Issues in Capital Account And Current Account Transactions

Issues in Capital Account And Current Account Transactions BARODA BRANCH OF WIRC, ICAI CA Rajesh H. Gandhi 16 February 2013

Agenda • Overview • Capital Account Transactions • Foreign Direct Investment (FDI) • External Commercial Borrowing (ECB) • Overseas Direct Investment (ODI) • Current Account Transactions • Liberalized Remittance Scheme (LRS) 2

Overview 3

Overview Of Current And Capital Account Transactions Capital Account Remittance Prohibited unless specifically permitted Freely permitted Subject to ceilings** Approving authority Foreign Investment Promotion Board Authorized Dealers Central Government/RBI Ø Illustration 4 Current Account Purchase of machinery on credit or borrowing outside India for such purchase Purchase of machinery for cash **Approval required where ceilings breached

Capital Account Transactions 5

Capital Account Regulations • Permissible Capital Account Transactions – Para 3 of the Capital Account Regulations (A) transactions of a person resident in India specified in Schedule I (B) transactions of a person resident outside India specified in Schedule II • Prohibited Capital Account Transactions – Para 4 of the Capital Account Regulations ‒ Business of chit fund ‒ Nidhi Company ‒ Agricultural or plantation activities ‒ Real estate business, or construction of farm houses, ‒ Trading in Transferable Development Rights (TDRs) Real estate business does not include development of townships, construction of residential/commercial premises, roads or bridges. 6

Permissible Capital Account Transactions Investment by person resident in India Investment by person resident outside India [Schedule I, Regulation 3(1)(A)] [Schedule II, Regulation 3(1)(B)] ü ü ü ü ü Direct investment in India External commercial borrowings Transfer of immovable property outside India Guarantees issued in favour of a person resident outside India Export, import and holding of currency/currency notes Maintenance of foreign currency accounts in India and outside India Loans and overdrafts to a person resident outside India. Remittance outside India of capital assets of a person resident in India. Sale and purchase of foreign exchange derivatives in India and abroad and commodity derivatives abroad. ü Investment in India i. e. , — o In security issued by a body corporate or an entity in India; and o to the capital of a firm or a proprietorship concern or an association of persons in India. ü Acquisition and transfer of immovable property in India. ü Guarantee in favour of, or on behalf of, a person resident in India. ü Import and export of currency/currency notes into/from India ü Deposits between a person resident in India and a person resident outside India. ü Foreign currency accounts in India ü Remittance outside India of capital assets in India of a person resident outside India. Subject to applicable conditions 7

FDI 8

Background • Inbound investments are regulated by ‒ Reserve Bank of India ("RBI") ‒ Department of Industrial Policy & Promotion (FC Section), Ministry of Commerce, Government of India • Under section 6(3)(b) of the FEMA ‒ RBI has the power to prohibit, restrict or regulate the transfer or issue of any security by a person resident outside India • RBI has issued FEM (Transfer or issue of security by a person resident outside India) Regulations, 2000 ("FEMA 20/2000") ‒ to regulate the transfer / issue of shares by certain persons resident outside India subject to certain terms and conditions specified in Schedules to the aforesaid Regulations ‒ FEMA 20/2000 -RB, dated 3 may 2000 [GSR 406(E), dated 3 May 2000] • RBI also issues annual master circular on "Foreign Investments in India" that deals with inbound investment in India ‒ Latest Master Circular on "Foreign Investments in India“ is dated 2 July 2012 (updated as on 12 February 2013) 9

Background… • Further, Ministry of Commerce and Industry (Department of Industrial Policy and Promotion), Government of India (GOI) has released Consolidated FDI Policy vide Circular 1 of 2012 dated 10 April 2012 which is effective from the same date. • DIPP issues Press Notes which provide guidance on various issues including foreign investment in India • Press Notes and FEMA Regulations are to be read together • FAQs on foreign Direct Investment in India updated on October 11, 2011 10

