Foreign Direct Investment – Key considerations and practical aspects
Foreign Direct Investment (‘FDI’) has been one of the most crucial components of India’s economic growth story in recent years. FDI, in addition to being a key driver of economic growth, has been a significant non-debt financial resource for India’s economic development. Foreign investors can invest directly in India, either on their own or through joint ventures in virtually all the sectors except in a very small list of activities where foreign investment is prohibited.
FDI has been coming into India because of the Government’s supportive policy framework, vibrant business climate, rising global competitiveness and economic influence. Since 1991, the regulatory environment and the process to get FDI has consistently been eased to make it investor-friendly, catapulting India into the position of one of the fastest-growing economies of the world.
India has emerged as one of the top destinations for FDI globally. As per the Economic Survey 2023, India has received the highest ever FDI amounting to USD 84.84 billion in the financial year 2021-22. UNCTAD World Investment Report (WIR) 2022 has ranked India at the 7th rank among the top 20 host economies for 2021, in terms of FDI.
Mauritius has traditionally been the leading country from where investments were made into Indian companies. As per the FDI data available on Department for Promotion of Industry and Internal Trade (DPIIT) website, Mauritius still ranks number one in terms of cumulative FDI received from April 2000 till December 2022, with a total FDI equity inflow of USD 162.5 billion which constitutes more than one-fourth of the total FDI equity inflow in India during this period.
However, after the amendment in the Double Taxation Avoidance Agreement with Mauritius, where the capital gains exemption was removed from April 2017, the FDI inflows from Mauritius have reduced significantly and now Singapore and USA are leading the pack (considering the last three-year data of FDI inflow).
Top Investing Countries: FDI Inflows (Amount in USD billions)
| Country | 2020-21 (April–March) | 2021-22 (April–March) | 2022-23 (April–Dec.) | Cumulative Equity Inflow (Apr 2000–Dec 2022) |
|---|---|---|---|---|
| Mauritius | 5.6 | 9.4 | 4.7 | 162.5 |
| Singapore | 17.4 | 15.9 | 13.1 | 144.0 |
| U.S.A. | 13.8 | 10.5 | 5.0 | 59.1 |
| Netherlands | 2.8 | 4.6 | 2.2 | 43.4 |
| Japan | 2.0 | 1.5 | 1.4 | 38.4 |
FDI in India is governed by the Foreign Exchange Management Act (‘FEMA’) and the regulations of the Reserve Bank of India (‘RBI’). FDI is considered as a Capital Account transaction as per the provisions of FEMA, because it is an investment in the share capital of an Indian company. Capital Account transactions are generally allowed only to the extent it is specifically permitted.
FDI is governed by the Consolidated FDI Policy of India which is reviewed and amended from time to time. Department for Promotion of Industry and Internal Trade (DPIIT) is the nodal department of Government which reviews and revises the FDI policy.
Who can invest?
The Foreign Direct Investment (FDI) policy in India allows for investment from eligible investors who are either individuals, entities, or governments located outside of India:
Indian citizens who reside outside of India can invest in Indian companies through the FDI route.
Foreign nationals who are not of Indian origin can also invest in Indian companies through the FDI route.
Foreign pension funds, mutual funds, and hedge funds registered with SEBI to invest in Indian stock markets.
SEBI-registered foreign entities investing in specialized sectors: technology, biotechnology, and R&D.
Can establish subsidiaries/JVs or make strategic equity investments in Indian start-ups and established companies.
Government-owned investment funds eligible to invest in Indian companies subject to specific conditions.
Institutions like World Bank, Asian Development Bank (ADB), and IFC are eligible to invest via FDI.
Restrictions on FDI from Land-Border Countries (Government Approval Route)
An entity of a country that shares a land border with India (Afghanistan, Bangladesh, Bhutan, China, Nepal, and Pakistan), or where the indirect beneficial owner of an investment is situated in or is a citizen of any such country, can make investment only under the Government Approval route.
Example: If a company based in Canada wishes to make an investment in an Indian company, but the Canadian entity is ultimately held by a Chinese company, prior approval from the Government of India is mandatory.
Who can receive investment?
FDI is allowed in most sectors, with a few exceptions. Investment can be made either through the automatic route or the approval route:
(i) Prohibited Sectors / Activities
- Lottery Business including Government/private lottery, online lotteries, etc.
- Gambling and Betting including casinos etc.
- Chit funds.
- Nidhi company.
- Trading in Transferable Development Rights (TDRs).
- Real Estate Business or Construction of Farm Houses. (Note: ‘Real estate business’ does not include development of townships, construction of residential/commercial premises, roads, bridges, and SEBI-registered REITs).
- Manufacturing of cigars, cheroots, cigarillos, and cigarettes, of tobacco or of tobacco substitutes.
