Key Takeaways:
Acquisition of JV/WOS by Indian parties
Approvals required for investment in JV/WOS by Indian parties
Understanding step-down subsidiary
Setting up step-down subsidiary outside India and reporting procedures involved
3. Legends Used in the Presentation
APR Annual Performance Report
AS Accounting Standards
CCPS Compulsorily Convertible Preference Shares
FATF Financial Action Task Force
FDI Foreign Direct Investment
JV Joint Venture
RBI Reserve Bank of India
SDS Step Down Subsidiary
WOS Wholly Owned Subsidiary
5. Introduction
Companies invest in overseas entities or set up foreign ventures mainly for ease of doing
business, to capture foreign markets and for a number of other reasons.
A person resident in India may enjoy foreign ownership through direct investment in
Joint Ventures or in Wholly Owned Subsidiaries or both.
RBI has notified FEM (Transfer or Issue of Foreign Security) Regulations, 2004 to deal
with such overseas direct investment.
The discussion that ensues will touch upon the criteria for setting up of JV/WOS and will be
concentric on the setting up of step down subsidiaries abroad.
6. Relevant Definitions
Wholly Owned Subsidiary
A foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country,
whose entire CAPITAL is held by the Indian party. [reg 2(q)]
Joint Venture
A foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country in
which the Indian party makes a direct investment; [reg 2(m)]
Joint Venture as per Accounting Standard 27 “Financial Reporting of Interests in Joint Ventures”
A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is
subject to joint control
Direct Investment
"Direct investment outside India" means investment by way of contribution to the CAPITAL or subscription to the
Memorandum of Association of a foreign entity or by way of purchase of existing shares of a foreign entity either by
market purchase or private placement or through stock exchange, but does not include portfolio investment. [reg 2(e)]
7. Caveats
The term ‘CAPITAL’ has not been defined in the regulation but in Clause B.12 ‘Restructuring of the balance sheet of
the overseas entity involving write off of capital and Receivables’, the term Capital (Equity / Preference Shares) has
been used. Therefore, it can inferred as capital includes both Equity and Preference share capital.
Difference between JV and WOS
• A foreign entity is termed as JV of the Indian Party/Resident Indian when there are other foreign promoters
holding the stake along with the Indian Party
• In case of WOS, entire capital is held by the one or more Indian Party/Resident Indian
Difference between definition of JV as per FEMA and definition of JV as per Accounting Standard 27 “Financial
Reporting of Interests in Joint Venture”
• As per the definition JV in FEMA, there is no need for control of the JV by the Indian Party, Direct investment in
JV is sufficient for the entity to become JV.
• Whereas, as per AS 27, a JV is a contractual agreement between two or more parties and such contractual
agreement establishes Joint Control.
• Therefore, in JV as per FEMA control is not mandatory but JV as per AS 27 control is mandatory
8. Meaning of Indian Party [reg 2(k)]
"Indian
party"
means
a company
incorporated
in India or a
body created
under an Act
of Parliament
or
a
partnership
firm
registered
under the
Indian
Partnership
Act or
a Limited
Liability
Partnership
(LLP)
registered
under the
LLP Act
making
investment
in a JV or
WOS abroad
and
includes any
other entity
in India as
may be
notified by
the Reserve
Bank
The definition of Wholly Owned Subsidiary (WOS) and Joint Venture (JV) does not include the investment
made by an Indian Resident.
To clarify this, RBI has made a comment in one of its FAQs that “Joint Venture (JV)/ Wholly Owned
Subsidiary (WOS) means a foreign entity formed, registered or incorporated in accordance with the laws
and regulations of the host country in which the Indian party or Resident Indian makes a direct
investment;”
10. Setting up JV/WOS
Setting up
JV/WOS
By Indian Party
Automatic Route Approval Route
By Resident
Individual
Automatic Route Approval Route
11. Automatic Route and Approval Route
Automatic Route
• Under the Automatic Route, an Indian Party does not require any prior approval from the Reserve
Bank for making overseas direct investments in a JV/WOS abroad.
