The Press Note 3 Conundrum
Updated: Jan 12, 2022
Senior Legal Consultant at Ministry of Finance
A significant time has passed since the notification of Press Note 3 (2020 Series) (“PN3”) and lot of clarity has already been established regarding the notification. The part of notification regarding FDI from all the neighbouring countries sharing land border is comparatively unambiguous, however, there are some chaos that are still prevalent in the industry regarding some of the nuances of the notification. This blog is an attempt to address some of the ambiguities lingering on the applicability and scope of Press Note 3.
The Foreign Direct Investment (“FDI”) regime in India is governed by the Consolidated FDI Policy Circular (“CFPC”) and various Press Notes (“PN”) that are notified from time to time. The CFPC governs entry of FDI in India which is implemented vide the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“FEMA NDR”) and its amendments.
The PN3 of 2020 dated April 17, 2020 (which now stands consolidated in the CFPC 2020, effective from October 15, 2020), is one such notification that caused a lot of ripples. PN3 was introduced to curb opportunistic takeover of stressed and strategic assets, or entities in light of the impact of COVID pandemic. India stood among the long list of nations including Australia, Israel, Canada, France among many others, that introduced similar measures to curb opportunistic takeovers of stressed and strategic assets at throw-away valuation during COVID times.
FDI in India is allowed either through the government route or the automatic route, based on the sector, also known as the entry route. The entry routes for each sector are enumerated in the CFPF and the FEMA NDR. PN3 notification is, however, sector agnostic in nature.
PN3 in Para 3.1.1(a) mandates that FDI from all the neighbouring countries sharing land border with India, and/ or where beneficial owner(s) is a resident from a country sharing land border with India, would be allowed to invest only through government route irrespective of original entry route. The notification essentially mandates that if the investment falls within the purview of the notification, the FDI would require government approval irrespective of the original entry route. The notification also applies to any direct or indirect transfer of ownership of any existing or future FDI and any such subsequent change in beneficial ownership.
The notification accordingly makes two notifiable changes: (i) the list of countries, investment from whom needs government approval has been widened to all countries sharing land border with India (ii) if “beneficial owner” of such investor is from a country sharing land border with India will also require government approval.
Investors feel that there are a lot of ambiguities in PN3 that have caused a lot of inconvenience. Investors claim that the implication of the term “beneficial owner”, “transfer, directly or indirectly” and “subsequent change in beneficial ownership”, have caused a lot of inconvenience due to the ambiguous nature of them. This article tries to address some of the ambiguities that investors have encountered in the notification.
III. Beneficial Owner
There are two views on how beneficial ownership can be triggered in PN3 cases. The first view holds that any individual or entity owning or holding not less than 10% in a company would be considered a beneficial owner. This view is hinged on the definition of Significant Beneficial Owner (“SBO”) that is derived from the co-joined reading of the provisions under the Companies Act, 2013 (“Companies Act”) and the Companies (Significant Beneficial Owners) Rules, 2018 (“Companies Rules”).
The other view on beneficial ownership is derived from the standards encompassed in PMLA. The PMLA defines a beneficial owner as
“an individual who ultimately owns or controls a client of a reporting entity or the person on whose behalf a transaction is being conducted and includes a person who exercises ultimate effective control[ii] over a juridical person.”
Accordingly, the view is that any individual holding a controlling interest in the entity whether acting alone or together or through one or more juridical persons would be considered a beneficial owner. This beneficial ownership in the current context would be 25%. It may be noted that SEBI also reiterates a similar view of “beneficial ownership” as under PMLA.
Depending on how the concept of “beneficial owner” is viewed it could either mean that an entity or an individual with a prescribed shareholding level of 10% in the investing entity (as is the case under the Companies Act of 2013) or the owner or holder of ultimate control over the investing entity (as defined under the Prevention of Money-laundering Act, 2002). However, both the views are not appropriate in the context of PN3. The intent of the policy can be identified with a plain reading of the policy itself and the corresponding FEMA NDR amendment and applying the mischief/Hyden’s rule of interpretation (if you may). The operative part of PN3 on beneficial owner reads:
“…beneficial owner(s) is a resident from a country sharing land border with India…”
On a plain reading of the policy, while keeping in mind the original intent of the policy, i.e., the issue or concern it tries to address, it can be inferred that neither the policy nor the FMEA NDR notification hinges its basis of the term beneficial owner from any other instrument, law, or regulation. Essentially, neither the policy nor the FEMA NDR prescribes any threshold for determining beneficial ownership, nor does it rely on the control aspect to determine a beneficial owner. Consequently, taking a conservative position on the policy, even a nominal ownership to the extreme of even holding one share by an entity in, or a citizen of a country that shares a land border with India, will come under the purview of PN3. Any such entity which is investing in India and has an investor or a beneficial owner from a country that shares a land border with India, and holds even one share, the investment would require government approval.
