Presentation on Foreign Direct Investment into India in the Financial Services Sector - Rajesh Kapadia - Chartered Accountant April 4, 2008 Zug ...
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Presentation on Foreign Direct
Investment into India in the Financial
Services Sector
Rajesh Kapadia – Chartered Accountant
April 4, 2008
Zug, Switzerland
G. M. KAP ADI A & CO.
CHAR TER ED ACCOU N TAN TSGenesis of Exchange Control Regulations
Defence of India Act, 1939
Foreign Exchange Regulation Act, 1947
Foreign Exchange Regulation Act, 1973
• Substantially modified
• Draconian Provisions
• Relaxation of some stringent provisions -
1993
• Repealed – May 31, 2000 – Sunset clause
May 31, 2002
Foreign Exchange Management Act, 1999
• Effective June 1, 2000
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CHAR TER ED ACCOU N TAN TSGenesis of Exchange Control Regulations contd…
• Primary Purpose:
– Conserve foreign exchange
– Protect Indian industry and economy
• Relaxations:
– Fully convertible on current account
– Capital convertibility norms liberalised
• Way Forward:
– Complete deregulation
– Full capital account convertibility
– Removal of sectoral caps
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CHAR TER ED ACCOU N TAN TSProvisions under FEMA
• Capital Account Transactions governed by Section 6 of FEMA
• Capital Account transactions defined in Section 2 (e) of FEMA
• RBI empowered to frame regulations and make rules etc. in consultation with the
Central Government
• Foreign Exchange Management (Permissible Capital Account Transactions)
Regulations, 2000 (Capital Account Regulations)
• Schedule II of Capital Account Regulations specifies classes of permissible capital
account transactions for non-residents
• Foreign Exchange Management (Transfer or Issue of Security by a Person Resident
outside India) Regulations, 2000 prescribe conditions for investments by persons
residents outside India (TIS Regulations)
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CHAR TER ED ACCOU N TAN TSClassification of Foreign Investment – Schematic
Representation
Foreign
Investments
Foreign Foreign Foreign Other Investments
Direct Portfolio Venture Investments on non-
Investments Investments Capital repatriable
Investments basis
Automatic
FIIs
Route
SEBI Regd. G-Sec;
NRI/ PIOs
FVCI NCDs etc.
Approval
NRIs/ PIOs
Route
FIIs
VCF/
IVCUs NRI/ PIOs
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CHAR TER ED ACCOU N TAN TSTIS Regulations
• Foreign Investment in Indian companies carrying on:
– Activities falling in Annexure “A” – Part A - FDI permitted with prior approval of
the Government of India
– Activities falling in Annexure “A” –Part B – No FDI is permitted
– Activities specified in Annexure “B” – FDI permitted upto the sectoral caps under
automatic route of RBI.
• Provided that:
– activity of the company does not require industrial license
– shares are not issued with a view to acquiring existing shares of an Indian
company [Issue of Operating cum holding company Press Note 9
compliance]
• Issue of optionally convertible preference shares and debenture not eligible for FDI
[Circular No 73 & 74 of June 8, 2007]
• Indian company also permitted to issue shares against royalty/ lumpsum payment
due and against outstanding External commercial Borrowings
• Issue and transfer of shares subject to pricing guidelines
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CHAR TER ED ACCOU N TAN TSFDI in Banking/ Financial Services
• Currently, the following banking/ financial services activities are open for foreign
investment:
– Banking
– Insurance
– Asset Management (covered under other financial services)
– Asset Reconstruction
– Credit Information Companies
– Other Financial Services
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CHAR TER ED ACCOU N TAN TSBanking
• FDI limit in Private Sector Banks is raised to 74% under the automatic route including
investment by Foreign Institutional Investors (FIIs).
• The aggregate foreign investment in a private bank from all sources will be allowed
up to a maximum of 74% of the paid up capital or the Bank. At all times at least 26%
of the paid up capital will have to be held by residents.
• Foreign banks may also set-up wholly owned subsidiaries (WOS) in India subject to
RBI regulations. However, after completion of minimum period of operation the
holding of the Foreign Parent in the WOS would need to be brought down to 74% and
resident shareholding of at least 26% would need to be maintained
• Foreign banks may also operate in India through branches set up in accordance with
the guidelines of the RBI
• The stipulations as above will be applicable to all investments in existing private
sector banks also.
• Applications for FDI in private banks having joint venture/ subsidiary in insurance
sector may be addressed to the RBI for consideration in consultation with the
Insurance Regulatory and Development Authority (IRDA) in order to ensure that the
26% limit of foreign shareholding applicable for the insurance sector is not breached.
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CHAR TER ED ACCOU N TAN TSBanking contd…
• In addition to what is stated earlier, it may be noted that as per existing RBI
Guidelines:
– no single entity or group of related entities can have shareholding or control
directly or indirectly in any private sector bank in excess of 10%/ 5% of the paid
up capital of a private sector bank.
– any acquisition in excess of 10%/5%, as the case may be, of the paid up capital
of a private sector bank will require prior RBI approval
– in deciding whether or not to grant approval , RBI may take into account all
matters that it considers relevant to the application, including ensuring that
shareholders whose aggregate holdings are above specified thresholds meet the
fitness and propriety tests.
– irrespective of the quantum of stake in the investee bank, voting rights of every
shareholder are currently statutorily capped at 10% of the total voting rights of all
the shareholders of the investee bank.
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CHAR TER ED ACCOU N TAN TSInsurance
• FDI upto 26% is permitted under the automatic route, subject to licensing and prior
approval by the IRDA
• It may be noted that in calculating the foreign holding, the IRDA would generally look
only to the investor in the insurance company and not to the foreign holding in such
investor company
• However, recently the Government has also started looking into indirect foreign
holding through Indian shareholders
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CHAR TER ED ACCOU N TAN TSAsset Reconstruction Companies
• FDI in Asset Reconstruction Companies (ARCs) registered with Reserve Bank is
under the Government Approval Route.
