Key Takeaways: - Regulations governing the issue of instruments. - Reporting procedures - Case Studies

1. Issue of Shares Against Import of
Capital Goods: FEMA Perspective
CA Jugal Gala

2. Credits & Acknowledgements
R Subash

3. Legends Used in the Presentation
CCPS Compulsorily Convertible Preference Shares
Form DI Form Downstream Investment
DPIIT Department for Promotion of Industry and Internal Trade
ECB External Commercial Borrowing
FDI Foreign Direct Investment
FEMA Foreign Exchange Management Act, 2000
PROI Persons Resident Outside India

4. Presentation Schema
Introduction Relevant Rules for Issue
Conditions for Issue of
Equity Instruments Against
Import of Capital Goods
Timing and Reporting of
Issue
Case Studies

5. Regulations and Reporting
Requirements

6. Introduction
“Import of goods” in its basic form, means bringing goods into India from a place outside India.
Consideration for import may be in the form of cash or kind (shares, goods etc.).
Whenever goods are imported, the regulations issued under FEMA are to be taken into consideration.
FEM (Non-debt instrument) Rules 2019 regulates issue of equity instruments to persons resident
outside India (PROI). As per the rules, equity instruments means equity shares, convertible
debentures, preference shares and share warrants issued by an Indian company.
The rules prescribe the entry routes, sectoral caps and pricing guidelines for issue of the above said
equity instruments to PROI.

7. Relevant Rules for Issue
Schedule I of FEM (Non-Debt Instrument) Rules,
2019 deals with issue of equity instrument to PROI.
Automatic Route
• The entry route through which investment by a person
resident outside India does not require the prior
approval of the Reserve Bank or the Central
Government;
Government Route
• The entry route through which investment by a person
resident outside India requires prior Government
approval and foreign investment received under this
route shall be in accordance with the conditions
stipulated by the Government in its approval.
• For obtaining approval from Government, application has
to be submitted via Foreign Investment Facilitation Portal
(https://fifp.gov.in/Forms/SOP.pdf) along with the
requisite documents.
As per para 1(d) of Schedule I:
An Indian company may issue equity
instruments to a person resident outside
India, if the Indian investee company is
engaged in an automatic route sector,
against import of capital goods or
machinery or equipment (excluding second
hand machinery).
Government approval shall be obtained if
the Indian investee company is engaged in a
sector under Government route.

8. Conditions for Issue of Equity Instruments Against
Import of Capital Goods
The import of capital goods, machineries, etc., made is in accordance with the Foreign Trade Policy notified
by the Directorate General of Foreign Trade (DGFT)
There is an independent valuation of the capital goods by a third party entity, preferably an independent
valuer from the country of import along with production of copies of documents/ certificates issued by the
customs authorities towards assessment of the fair-value of such imports;
The equity instruments issued by listed Company shall be valued in accordance with SEBI guidelines and in
case of an unlisted company it shall be valued by a Chartered Accountant or Merchant Banker registered
with SEBI or Cost Accountant.
• The application should be accompanied by documents evidencing the valuation of capital goods
and a special resolution of the company for issuing capital instruments;
• The application should clearly indicate the beneficial ownership and identity of the importer
company as well as the overseas entity; and
• Applications for capitalization (of import payables) should be submitted within 180 days from the
date of shipment of goods.
In case of applications submitted for Government approval:
As per RBI’s Master Direction on Foreign Investment in India, the following conditions
have to be satisfied for issuing equity instruments against import of capital goods

9. Timing and Reporting of Issue
The equity instruments have to be issued within 180 days from the date of shipment of capital goods/
machinery/ equipment etc.
The reporting shall be made in Form FC-GPR along with relevant attachments within 30 days from the
date of issue .

10. Practical Case Studies

11. Case Study 1- Breach of Sectoral Cap
ABC Pvt. Ltd is a Telecom Infrastructure Provider in India. NAC Ltd in UK has invested in the CCPS of ABC
Pvt Ltd in such a manner that it holds 49% in ABC Pvt Ltd on a fully diluted basis.
The sectoral cap applicable for foreign investment in Telecom services is as follows:
Sectoral Cap Route
Upto 49% Automatic Route
Beyond 49% Approval Route
ABC Pvt Ltd imported capital goods from NAC Ltd worth USD 10 Mn. The consideration was agreed to
be settled in equity shares of ABC Pvt Ltd.
The shares, if issued, would result in NAC Ltd holding an additional 10% stake in ABC Pvt Ltd.
Therefore for the purpose of this arrangement, government approval has to be sought by ABC Pvt Ltd
for issuing shares to NAC ltd.

