The new PN3 norms and lack of clarity on what constitutes beneficial ownership are the primary reasons for the decline in investments from China and Hong Kong, experts believe. PN3 has especially dealt a major blow to start-ups by depriving them of funds from cash-rich China/Hong Kong-based investors.
The PN3 guidelines state that an entity of a country that shares a land border with India can invest only under the government route. The guidelines also included the beneficial owner (BO) of an investment into India who is located in any such country and also its citizens. The note, however, does not define the term “beneficial owner”. Authorised dealer banks are applying different thresholds for determining BO for FDI
coming into India — ranging from 25 per cent to 10 per cent, to even 1 per cent.
“The language of the regulation is very broad and it is silent on what constitutes beneficial ownership. So, there is very little flexibility for parties looking at alternative structures that are permissible under the FDI
route. This leaves very little leeway for any form of investments from these jurisdictions,” said Vivek Sriram, partner, Khaitan & Co.
Investments that have Chinese, Taiwanese, Hong Kong, and Macau beneficial ownership now require prior government nod, irrespective of the percentage or quantum of investment. All applications from these regions are also required to undergo a mandatory security clearance by the Ministry of Home Affairs.
In the past few years, sectors — such as technology and internet businesses — have been the chief beneficiaries of PE/VC investments
from China. Sectors, such as financials and pharma, have also seen significant Chinese interest.
“China is a key contributor to India FDI and industry players are hopeful that the government will soon clarify on the threshold for determining beneficial ownership. That will give a little more clarity for Chinese entities to structure their investments,” Sriram said. Before the introduction of PN3, only FDI from entities which were based in Pakistan or Bangladesh required prior government approval.