India may set 10% beneficial ownership cap for FDI flowing from 7 countries

The government wants to keep the lowest threshold possible since it does not want to put existing FDI inflows from China under undue pressure
India is likely to set a 10 per cent ‘beneficial ownership’ cap for foreign direct investment (FDI) flowing from seven bordering countries including China. Beyond this, a government nod would be required for any investing entity or individual from these nations.

The 10 per cent threshold is in line with the rules for significant beneficial owners (SBOs) under the Companies Act, 2013. According to these norms, companies must take necessary steps to identify such owners if they don’t reveal themselves. SBOs, under this definition, are mandatorily required to make elaborate declarations regarding their ownership, shareholding structure and so on. This helps the government identify benami transactions and prevent money laundering activities.

The government wants to keep the lowest threshold possible since it does not want to put existing FDI inflows from China under undue pressure, said a senior government official. A comprehensive notification on this is expected soon, after considering the inputs from all related departments and ministries, the official said. 

The move will help the government protect domestic firms from hostile takeovers by opportunistic foreign firms, especially from these countries. At the same time, it will provide some clarity around how foreign investors should interpret the new FDI rules announced in April, mandating prior government approval for investments flowing in from countries sharing a land border with India.

Sources say that after the announcement, several stakeholders, lawyers and custodians approached the government seeking clarity. That prompted the government to review the ownership definition. At present, there is no legal definition or norms about beneficial ownership under the FDI policy, thereby putting big-ticket private equity funds and venture capital firms in a spot.

The Department for Promotion of Industry and Internal Trade (DPIIT) is in favour of adopting the existing domestic definition of ‘beneficial ownership’, which pegs it at 10 per cent of company shares, for purposes of foreign investment, said an official in the know. However, the final decision would be taken after evaluating inputs from home and finance ministries.

Sources stressed the coverage area of the new definition will be global, covering inflows from all nations. However, latest rules requiring mandatory government approval for transfer of ownership of existing or future FDI, will kick into effect only if citizens or entities in the seven neighbouring nations are found to be holding directly or indirectly 10 per cent shares or voting rights in an Indian firm.

This is particularly important as Chinese companies are alleged to often have opaque beneficial structures. 

Significant Chinese investment has come into Indian start-ups and the exact holding pattern of most such companies remains unknown to the government. According to experts, apart from continuing disclosures of their respective SBOs by listed companies, no other legislation currently uses this definition. This would be the second such legislation. "The Companies Act standard focuses on individuals — alone or acting together — who directly or indirectly hold 10 per cent or more. This will help resolve matters for state-owned corporations and other similar companies where eventually, there are no individuals at the top," said Sameer Sah, Partner, Khaitan & Co. 

 

 
Taking reference from Companies Act definition will also give a certainty to PE funds and the like whether they should be going all the way up to LPs or not. For funds, there is a separate pooled investment vehicle regime under SBO declarations that diverts to the investment manager and the general partner, and, hence, should ordinarily not go back to the limited partners.

Shah further explained that a concern has been raised that the Press Note 3 type scenario would impact global deals where India is only a small element of the overall transaction. Most global corporations have clear and identified streams of beneficial ownership compliance, and would be able to relatively quickly take a view on the SBO requirements, he said. “As a result, this will give a lot of comfort to purchasers in such transactions as well." 

The Companies (Significant Beneficial Owners) Rules, 2018, peg beneficial ownership at 10 per cent. But the PMLA defines the beneficial owner as a natural person holding in excess of the threshold, 15 per cent or 25 per cent, as applicable' according to a circular issued by Securities and Exchange Board of India back in June, 2016. However, the Reserve Bank chalks up 'controlling ownership interest' to having more than 25 per cent of a company's shares. 


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