• Automatic Route is not available for such investments.
• FDI is restricted to 49% of the paid up capital of the ARC.
• Further, where investment by any individual entity exceeds 10% of the paid up equity
capital, ARC should comply with the provisions of Section 3(3) (f) of Securitization
and Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002 relating to compliance with prudential norms specified by the RBI.
• The minimum capitalisation requirements for ARCs under the Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 is
Rs.1 billion (approx USD 25mn)
• FIIs registered with SEBI can invest in the Security Receipts (SRs) issued by ARCs
registered with Reserve Bank. FIIs can invest upto 49% of each tranche of scheme of
SRs, subject to the condition that investment by a single FII in each tranche of
scheme of SRs shall not exceed 10% of the issue.
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CHAR TER ED ACCOU N TAN TSCredit Information Companies
• Earlier, investment in credit reference agencies, was covered in along with other
financial services
• However, vide Press Note 1 of 2008 dated March 12, 2008 the Government has
provided separate guidelines for FDI in Credit Information Companies and
consequently, credit reference agencies were removed from other financial services
• As per the said press note, foreign investment (FDI + FII) is allowed in Credit
Information Companies registered under the Credit Information Companies
(Regulation) Act, 2005 upto 49% subject to prior approval of the Government and
regulatory clearance of the RBI
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CHAR TER ED ACCOU N TAN TSOther Financial Services
• Other financial services include:
– Merchant banking – Factoring
– Underwriting – Credit Rating Agencies*
– Portfolio Management Services – Leasing & Finance
– Investment Advisory Services* – Housing Finance
– Financial Consultancy* – Forex Broking*
– Stock Broking – Credit card business
– Asset Management – Money changing business*
– Venture Capital – Micro credit
– Custodial Services – Rural credit.
*Non-fund based activities
• Investment is permitted only in companies carrying on specified activities, Companies
carrying on investment activity or acting as holding company will require FIPB
approval subject to the minimum capitalization norms. Holding company may also
require compliance of Press Note 9 of 1999
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CHAR TER ED ACCOU N TAN TSOther Financial Services contd…
• Minimum Capitalisation Norms for fund based NBFCs are as under:
– For FDI up to 51% - US$ 0.5 million to be brought upfront
– For FDI above 51% and up to 75% - US $ 5 million to be brought upfront
– For FDI above 75% and up to 100% - US $ 50 million out of which US $ 7.5
million to be brought upfront and the balance in 24 months
• Minimum capitalisation norms for non-fund based activities is US $ 0.5 million is
applicable in respect of all permitted non- fund based NBFCs with foreign investment.
• It may be noted that securities premium may not be considered for the purpose of
computing minimum capitalisation.
• A clarification has also been obtained that under the exchange control regulations the
amounts received as minimum capitalisation need not be retained and may be used
for the business purposes of the Company.
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CHAR TER ED ACCOU N TAN TSRBI Guidelines Applicable to NBFCs
• Definition of NBFC – a company which:
– which is a financial institution
– which has as its principal business of -
• receiving any deposits, under any scheme or arrangement or in any manner;
• or lending in any manner;
• Registration with RBI
• Categorisation as and NBFC - income test and asset test
• Types of NBFCs - Loan company, Investment company, Asset finance company,
Mutual benefit financial company
• Classification of NBFCs
– Deposit accepting – regulations relating to capital adequacy, prudential norms,
maintenance of net owned funds, reporting requirements
– Non-deposit accepting systemically important (assets in excess of Rs. 1 bn) – at
par with deposit accepting NBFCs
– Non-deposit taking non- systemically important – only certain regulations apply
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CHAR TER ED ACCOU N TAN TSTransfer of shares of a company engaged Financial
Services
• Transfer from non-resident to resident is permitted under the automatic route subject
to compliance with pricing guidelines and documentation requirements
• Transfer from resident to non-resident requires prior approval of RBI
• Government has permitted transfer from resident to non-resident under the automatic
route vide Press Note 4 of 2006; however, operational guidelines in this regard have
not been issued by RBI
• Change in management of NBFCs registered with the RBI requires public notice.
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CHAR TER ED ACCOU N TAN TSIncome Tax Provisions – a snapshot
• India follows a residence based taxation system
• Effective tax rate of 33.99% for Companies i.e. (30% + surcharge of 10% + additional
cess on income tax and surcharge viz. education cess of 3%).
• Minimum Alternate Tax – applicable in case of companies having “book profits” but
not assessable to tax under the normal provision of the Income Tax Act – 11.33%
• Dividend distribution tax – 16.995%; consequently dividend exempt in the hands of
shareholder
• Due date of filing corporate tax returns - 30th day of September following the end of
the financial year – uniform accounting year
• Liability to pay advance tax and deduct tax at source
• Levy of “fringe benefits tax”
• Transfer pricing regulations in force
• India has signed double taxation avoidance agreements (DTAAs) with over 70
countries; the beneficial provisions of any Double-Taxation Avoidance Agreement will
prevail over the provisions of the Income Tax Act
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CHAR TER ED ACCOU N TAN TSPress Note 1 of 2005
• FDI in companies where the foreign investor already has a Joint Venture (“JV”)
(whether by investment, technical collaboration or trade-mark agreement) with
another Indian company in the “same” field would require approval of the FIPB.
• “Same field” defined as same 4 digit NIC code
• A no-objection letter from exiting joint venture partners would need to be enclosed
alongwith the FIPB application.
• FIPB to be the deciding authority whether the provisions of Press Note 1 will be
attracted or not.
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