- Activities/sectors not open to private sector investment: (I) Atomic Energy and (II) Railway operations (other than permitted activities per para 5.2).
Note: Foreign technology collaboration in any form (franchise, trademark, brand name, management contract) is strictly prohibited for Lottery Business, Gambling and Betting.
(ii) Approval Route
Subject to prior approval from Government of India or RBI. Applicable to sensitive sectors like telecom services, media, civil aviation, and brownfield pharmaceuticals.
(iii) Automatic Route
Permitted in all sectors not listed under prohibited or approval routes without prior clearance, subject to post-inflow reporting. Note: Certain sectors have statutory equity caps under automatic route (e.g., 49% in Power Exchanges and Insurance Companies).
(iv) Eligible Recipient Entities
- Indian Companies: Eligible to receive FDI up to prescribed sectoral caps.
- Limited Liability Partnerships (LLPs): Eligible only in sectors where 100% FDI is allowed under automatic route without FDI-linked performance conditions.
- Proprietorships & Partnerships: Generally ineligible. NRIs may invest on a non-repatriable basis (excluding agriculture/plantation, real estate, or print media). NRIs and non-residents may invest on a repatriable basis under Government Approval.
- Trusts: FDI is prohibited in trusts, except in SEBI-registered Venture Capital Funds and Investment Vehicles (e.g., InvITs/REITs).
Modes of FDI in India
Foreign investors can invest in India through three recognized eligible instruments:
(i) Equity Investments
Subscription to new equity shares or acquisition of existing equity shares. Can include partly paid equity shares.
(ii) Compulsorily Convertible Preference Shares (CCPS)
Must be fully paid-up and mandatorily convertible into equity shares at a specified date/event to qualify as FDI.
(iii) Compulsorily Convertible Debentures (CCDs)
Treated at par with equity for FDI purposes provided they are fully paid-up and mandatorily convertible into equity shares.
Vital Legal Distinction: While equity shares may be partly paid, CCPS and CCDs must be fully paid-up and mandatorily/fully convertible. Any non-convertible or optionally convertible preference shares or debentures are treated as debt and must strictly comply with External Commercial Borrowings (ECB) guidelines.
Compliance Requirements
All foreign investments are regulated by FEMA and RBI guidelines and must be reported on the RBI online portal:
(i) At the time of receiving the money:
- Separate Bank Account: Mandatory separate bank account for inward private placement remittances.
- Banking Channels & FIRC: Inward remittance received through RBI-approved channels (preferably SWIFT) to secure Foreign Inward Remittance Certificate (FIRC) and investor KYC.
- 30-Day Reporting: Inflow reporting to RBI within 30 days of receipt via the online FIRMS portal (https://firms.rbi.org.in).
(ii) Valuation of shares:
- Valuation must be certified by a Registered Valuer per Companies Act 2013 and RBI regulations.
- Conducted per internationally accepted pricing methodology on arm’s length basis (unlisted: Discounted Cash Flow / DCF method; listed: SEBI ICDR Regulations).
- Valuation report submitted to RBI along with investment reporting forms.
(iii) Allotment of shares & Form FC-GPR:
- Allotment must be completed within 180 days from the receipt of inward remittance.
- Shares cannot be allotted below the minimum fair value floor price determined under RBI pricing guidelines.
- Allotment reported to RBI using Form FC-GPR within 30 days of allotment via the online FIRMS portal.
(iv) Annual Filing of Foreign Liabilities and Assets (FLA) Return:
- Mandatory annual filing for all Indian companies and LLPs that have received foreign investment.
- Filed online on the RBI FLAIR portal (https://flair.rbi.org.in/fla/) by July 15 every year for the previous fiscal year ending March 31.
- Mandatory even if there is no fresh foreign investment or zero outstanding foreign assets/liabilities during the year.
Angel tax provisions on FDI (Finance Act, 2023 Amendment)
The recent Finance Act 2023 brought in taxation provisions under Section 56(2)(viib) on the share premium received by Indian companies from non-resident shareholders as well (where share premium received exceeds fair market value computed per Indian Income-tax Rules).
Previously, Section 56(2)(viib) was confined solely to resident investors. Extending Angel Tax to foreign investors introduces potential tax friction and unwarranted litigation risks across large FDI inflows entering Indian ventures.
Conclusion
In conclusion, India’s FDI regulations have undergone significant reforms in recent years to attract more foreign investment into the country. The Government has taken several measures to liberalize the FDI regime and make it more investor-friendly by simplifying procedures, easing restrictions, and increasing transparency.
However, investors should be aware of the sectoral caps, entry routes, and other regulatory requirements before investing in India. It is recommended to seek professional advice and due diligence before making any investment decisions.
Overall, India offers significant opportunities for foreign investors, and the country’s growing economy, vast market, and skilled workforce makes it an attractive destination for FDI.