Background… Foreign Investments FDI Portfolio Investments Automatic route Approval Route NR FII Venture Capital Investments Other investments (G-sec, NCDs, etc. ) FIIs NRI, PIO, QFI SEBI regd. FVCIs VCF, IVCUs 11 Investment on non repartriable basis NRI, PIO, QFI NRI, PIO

India’s FDI Policy – Sectoral view Sectors – Automatic Route (Illustrative) ü ü ü ü ü Agriculture & Animal husbandry NBFC (subject to minimum capitalization norms) Insurance – 26% Special Economic Zones Alcohol Distillation Private Sector Banking up to 49% Mining Petroleum & Natural Gas Cash & Carry wholesale trading Sectors –Approval Route (Illustrative) l Existing Airports beyond 74% l Asset Reconstruction Companies - 49% l Broadcasting l Telecom Service beyond 49% upto 74% l Private Sector Banking beyond 49% l Print Media l Tea Sector l Defence - 26% 12 Sectors – Negative List (Illustrative) Atomic energy Lottery, betting and gambling Business of chit fund Nidhi company Trading in Transferable Development Rights Cigars, cheroots, cigarillos and cigarettes Real estate business

Question Break - Can FDI be received in a business / venture which is not incorporated under any law in India?

Single Brand Retail Trading • 100% permitted under approval route • Conditions ‒ Single brand products only ‒ Product should be sold under same brand internationally ‒ Products are branded during manufacturing ‒ Only one non-resident entity, whether owner of the brand or otherwise, permitted to undertake single brand product retail trading for the specific brand (earlier condition that foreign investor should be owner of brand deleted) ‒ Retail trading by means of e-commerce not permitted • Application for approval to indicate the product / product categories proposed to be sold under a “single brand” • Fresh approval required for any addition to product / product category • For proposals beyond 51%, mandatory sourcing of at least 30% of value of manufactured / processed products from India preferably from MSMEs, village and cottage industries, artisans and craftsmen • First compliance over a period of 5 years from the year of receipt of 1 st tranche of FDI. Subsequently on an annual basis

Multi Brand Retail Trading • 51% permitted under approval route • Conditions ‒ Minimum amount to be brought in – USD 100 million ‒ 50% of the total FDI brought in shall be invested in ‘backend infrastructure’ within 3 years of the first tranche of FDI. It will include capital expenditure on all activities, excluding that on frond-end units (clarified to include investment towards processing, distribution, quality control, storage etc. ) ‒ At least 30% of value of manufactured / processed products purchased to be sourced from Indian small industries/village and cottage industries, artisans and craftsmen. First compliance over a period of 5 years from the year of receipt of 1 st tranche of FDI. Subsequently, on an annual basis ‒ Retail sales outlets to be set up only in areas meeting specified criteria ‒ Government will have the first right to procurement of agricultural products ‒ Retail trading by means of e-commerce not permitted Expenditure on land rent will not be counted for the purpose of ‘backend infrastructure’

Multi Brand Retail Trading ~ Issues… • Whether entire capital of 100 million to be brought upfront or within specified time frame • Whether investment in purchase of existing business would be considered towards meeting the minimum investment criteria • Continuous requirement to invest 50% in backend capital expenditure may be difficult to achieve • Mandatory sourcing of 30% from small scale industries ‒ Challenges in achieving economies of scale and consistency in quality ‒ Increase in cost on account of procurement in small quantity and training of multiple suppliers ‒ Challenges associated with switching to another supplier when small scale supplier outgrows its size

Transfer of Shares • Transfer of shares from NR to R or R to NR freely permitted subject to sectoral restrictions ‒ However transfer of shares from NRI to NR requires prior permission of RBI • Deferred payment ‒ Transfer from R to NR – Prior approval required from RBI ‒ Transfer from NR to R – No specific provision ‒ Reporting in form FC TRS to be done within 60 days from date of receipt of consideration (initial/final? ) • Reduction of share capital – no specific reporting requirement • Liquidation of companies ‒ Proceeds can be remitted to NR only after receipt of approval of official Liquidator ~ Liquidator would grant final approval only after remittance is made

Question Break - Can a foreign company (other than FII/QFI) buy/sell Indian shares on the stock market

Indirect Foreign Investment • Direct Investment ‒ Any non-resident investment in an Indian company • Indirect Foreign Investment ‒ Investment in an Indian company by another Indian company having foreign investment. • Investing company ‒ An Indian company holding only investment in other Indian company/(ies), directly or indirectly, other than for trading of such holding / securities.