• Indian Party should approach an Authorized Dealer Category – I bank with an application in Form ODI
and prescribed enclosures / documents for effecting the remittances towards such investments.
Approval Route
• Proposals not covered by the conditions under the automatic route require prior approval of the
Reserve Bank.
• For this purpose, a specific application in Part I of Form ODI with the documents prescribed therein is
required to be made through an Authorized Dealer Category – I bank.
A JV/WOS can be set up under the automatic route or, if eligibility criteria are not met, under the
approval route.
12. Acquisition or Setting up JV/WOS by Indian Parties
through Automatic Route- Regulation 6
Indian Party may make direct investment in a JV/WOS outside India, if it satisfies the following conditions specified in
regulation 6(2) of FEM (Transfer or Issue of Any Foreign Security) Regulations:
Financial commitment of the Indian Party in JV/WOS <= 400% of the net worth of the Indian Party as on the date of
the last audited balance sheet.
Financial commitment* is the aggregate of the amount of direct investment by way of contribution to equity or
preference shares or CCPS, loans and 100% of the amount of guarantees and 50% of the performance guarantees
issued by an Indian party to or on behalf of its overseas JV/WOS;
The direct investment is made in an overseas JV or WOS engaged in a bona fide business activity.
The Indian Party is not on the RBI's Exporters caution list/list of defaulters to the banking system circulated by the
RBI/CIBIL or under investigation by any investigation/enforcement agency or regulatory body.
All transactions relating to the investment in a JV/WOS are routed through only one branch of an authorised dealer.
Investment is not made in an overseas entity [set up or acquired abroad directly as JV/WOS or indirectly as Step Down
Subsidiary) located in the countries identified by the Financial Action Task Force (FATF) as "non co-operative countries
and territories“.
13. Contd…
i. has earned net profit during the preceding three financial years from the financial services activities;
ii. is registered with the appropriate regulatory authority in India for conducting financial services activities;
iii. has obtained approval for undertaking such activities from the regulatory authorities concerned both in India
and abroad before venturing into such financial activity;
iv. has fulfilled the prudential norms relating to capital adequacy (For example, banks should have sufficient capital to
provide a stable resource to absorb any losses arising from the risks in its business) as prescribed by the regulatory
authority concerned in India; and
Eligibility Norms for Direct Investment in Financial Services Sector through Automatic Route
Only an Indian company engaged in financial services sector activities can make investment in a JV/WOS abroad in
the financial services sector, provided it fulfills the following additional conditions specified in regulation 7 of the said
regulations:
Any additional investment by an existing JV/WOS or its STEP DOWN SUBSIDIARY in the Financial Services Sector shall
be made only after complying with the above conditions.
According to FEM (Transfer or Issue of Security by a Person Resident outside India ) Regulations,2005
Financial Services shall mean service rendered by banking and non-banking companies regulated by the Reserve
Bank, insurance companies regulated by Insurance Regulatory and Development Authority (IRDA) and other
companies regulated by any other financial regulator, as the case may be.
14. Acquisition or Setting up of JV/WOS by Indian
Parties through Approval Route
Foreign entity with Indian investment issuing Indian rupee linked derivatives
Financial commitment without equity contribution in JV/WOS provided it is as per the business
requirement of the Indian party and also as per the legal requirement of the host country.
Any financial commitment i.e. equity, loan or guarantee exceeding USD 1 billion (or its equivalent) in a
financial year
Investment in foreign entity engaged in real estate (Buying & Selling of real estate and Transferable
Development Rights. However, development of townships, construction of buildings, bridges &
roads are permitted under automatic route
Investment by proprietorship concerns and unregistered partnership firms
Investment by Registered Trusts / Societies (satisfying certain eligibility criteria) engaged in the
manufacturing / educational / hospital sector in the same sector in a JV / WOS outside India;
Investment by Indian Party which does not satisfy the eligibility norms under Regulation 6 (general
eligibility) or regulation 7 (additional conditions for financial services sector).
