Business Laws

RBI regulations on offshore investments

| | Updated on: Oct 31, 2021
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The legitimacy of ‘Round Tripping Structures’ has been a topic of elevated debate by all stakeholders

Start-ups and other businesses have often considered setting up headquarters outside India while the key owners in control of the business remain here. Structures involving investments by resident Indians in a foreign entity that invests or already has investment back in India are popularly referred as ‘Round Tripping Structures’. The legitimacy of such structures has been a topic of elevated debate. Round tripping often becomes necessary to meet eligibility criteria by certain larger offshore investors/ business accelerators, nonetheless, these are also preferred for several other reasons such as availability of capital, regulatory environment, mature markets understanding their products, etc. An FAQ list by the RBI on Indian overseas investment regulations (ODI regulations) permits such investment structures only with a prior approval from the RBI, which practically is not easily forthcoming. To achieve these desired structures, most Indian founders resort to a mode usually involving a cashless receipt of shares, whereby a third party sets up a foreign entity and makes a gift to the Indian residents. In absence of any guidelines governing this route, the regulatory provisions come to haunt at the time of exit or divestment where the RBI has sometimes alleged contravention of regulations and ordered for the unwinding of such structures.

New framework

Recently, the RBI proposed a completely new framework for overseas investments (draft Foreign Exchange Management (Non-debt Instruments-Overseas Investment) Rules, 2021), which once notified (hopefully sometime soon) would replace the existing ODI regulations. Interestingly, the round tripping structures – which had no mention in the existing regulations – have found a specific mention in the proposed new rules. A person resident in India would now be allowed to make investments in a foreign entity that has invested or invests back into India (without any prior approval from the RBI) as long as these structures are not designed for the purpose of tax evasion/ tax avoidance. The draft rules also propose to contain the indiscriminate gifting of shares of overseas companies to Indian residents by permitting receipt of gifts only from relatives of an individual. Further, acquisition of foreign securities through ESOPs is proposed to be restricted only to genuine cases of employment with an additional rider that the ESOP to any Indian employee shall not lead to the control of the foreign entity. It is pertinent to note that the definition of control under the draft rules includes entitlement to 10 per cent or more of voting rights in the foreign entity.

These draft rules are a welcome move. These would also warrant more clarity on certain aspects. For instance, what exactly constitutes tax evasion or avoidance needs to be clarified. As is the case with the Indian Income Tax, where anti-avoidance rules were introduced in 2018, the authorities and the tax pundits are still interpreting these terms because of the inherent subjectivity associated with them. Also, which authority would be empowered to determine cases fitting into the criteria of evasion or avoidance of tax – would it be the RBI, or it would be the RBI working with tax authorities, or would the onus to prove contrary would rest with the investor? The draft rules do bring in liberalisation for the Indian start-up ecosystem and corporates in genuine cases of overseas investments with underlying Indian investments. It would also be worthwhile for the RBI to consider permitting an overseas company having investments from Indian resident individuals to set up a step-down subsidiary, to help achieve the growth aspirations of Indian start-ups in the global arena.

(The authors are Partner and Associate Director, respectively, at BDO India, a Tax and Accounting Advisory Firm)

Published on November 01, 2021

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