New definition on control to remove FDI loopholes

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Bangalore, India (prHWY.com) May 17, 2012 - THE government will make it tough for foreign firms to exercise control over Indian businesses through indirect arrangements by updating the ambiguous definition of "control" in foreign direct investment policy with the precise one used in the Companies Bill. Finance secretary Ashok Chawla has asked RP Singh, secretary at the Department of Industrial Policy and Promotion, to amend the definition of "control" in FDI guidelines.

"The DIPP would take necessary steps to amend the definition of control in Press Note 2 of 2009, subject to the receipt of written confirmation from the ministry of corporate affairs, on the specific formulation of "control", which has been proposed in the draft company's bill," Mr Chawla said in a letter to Mr. Singh.

While the DIPP is the nodal department for FDI policy, the finance secretary heads the Foreign Investment Promotion Board (FIPB), which vets investment proposals not falling within certain guidelines fixed by the government. The current foreign investment policy says any Indian company "owned or controlled" by a foreign company would be considered a foreign company.

While a more-than-50% equity holding was sufficient for establishing foreign ownership, control was defined as ability to appoint a majority of directors. This precluded other indirect ways of obtaining control such as lien over voting rights and equity purchase agreements -- a loophole used extensively by foreign investors to control Indian ventures without violating the sectoral caps. Such arrangements violated the FDI policy in spirit while paperwork was in order. "A number of companies that show foreign investment much below 50% have issued quasi-equity instruments with voting rights to foreign investors," said a government official dealing with FDI policy changes.

"This allows the investor to effectively exercise control over the entity indirectly," he said, requesting anonymity. The Companies Bill, which is under Parliament's Consideration, has a more comprehensive interpretation of control. Apart from the already mentioned right to appoint a majority of directors, the bill defines control to include the ability to influence management or policy decisions. The bill goes on to say that this ability to influence decisions could be by virtue of direct powers such as shareholding or management rights, or indirect ones such as shareholders agreements or voting agreements or in any other manner. Effectively, the new bill
Covers every possible way of exercising control. Company law experts say inclusion of the new definition of control will remove the loopholes in the FDI policy.

"The strengthening of definition of control will definitely check potential misuse of indirect foreign investment route in sensitive sectors," said Akash Gupt, executive director at consulting firm PwC. The finance ministry has been pitching for changes in the new FDI policy, unveiled in 2009, to remove loopholes and the inadvertent opening of prohibited sectors
to foreign investment through indirect investments. This move will hit companies that have marginally less than 50% foreign investment. If they have instruments that could be converted into equity in addition to their direct stake, they could easily be labeled as a foreign company.
All downstream investments of such companies could then become foreign investment, subjecting them to restrictions prescribed in the FDI policy.

Though the new FDI circular attempt to clear the ambiguity in this respect by including equity and convertible preference shares as part of capital, the possibility of control through other agreements remained. "A clarification in this regard may be issued in the form of an amended guideline on FDI," said the official. Mr. Gupt said this would reduce uncertainties and facilitate Indian promoters in raising foreign capital in sectors where the FDI caps are in force.

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