Prior Approval from RBI has to be acquired for the following transactions undertaken by Indian Party:
15. Acquisition or Setting up JV/WOS by Resident
Individuals through Automatic Route
Indian party may make direct investment in a JV/WOS outside India, if it satisfies the following conditions specified in
Schedule V of FEM (Transfer or Issue of Any Foreign Security) Regulations:
Investment is not in a JV or WOS abroad which is engaged in the real estate business or banking business or in the
business of financial services activity. The same is prohibited.
The resident individual shall not be on the RBI's Exporters Caution List or List of defaulters
Investment shall not be in entities located in the countries identified by the FATF as "non-co-operative countries
and territories" (North Korea and Iran) or as notified by the Reserve Bank.
At the time of investments, the permissible ceiling shall be within the overall ceiling prescribed for the resident
individual under Liberalised Remittance Scheme. Currently the LRS limit is USD 250,000. Investment made out of
EEFC and RFC shall not be considered for the purpose of this limit
The JV or WOS acquired/set up shall be an operating entity only and no step down subsidiary is allowed to be
acquired or set up by the JV or WOS.
Resident individual shall only make direct investment in JV or WOS and any other financial commitment with the
JV/WOS is prohibited. However, indirect resident individual promoters of the Indian party may issue personal
guarantee on behalf of the overseas JV / WOS of the Indian party
Any investment in JV or WOS by resident individuals which is not satisfying the conditions prescribed above, shall
require prior approval from RBI.
16. Factors for Approval of ODI by RBI
Expertise and experience of the Indian Party in the same or related line of activity as of the
JV / WOS outside India.
Financial position and business track record of the Indian Party and the foreign entity; and
Contribution to external trade and other benefits which will accrue to India through such
investment (or financial commitment);
Prima facie viability of the JV / WOS outside India;
According to FEM (Transfer or Issue of any Foreign Security) Regulation, Reserve Bank would, inter
alia, take into account the following factors while considering such applications:
18. Step Down Subsidiary- Meaning
It is imperative to note that the term “step down subsidiary” has not been defined in any of
the Indian Statues.
In general parlance, step down subsidiary means the subsidiary of another subsidiary
company. This view is also supported by judicial precedents.
A Ltd B Ltd C LtdSubsidiary
of B Ltd
Subsidiary
of A Ltd
“Subsidiary Company" or “Subsidiary” – Sec 2(87) of The Companies Act, 201
Subsidiary Company means a company in which the holding company
(i) controls the composition of the Board of Directors; or
(ii) exercises or controls more than one-half of the total voting power either at its own or together
with one or more of its subsidiary companies
19. Judicial Precedents
As per explanation to section 2(87) of Companies Act 2013, a company shall be deemed to be a subsidiary
company of the holding company even if the control is of another subsidiary company of the holding
company;
In the case of “Emami Infrastructure Ltd. vs ITO”, since the term “subsidiary” has not been defined in Income
Tax Act, the above explanation was imported, to hold that “a step down subsidiary i.e. subsidiary of another
subsidiary company will also be considered as subsidiary of the holding company”
A similar view was taken in cases such as “Kalindi Investments (P.) Ltd. v. CIT ” and “Petrosil Oil Co.Ltd. v. CIT”
where it was implicitly held that a step down subsidiary would mean the subsidiary of another subsidiary
company of the holding company.
20. Calculating the Level of SDS
Level of SDS should be calculated treating the JV/ WOS as the parent entity.
An SDS under the direct JV/ WOS should be treated as first level SDS. Accordingly an SDS under the first
level SDS would be treated as second level SDS.
A Ltd (Indian
Party)
B Ltd (Joint
Venture 30%
stake held by
A Ltd)
C Ltd (wholly owned
step down subsidiary
of B Ltd )
In the above case, C Ltd will be the first level step down subsidiary.
