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Himanshu Pimpalkhute

Corporate Consultant, Pillsbury Winthrop Shaw Pittman LLP

Quotation Marks
“India implements capital controls, meaning there are restrictions on who can invest, where they can invest and how.”

Navigating India’s investment landscape

Navigating India’s investment landscape


While India offers many attractive investment opportunities, there are various regulatory factors to be aware of

India, a rapidly expanding market, ranks among the world's fastest-growing economies. Projected to be the world's third largest economy in the coming decades and recently becoming the most populous country, India is poised to become a significant player in the global economic landscape. This promising growth presents many enticing investment opportunities.

Unlike other democracies like the UK, US and EU, India implements capital controls, meaning there are restrictions on who can invest, where they can invest and how. However, these controls do not substantially hinder investment opportunities, it just means some paperwork and formalities when money goes in and comes out are needed.

Currently, India has classified investors in two broad categories:

·        A legal person: This is subdivided in multiple parts not only based on your legal set up but also the manner in which you invest. For example, when  a UK company subscribes to 30 per cent of issued capital of an Indian listed company it is foreign direct investment (FDI). If the same UK company buys up to 10 per cent of issued shares of the same listed Indian company on stock market, it becomes a foreign portfolio investment (FPI). The rules are different for FDI and FPI.

·        A natural person: This is subdivided in three sub-categories; an Indian citizen residing overseas (NRI), a person of Indian origin who has acquired new citizenship and is registered as Overseas Citizen of India (OCI), and foreign nationals.

Investor classes

India’s regulations prescribe eligibility criterion for; the investor, this is the answer to ‘who can invest;’ the desired sector to invest in, this is the answer to ‘where to invest;’ and mode of investment, this is the answer to ‘how to invest.’

If you pass in all three fields your investment falls under automatic route. It means you don’t need prior approval from anybody. If you fail in any of the fields, your investment is under government route. It means you need prior approval from either Securities Exchange Board of India (SEBI) or Reserve Bank of India (RBI) or one of the designated government departments.

Notable restrictions are for people and corporate entities from countries that shares land border with India or if an investor’s country of origin does not have robust anti-money laundering regulations or they are on one of the sanction lists.

From an investment perspective, Indian companies can be broadly classified in three different categories:

·        Companies that remain within the same family. These companies were set up by the grandfather or great grandfathers of the current generation who actively manage the company. These are traditional, conservative business with consistent fair returns. If you are willing to be part of the family’s enterprise, your money will steadily grow and generate reasonable returns. The risks associated with these companies are relatively low.

·        Companies with a mix of family members and professional managers: Some members of the current generation have been educated in the US or  UK and have learned the benefits of professional management. These companies strike a balance between family members and professional managers. They often pursue both horizontal and vertical expansion, and constantly seek funds for new projects or buying other businesses. Investing in these businesses can provide more rapid returns, but there are still risks of new ventures failing.

·        Start-ups and unicorns. These are set up by ambitious and maverick professionals aiming to leverage technology, innovations and intellectual property. These are capital hungry companies with high reward if they succeed but can also result in total loss if they go bust.

Interestingly, different regulations fit in for each different category, although it may not have been the intention of lawmakers to create these distinctions.

Let us look at these three regulations. 

Foreign Direct Investment (FDI)

Usually, FDI is discussed as part of ‘Doing Business in India’, however, it is not necessary for an individual to play an active role in the business. India is a rapidly growing economy, so a practical business model with competent promoters would rarely result in financial losses. 

FDI is prohibited in a small number of sectors, such as lottery, gambling, credit societies, real estate, tobacco and activities reserved for the government such as atomic energy and railways. FDI is welcome in the remaining sectors, although some conditions are attached to some activities. Overseas corporate entities can buy part of the equity in both listed and unlisted companies.

Obligations for regulatory compliance lies with the investee company. It is required to report the investment, pricing, disinvestment and all corporate actions. The investor usually enters into a subscription agreement detailing terms and conditions of these requirements.