Indirect Foreign Investment NREs Overseas India Say, 51% Say, 49% Investing Company Say, 26% / 80% Indian Company 20 RICs / ICs Owned by RIC and IC If more than 50% of the equity interest is beneficially owned by RIC and ICs which are owned and controlled ultimately by RICs Control by RIC and IC If RIC and IC which are owned and controlled by RIC have the power to appoint majority of its directors Yes Whether indirect foreign investment by investing company in Indian company counted? Not counted • Shareholding of investing company into Indian company will not be considered as foreign investment • In this case, foreign investment will be NIL

Indirect Foreign Investment NREs Overseas India Say, 49% Say, 51% Investing Company 80% Indian Company 21 RICs / ICs Owned by RIC and IC If more than 50% of the equity interest is beneficially owned by RIC and ICs which are owned and controlled ultimately by RICs Control by RIC and IC If RIC and IC which are owned and controlled by RIC have the power to appoint majority of its directors Yes No Counted No Yes Counted No No Counted Whether indirect foreign investment by investing company in Indian company counted? • Proportionate theory will not apply • Shareholding of investing company into Indian company will be considered as foreign investment • In this case, 80%

Indirect Foreign Investment NREs Overseas India Say, 49% RICs / ICs Say, 51% Investing* Company Say, 100% Indian Company *Including operating-cum-investing company 22 • Exception – if operating-cum-investing company / investing company invests 100% in Indian company then the foreign investment limited to the foreign investment in the operating cum investing / investing company • It is clarified that this exception is being made since the downstream investment of a 100% owned subsidiary of the holding company is akin to investment made by the holding company and the down Stream investment should be a mirror image of the holding company. • In this case, 51%

Issues in Indirect Foreign Investment • Operating-cum-investing Indian company is owned or controlled by NREs Overseas India Say, 26% Say, 74% Operatingcum-Investing Company Say, 95% Indian Company RICs / ICs • Operating-cum-holding company holds 95% in its subsidiary • Whether indirect foreign investment will be considered in Indian Company? • Whether loan or investment in redeemable preference shares will be allowed? The Indirect Foreign Investment rules only cover cases of Operating -cum-Investing companies which own 100% of Indian Company

Question Break - Can Downstream Investment be made using internal accruals?

Investment in Limited Liability Partnership (‘LLP’) - FDI in LLPs is permissible under the approval route where operating in sectors / activities where 100% FDI is allowed under the automatic route - No FDI linked performance conditions - FDI in agricultural/plantation activity, print media or real estate not allowed - No FDI by FII and FVCI - Downstream investment by IC having FDI allowed, if both (the IC and LLP) operate in 100% automatic sector - No downstream investment by LLP with FDI - An LLP is not allowed to make an outbound investment under the automatic route. It would need to access the approval route which could be ordinarily granted (ROC does not allow LLPs to register if they have investments as part of their objects). - RBI approval would be needed for a company wanting to convert itself into an LLP if it holds overseas investments

Issues on Indirect Investment in LLP • Operating-cum-investing Indian company is owned or controlled by NREs Overseas India Say, 26% RICs / ICs Say, 74% • Does LLP have any foreign investment (direct or indirect)? - No? Operatingcum-Investing Company Say, 95% LLP • Operating-cum-holding company holds 95% in its subsidiary . ? ? A Co • Can LLP make any downstream investment? - Yes?

