Govt issues FEMA notification to enforce change in FDI rules

The government has issued an amendment to the Foreign Exchange Management Act (FEMA) rules to enforce the change in Foreign Direct Investments (FDI) rules announced earlier. The change, aimed at Chinese investors coming through the automatic route, was to prevent “opportunistic takeover of Indian companies due to the Covid-19 pandemic”.

The FEMA notification clarifies that investments through Foreign Portfolio Investment, Foreign Venture capital investment (FVCI) and Alternative Investment Funds and debt are exempt from this. 

As per the new FDI rules, entities with ‘beneficial ownership’ or individuals from bordering nations must seek government approval to invest in India. 

The move is in line with international policy moves by countries including the US, European Union and Australia, according to Atul Pandey, mergers and acquisitions partner at legal firm Khaitan & Co. 

However, there is no clarity on the criteria of ‘beneficial ownership’ in the notification, he said. 

“If two funds from the US and two headquartered in China are co-investing in a startup, there is no way of deciding beneficial ownership. Similarly, beneficial ownership is in question when, among the limited partners in a fund, few are from a bordering nation,” he said. 

There is no clarity on the application of the new rules to companies in which Chinese entities are already majority shareholders, he added. 

The rules will have a direct impact on startups that are looking to raise funds from investors either headquartered in China or investing through entities in Singapore and Hong Kong, which are backed by Chinese individuals or companies. Startups looking to raise funds in a post-Covid world will also have to wait for three-four months to get government approval for investments, Pandey said.

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The requirement for government approval for FDI under the automatic route was previously restricted only to entities and individuals based in Pakistan and Bangladesh. 

Also, the change in guidelines do not distinguish between sensitive sectors such as defence and space technology, and non-sensitive sectors including logistics, retail and ecommerce. 

Additionally, the move invited sharp criticism from China, which accused India of discriminatory practices and said that it was not in line with India’s commitments at the World Trade Organisation (WTO) and other multilateral commitments.