Setting up a foreign entity? Did you consider these Indian compliances!

Introduction

As per the Foreign Exchange Management (Overseas Investment) Rules 2022 (“OI Rules”) ‘Overseas Direct Investment’ or ‘ODI’ means (a) investment by way of acquisition of unlisted equity capital of a foreign entity;  or (b) subscription as a part of the memorandum of association of a foreign entity; or (c) investment in ten per cent, or more of the paid-up equity capital of a listed foreign entity; or (d)  investment with control where investment is less than ten per cent of the paid-up equity capital of a listed foreign entity.

Regulation 9(2) of the Foreign Exchange Management (Overseas Investment) Regulations, 2022 (“OI Regulations”), provides that a resident Indian should obtain a Unique Identification Number (‘UIN’) from RBI (through its AD Bank) for the foreign entity in which ODI is intended to be made before sending outward remittance or acquisition of equity capital in the foreign entity whichever is earlier. Correspondingly, Clause 16 (3) of Foreign Exchange Management (Overseas Investment) Directions, 2022 (“Master Directions”) provides that Form FC should be submitted for obtaining UIN on or before making initial ODI.

Thus, Form FC should be submitted before even subscribing to the memorandum of association (“MOA”) of the foreign entity since the OI Regulations require UIN to be obtained before sending outward remittance or acquisition of equity capital including by way of subscription to the MOA.

The previous regime

Contrary to the above, the previous regime provided[1] that for the purposes of making investment / undertaking financial commitment in overseas Joint Venture (JV)/ Wholly Owned Subsidiary (WOS) Abroad, the Indian Party should approach an AD Category 1 Bank with an application in Form ODI along with prescribed enclosure / documents for effecting such remittances. Thus, Form ODI was filed post incorporation of the foreign entity even though “Direct Investment outside India” under the old regime was defined to mean “investment by way of contribution to the capital or subscription to the Memorandum of Association of a foreign entity or by way of purchase of existing shares of a foreign entity either by market purchase or private placement or through stock exchange but does not include portfolio investment”. Thus, Indian parties would incorporate the company followed by filing of Form ODI with its AD Bank.

Current Regime

The above process of setting up the foreign entity and then filing Form FC was also being followed under the current regime. However, there seems to have been clarity brought about in this process practically in line with the OI Rules and OI Regulations. Accordingly, an Indian Party which has already set up the foreign entity outside India and is thereafter approaching its AD Bank to file Form FC should be considered as a case of delay of reporting as Regulation 9 of the OI Regulations which requires Form FC to be filed before sending outward remittance or acquisition of equity capital in the foreign entity, whichever is earlier. In this context, Regulation 11 of the OI Regulations provide that a person resident in India who does not make any filing within the time specified under OI Regulations should be required to make the filing along with Late Submission Fee (LSF) within the prescribed timelines and at the rates and in the manner which has been specified.  The option of LSF has been made available up to 3 (three) years from the due date of reporting/submission under OI Regulations.

Another common issue that is seen in almost all cases is with respect to issuance of shares of the newly incorporated foreign entity to the Indian shareholders. Typically, shares of the foreign entity are issued to the Indian shareholders immediately after the incorporation of the foreign entity whether or not subscription money for the shares has been remitted from India. In order to be compliant with the OI Regulations and OI Rules, it is advisable that either in the MOA of the foreign entity, it is stated that the subscription money for issuance of shares will be paid on a later date, or a deferred payment agreement is signed between the Indian party and the foreign entity stating that the subscription money for issue of shares will be paid on a definite later date. Regulation 7 of the OI Regulations provides for acquisition or transfer of shares by way of deferred payment and state that the payment of amount of consideration for the equity capital acquired may be deferred for such definite period from the date of the agreement as provided in such agreement subject to the following terms and conditions, namely:

a) the foreign securities equivalent to the amount of total consideration shall be transferred or issued, as the case may be, upfront by the seller to the buyer;

b) the full consideration finally paid shall be compliant with the applicable pricing guidelines. Interestingly in practice, for new incorporated entities, a valuation report is not required by the AD Banks since the investment is undertaken at face value.

Conclusion

It is very common for Indians to set up companies outside India without making any filings. While the filings could have been done after the incorporation till very recently, the recent change in approach should be considered by anyone setting up an entity outside India – it should be noted that this approach is in line with the OI Regulations and the OI Rules.

To summarize, if an Indian party wants to set up a foreign entity, it should at the very outset file Form FC with the relevant details and obtain the UIN. This should be considered as a non-fund based commitment and relevant information in the Form FC should be provided accordingly. Pursuant to receiving the UIN, the Indian party should subscribe to the MOA of the foreign entity and enter into a deferred payment agreement for remittance towards the first subscription of shares. Once the bank account is opened (which may take 3 – 6 months), the Indian party should file Form FC with the issued UIN and remit the share subscription money to the foreign entity and submit the share certificates within 6 (six) months to the AD Bank as evidence of such investment in the foreign entity.

For those who have set up entities outside India without form filing, a late submission fee may be payable and in case shares have also been issued without remittance of the subscription money and there is no deferred payment agreement in place, permission may be required from RBI before remittance can be made.

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[1] Master Direction on Direct Investment by Residents in Joint Venture (JV)/ Wholly Owned Subsidiary (WOS) Abroad, 2016