21. Limit for SDS
As per rule 2 of Companies (Restriction on number of layers) Rules, 2017, no company, other than
companies belonging to a specified class shall have more than two layers of subsidiaries. Similar
restriction on number of layers is already in force under Section 186 (1) “Loans and Investment” of the
Companies Act, 2013
However proviso to the rule states that the rule shall not affect a company from acquiring a company
incorporated outside India with subsidiaries beyond two layers as per the laws of such country.
Therefore the number of layers of subsidiaries is subject to the relevant laws of the host country.
22. Setting up SDS
Setting up Step
Down Subsidiary
By Indian Party
Automatic Route Approval Route
By Resident
Indian
Approval Route
23. Setting up SDS Abroad by JV/WOS of
Indian Party
The eligibility norms specified in regulation 6 that
are applicable for direct investment in JV/WOS will
however apply for direct investment by Indian
Party in Step Down Subsidiary abroad.
There are no conditions that are to be satisfied for
setting up or acquiring a step down subsidiary by a
JV/WOS unlike in the case of Indian Party for
setting up JV/WOS.
General permission has been given under
regulation 13 of said regulations for a JV/WOS set
up by the Indian party to set up step down
subsidiary or to diversify its activities/shareholding
pattern.
Automatic Route
Direct Investment in Step Down Subsidiary which does not
satisfy the conditions prescribed in regulation 6.
Corporate guarantee issued by the Indian Party to second
and subsequent level of Step Down Subsidiary (SDS).
Proposal would be considered only where the Indian Party
holds indirectly at least 51% stake in such subsidiary.
Following transactions between the Indian Party and Step
down subsidiary require prior approval from RBI:
Approval Route
24. Step Down Subsidiary for Individuals
A Ltd B Ltd
Subsidiary
of A Ltd
Mr. X
(Resident Indian)
WOS
Step Down Subsidiary of Mr. X
RBI has clarified in FAQs on Overseas Direct Investments that Wholly Owned Subsidiary (WOS) means a
foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host
country in which the Indian party or Resident Indian makes a direct investment
In the above example Mr. X, a resident Indian makes a direct investment in A Ltd.
Therefore, A Ltd will be the WOS of Mr. X
Further, when A Ltd sets up a subsidiary company B Ltd, it will become the step down subsidiary of Mr. X
25. Setting up SDS Abroad by JV/ WOS of Resident
Individuals
No specific form has been specified for resident individuals by RBI for obtaining prior approval for this
purpose. Therefore, a covering letter with relevant enclosures has to be submitted to RBI through the
Authorised Dealer Bank along with Part I of Form ODI.
Since, it is not prohibited for individuals to invest in sub subsidiary, it is inferred that it can be done
under approval route.
As per Schedule V of the said regulations the JV or WOS, to be acquired/set up by a resident individual
under this Schedule, shall be an operating entity only and no step down subsidiary is allowed to be
acquired or set up by the JV or WOS.
Approval Route
26. Automatic Route - Illustration
A Ltd
Indian Party
B Ltd
Indian Party
D Ltd
(WOS)
C Ltd
Indian Party
E Ltd
Subsidiary
51% in Equity
/ Control
27. Approval Route – Illustration 1
E Ltd
(JV)
B Ltd
Indian
Party
C Ltd
Indian
Resident
D Ltd
Foreign
Promoter
A Ltd
Indian
Party
E Ltd
(JV)
F Ltd
Subsidiary
28. Illustration 2
Mr. X
Indian
Resident
A Ltd
(WOS)
B Ltd
(Subsidiary)
Illustration 3
A Ltd
Indian Party
B Ltd
Indian Party
C Ltd
(WOS)
Special
Purpose
Vehicle
29. Reporting Procedures for setting up a Step
Down Subsidiary
The Indian Party/ Resident Individual has to include the details of such step down subsidiary in its
Annual Performance Report to be forwarded annually to RBI by 31st December
The details of decisions taken by JV/WOS to set up step down subsidiary has to be reported to RBI in
Section B of Form ODI within 30 days of the approval of those decisions by the competent authority
(BOD, shareholders etc.) in terms of local laws of the host country. [However this conditions is not
applicable to resident individuals.]