ECBs 27

Discussion points • Conversion of ECB into Equity ‒ Conversion permissible even though the ECB is not due for repayment • End-use ‒ Permitted end-use includes investment in new projects and modernization / expansion of existing production units ‒ Can proceeds of ECB be used for acquiring an industrial undertaking on a slump sale basis 28

ODI 29

Background • Outbound investments are regulated by ‒ Reserve Bank of India ("RBI") • Under section 6(3)(a) of the FEMA ‒ RBI has the power to prohibit, restrict or regulate the transfer or issue of any foreign security by a person resident in India • RBI has issued Foreign Exchange Management (Transfer or issue of any foreign security) Regulations, 2004 ‒ to regulate acquisition and transfer of a foreign security by a person resident in India i. e. investment by Indian entities in overseas joint ventures (“JV”) and wholly owned subsidiaries (“WOS”) as also investment by a person resident in India in shares and securities issued outside India ‒ FEMA 120/RB-2004 dated July 7, 2004 • RBI also issues annual Master Circular on "Direct Investment by Residents in Joint Venture (JV) / Wholly Owned Subsidiary (WOS) Abroad " that deals with Outbound investment of India ‒ Latest Master Circular on Direct Investment by Residents in Joint Venture (JV)/ Wholly Owned Subsidiary (WOS) Abroad dated 02 July 2012 • FAQ on Overseas Direct Investment updated on June 20, 2012

Outbound investment under the automatic route • An Indian party can invest upto 400% of its net worth (as per last audited Balance Sheet) in JV / WOS for any bona fide activity permitted as per the law of the host country, if certain other specified conditions are satisfied. ‒ For the purpose of reckoning the net worth of 400%, the Indian party may use the net worth of its parent company (holding at least 51% in Indian company) or its subsidiary company (in which 51% is held by the Indian Company) to the extent holding or subsidiary have not availed of by the holding company or subsidiary company independently. • Discussion Points ‒ Does the 400% net worth criterion apply only at the time of making the investment or through out the period of investment (fall in net worth)? ‒ Net worth of indirect parent and subsidiary cannot be considered ‒ JV not defined ~ level of investment / contribution? Net worth means paid up capital (including preference shares) and free reserves 31

Other Points • JV / WOS through a Special Purpose Vehicle ‒ Direct investment through the medium of a SPV is permitted under the Automatic Route for the purpose of investment in JV / WOS overseas ‒ Can an Indian company have more than one SPV for making investment in various JV / WOS ‒ Loan not permitted to step down subsidiary unless Indian company has equity investment in step down ~ extent of equity investment required not specified • No clarity on whether Indian resident can be a beneficiary of a foreign trust ~ discretionary vs. non discretionary trust ~ whether a capital account transaction • Designated Authorized Dealer ‒ In case the JV/WOS is being set up abroad by two or more Indian promoters, then all Indian promoters would be required to route all transactions in respect of that JV/WOS only through one ‘designated authorized dealer’ 32

Expatriates • Whether foreign citizens and other persons permanently resident in India allowed to invest abroad out of foreign currency resources ‒ In terms of section 6(4) of FEMA person resident in India can continue to hold or invest in foreign assets if such asset was held when the person was a resident outside India ‒ RBI Circular 37 of 19/10/2011 clarifies that under section 6(4), person resident in India can reinvest out of proceeds of assets sold outside India and income and sale proceeds of assets need not be brought to India ‒ Whether above relaxation applies to foreign citizens (heading of Circular only refers to NRIs) ‒ As per ODI regulations, only persons not permanently resident in India allowed to purchase foreign securities from foreign resources outside India – Whether persons permanently resident in India (including foreign citizens) not allowed to invest out of foreign resources inspite of relaxation under Circular 37 33

Current Account Transactions 34

Current Account Transaction Rules • Any person may sell or draw foreign exchange to or from an authorised person if such sale or drawal is a current account transaction, unless restricted by RBI • FEM( Current Account Transactions) Rules, 2000 ‒ Transactions for which foreign exchange withdrawal is prohibited (Schedule I) ‒ Transactions require approval of the Central Government ( Schedule II) ‒ Transactions require approval of Reserve Bank of India (Schedule III)

Current Account Transaction Rules… Rule 3 [Schedule I] Transaction prohibited (Illustrative) ü ü ü Remittance out of lottery winnings ü Payment of commission on exports made towards equity investment in Joint Ventures/Wholly Owned Subsidiaries abroad of Indian companies ü Remittance of interest income on funds held in Non-resident Special Rupee Scheme Account 36 Remittance of income from racing/riding etc, or any other hobby Remittance for purchase of lottery tickets, banned/prescribed magazines, football pools, sweepstakes etc

