions which are not under the purview of general permission, will need to be
decided after consultation with Central Government.
The RBI has been the final authority for approving such transactions in the past. The new
provisions are a deviation which will result in a greater involvement of the Central
Government into the nongeneral permission matters.
2. Changes in definitions: The following definitions have been changed:

(a) "listed Indian company" means an Indian company which has any of its equity
instruments or debt instruments listed on a recognized stock exchange in India and the
expression "unlisted Indian company" shall be construed accordingly.

(b) "sectoral cap" means the maximum investment including both foreign investment on a
repatriation basis by persons resident outside India in equity and debt instruments of a
 company or the capital of an LLP, as the case may be, and indirect foreign investment, unless
provided otherwise. This shall be the composite limit for the Indian investee entity.

3. Transfers: A clarification has been introduced to provide that in case of transfer of equity
instruments held on a non-repatriation basis, to someone who wants to hold it on a
repatriation basis, the transferee will have to comply with the other requirements of
pricing, and sectoral caps, among others, similar to any other non-resident investor
holding shares on a non-repatriation basis. Further, under TISPRO, for transfers which
were not under the general permission, a permission was to be sought only from RBI.
However, the Rules now require the permission to be sought from RBI in consultation
with the Central Government.

Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments

Schedule I of the regulation: Purchase or sale of equity instruments of an Indian company by

a person resident outside India.

Schedule II: Investments by Foreign Portfolio Investors.

Schedule III: Investments by Non-Resident Indian (NRI) or Overseas Citizen of India (OCI)
on repatriation basis.

Schedule IV: Investment by NRI or OCI on non-repatriation basis.

Schedule V: Investment by other non-resident investors.

Schedule VI: Investment in a Limited Liability Partnership.

Schedule VII: Investment by a Foreign Venture Capital Investor.

Schedule VIII: Investment by a person resident outside India in an Investment Vehicle.

Schedule X: Issue of Indian Depository Receipts.

Issuing of Convertible Notes by an Indian Start-up: A start-up 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/ Escrow
account maintained by the person concerned in accordance with the Foreign Exchange
Management (Deposit) Regulations, 2016.

Reporting Requirements:-

Form Foreign Currency-Gross Provisional Return (FC-GPR): An Indian company issuing

equity instruments to a person resident outside India and where such issue is reckoned as
Foreign Direct Investment, defined under the rules, shall report such issue in Form FC-GPR,
not later than thirty days from the date of issue of equity instruments.

Annual Return on Foreign Liabilities and Assets (FLA): An Indian Company which has
received FDI or an LLP which has received investment by way of capital contribution in the
previous year including the current year, shall submit form FLA to the Reserve Bank on or
before the 15th day of July of each year.

Form Foreign Currency-Transfer of Shares (FC-TRS): Form FCTRS shall be filed for
transfer of equity instruments in accordance with the rules, between a person resident outside
India holding equity instruments in an Indian company on a repatriable basis and person
resident outside India holding equity instruments on a non-repatriable basis.

Also, any person resident outside India holding equity instruments in an Indian company on a
repatriable basis and a person resident in India.

** Transfer of equity instruments in accordance with the rules by way of sale between a
person resident outside India holding equity instruments on a non-repatriable basis and
person resident in India is not required to be reported in Form FC-TRS.

What else in Form TC-TRS?

Transfer of equity instruments on a recognized stock exchange by a person resident outside

India shall be reported by such person in Form FC-TRS. And, transfer of equity instruments
prescribed in Rule 9(6) of the Rules, shall be reported in Form FC-TRS on receipt of every
tranche of payment. The onus of reporting shall be on the resident transferor / transferee.

Also, The form FCTRS shall be filed within sixty days of transfer of equity instruments or
receipt / remittance of funds whichever is earlier.

Form Employees' Stock Option (ESOP): An Indian company issuing employees' stock option
to person resident outside India who are its employees / directors or employees / directors of
its holding company / joint venture / wholly owned overseas subsidiary / subsidiaries shall
file Form-ESOP, within 30 days from the date of issue of employees' stock option.

Form Depository Receipt Return (DRR): The Domestic Custodian shall report in Form DRR,
the issue / transfer of depository receipts issued in accordance with the Depository Receipt
Scheme, 2014 within 30 days of close of the issue.

Form LLP (I): A Limited Liability Partnerships (LLP) receiving amount of consideration for
capital contribution and acquisition of profit shares shall file Form LLP (I), within 30 days
from the date of receipt of the amount of consideration.

Form LLP (II): The disinvestment / transfer of capital contribution or profit share between a
resident and a non-resident (or vice versa) shall be filed in Form LLP(II) within 60 days from
the date of receipt of funds. The onus of reporting shall be on the resident
transferor/transferee.

LEC(FII): The Authorized Dealer Category I banks shall report to the Reserve Bank in Form
LEC (FII) the purchase / transfer of equity instruments by FPIs on the stock exchanges in
India.