Additionally, investors also enter into a shareholders agreement detailing how the company should be managed, actions directors can or cannot take without the investor’s consent, rights and restrictions associated with investor and promoter shares, dispute resolution mechanisms and exit options. It is advisable to keep open an option to nominate a director on the board for deeper oversight of the business.

If one intends to maintain a long-term investment in the same company, become part of the promoter family and receive steady returns on investment, the first category companies are the best option for FDI. Of course, there are still some downsides to this. For instance, as the business always remains in the family, any dispute among family members can adversely affect your investment.

Foreign Portfolio Investor (FPI)

If you have a general belief in emerging markets or a specific sector such as IT or energy and want to diversify your investments, FPI is the best option. Overseas entities, such as corporate bodies, regulated funds, asset managers, investment managers, brokers and others can register with the SEBI as FPIs. Each FPI can buy up to 10 per cent of the issued capital or debentures of a listed company. You can buy in the secondary market and you can also subscribe to public offerings and private placements.

Unlike other investment routes, there is no subscription agreement and shareholders agreement associated with FPI. FPIs have no special privileges; they have the same rights and entitlements as any other shareholder. Yet FPIs are obligated to submit reports to SEBI giving details of investments and variations thereof as well as other regulatory information such as control and ownership of the FPI entity.

FPI investment is allowed in any Indian listed company that is eligible to accept FDI. Collectively, all FPIs along with all overseas entities can buy up to 24 per cent of the equity instruments. Investment beyond this threshold is considered FDI, requiring both the investor and investee company to comply with FDI regulations.

Many aggressive companies with professional management (category 2 as mentioned earlier) are rapidly growing in sectors such as Energy, IT, logistics, infrastructure and manufacturing. FPIs can freely buy and sell shares provided they take physical delivery. You can flexibly define your investment strategy, make changes to it and keep shuffling your portfolio.

However, it’s important to be aware of the liquidity depth of the market. Public shareholding in some companies can be as low as 25 per cent, resulting in a limited number of daily traded shares, often in the low thousands. This compromises your ability to offload larger chunk, say 1 per cent or more of the issued shares. You may need to sell them over a longer time frame or accept a larger drop in the quoted price. 

Foreign Venture Capital Investor (FVCI)

According to published data, India currently has over 61,400 start-ups, with around 14,000 recognised during the fiscal year 2022 alone. In India, a start-up is a private company, LLP or a firm registered as such with government authorities.

A start-up is essentially an entity working towards innovation, the development or improvement of products, processes or services, or it has a scalable business model with high potential of employment generation or wealth creation. There are couple of other stipulations for age and turnover. Start-ups enjoy  many regulatory benefits under income tax laws, SEBI regulations, the Companies Act, labour laws, the Foreign Exchange Management Act, intellectual property regulations and environmental laws.

FVCIs can invest in equity or debt instruments of a start-up operating in any sector. FVCIs can also invest in other innovative companies engaged in biotechnology, nanotechnology, seed research, dairy, poultry, bio-fuels, IT, pharma and infrastructure.

FVCIs are registered separately from FPIs and undergo a higher level of scrutiny conducted by SEBI. This process involves evaluating factors such as:

·        track record i.e. professional competence, financial soundness, experience, general reputation of fairness and integrity.

·        corporate structure.

·        whether one proposes to be FVCI or AIF.

·        whether one is regulated in their home country.

·        whether the candidate is a fit and proper person.

·        their investment strategy.

FVCIs can invest all of their committed funds in one VC Fund or AIF registered in India. These entities can make downstream investments. FVCIs have to invest at least 66.67 per cent of the funds in unlisted equity or equity linked instruments and can invest the remaining funds through public offers by investee companies, both in equity and debt instruments.

