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New Restriction on FDI where Chinese Companies or Chinese National are Beneficial Owners

The Government of India (‘GOI’) had released a Press Note dated April 17, 2020 read with the Foreign Exchange Management (‘Non-debt Instruments’) Amendment Rules, 2020 dated April 22, 2020, revising the existing FDI policy. This has been brought in to curb opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19 pandemic. Recently The People’s Bank of China had increased its shareholding in HDFC Bank, one of India’s largest private sector banks, to 1.01%, between January and March 2020 and it was observed globally that transactions pertaining to purchase of assets at low valuations by Chinese firms and institutions have increased, which triggered this change. 
The Government revisits the FDI norms as follows:
1. Investment
An Entity, Citizen or “Beneficial Owner”, based in a country which shares *land border with India can invest (equity/preference shares/fully convertible instruments i.e. non-debt) only under the Government route. This means that government approval would be required.
2. Transfer/Change in Beneficial Ownership
In the event of transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly to any entity, citizen or beneficial owner, based in a country which shares land border with India will also require Government approval.
3. A citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors/activities other than defence, space, atomic energy and sectors/activities prohibited for foreign investment.
*Countries which shares Land Border: India shares land borders with seven countries namely- Pakistan, Bangladesh, China, Nepal, Myanmar, Bhutan and Afghanistan.
One of the key aspects is that the term “Beneficial Owner (‘BO’)” is not defined specifically under the Foreign Exchange Management Act, 1999 and there is no threshold given to determine the Beneficial Owner under the Press note. It is defined differently under the Companies Act, 2013, the Prevention of Money Laundering Act, 2002 and the RBI Master Direction-Know Your Customer (‘KYC’) Direction, 2016, hence one need to be very conscious while determining the BO of an investing entity and overall structure of the foreign entity to be scrutinized before getting an investment in India. The amendment would be having an impact on all foreign investments coming to India where there could be a Chinese BO. 
Other key aspects under the new FDI norms:
  • The additional requirement applies to all sectors, and all size of investments. 
  • The requirement for the Government approval will apply even for cases of transfer of ownership of any existing or future FDI in an entity in India, whether directly or indirectly. 
  • The earlier position had restriction only for direct investments from Bangladesh and Pakistan, i.e. investment by a citizen of Bangladesh/Pakistan or an entity incorporated in Bangladesh/Pakistan.
  • The revised position now imposes restrictions in indirect investments i.e. situations where the individual/entity is not based out of countries that share land border with India, but the “beneficial owner” of the investment is situation in or is a citizen of any such country. For instance: If the investment is being made from U.S., however the beneficial owner of the investment is based out of China, such an investment will require prior approval from the Government of India before investing in India.  
  • However, the funding in form of loans i.e. External Commercial Borrowings has not been impacted due to this change.