Deconstructing Press Note 3 (2020 Series) of the FDI Policy: Security, Clarity and Exiguity

The Government of India (“GOI”) revised its foreign direct investment (FDI) policy vis-à-vis its neighbours,
primarily China, to prevent opportunistic takeovers of Indian companies during the global pandemic, vide
Press Note No. 3 (2020 Series) dated April 17, 2020 (“PN3”) which was reiterated in the Consolidated FDI
Policy, 2020, effective from October 15, 2020 (“FDI Policy”).

As per the FDI Policy, FDI may be received either under automatic route or approval/government route,
depending upon the sector in which the entity receiving FDI is engaged. Prior to PN3, only FDI proposals
from Bangladesh and Pakistan required the approval of GOI. The sweeping change made by the GOI
mandates that FDI would be allowed from all neighbouring countries to India (with whom India shares a
land border) only after obtaining approval of the GOI, even in sectors where “automatic” clearances were
previously permitted. PN3 also extends to those investors from countries that do not share a land border
with India if such investors have direct or indirect beneficial owners resident in a country that shares a
land border with India. Additionally, investment by citizens of Pakistan and entities incorporated in
Pakistan in defence, space, atomic energy and other sectors/activities prohibited for foreign investment
remains completely prohibited as earlier. While PN3 does not attack existing FDI, any changes in the
ownership of the existing FDI – irrespective of quantum – would also require clearance from the GOI.

Rule 6(a) of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”) was
amended to give effect to PN3. PN3 and the amendment to the NDI Rules reflect that investments from
any country sharing a land border with India or beneficial owner of any such entity situated in such
countries have to obtain prior approval of GOI for FDI.

In this article, we attempt to deconstruct and critically analyse PN3, the consequent amendment to the
NDI Rules and the process for filing an FDI approval application in this respect. Given below is an extract
of the operative portion of PN3:

3.1.1(a) A non-resident entity can invest in India, subject to the FDI Policy except in those
sectors/activities which are prohibited. However, an entity of a country, which shares land border
with India or where the beneficial owner of an investment into India is situated in or is a citizen
of any such country, can invest only under the Government route. Further, a citizen of Pakistan
or an entity incorporated in Pakistan can invest, only under the Government route, in
sectors/activities other than defence, space, atomic energy and sectors/activities prohibited for
foreign investment.

3.1.1(b) In the event of the transfer of ownership of any existing or future FDI in an entity in India,
directly or indirectly, resulting in the beneficial ownership falling within the restriction/purview
of para 3.1.1(a), such subsequent change in beneficial ownership will also require Government
approval. (emphasis provided)

Transfer

The term ‘transfer’ has not been defined specifically for the purpose of PN3. This being the case, one has
to refer to the definition for the term provided under Section 2(ze) of the Foreign Exchange Management
Act (“FEMA”), which defines a transfer to means sale, purchase, exchange, mortgage, pledge, gift, loan or

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any other form of transfer of right, title, possession or lien. On applying this definition for ‘transfer’ to the
context in which the term is employed in PN3, not only a sale of shares but also a pledge of shares resulting
in a change in beneficial ownership would require GOI approval.

Another pertinent point to note is that indirect transfer of ownership is also covered by PN3. For example,
if ‘A’ is a foreign entity (not being a resident of the land bordering country) that owns more than 51% of
the shares in an Indian entity, but more than 50% of shares in A are being sold to ‘B’, a foreign individual
(who is a resident or citizen of a land bordering country) or a foreign entity (which is a resident of a land
bordering country), there would be an indirect transfer of ownership of the existing FDI in Indian entity
from A to B.

Beneficial Ownership

The NDI rules include references to beneficial ownership but do not define beneficial ownership.
However, the Companies Act, 2013, under the Companies (Significant Beneficial Owners) Rules 2018
(“Companies Rules”) prescribes a threshold of 10% ownership for determining beneficial holding, and the
Prevention of Money Laundering Act, 2002 (PMLA), under Prevention of Money-laundering (Maintenance
of Records) Rules, 2005 prescribes a threshold of 25% ownership for determining the beneficial holding
for companies and a threshold of 15% for other unincorporated entities.

