Legal Framework for Foreign Owned and Controlled Companies (FOCCs) in India

The legal framework governing Foreign Owned and Controlled Companies (FOCCs) in India is primarily structured around the Foreign Exchange Management Act, 1999 (FEMA), and its associated rules and regulations. FEMA was established to facilitate external trade and payments and to promote the orderly development and maintenance of the foreign exchange market in India. It provides a legal framework for the regulation of foreign exchange transactions.

Under FEMA, the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules) play a significant role in governing investments in non-debt instruments, including equity instruments. These rules outline the conditions for foreign investments, sectoral caps, and pricing guidelines. Specifically, Rule 23(1) mandates that any Indian entity receiving indirect foreign investment must comply with the entry routes, sectoral caps, pricing guidelines, and other conditions applicable to foreign investments. Rule 23(5) imposes pricing guidelines on transactions between FOCCs and persons residing in India, creating a framework for such transactions.

However, a notable ambiguity arises from the definition of a “person resident in India” under Section 2(v) of FEMA, which includes any person or body corporate registered or incorporated in India. This creates confusion for FOCCs, as they are incorporated in India but controlled by foreign entities, leading to a dual treatment in regulatory terms. The NDI Rules, while treating FOCCs as residents, also impose conditions applicable to non-residents, particularly in terms of pricing guidelines and other regulatory requirements.

RBI’s Master Directions on Foreign Investment in India consolidate the regulatory framework for foreign investments. These guidelines, updated periodically, outline the rules and regulations for FDI, including reporting requirements, pricing guidelines, and sectoral caps. They provide a comprehensive reference for understanding the regulatory landscape for FOCCs.

Downstream investments, which refer to investments made by an Indian company or entity with foreign investment into another Indian company or entity, are also regulated under this framework. FOCCs making downstream investments must comply with the sectoral caps and entry route norms applicable to foreign investments in the target company incorporation. This ensures that the regulatory safeguards are maintained across different layers of investment.

A specific regulatory provision under the NDI Rules, known as the 18/25 Rule, addresses deferred payment considerations in transactions. According to this rule, deferred consideration must be paid within 18 months and cannot exceed 25% of the total transaction value. However, the application of this rule to FOCCs is ambiguous due to their dual treatment as residents and non-residents. Rule 9(6) of the NDI Rules mentions the 18/25 Rule for deferred payments in transactions involving residents and non-residents but does not explicitly address its applicability to FOCCs.

This ambiguity has led to various interpretations and practices in the industry. One interpretation suggests that no deferred consideration is allowed in transactions involving FOCCs, while another interpretation allows for deferred considerations but within the confines of the 18/25 Rule. The RBI has reportedly taken a conservative stance, inferred from its rejection of forms reporting downstream investments involving deferred considerations by FOCCs and issuing notices to FOCCs structuring share purchases with deferred consideration.

Several key cases, while not directly addressing the issue of deferred consideration for FOCCs, provide insights into the interpretation of FEMA and its rules. The Vodafone International Holdings BV v. Union of India (2012) case highlighted the need for clear regulations concerning foreign investments and their tax implications. Similarly, the Cairn UK Holdings Limited v. Union of India (2020) arbitration ruling underscored the necessity for consistent and transparent regulatory practices to protect foreign investors’ interests.

Conclusion:

In conclusion, the legal framework governing FOCCs in India, primarily driven by FEMA, NDI Rules, and RBI guidelines, aims to facilitate foreign investments while ensuring compliance with sectoral caps, pricing guidelines, and other conditions. However, the ambiguity regarding the treatment of FOCCs as residents or non-residents and the applicability of deferred consideration rules calls for further regulatory clarity. This would ensure a smoother investment process and enhance the confidence of foreign investors in the Indian market.

Contributed by – Surbhi Kapoor

King Stubb & Kasiva,
Advocates & Attorneys

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