Current Account Transaction Rules… Rule 4 - Approval of the Central Government (Illustrative) ü ü Cultural Tours Remittance of hiring charges of transponders by: (a) TV Channels Ministry of Information and Broadcasting; (b) Internet Service Providers Ministry of Communication and Information Technology ü Remittance of prize money/sponsorship of sports activity abroad by a person other than International / National / State Level sports bodies, if the amount involved exceeds USD 1, 000 ü Advertisement in foreign print media for the purposes other than promotion of tourism, foreign investments and International bidding (exceeding USD 10, 000) by a State Government and its Public Sector Undertakings ü Multi-model transport operators making remittance to their agents abroad

Current Account Transaction Rules Rule 5 – Approval of the Reserve Bank (Illustrative) ü Release of exchange exceeding USD 10, 000 or its equivalent in one financial year for one or more private visits to any country (except Nepal and Bhutan) ü Gift remittance exceeding USD 5, 000 per financial year per remitter or donor other than resident individual ü Exchange facilities exceeding USD 100, 000 for persons going abroad for employment ü Exchange facilities for emigration exceeding USD 100, 000 or amount prescribed by country of emigration. ü Remittance for maintenance of close relatives abroad (i) exceeding net salary (after deduction of taxes, contribution to provident fund and other deductions) of a person who is resident but not permanently resident in India and— (a) is a citizen of a foreign State other than Pakistan; or (b) is a citizen of India, who is on deputation to the office or branch or subsidiary or joint venture in India of such foreign company (ii) exceeding USD 100, 000 per year per recipient, in all other cases

Travel Abroad Purpose Foreign Exchange Compliance When can foreign exchange be drawn for going abroad • Not before 60 days prior to the date of travel One or more private visit to any country • • Foreign currency notes equivalent to USD 3, 000 Total foreign currency drawal upto USD 10, 000. Exchange facilities for persons going abroad • Upto USD 1, 000 Exchange facilities for emigration • Upto USD 1, 00 or amount prescribed by country of emigration For business travel, or attending a conference or specialized training, study tour, or for maintenance expenses of a patient going abroad • Upto USD 25, 000 per visit, for a person, irrespective of period of stay For meeting expenses for medical treatment abroad • Upto USD 1, 000 or amount as per the estimate from a hospital/doctor in India/abroad, whichever is higher For studies abroad • Upto USD 1, 000 per academic year or as per the estimate from the institution abroad, whichever is higher

Travel Abroad… Purpose Drawal of currency permissible Maximum amount in INR that could be carried while on a visit abroad and brought back on return • INR 7, 500 Maximum cash in foreign currency that could be carried while on a visit abroad and brought back on return • Foreign currency notes equivalent to USD 3, 000 while going abroad On return, without any limit. However, if the aggregate value of foreign exchange exceeds USD 10, 000 or foreign currency notes alone exceeds USD 5, 000, it should be declared to the Customs Authorities at the Airport in the Currency Declaration Form on arrival in India. Maximum amount that can be paid in cash for drawing foreign exchange • • • Upto Rs 50, 000 If the Rupee equivalent exceeds Rs. 50, 000, entire payment should be made by way of a crossed cheque / banker’s cheque / pay order / demand draft, etc.

Expatriates • Employees of foreign companies on deputation to Indian subsidiary / branch / joint venture allowed to receive salary directly in foreign bank account subject to payment of tax in India ‒ Whether Indian company to whom the employees are deputed can directly pay salary into the foreign bank account • Employees who are (i) citizens of foreign State or (ii) citizens of India on deputation to office/branch/subsidairy/joint venture in India can make remittance for close relatives outside India as under: ‒ Upto net salary if the employment is for a specific duration (irrespective of length) or a specific job which does not exceed a duration of three years ‒ Upto USD 100, 000 in other cases 41

