Convertible notes may get FDI tag

NEW DELHI: The finance ministry wants to tighten the definition of foreign investments to include instruments that carry potential voting rights, such as convertible debentures, but some experts say the rule may be cumbersome.

This could be worrying for companies that have marginally less than 50% foreign investments and have such convertibles on their balance sheet, for they could be labelled a foreign company if the overseas stake in them crosses 50% after including these instruments.

“There is a need to fine-tune the definition of control so that there is more clarity on the issue. The government needs to look at issues of potential voting rights and instruments that give this option to investors,” said a government official.

The new FDI policy classifies a company as Indian if it has less than 50% foreign investment and the majority of directors on the company’s board are resident Indians.

A number of companies have less than 50% foreign investment but have issued quasi-equity instruments such as convertible debentures with voting rights to foreign investors, allowing investor to effectively exercise control over the entity.

“This should reflect when ownership or control is established in a company,” the official said.
PwC associate director Goldie Dhama agrees with the logic of the rule. “ The government has issued a policy that downstream investment by an Indian-owned-and-controlled company should not be seen as foreign direct investment. Hence, as a principle, a company should in letter and spirit also qualify as an Indian-owned-and-controlled company.”

But others feel it may be difficult to operationalise the rule. “It would be very difficult to compute such a percentage if the conversion ratio is dependent upon any future event or contingency,” said Punit Shah, executive director, KPMG.

A company that is classified as a foreign one faces many restrictions under the new FDI policy. All investments by such a company in a subsidiary or joint venture is counted as foreign investment.

This limits ability of foreign companies from investing in sectors that are closed to foreign investments such as multi-brand retail or sectors that have low limits on foreign investments.

The new FDI circular has attempted to clear the ambiguity in this respect including convertible preference shares issued to overseas investors while calculating foreign investment in a company, but the finance ministry is still pushing for more clarity on the issue.

The ministry has also proposed stringent norms for companies having foreign investment of less than 50%. Such companies will be required to take an approval from the Foreign Investment Promotion Board to invest in a sector with cap on FDI, he said. A clarification in this regard may be issued as an amended guideline on FDI in the form of Press Notes.