NEW DELHI : Several foreign-owned or controlled companies (FOCCs) are under the Reserve Bank of India’s (RBI) scrutiny for alleged violation of foreign exchange rules, two people privy to the development said.
The companies have received notices from the regulator inquiring whether they would want to settle the case, the people said on condition of anonymity. If firms don’t settle the case, RBI can pass orders.
In some of these transactions, RBI observed that the investment was made in tranches. According to India’s foreign exchange rules, all share purchases by FOCCs must be made upfront.
The development assumes significance as FOCCs generally invest in the startup sector, where there is often uncertainty over a company’s performance. Hence, investors tend to stagger the total consideration payment depending on fulfilling various targets.
FOCCs are normally India-incorporated firms that are subsidiaries of a foreign company where non-residents exercise control. These are generally large multinational companies that open Indian subsidiaries to handle local business.
An email sent to RBI remained unanswered.
In one such notice reviewed by Mint, the central bank observed that the firm paid the money in two tranches.
“There appears to be a deferment of the consideration amount, which is not in accordance with the guidelines permitted for downstream investments,” said the four-page memorandum for compounding sent by RBI. “In terms of Section 15 of the Foreign Exchange Management Act 1999(FEMA), any contravention under Section 13, on an application made by the person committing such contravention, be compounded as referred to in the said section.”
Compounding is a process through which an entity in contravention of rules can pay a fee and settle the matter with RBI. “Unlike the upfront share purchases that individual investors make, most of the institutional acquisitions in private markets happen in a staggered manner where 20-30% of the deal consideration is paid upfront, and the rest is paid after a specific period of time,” said a person cited above. “This shields the investors from any drastic swings in the valuation of the company, and investors also want to gain some comfort before shelling out the total consideration.”
The person added not just foreign companies even domestic companies, private equity funds and angel investors commonly make such staggered payments for share acquisitions. However, the current rules put FOCCs at a disadvantage to domestic firms or even foreign firms.
“Foreign companies can make staggered payments, but if they have incorporated a subsidiary in India (which becomes FOCC), they are not allowed to make staggered payments,” said the second person. “This anomaly would discourage foreign companies from incorporating subsidiaries in India that would undertake share purchase activities. Instead, they would just invest from their own country into India through the foreign direct investment (FDI) route.”
Several foreign firms, especially the early entrants into India, have such subsidiaries. In the 1970s and 1980s, any foreign firm wanting to do business in India was required to float an Indian unit. In fact, during the time, it was also mandatory for such subsidiaries to list on Indian exchanges.
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Updated: 05 Sep 2023, 11:58 PM IST
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