Why the ODI rules apply
The Overseas Investment Rules, 2022 (G.S.R. 646(E), 22 August 2022) define a "foreign entity" as an entity formed, registered or incorporated outside India, including International Financial Services Centre, that has limited liability (rule 2(1)(h)). "Host jurisdiction" also includes the IFSC. Overseas direct investment (ODI) includes acquiring unlisted equity capital of a foreign entity or subscribing as part of its memorandum of association (rule 2(1)(q)). An Indian company's subscription to the shares of its new IFSC subsidiary is therefore ODI.
Rule 15 sends investment in an IFSC to Schedule V. The investor follows the ordinary schedule for its category (Schedule I for ODI by an Indian entity, Schedule II for portfolio investment, Schedule III for individuals, Schedule IV for others), with the IFSC-specific provisos below. A recognised stock exchange in an IFSC is treated as a recognised stock exchange outside India.
What Schedule V changes
| Point | General rule | Investment in an IFSC |
|---|---|---|
| Indian entity in financial services investing in a financial-services entity | Net profits in each of the preceding three financial years; registered with or regulated by an Indian financial services regulator; approvals from the regulators in India and the host jurisdiction (Schedule I, para 2(1)) | Where approval of the financial services regulator concerned is needed, it is to be decided within 45 days of a complete application, failing which it is deemed approved |
| Indian entity not in financial services investing in a financial-services entity (not banking or insurance) | Net profits in the preceding three financial years (Schedule I, para 2(2)) | May invest in an IFSC even if it does not meet the net profit condition |
| Contribution to an investment fund or vehicle | Depends on the instrument | Treated as overseas portfolio investment |
| Banks and NBFCs regulated by RBI | Subject also to the conditions RBI lays down for them (Schedule I, para 2(4)) | The same RBI conditions apply |
A foreign entity is engaged in financial services if it undertakes an activity that, if carried out in India, would require registration with or regulation by a financial sector regulator in India.
Limits and restrictions
- Financial commitment limit. An Indian entity's total financial commitment in all foreign entities, at the time it is made, must not exceed 400 per cent of its net worth on its last audited balance sheet (Schedule I, para 3). Financial commitment covers equity ODI, debt and non-fund-based facilities extended to or for the foreign entity (rule 2(1)(f)).
- Portfolio investment by an Indian entity is capped at 50 per cent of net worth (Schedule II).
- Bona fide business. Investment must be in a foreign entity engaged in a bona fide business activity, directly or through a step-down subsidiary or SPV (rule 9(1)).
- Prohibited activities. No ODI in a foreign entity engaged in real estate activity, gambling, or dealing with financial products linked to the Indian rupee without specific RBI approval (rule 19(1)). The last item matters for IFSC units planning rupee-linked products.
- Layers. No financial commitment in a foreign entity that has invested, or invests, into India in a way that results in a structure with more than two layers of subsidiaries, subject to listed exceptions (rule 19(3)).
- No objection certificate. An investor with an account classified as non-performing, a wilful defaulter, or under investigation by a financial service regulator, the CBI, the Enforcement Directorate or the SFIO needs an NOC first; silence for 60 days is treated as no objection (rule 10).
- Pricing and exit. Issue and transfer prices must be on an arm's length basis (rule 16). On disinvestment of ODI, the investor must generally have stayed invested for at least one year (rule 17(4)).
Procedure and reporting
The Overseas Investment Regulations, 2022 (FEMA 400/2022-RB) set the mechanics. All reporting goes through a designated authorised dealer (AD) bank.
- Designate an AD bank and obtain a Unique Identification Number (UIN) for the IFSC entity from RBI before the first remittance (regulation 9(2) and (3)).
- Report the financial commitment at the time of the outward remittance or the commitment, whichever is earlier (regulation 10(2)).
- Submit share certificates or other evidence of investment to the AD bank within six months of the remittance (regulation 9(1)).
- File an Annual Performance Report for each foreign entity by 31 December each year, based on audited financial statements, including changes in step-down subsidiaries (regulation 10(4)). An Indian entity with ODI also files the Annual Return on Foreign Liabilities and Assets (regulation 10(5)).
- Report disinvestment, and any restructuring, within thirty days (regulation 10(2)); realise and repatriate dues and disinvestment proceeds within ninety days (regulation 9(4)).
Late filings can be regularised with a late submission fee within three years of the due date (regulation 11). Until then, no further financial commitment may be made in that entity (regulation 12). In a growing IFSC subsidiary, a missed filing can therefore block the next capital call.
Points of practice
- Sequence. Align the ODI steps with the IFSCA and SEZ approvals: capital normally goes in after in-principle approval. See set-up sequence.
- Downstream investment. Under rule 4(a), the Rules do not apply to investments made outside India by a financial institution in an IFSC. The Indian parent still reports step-down subsidiaries in its Annual Performance Report.
- Tax and substance. The IFSC subsidiary's tax position turns on section 147 and on genuine substance in GIFT City. See substance.