Liberalized Remittance Scheme 42

Background • Under the LRS, all resident individuals, including minors are allowed to freely remit up to USD 2, 000 per financial year for any permissible current or capital account transaction, which is given below • Consolidation of remittance facility in respect of family members, subject to compliance with the terms and conditions of the scheme. Permissible usage of LRS (Illustrative) ü Current account transactions ü 43 Permitted capital account transactions ü Remittance for purchase of objects of art subject to other relevant regulations ü Remittance of funds for acquisition of ESOP (this is in addition to acquisition of ESOPs linked ADR / GDR) ü Repayment of loan availed abroad as an NRI Usage prohibited (Illustrative) Remittance for any purpose specifically prohibited under Schedule-I (like purchase of lottery tickets/sweep stakes, proscribed magazines, etc. ) or any restricted items; Remittances for purchase of FCCBs issued by Indian companies in the overseas secondary market; Remittance by a resident individual for setting up a company abroad; Remittances directly or indirectly to countries identified by the FATF as ‘non co-operative countries and territories’ No need to repatriate to India the income generated from property acquired abroad out of LRS

Issues • Whether remittance can be made under LRS for investment in unlisted (private) companies ‒ Specific restriction for remittance towards setting up new companies ‒ No specific restriction / permission for acquisition of stake in private companies ~ not a “permissible capital account transaction” • However remittance allowed for acquisition of immovable property abroad which is also not a permissible capital account transaction • Form 15 CA/CB required even if the remittance is not taxable ~ variance in practice followed by Banks • Cases where Banks have insisted on form A 2 even though not required under LRS Remittance for travel, medical, studies etc. (except gift and donation) over and above limit under LRS 44

Issues • Rupee gift by resident to NRI relative allowed under LRS ~ amount to be credited to NRO account ‒ Does it circumvent restriction of USD 5, 000 for gifts under current account rules considering NRI can remit USD 1 million out of NRO account balance • Loans to non residents not permitted except to NRI/PIO close relatives subject to conditions • Limit of USD 200, 000 cannot be exceeded even if proceeds of investments bought back to India 45

Glossary FEMA Foreign Exchange Management Act, 1999 Capital Account Regulations The Foreign Exchange Management (Permitted Capital Account Transactions), Regulations 2000 RIC Resident Indian Citizens IC Indian Companies NRE Non Resident Entities FII Foreign Institutional Investors FVCI Foreign Venture Capital 46

Section 2(e) – Definition - Capital Account Transaction Section 2(e) • “Capital account transaction" means a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or assets or liabilities in India of persons resident outside India, and includes transactions referred to in sub-section (3) of section 6 47

Section 6(3) - Capital Account Transaction Section 6(3) “Without prejudice to the generality of the provisions of sub-section (2), the Reserve Bank may, by regulations prohibit, restrict or regulate the following, — a) transfer or issue of any foreign security by a person resident in India; b) transfer or issue of any security by a person resident outside India; c) transfer or issue of any security or foreign security by any branch, office or agency in India of a person resident outside India; d) any borrowing or lending in foreign exchange in whatever form or by whatever name called; e) any borrowing or lending in rupees in whatever form or by whatever name called between a person resident in India and a person resident outside India; f) deposits between persons resident in India and persons resident outside India; g) export, import or holding of currency or currency notes; h) transfer of immovable property outside India, other than a lease not exceeding five years, by a person resident in India; i) acquisition or transfer of immovable property in India, other than a lease not exceeding five years, by a person resident outside India; j) giving of a guarantee or surety in respect of any debt, obligation or other liability incurred, — i. by a person resident in India and owed to a person resident outside India; or ii. by a person resident outside India” 48

Section 2(j) – Definition - Current Account Transaction Section 2(j) • “current account transaction" means a transaction other than a capital account transaction and without prejudice to the generality of the foregoing such transaction includes, — i. payments due in connection with foreign trade, other current business, services, and short-term banking and credit facilities in the ordinary course of business, ii. payments due as interest on loans and as net income from investments, iii. remittances for living expenses of parents, spouse and children residing abroad, and iv. expenses in connection with foreign travel, education and medical care of parents, spouse and children; 49