India Updates Foreign Exchange Rules, Simplifies Cross-Border Share Exchanges

India has introduced major updates to the Foreign Exchange Management (Non-Debt Instruments) Rules (Fourth Amendment), 2019, with the goal of simplifying cross-border share exchanges and promoting the ease of doing business. The new changes also include mandating central government’s approvals for all investments originating from countries that share land borders with India.

On August 16, 2024, India’s Union Ministry of Finance announced the fourth amendment to its Foreign Exchange Management (Non-Debt Instruments) Rule, 2019, with the objective of attracting increased investment, particularly in startups. The amendments also introduce a requirement for government approval for Foreign Direct Investment (FDI) originating from neighboring countries.

According to the announcement, the changes in regulations, led by the Department of Economic Affairs (DEA) under the Ministry of Finance, align with the Union Budget 2024-25’s focus on streamlining FDI and overseas investment regulations.

Latest amendments to India’s Foreign Exchange Management (Non-Debt Instruments) Rule, 2019

A key change is allowing Indian companies to issue or transfer equity in exchange for equity in foreign companies. This modification aims to support the international growth of Indian businesses by facilitating smoother mergers, acquisitions, and strategic collaborations with global partners. By making cross-border transactions easier, India hopes to boost the global competitiveness of its domestic firms.

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Additionally, the fourth amendment also clarifies the treatment of downstream investments made by entities of Overseas Citizens of India (OCI) on a non-repatriation basis, aligning it with the rules applied to entities owned by non-resident Indians (NRIs). This adjustment is expected to encourage more OCI-owned businesses to participate in India’s economy.

Other important changes include the establishment of a standardized definition of ‘control’ to enhance consistency across various regulations, easing business compliance. The updated rules state that two or more foreign portfolio investors (FPIs), including foreign governments, will be classified as an investor group if they share over 50 percent common control.

The definition of a ‘startup company’ has been harmonized with the government’s 2019 notification, simplifying regulations for startups and making it easier for them to benefit from government schemes. As per the 2019 notification of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, a business qualifies as a startup if it meets the following criteria:

• It must be within 10 years of its incorporation or registration, formed as a private limited company under the Companies Act, 2013, or
• Registered as a partnership firm under the Partnership Act, 1932, or as a limited liability partnership.

Additionally, the entity’s turnover must not have exceeded INR 1000 million (US$11.9 million) in any financial year since its establishment.

India has also allowed FDI in white-label ATMs to promote financial inclusion by improving access to banking services in under-served areas.

What is the foreign exchange management rule, 2019?

The Foreign Exchange Management Act, 1999 (FEMA) grants the central government authority to regulate cross-border financial transactions, requiring approval for any dealings involving foreign securities or exchange.

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The Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, were formulated by the central government to regulate foreign exchange transactions related to non-debt instruments, such as equity investments. These rules were introduced under FEMA to replace older regulations and streamline foreign investment practices.

Key aspects of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 include:

1. Regulation of FDI: The rules govern FDI in various sectors, specifying the conditions under which foreign investors can invest in Indian businesses and outlining sector-specific caps on foreign investment.
2. Classification of Foreign Investment Types: The rules define various types of foreign investments, including FDI, Foreign Portfolio Investment (FPI), and investments by Non-Resident Indians (NRIs) and Overseas Citizens of India (OCIs).
3. Entry Routes: The rules detail the different entry routes for foreign investment, including automatic routes (which do not require government approval) and government routes (which do require approval).
4. Sectoral Caps and Guidelines: The rules specify sectoral limits on foreign investment and outline the procedures for foreign investors to comply with these regulations.
5. Foreign Exchange Transactions: The 2019 rules address how foreign exchange transactions, particularly those related to equity instruments, are to be conducted in India, including provisions for share swaps, repatriation of profits, and treatment of downstream investments.

(US$1 = INR 83.76)

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