Ananya Ahajoy & Param Kailash
Introduction & Background
The 2024 Economic Survey proposes that higher inflows of Foreign Direct Investments (FDI) from China through the ‘China plus one strategy’ could be advantageous to India. The strategy calls for the diversification of supply chains beyond China, thereby improving investment onto other low-cost nations such as India, Vietnam, et al. This inherently implies a revaluation of the existent scheme of approvals for investments by Chinese entities, regulated by the Press Note 3 (PN3).
The COVID-19 pandemic created fear that the vulnerability of the Indian markets would lead to opportunistic foreign takeovers and acquisitions. To prevent such takeovers and ‘killer acquisitions’ non-resident and foreign entities from the countries sharing borders with India, could only invest through investment routes set up by the Government. In light of this notion, the PN3 was released in 2020 to strengthen existent protection mechanisms for Indian companies and lays down significant restrictions for stakeholders residing in countries bordering India.
While PN3 does not explicitly define the expression ‘sharing land-border with India,’ it may be understood that investments from Afghanistan, Bhutan, Bangladesh, China (including Hong Kong and Macau), Myanmar, Nepal, and Pakistan, would trigger the special situation approval mechanism articulated via PN3. The resultant amendment to the FDI Policy, and Foreign Exchange Management (Non-debt Instruments) Rules 2019 (‘NDI Rules’) through PN3, has raised concerns on whether the protection mechanism has overstayed its welcome.
This post critically examines the prolonged stay of PN3 in India, with emphasis on navigating through the grey area of the term ‘beneficial ownership’, and issues surrounding transfer of ownership, along with key recommendations to facilitate ease of doing business for stakeholders involved.
Analysis
The PN3 has worked towards curbing strategic takeovers through mandatory declarations and has restricted foreign directorship of nationals and residents and existing directors from neighbouring countries in Indian companies. Yet, the lack of effective implementation has allowed for legal circumventions and loopholes. The partnership between Reliance Retail Ventures Ltd. and Shein did not require any FDI approval as Shein would not hold any equity in the newly established operations. Such a circumvention of the FDI policy presents the need for stronger policies in this regard. While the PN3 was implemented during the pandemic, as a protectionist policy, it continues to exist in 2025. If India were to take on joint venture proposals with Chinese companies such as Haier, and the China Highly Group, it is pertinent that ambiguities with regard to the PN3 are cleared.
The Enigma of ‘Beneficial Ownership’
The term ‘beneficial owner’ in the Companies Act, 2013, the Prevention of Money Laundering (Maintenance of Records) Rules, 2005 (‘Maintenance of Records Rules’) and the KYC Norms differ. However, the PN3 and NDI Rules do not define the threshold for identifying beneficial ownership.
A view on this ambiguity has been to adopt the definition of ‘significant beneficial owner’ from the Companies (Significant Beneficial Owners) Rules of 2018, read with the meaning offered in the Companies Act, making the beneficial owner an individual or an entity holding not less than 10% of the shares in an entity. Another view is to understand it in terms of the definition offered in the Maintenance of Records Rules, which states that a beneficial owner is an individual with 25% ownership of an entity or controlling ownership interest. Such a disparity creates ambiguity in comprehending who can be considered a beneficial owner.
Additionally, owing to the large number of limited partners and shareholders from neighbouring countries, complexities arise for Private Equity Funds and listed entities as such entities shall become subject to the special situation approval mechanism stipulated by the PN3.
Moreover, the Standard Operating Procedure for Processing Foreign Direct Investment Proposals (‘FDI Approval SOP’) does not define the term, although it governs PN3 approval applications as well.
Furthermore, the PN3 presents an approach that stands inconsistent with the Companies (Prospectus and Allotment of Securities) Amendment Rules 2022 (‘Allotment Rules’), which states that an Indian investee company cannot make an offer or invitation of securities to a body corporate that is a national of or was incorporated in a neighbouring country without prior approval from the Government of India under the NDI rules. The PN3 restricts investment routes to the immediate investor and any ultimate beneficial owner of the immediate investor. Such an implication is not mentioned by the Allotment Rules. The Allotment Rules apply only to investments made by an Indian company through a private placement, while the PN3 applies to all investments made into India by nationals or residents or companies in neighbouring countries, leading to a greater lack of clarity on the matter.
