From ‘Direct’ to ‘Portfolio’- India opens a new way for Foreign Investors

India allows 100 per cent FDI in business-to-business (B2B) e-commerce through automatic route, but not in B2C companies selling directly to consumers.

With the introduction of a composite cap in foreign investment policy, portfolio investors can now park up to 49 per cent in multi-brand retail and online wholesale companies without government approval. Promising a simpler foreign investment regime, the government has introduced a concept of composite cap for all kinds of overseas inflows, including through Foreign Direct Investment (FDI), Foreign Institutional Investor (FII) and Non Resident Indians (NRI) routes.

Previously, portfolio investment was governed under different laws i.e. the SEBI (Foreign Institutional Investors) Regulations, 1995 (“FII Regulations”) for FIIs and their sub-accounts and SEBI circulars dated August 09, 2011 and January 13, 2012 governing QFIs, which are now repealed under the SEBI (Foreign Portfolio Investors) Regulations, 2014 (“FPI Regulations”) that govern FPIs. Essentially, foreign portfolio investment entails buying of securities, traded in another country, which are highly liquid in nature and, therefore, allow investors to make “quick money” through their frequent buying and selling. Such securities may include instruments like stocks and bonds, and unlike shares, they do not give managerial control to the investor in a company. To govern FPIs, SEBI introduced the FPI Regulations by a notification dated January 7, 2014.

Under FPI Regulations, the following three categories of FPIs have been created on the basis of associated risks -(a) Category I includes foreign investors related with the government such as central banks, government agencies, sovereign wealth funds; (b) Category II includes regulated entities like banks, assets management companies, investment managers etc. and broad-based funds, which may be regulated such as mutual funds, investment trusts etc. or non-regulated; and (c) Category III includes investors, which are not covered under categories I and II. FPIs registration is carried out by SEBI designated depository participants (“DDPs”) on permanent basis unless suspended or cancelled.

FPIs can invest in instruments such as listed or to be listed shares, government securities, units of mutual funds or collective investment schemes, treasury bills, corporate debt and Indian depository receipts. For foreign corporate and foreign individuals, the investment limit now stands increased from 5 to 10% of a company’s total issued capital. Also, investment in equity shares which was previously permissible up to 10% of a company’s total issued capital is now restricted to below 10%. FPI Regulations prohibit investments in unlisted equity shares of a company.Investment process for QFIs is easier under the FPI regulations as they can now, while operating as FPIs, issue investment instructions directly to their stockbrokers instead of doing it through qualified depository participants. They may also now invest in additional instruments such as derivatives. Now, only FPIs, which are regulated and also fall under Category I or II can issue Offshore Derivative Instruments (“ODIs”). ODIs are significant because they allow foreign investors, such as high net worth individuals and hedge funds based overseas, to invest in the Indian market without being registered with the SEBI.

Introduction of composite cap has opened the gates for portfolio investors (foreign institutional investors, foreign portfolio investors and qualified foreign investors) to pick up to 49 per cent in the sector without government’s nod.

However, there are a few exceptions: foreign investment above 49 percent in the retail sector will require approvals. And the changes to the composite caps do not include the banking and defence sectors, which have limits of 74 percent and 49 percent respectively. There will likely be further increased cap limits for some sectors, but those numbers are still on the table.

As for the taxation, the Central Board of Direct Taxes (“CBDT”) came out with a notification dated January 22, 2014 deeming FPIs registered under the FPI Regulations as FIIs for taxation purposes. The notification indicates that all investor classes forming the FPIs would be taxed similarly to FIIs.

Prepared By:

Mohita Jindal

Associate Lawyer & Company Secretary

SMA Legal

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