Challenges faced by Indian companies, due to amendment in the foreign investment rules

Source: The post challenges faced by Indian companies, due to amendment in the foreign investment rules has been created, based on the article “India growth story has a ‘beneficial ownership’ hurdle” published in “The Hindu” on 15th June 2024

UPSC Syllabus Topic: GS Paper 2 – Governance- Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

Context: The article discusses challenges faced by Indian companies, especially startups, due to a 2019 amendment in the foreign investment rules which require (PN3 Requirement) government approval for investments from countries bordering India.

For details information on What is PN3 guidelines read this article here

What are the Challenges with the Current Foreign Investment Rules?

1.Unclear Definition: The term ‘beneficial owner’ is not defined, leading to confusion. This has led to conservative interpretations by the Reserve Bank of India (RBI).

2.Impact on FOCCs: FOCCs face restrictions similar to those imposed on non-residents. This has caused issues with downstream investments, as seen in 2023 when many FOCCs received notices from the RBI regarding their compliance.

3.Approval Delays: The government approval process is slow and has a high rejection rate. For example, proposals worth ₹50,000 crore are pending, withdrawn, or rejected, with 201 applications rejected in the past three years.

4.High Penalties: Fines for non-compliance can be up to three times the investment, risking insolvency for startups. These companies often receive investments beyond their revenue, making fines particularly damaging.

What should be done?

1. Indemnity Challenge: Indian companies should require foreign investors to provide representations backed by indemnities about their compliance with the PN3 Requirement. This could reduce the risk for Indian companies but may discourage foreign investment due to potential liabilities.
2. Beneficial Owners: Clearly define ‘beneficial owners’ to include specific ownership thresholds, ranging from 10% to 25%. Include control tests that consider rights overboard meetings, veto powers, and operational matters. For example, Foreign Owned or Controlled Companies (FOCCs) faced RBI notices about investments due to ambiguous definitions.
3. Consultation Mechanism: Introduce a time-bound consultation process with regulatory authorities to clarify control-conferring clauses in investment agreements. This mechanism would help resolve ambiguities like Indian competition law. For Example, Industry practices and legal advice on beneficial ownership have become conservative due to the RBI’s strict interpretations.

Question for practice:

Discuss the potential solutions to mitigate challenges faced by Indian companies under the 2020 foreign investment rules.