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In the latest review of consolidated Foreign Direct Investment (FDI) Policy, Department of Industrial Policy & Promotion(DIPP), issued a circular 1of 2011 that came into effect from 1st April,2011. This note recaps the major changes that have been introduced in the FDI Policy vide circular 1 of 2011. The  changes that have been introduced are as follows:-

1. Pricing of Convertible instrument: greater flexibility introduced

As per Circular 2 of 2010, Indian companies were allowed to issue equity shares, fully, compulsorily and mandatorily convertible debentures and fully, compulsorily and mandatorily preference shares. The pricing of the capital instruments was to be determined upfront at the time of issuance of relevant instruments. Such upfront determination eliminated the scope of commercial benefit of investing through convertible instruments. Therefore, DIPP with a view to recognize and address this issue has amended the FDI Policy.

The new FDI policy has now provided vide Circular 1 that instead of specifying the price of convertible instruments upfront, companies will have the option of prescribing a conversion formula subject to FEMA which prescribes the Discounted Cash flow method of valuation for unlisted companies and in case of listed companies, valuation in terms of SEBI( Issue of Capital and disclosure Requirement) Regulations, 2009. The introduction of conversion formula will help the recipient companies to obtain a better valuation of convertible instruments based on their performance. 

2. Share against non cash consideration:

The FDI policy allows issue of shares by Indian companies to foreign investors only against cash      remittances received through normal banking channels. However, the only exceptions to this are conversion of external commercial borrowings outstanding as well as payment obligations towards lump sum fee or royalty for technical collaborations. Any other type of transaction involving an issue of shares to foreign investors for consideration other than cash requires approval of the Government of India through the Foreign Investment Promotion Board (FIPB). Although the Government had been initially hesitant in granting approvals for such transactions, it has adopted a more liberal stance lately.

In this background, and in order to provide more investment options, the Government issued a discussion paper in September 2010 considering additional methods of issue of shares for consideration other than cash.

These included:

· Import of Capital Goods/ Machinery/ Equipment, Services,

· Import of Raw Material/ Trade Payables, Pre-operative/ Pre-incorporation Expenses, Share Swaps,

· Intangible Assets (including franchisee rights), and One Time Extraordinary Payments (including arbitration awards).

In the new policy that the Government announced yesterday, only the following additional methods have been accepted for issue of shares for consideration other than cash (para. 3.4.6 of the Policy):

· Import of capital goods/ machinery/ equipment (including second-hand machinery);

· Pre-operative/ pre-incorporation expenses (including payments of rent, etc.).

Issuance of equity instruments under this category will be subject to the following conditions prescribed by DIPP:

· Submission of foreign inward remittance certificate(FIRC) for remittance of funds by the overseas promoters for the expenditure incurred.

· Verification and certification of the pre-incorporation/ pre-operative expenses by the statutory auditor.

· Payment should be made directly by the foreign investor to the company. Conversion of payments made through third parties citing the absence of a bank account or similar such reasons will not be permitted.

· The capitalization should be completed within the stipulated period of 180days from the date of receipt of advance against equity.

· FIPB approval would be subject to pricing guidelines of the Reserve Bank of India and appropriate tax clearance.

The benefits of this  changes are that

· It enables Indian companies to procure equipment and services from foreign enterprises (particularly collaborators) when they are either unable to pay cash, or when a cash transaction is not desirable from a financing standpoint.

· It allows payment by Indian companies through issue of its own shares. Such a method also ensures that suppliers and collaborators have an interest in the success of the Indian company’s business by taking a stake in it (and thereby assuming risk).

3. Rationalization and Simplication of Policy for downstream Investment:

Indirect foreign investment into Indian companies had been a subject matter of ambiguity in the FDI policy. For instance, if an Indian company (that has foreign investors) makes investments into another Indian company, would that downstream investment be treated as domestic investment or foreign investment? While rules govern such investment?

And order to streamline the policy, the Government had issued Press Notes 2, 3 and 4 of 2009 to clear the confusion on downstream investments. However, the policy continued to operate in a complex manner, particularly because there were differences based on the type of intermediate company:

· operating company;

· operating-cum-investing company;

· investing company.

To simplify the process further, the new Consolidated FDI Policy, Circular No. 1 of 2011 eliminates the differences regarding the type of intermediate company, and applies a common set of principles to so long as the Indian intermediate company is owned and/or controlled by non-resident entities. Investments by such an intermediate company would be considered a foreign investment for the purpose of sectoral caps and other conditionalities.

The relevant part of the policy reads:

· Downstream investment by an Indian company, which is owned and/ or controlled by non-resident entity/ies, into another Indian company, would be in accordance/compliance with the relevant  sectoral conditions on entry route, conditionality’s and caps, with regard to the sectors in which the Indian company into which the downstream investment is being made, is operating.

However, some distinctions have been maintained to the policy regarding foreign investment into the intermediate company itself depending on its nature. For example, if that is an investing company, then foreign investment is allowed into it only under the approval route.

The relevant policy states:

· Foreign investment into an Indian company, engaged only in the activity of investing in the capital of other Indian company/ies, will require prior Government/FIPB approval, regardless of the amount or extent of foreign investment.

Whilst the circular 1 of 2011 deals with applicability of relevant sectoral conditions and caps, etc on downstream investments, it still needs to be clarified whether such downstream investment would be subjected to other FDI regulations viz. transfer of shares, issuance of preference shares regarded as external commercial borrowings etc.

4. Previous Venture:

Under the previous FDI Policy, a foreign investor was required to obtain a no- objection letter from the existing Indian Joint venture partner in case the foreign investor intended to invest in the same field where they had a previous joint venture. In such cases, automatic is not available.

This condition has been completely abolished under the circular 1 of 2011. Going forward this requirement does not apply to any joint venture past or present and foreign investors would be free to enter into new ventures in the same field without the NOC of their existing Indian partner. Foreign investors are no longer required to obtain government approval even if they had previous ventures in India so long as the new investment otherwise falls within the automatic route. It is perhaps the most significant and likely impactful change introduced in the new policy.

5. Sectoral Rules:

Earlier, FDI under the automatic route up to 100% was available for floriculture, horticulture, development of seeds, animal husbandry, pisciculture,  aquaculture and cultivation of vegetables & mushrooms under controlled conditions and services related to agro and allied sectors.

The new FDI policy broaden the category and allows FDI in development and production of seeds and planting material, even if the same has not been done under controlled condition.


Circular 1 of 2011 has many explicit helps, and no visible hurts for foreign investors, with the removal of ‘Press Note 1’ condition being bold and impactful. There were several more reforms that were anticipated, for example liberalization to permit foreign investment into Limited Liability Partnerships (the new policy provides that the Government is reviewing its policy to allow FDI in LLPs), liberalization of the policy on investment into real estate, as well as clarifications required on certain provisions of the current policy regarding lock-in on original investment (erstwhile Press Note 2 of 2005), liberalization of investment in multi brand retail, and so on and so forth. It is hoped that the government will embark on far reaching reforms to address these needs in the coming months.

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