FVCIs have to maintain a full set of books of accounts, records and documents that give an accurate picture of the state of affairs. They have to report the location of these records and allow inspection when requested by SEBI. FVCIs must appoint a domestic custodian to hold securities and this entity is responsible for monitoring investments and providing periodic reports to SEBI.

Start-ups in India carry additional risks. The average age of Indian start-up founders continues to fall while venture funding brings rapid growth within a short time. High-paced success combined with lower maturity and less experience can adversely affect the mindset of some young entrepreneurs. They can potentially lose their way with money and management. FVCIs need proactive approach to maintain internal checks and balances. As an FVCI, it is essential to insist robust internal audit function, experienced independent directors who can remain vigilant and a strong whistle-blower policy.

General compliance

FPIs and FVCIs are also required to obtain the permanent account number (PAN) from Indian Income Tax authorities. This helps an investor  entity claim tax credits deducted at source, filing tax returns and availing benefits of double taxation avoidance agreements (DTAAs) between an investor’s own country and India. If investments are to be held electronically, one would need a DMat account, which is akin to a Euroclear account, only with Indian depository participant (DP), which incidentally is the custodian for FVCIs. You also have to nominate an Indian bank, known as an Authorised Dealer Bank (AD Bank) where you hold an account. All remittances and withdrawals should be conducted through this designated account. 

NRI and OCI investments

Certain chapters in RBI and SEBI regulations stipulate rules for NRI and OCI investments in India. These individuals can invest on either a repatriation or non-repatriation basis.

On a repatriation basis and as individuals, they can freely buy and sell equity shares or other equity-linked instruments of a listed Indian company. However, there is a limit of up to 5 per cent of issued equity shares for an individual and aggregate NRI and OCI holdings cannot exceed 10 per cent of the equity capital of the company.

NRIs and OCIs can also buy units of domestic mutual funds, shares in public enterprises, subscribe to the national pension scheme and buy immoveable property except agricultural land. The original investment and gains made can be withdrawn at any time.

NRI and OCI have a wider choice of investment options on a non-repatriation basis. They can set up a company, partnership or trust outside India and either individually or via legal setup buy equity interests in any company, LLP or firm. The original investment and gains therefore cannot be taken out of India. These investments are relevant for NRIs and OCIs who are planning to relocate back to India.

A quirk in the law

While NRIs and OCIs can individually buy equity shares of a listed company and FPIs can do so as corporate entities, there is a quirk in the law. As per regulations only foreign nationals can set up and manage FPI entities while NRIs and OCIs cannot do so. The intention of lawmakers is clear here. They want NRI and OCI to make investments in their personal names while foreign nationals do so via corporate setups. Presumably, this facilitates the monitoring of limits set forth in regulations.

General permission

Indian companies are allowed to issue American Depository Receipts (ADRs), Global Depository Receipts (GDRs) and Foreign Currency Convertible Bonds (FCCBs) to all overseas investors. ADRs and GDRs are equity instruments issued by overseas depositories against the deposit of equity shares by the company. On the other hand, FCCBs are debt instrument that are convertible into equity shares.

All these instruments are denominated in international currencies such as dollars, sterling or euros, and are generally listed in London, New York, Singapore or Hong Kong. These instruments are the best options for buying a sizable chunk of a business without obligation to comply with Indian regulations.

The investee company must comply with Indian regulations and the listing rules of domestic and overseas stock exchanges. They are also required to produce a full prospectus. When participating in the company’s issuance, you can subscribe to entire issue or a portion of it. Furthermore, you can also freely buy and sell ADRs, GDRs and FCCBs issued earlier.

When selling these instruments on an overseas stock exchange, you will receive payment in the currency of the specific issue. Additionally, you have the ability to convert these instruments into the underlying equity shares of the company. These underlying equity shares can be freely traded in the Indian Stock market. And when  you sell them, you will receive payment in Indian rupees. This sum can be repatriated to your home country.

Himanshu Pimpalkhute is a corporate consultant at Pillsbury Winthrop Shaw Pittman LLP