Investing Beyond Borders: Understanding India’s ODI Regulations
As Indian businesses increasingly look beyond domestic markets, overseas expansion has become an important part of corporate growth. However, investing outside India is not merely a commercial decision. It also involves compliance with India’s foreign exchange regulations.
The legal framework governing Overseas Direct Investment (ODI) in India is primarily set out under the Foreign Exchange Management Act, 1999 (FEMA), Foreign Exchange Management (Overseas Investment) Rules, 2022, Foreign Exchange Management (Overseas Investment) Regulations, 2022, RBI Master Direction – Overseas Investment
Understanding ODI
The first step for an ODI investment is to check whether the proposed transaction qualifies as ODI. Broadly ODI includes the acquisition of unlisted equity capital of a foreign entity, subscription to the Memorandum of Association of a foreign entity, and investment of 10% or more of the paid-up equity capital of a listed foreign entity. Even an investment below 10% can qualify as ODI if it gives the investor control over the foreign entity.
An important principle is “once ODI, always ODI.” Once an investment is classified as ODI, it continues to be treated as ODI even if the investor’s shareholding subsequently falls below 10% or the investor loses control.
Routes for Overseas Investment
Under India’s foreign exchange framework, investments are broadly permitted through two routes: the Automatic Route and the Government (Approval) Route. These routes determine whether an investor can proceed with a transaction without obtaining prior regulatory approval or whether approval is required before the investment is made.
For Overseas Direct Investment (ODI), the Automatic Route generally permits Indian residents and entities to invest in foreign entities engaged in bona fide business activities, subject to the conditions and limits prescribed under the Overseas Investment framework. Such investments can generally be made without obtaining prior approval from the RBI or the Central Government. The financial commitment of an Indian entity is ordinarily subject to the overall limit of 400% of its net worth, subject to applicable exclusions and exceptions.
The Government or Approval Route, on the other hand, applies where the proposed overseas investment does not fall within the scope of the general permission available under the Automatic Route or where specific approval is prescribed. In such cases, the investor is required to submit an application through its Authorised Dealer (AD) bank, which is processed by the appropriate regulatory authority.
Prior approval may be required, among other circumstances, for certain high-value financial commitments, investments involving specified jurisdictions, overseas investment by certain trusts or societies, and transactions involving strategic sectors where the prescribed limits or conditions are exceeded.
The distinction between these two routes is therefore important for an Indian entity planning an overseas investment, as it determines the approvals, documentation and regulatory process that must be completed before the transaction can proceed.
Where can an Indian company invest?
An overseas investment cannot be made in just any business. The foreign entity should generally be engaged in a bona fide business activity in simple terms, a legitimate activity that is permitted under Indian law as well as the law of the country where the foreign entity operates.
Indian companies may make investments directly or through structures such as Special Purpose Vehicles (SPVs) and Step-Down Subsidiaries (SDSs), subject to the applicable conditions.
The foreign entity is ordinarily required to have limited liability. However, certain relaxations are available where the investment is made in a strategic sector.
The 400% financial commitment limit
One of the most important aspects of ODI compliance is the limit on the amount an Indian entity can commit overseas. Generally, the total financial commitment of an Indian entity across all foreign entities cannot exceed 400% of its net worth, based on its last audited balance sheet.
Certain transactions, such as the capitalisation of retained earnings, are excluded from the calculation. Special exemptions are also available in specified circumstances for certain public sector undertakings investing in strategic sectors.
When is an NOC required?
Another important compliance requirement applies to investors facing certain financial or regulatory issues.
A prior No Objection Certificate (NOC) is required where the investor has an account classified as a Non-Performing Asset (NPA), has been classified as a wilful defaulter by a bank, or is under investigation by a financial sector regulator or specified investigative agency.
The framework also provides that where the relevant authority does not communicate its decision within the prescribed 60-day period, the NOC may be deemed to have been granted.
Valuation and pricing
Another important aspect is the pricing of the overseas transaction. The issue, acquisition or transfer of equity capital must generally be undertaken on an arm’s length basis and using an internationally accepted valuation methodology.
The Authorised Dealer (AD) bank plays an important role in examining the transaction and verifying its bona fide nature. Depending on the transaction, an appropriate valuation report may therefore be required.
Compliance after the investment
One of the most overlooked aspects of ODI is that compliance does not end once the money is remitted.
The investor must obtain a Unique Identification Number (UIN) through its designated AD bank before the first outward remittance or acquisition of equity capital, whichever is earlier.
The investor must also submit evidence of the investment, such as relevant share certificates or statutory documents, within the prescribed period. Further, applicable investors must comply with annual reporting requirements such as the Annual Performance Report (APR) and Foreign Liabilities and Assets (FLA) Return.
Failure to comply with these requirements can have practical consequences. In certain cases, an investor may be prevented from making further financial commitments or transferring its overseas investment until the reporting delay is regularised. Delays may also attract a Late Submission Fee (LSF).
What investments are prohibited?
The ODI framework also places clear restrictions on certain activities. Indian residents cannot generally make ODI in foreign entities engaged in gambling, prohibited real estate activities, or certain transactions involving financial products linked to the Indian Rupee, unless specifically permitted.
There are also restrictions on creating excessively layered corporate structures, including the general two-layer subsidiary limitation.