Finally, the term ‘subsequent change in the beneficial ownership’ implies that any changes regarding FDI, which results in any increase in the shareholdings of the beneficial owner from a neighbouring country, would additionally require approval from the government. However, this could imply a transfer of ownership by a foreign beneficial owner from the neighbouring countries, wherein beneficial ownership is not affected by the transfer, despite which approval from the government is required. In such a case, A, who is a foreign beneficial owner, would need government approval to make changes to FDI that could affect shareholdings, and for changes to FDI when beneficial ownership is not affected.
The Issue of Transfer
Section 2(ze) of the Foreign Exchange Management Act 1999, defines transfer as “sale, purchase, exchange, mortgage, pledge, gift, loan or any other form of transfer of right, title, possession or lien.” However, this term has not been defined specifically for the PN3. The applicability of this definition in the context of the PN3 would mean that pledges of shares that would result in any changes to beneficial ownership would require approval from the government, of which beneficial ownership is not well-defined, as substantiated above. However, the PN3 mandates government approval even if the beneficial owner is at the highest level of the transfer of shares and does not impact the immediate investor who has invested in the Indian entity.
For FDI originating from nations sharing borders with India, government authorisation is necessary if the beneficial owner is a resident or a citizen of such countries. However, ambiguity remains over investments from non-citizens who are residents or beneficial owners, impeding the flow of foreign investments.
Indirect transfer of ownership of existing FDI is regulated by the PN3. Illustratively, the transfer of shares owned by a foreign entity ‘X,’ which is not one of the countries sharing land boundaries with India to foreign entity ‘Y,’ in a land-bordering country would be regulated by the PN3. Such transfers, which do not affect the Indian entity directly and take place at an offshore level, must be exempted from the ambit of the PN3.
Procedural Delays
The FDI Approval SOP states that proposals shall be granted approval within 12 weeks, but several proposals remain in bureaucratic limbo for years. Since 2020, only 124 of 526 proposals have secured approval, with 200 applications languishing in the system, indicating the existent system’s proclivity towards neglecting needed change to address procedural inefficiencies and enhancing the efficacy of the stipulated timelines.
Recommendations
The palpable decline in foreign investment indicates the prevalence of an unwelcoming market environment for mergers and acquisitions, with the imposition of an unregulated government route causing significant administrative bottlenecks for investors to channel funds into the Indian Economy. In light of the same, implementing the following steps, if PN3 is still required to be kept enforceable, shall ease FDI inflow while also strengthening regulations surrounding the government route.
Introducing unencumbered thresholds on participation in barred countries for investment entities, to exclude those who have minuscule levels of participation as a beneficial owner in said countries shall serve crucial. The nature of such thresholds is similar to that of the de-minimis rule, thereby excluding players posing negligible or inconsequential risk to national security. The same ensures that entities holding sizeable investments in barred countries shall still come under the regulatory purview of the government, whereas other entities may be free to pursue the FDI route. Additionally, such an amendment would remain in alignment with the definitions provided for ultimate beneficial owners and the significant beneficial owner under the Companies Act and the Maintenance of Records Rules.
Moreover, the move from a geography-specific approach to a sector-specific approach can ensure key result areas of the economy, including sectors holding a key role towards the protection of national interest, are secured. Laying down firm thresholds in sectors crucial to national security such as Defence Technology, Space security et al, shall allow funds to be channeled onto other sectors, serving as a necessary amendment to the current system. The same must be accompanied by a time-bound method for approvals as set up by the FDI Approval SOP.
Conclusion
The computation of beneficial ownership cannot be ambiguous for investments structured over a myriad of jurisdictions. The PN3 must provide clear definitions and must form consonance with other laws, or it is redundant. Further, it must prescribe a threshold for beneficial ownership, as prescribed for the ultimate beneficial owner and the significant beneficial owner under the Companies Act, and the Maintenance of Records Rules.
In light of rising issues with regard to investments from neighbouring countries, it is quite important to review the PN3 in its entirety, as such FDI can aid the Indian economy. One approach is to uphold PN3, with key inclusions and definitions added in order to aid in navigation through the grey area of significant beneficial ownership for Investors. The other approach, calls for the complete revocation of PN3, with reliance placed solely on existent regulations to govern all form of investments. The commonality between the two approaches shall be that both call for more regulatory clarity, in comparison to the current framework.
The authors are 4th – year students of B.A. LL.B. (Hons.) at the Symbiosis Law School, Pune.
NUALS Law Journal 