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Indirect Investment and Downstream Investment in Terms of Foreign Exchange Management Act, 1999
Foreign Direct Investment (FDI) in India is governed by the FDI Policy announced by the Government of India and the provisions of the Foreign Exchange Management Act (FEMA), 1999. Reserve Bank has issued Notification No. FEMA 20 /2000-RB dated May 3, 2000 which contains the Regulations in this regard. This Notification has been amended from time to time.
In terms of Press Note No. 9 of 1999 issued by DIPP certain guidelines were laid down for the downstream investment made by foreign owned Indian holding companies that required prior FIPB/Government approval. Recently, the Government has come out with a fresh set of guidelines/press notes on the subjects of indirect investment and downstream investment. Press
Note No. 2 of 2009 was issued, wherein guidelines for calculation of total foreign investment were detailed.
There are different ways in which investment can be made in Indian Companies.
In this method, Investment is directly routed to the Indian Company from Foreign Company.
Pictorial presentation is represented below:
Foreign Company can also resort an indirect way to Invest in Indian Companies.
In the above method Indian Company (I Co1) is the shareholder in I Co2. In other words,
Foreign Company owns shares in I Co2 through I Co1. In the Indirect Method herein above
referred, total foreign investment is total of Foreign Direct Investment + Indirect Investment.
Press Note 4 of 2009 (Press Note 4) seeks to clarify compliance with foreign investment norms
compared with downstream investments. Although the language in the operating part of the
press note is not very clear, the introductory paragraph suggests that it is restricted to
downstream investments by an Ico1 if the Ico1 is owned or controlled by non-resident entities.
It categorizes I Co2 into three baskets:
1. Operating companies: Sectoral caps and Conditions of FEMA have to be complied with.
2. Operating-cum-investment companies: Sectoral caps and Conditions of FEMA have to
be complied by I Co2 as well by the I Co3 (Domestic Company) in which the
investment is proposed by the I Co2.
3. Investment companies: If the I Co2 is an investment company (i.e. neither an operating
company nor an operating-cum-investment company), FIPB approval is required
regardless of the amount or extent of foreign investment. Further, the Domestic
Company will have to comply with conditions and sectoral caps?
If the ICo2 is an operating-cum-investing company, or an investment company, additional
conditions are prescribed in relation to downstream investment by an I Co2 in Domestic
• Two conditions are procedural and require certain intimations of downstream
investment within 30 days of investment and certain board resolutions to be submitted
to FIPB/ SIA.
• Other conditions are substantive and require compliance with certain pricing guidelines.
The key principle emerging from Press Note 2 is that as long as an Indian company is owned
and controlled ultimately by resident Indians, foreign investment in the Indian company would
be ignored in relation to downstream investments made by the Indian company.
“Two Tests” to be satisfied for deciding the applicability of Press Note 2 and 4 are as under:
1. Control and Ownership of the Indian Investing Company
2. The pattern of "Downstream Investment‟ in the Sector in which the Investment is being
made for being able to.
First Test: Control and Ownership of the Indian Investing Companies.
Definition of “owned” and “controlled” given in Press Note 2 and which have been reproduced
“Owned” by resident Indian citizens and Indian companies, which are owned and controlled by
resident Indian citizens, if more than 50% of the equity interest in it is beneficially owned by
resident Indian citizens and Indian companies, which are owned and controlled ultimately by
resident Indian citizens.
“Controlled” by resident Indian citizens and Indian companies, which are owned and controlled
by resident Indian citizens, if the resident Indian citizens and Indian companies, which are owned
and controlled by resident Indian citizens, have the power to appoint a majority of its directors.
Conversely, an Indian company may be taken as being “owned” by „non resident entities‟, if
more than 50 percent of the equity interest in it is beneficially owned by non-residents
“controlled” by „non resident entities‟, if non-residents have the power to appoint a majority of
its directors. Thus in the instant case, CFPL is owned and controlled by resident Indian Citizens.
Second Test: Downstream Investment
Please note that Press Note 4 is applicable only to downstream investment by investing Indian
companies owned or controlled by non-residents. In other words, if the investing Indian
companies are not foreign owned or controlled, Press Note 4 does not apply