The situation seems even more tricky for Private Equity funds and listed entities. Private Equity funds may have numerous Limited Partners (“LPs”) and similarly listed entities may have numerous shareholders who may be having an infinitesimal or insignificant percentage infused in the funds or shareholding in the listed entities, and would be from countries sharing land borders with India. In such cases, the entities and funds would also fall under the purview of PN3 and have to seek prior approval of the government for the investment.
IV. Indirect transfer and subsequent change in beneficial ownership
The second part of the PN3 notification in para 3.1.1(b) states that:
“In the event of any transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction/purview of the para 3.1.1(a) i.e., FDI from all the neighbouring countries sharing land border and/ or where beneficial owner(s) is a resident from a country sharing land border with India, such subsequent change in beneficial ownership will also require Government approval.”
The segments of the provision that the investors are facing challenges in and are expecting a clarification are: “transfer”, “indirectly (or indirect transfer)” and “subsequent change in beneficial ownership”.
Section 2(ze) of the Foreign Exchange Management Act (“FEMA”), defines transfers which includes sale, purchase, exchange, mortgage, pledge, gift, loan, or any other form of transfer of right, title, possession, or lien. Accordingly, any measure that leads to change in ownership of the shares in above manner would automatically fall under the purview of transfer. PN3 would be applicable to any transfer that occurs with respect to shares that are currently held, and for any such shares that are acquired in the future and are subsequently transferred to an entity that falls under the purview of para 3.1.1(a) of PN3.
B. INDIRECTLY (OR INDIRECT TRANSFER)
When the policy mentions indirect transfers of ownership of such shares, it fundamentally means that even if the beneficial owner at the top-most level changes by way of transfer of such shares (which may not results in the change of the immediate investor of the India investee entity or any change in the shareholding pattern in the Indian investee entity), resulting in the new (beneficial) owner to be from a country sharing land border with India, such transfer would also require government approval.
For example, entity A holds shares of entity B. Entity B has FDI in Indian entity C, now in case entity A transfers its shareholding in entity B either partially or fully to D (where D is either an entity or an individual from a country sharing land border in India), the transfer of shares of B from A to D would also require government approval.
C. SUBSEQUENT CHANGE IN BENEFICIAL OWNERSHIP
When the policy talks about “such subsequent change in the beneficial ownership”, it is to be understood that any transfer of existing or future FDI that results in the incremental change of shareholding of the beneficial owner and / or results in the transfer of shares to a new beneficial owner who is from a country sharing land border with India, would require government approval. The term “such subsequent change in the beneficial ownership” is essentially talking about the change in beneficial ownership and / or shareholding that is undertaken subsequent to any FDI made in India, be it any existing FDI or future FDI.
As already stated above, the governments around the world have been forced to implement unprecedented measures with a view to safeguard public interest. The PN3 notification is an attempt to boost regulatory oversight and to weed out investments that might be detrimental to the national security and not to curtail investment in any manner. It may have led to some inconvenience and investors are expecting some respite or some clarification specifically in line with beneficial owners and the position regarding PE funds and listed entities. However, investors planning to currently invest in India should rely on the policy as it stands today and proceed with their investments.
[i] All the opinion and views presented here are personal in nature and may not be construed as the view or the position of the organisation the author is currently working with. The observations may not be taken as a legal opinion, readers are advised to take professional opinion and advise before acting.
[ii] Controlling ownership interest means ownership of/entitlement to more than 25 percent of shares or capital or profits of the juridical person, where the juridical person is a company; ownership of/entitlement to more than 15% of the capital or profits of the juridical person where the juridical person is a partnership; or, ownership of/entitlement to more than 15% of the property or capital or profits of the juridical person where the juridical person is an unincorporated association or body of individuals.