India’s Growth and the ‘Beneficial Ownership’ Hurdle

India’s Growth and the ‘Beneficial Ownership’ Hurdle

Sub: Economy

Sec: External Sector

Overview

India aims to become a $5 trillion economy by 2025-26, and foreign investments are critical in achieving this goal. However, regulatory challenges, particularly regarding the ‘beneficial ownership’ clause in the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (FEMA NDI), are creating obstacles.

FEMA NDI Amendment: Press Note 3 of 2020

• Objective: Introduced to prevent opportunistic takeovers by entities from countries sharing land borders with India during the COVID-19 pandemic.
• Requirement: Investments from these countries, or where the beneficial owner is from these countries, need prior government approval.

Challenges Posed

• Lack of Definition: The term ‘beneficial owner’ is not clearly defined, leading to interpretation issues.
• RBI’s Conservative Stance: Since late 2023, the RBI has adopted a stricter interpretation, impacting Foreign Owned or Controlled Companies (FOCCs).
• Regulatory Uncertainty: Lack of clarity on beneficial ownership thresholds creates compliance risks and hesitancy among foreign investors.
• Time-Consuming Approvals: The approval process is slow and has a high rejection rate, with significant investments pending or rejected.
• Penalties: Severe penalties for non-compliance, potentially up to three times the investment received, pose existential threats to companies.

Proposed Solutions

• Define ‘Beneficial Owner’:
  • Ownership Thresholds: Establish clear thresholds, such as 10% (as per Indian company law) to 25% (recommended by the Financial Action Task Force).
  • Control Rights: Specify control-conferring rights, excluding typical investor protection rights like veto powers over mergers.
• Consultation Mechanism:
  • Introduce a time-bound consultation process with regulatory authorities to determine whether specific clauses confer control.
• Indemnity Provisions:
  • Require foreign investors to provide representations and indemnities, although this may deter some investments.

Implications for India’s Growth

• Enhanced Clarity: Clear definitions and guidelines can reduce compliance risks and attract more foreign investments.
• Increased Efficiency: A streamlined approval process can facilitate quicker investments, vital for start-ups and small enterprises.
• Economic Stability: Better regulatory frameworks can enhance investor confidence, contributing to economic stability and growth.

Conclusion

Addressing the ambiguities in the FEMA NDI regulations, particularly concerning beneficial ownership, is crucial for India to attract and sustain foreign investments.

Clear definitions, efficient processes, and reasonable compliance requirements will help India move closer to its $5 trillion economy goal while safeguarding its economic interests.