LEC(NRI): The Authorised Dealer Category I banks shall report to the Reserve Bank in Form
LEC (NRI) the purchase / transfer of equity instruments by Non-Resident Indians or
Overseas Citizens of India on stock exchanges in India.

Form InVI: An Investment vehicle which has issued its units to a person resident outside
India shall file Form InVI within 30 days from the date of issue of units.

Convertible Instruments then and now?

The TISPRO Regulations required that the price / conversion formula of the convertible
instrument should be determined upfront at the time of issue of the instrument. It further
provided that the price at the time of conversion should not in any case be lower than the fair
value worked out at the time of issuance of such instruments as per the TISPRO Regulations.
This necessitated carrying out a valuation even at the time of conversion. The Non-Debt
Instruments Rules has dropped this requirement. Going forward, convertible instruments
would need to be valued at the time of their issuance.
(The requirement to undertake a valuation at the time of conversion was limiting the upside
available to foreign investors. It resulted in lesser number of shares to them at the time of
conversion as the pricing norms restricted an Indian company from issuing shares at lesser
than fair value. These changes ensure foreign investors get the full benefit of an upside in
case of convertible instruments. Therefore, these changes could be welcomed by the investor
community.)

Foreign Portfolio Investors (FPI): The non-debt instrument rules make a couple of key
changes governing FPI investment into Indian companies.

Caps on aggregate FPI Investment: Limits are linked to the sectorial caps as a default rule. In
case an Indian company wants to reduce the FPI limits to a lower threshold of 24%, 49% or
74%, they would need to do so before 31st March 2020. Further, once the limits are
enhanced, the Indian company cannot reduce the limits. The above changes would apply to
sectors where FDI is not prohibited. In sectors where FDI is prohibited, the aggregate FPI
limits is capped at 24% of the company's paid-up equity capital on a fully diluted basis or
such same sectoral cap percentage of paid-up value of each series of debentures or preference
shares or share warrants.

Sectoral Cap: Press Note 4 of 2019 (the "Relevant Press Note") had introduced many
changes to the foreign investment norms governing single-brand retail trading, contract
manufacturing, coal mining and digital media. The Relevant Press Note clearly provides that
policy pronouncements contained therein would take effect from the date of notification of
amendments to the TISPRO Regulations.

The changes announced in Press Note 4 of 2019 relating to single-brand retail trading and
contract manufacturing were aimed at increasing India's competitiveness and making it a
manufacturing hub, thereby creating more jobs. These policy announcements had also
garnered a lot of global attention. However, it is curious that the Government did not use this
opportunity to notify the changes to the regulatory regime. Therefore, a clarification from the
Central Government on this aspect is keenly awaited.

Reporting of Foreign Investment Transactions: RBI has framed the Foreign Exchange
Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019.
The Reporting Regulations provides the regulatory guidance regarding the mode of payment
and remittance of sale proceeds involving non-debt instruments and the reporting obligations
related to the same. The Reporting Regulations and is largely in line with the TISPRO
Regulations. However, the fact that the regulations governing remittance and reporting
regulations are now consolidated in one regulation would be useful to the stakeholders and is
a welcome change in that sense.

Conclusion:

While the Non-Debt Instruments Rules does not per-se alter the regulatory framework
governing foreign investment transactions dramatically, it highlights the shift in the
regulatory approach going forward. Therefore, one could expect a more streamlined approach
between the RBI and the Central Government regulating foreign investments. However, the
Government should step in to address some of the anomalies and inconsistencies pointed out
above, particularly, those relating to sectoral caps and conditions, to avoid any further
confusion on these aspects. In sum, the NDI Rules are the result of changes affected in
FEMA through the Finance Act 2015. At the first cut, these appear to be a quick job ticking
off the to-do list, but they have brought about some deep changes, the impact of which will
play out in time. The opportunity could have been availed to clean up a lot of regulations that
are cumbersome, but instead, regulations appear to have simply moved one level up to the
Rules under the Ministry of Finance. This is a good start, the advantage being that a unified
view is now possible on the various kinds of foreign investment flows into various entities
because all the financial sector regulators ultimately come under the Ministry of Finance,
which is also the administering ministry for FEMA.
Sources referred:

1. https://corporate.cyrilamarchandblogs.com/2019/11/non-debt-instruments-new-rules-
foreign-flows/
2. http://www.mondaq.com/india/x/865530/Inward+Foreign+Investment/Foreign+Invest
ment+NonDebt+Instruments+Rules
3. https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11723&Mode=0
4. https://www.bsamrishindia.com/tag/fema-20r/
5. https://corporate.cyrilamarchandblogs.com/2018/06/india-simplifies-foreign-
investment-reporting-process/#more-2393
6. http://www.mondaq.com/india/x/863000/Inward+Foreign+Investment/New+Foreign+
Investment+Rules+And+Regulations+The+Bank+Surrenders+The+Baton