RBI, Sebi unveil rules for converting excess investment by FPIs into FDI

FPIs will need to seek government approval before reclassification in applicable cases

Financial regulators, the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi), issued new guidelines on Monday directing foreign portfolio investors (FPIs) to secure government approval and concurrence from investee companies if they acquire equity stakes that exceed prescribed limits.

 

The regulators introduced an operational framework for reclassification of FPI investments to foreign direct investments (FDI) should holdings surpass the stipulated thresholds. This framework outlines steps to follow if such a breach occurs.

 

Under the Foreign Exchange Management Act (Fema), FPIs are allowed to hold up to 10 per cent of a company’s total paid-up equity capital. Any FPI breaching this limit now has the option to divest holdings or reclassify such holdings as FDI, subject to several conditions. The new rules provide a window of five days from the settlement of trades to do the same.

 

Once reclassified, the entire investment of an FPI will be deemed FDI and remain so, even if holdings fall below 10 per cent at a later date, according to the framework.

 

Experts said the notification clarifies that government approval is a must before making any additional investment beyond the prescribed limit. Additionally, FPIs must state their intent to reclassify the investment as FDI.

 

The operational framework will now enable increased investment by FPIs in Indian companies beyond the 10 per cent limit. While no corresponding clarifications have been issued by the Central Board of Direct Taxes (CBDT), one could argue that the investment should be considered as an FDI even for tax purposes, which means that tax deducted at source (TDS) would be applicable on the sale of investments after reclassification,” said Rajesh Gandhi, partner, Deloitte.

 

However, the facility to reclassify from FPI investment to FDI is restricted in certain prohibited sectors. “Necessary approvals from the government, as applicable, including approvals required in the case of investment from land-bordering countries, must ensure that the acquisition beyond the prescribed limit is made in accordance with the provisions applicable for FDI. This means that the investment should adhere to the entry route, sectoral caps, investment limits, pricing guidelines, and other attendant conditions for FDI under Schedule I to the Rules,” said the circular.

 

The RBI and Sebi have separately shared the procedure to be followed for reporting such breaches and reclassification by FPIs and custodians. “After ensuring that the reporting for reclassification is complete in all aspects, the custodian shall unfreeze the equity instruments and process the request. The date of the investment causing the breach in such cases shall be considered the date of reclassification,” said the circular.

 

Dubbing the new framework a “welcome move” that would foster a “conducive environment for foreign investment”, Sunil Kumar, tax partner at EY India, noted: “This reclassification is subject to adherence to FDI norms, including sectoral caps, seeking Indian Investee Company’s concurrence and the necessity of obtaining government approval, where applicable.”

 

This initiative will offer greater flexibility to FPI to transit to a more strategic and enduring engagement with Indian companies,” Kumar added.

 

With inputs from Asit Ranjan Mishra