Since NDI rules do not prescribe any threshold for determining beneficial ownership, even nominal or
minuscule ownership held beneficially by an entity in, or a citizen of a country that shares a land border
with India, could be forced to fall within the approval route. While the GOI has clarified that beneficial
ownership is to be interpreted in line with the PMLA in the context of public procurement, clarity in
respect of PN3, is still awaited.

Change in Beneficial Ownership

With respect to the construction of language in 3.1.1(b), there is scope for more than one interpretation.
There is no use of the words ‘change in beneficial ownership’ in the first part of 3.1.1(b). However, the
second part of 3.1.1(b) uses the words ‘such subsequent change in beneficial ownership’. Generally, ‘such’
would be referring to terms used earlier in the provision and in this case being the ‘result of the beneficial
owner being situated in or being a citizen of a country, which shares a land border with India’. There is no
mention of ‘change’ in beneficial ownership earlier in the provision.

On the one hand, it can be interpreted that a GOI approval will be required only if there is a change in
beneficial ownership resulting in the beneficial owner being a resident or citizen of a land bordering
country, pursuant to the transfer of ownership of existing FDI or future FDI. On the other hand, it can be
interpreted that if the beneficial owner is situated in or a citizen of a country sharing a land border with
India, then such transfer of ownership will require GOI approval, even in a case where there is no ‘change’
in beneficial ownership because of such transfer. It would be safer to adopt the latter interpretation
considering the intention of GOI to construct a strict investment regime with respect to land bordering
countries, driven by national security concerns.

Process of making application for FDI

Applications for FDI seeking prior approval of the GOI that have to be addressed by the concerned
Ministries/Departments of the GOI (“Competent Authority”) within 8-10 weeks after receiving an

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application as per the Standard Operating Procedure dated November 09, 2020, may practically take
anywhere between 6-10 months for obtaining approval, depending upon the Competent Authority
processing the application, through a single integrated window i.e. Foreign Investment Facilitation Portal
(“FIFP”). The FIFP is administered by the Department of Promotion of Industry and Internal Trade, Ministry
of Commerce and Industry, Government of India (“DPIIT”). DPIIT processes the applications received
under the approval route and coordinates with the Competent Authority that has the primary
responsibility for the relevant sector to jointly review such applications. Pursuant to PN3, transactions
falling under the scope of PN3 (though it may not involve investment in sensitive sectors) have been
grouped along with investment in sensitive sectors like civil aviation, defence, telecom, private security,
information and broadcasting in being subject to an additional layer of security clearance from the
Ministry of Home Affairs (MHA), that have to be addressed within 2 weeks of clearance from the
Competent Authority processing the application, which may take additional 1-2 months.

Amendments to FIFP Website vis-à-vis PN3

Pursuant to PN3, the FIFP website has been slightly modified to include at the threshold itself, a qualifier
that segregates applications according to whether the application falls within the ambit of PN3.

Upon selecting “Yes” in the qualifier as described above, the application form also mandates that the
information pertaining to the Beneficial Owner be disclosed in this regard.

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Further, the application form also mandatorily requires that the details of ‘Significant Beneficial Owners’
of the Investor Company and the Investee Company be provided.

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Apart from the above, there are no other changes effected to the FIFP vis-à-vis PN3. The changes effected
to the FIFP vis-à-vis PN3 as of now may not be sufficient considering there may be proposals wherein the
applicant may not be the investee or direct investor as such and where the subject of the proposal is the
transfer in ownership (direct or indirect) of existing FDI.

Conclusion

PN3 was released by the GOI and brought into force quickly soon after the pandemic hit India triggered
by national security reasons. However, when deconstructed, there appears to be much scope for
clarification with respect to the meanings that would have to be attributed to ‘transfer’, ‘beneficial
ownership’ and ‘change in beneficial ownership’ along with the need for the FIFP to bring about a
comprehensive updation in the application filing process for various type of transactions falling under the
scope of PN3 to overcome the exiguity the current FIFP showcases.

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