12. Case Study 2 - Conversion of ECB
• Company A Pvt Ltd in India, engaged in “Mining activity” is a subsidiary (not wholly owned subsidiary) of B
Inc in USA. A imported capital goods from Zambia for which the consideration was paid by B.
• The consideration paid by B shall be considered as deemed ECB by A as per regulations relating to ECB. B
has agreed to convert the same into equity on A’s request. A needs to know the following:
• Whether the conversion of debt to equity would result in foreign investment by B in A
• Compliance requirements arising from this arrangement under FEMA.
As per Rule 23(3)(a)- “any equity holding by a person resident outside India resulting from
conversion of any debt instrument under any arrangement shall be reckoned for total foreign
investment”
Since the conversion results in increase of B’s equity holding in A, the conversion qualifies as
foreign investment by B in A.

13. As per the extant provisions of ECB Framework and FEM
(Non-Debt) Instrument Rules, the following are the
compliance procedures for such an arrangement
Approval has to be obtained from Government if the foreign investment resulting from conversion is in the
government route. Since, 100% FDI is allowed in automatic route to Mining activities, this condition is
satisfied. (If the sector had cap less than 100% say 49% and after conversion, the shareholding exceeds 49%,
then approval from Government would have been required)
Since this type of borrowing is not covered under the general parameter of ECB framework, A has to obtain
approval from RBI in Form ECB submitted through its AD Bank.
The conversion should be with the lender’s consent and should not result in contravention of applicable sector
cap on the foreign equity holding under FDI policy; As mentioned, the conversion of ECB is requested by A and
100% FDI is allowed in “Mining”.
A has to comply with the applicable pricing guidelines and
Reporting is to be made in Form FC-GPR for such conversion.
Contd

14. Case Study 3 - Downstream Investment
• Company A and Company B are Indian companies engaged in “Pharmaceuticals” industry with Mr. X as the common
director (resident Indian). Both the companies have foreign investment from US company C.
• C has 74% equity holding in Company B and it holds 51% of the equity stake in Company A
• The maximum limit allowed under automatic route in this sector (where Company A and B operate) is 74%
• A is in need of AI machineries for the purpose of sorting goods in its warehouses according to various parameters. For this
purpose, it imported machineries worth USD 100 Mn from company D in UK. The consideration for such import was paid by
B.
• The amount payable by A to B was agreed to be settled in equity instruments. Settlement of this type would result in B
holding 30% stake in A.
Even though the shares are issued only to a resident Indian company, the concept of indirect foreign investment
has to be considered.
A company which has received indirect foreign investment shall also comply with entry route, sectoral cap, pricing
guidelines and other conditions.
“Indirect foreign investment” means downstream investment received by an Indian entity from,- (A) another
Indian entity (IE) which has received foreign investment and (i) the IE is not owned and not controlled by
resident Indian citizens or (ii) is owned or controlled by persons resident outside India; or
(B) an investment vehicle whose sponsor or manager or investment manager (i) is not owned and not controlled
by resident Indian citizens or (ii) is owned or controlled by persons resident outside India

15. Company A
Company C (USA)
Company B
Company D (UK)
74% foreign investment
Import of AI machineries
Settlement of import dues
of Company A.
Issue of shares (30%)
Indirect foreign
investment (30%)
51% foreign investment
If the settlement is made through equity shares of Company A, total foreign investment i.e. (direct + indirect) in
Company A would be 81% (51% from C+ 30% from B) which is more than the sectoral cap of 74% allowed under
automatic route.
Contd

16. Contd
Following are the compliance procedures to be followed by B and A to make good this
arrangement
Since, the issue of shares to B would result in breach of sectoral cap, approval from Government is required for
such an issue.
As per Rule 23(6) of Non-Debt Instrument Rules,
• The first level Indian Company i.e. B shall be responsible for ensuring compliance with the provisions of
these rules for the downstream investment made by it at second level and so on. Therefore B has to seek
approval from Government for making downstream investment.
• B shall also obtain a certificate to this effect from its statutory auditor on an annual basis and such
compliance of these rules shall be mentioned in the Director’s report in the Annual Report.
As per Rule 23(4) of Non-Debt Instrument Rules,
• the Indian entity making the downstream investment (i.e B) shall bring in requisite funds from abroad. In
the present case since there is no remittance involved, such shortfall should also be mentioned in the
application for approval.
• Board Resolution should also be passed by A for receiving the downstream investment from B.
As per para 4(11) of FEM (Mode of Payment and Reporting) Regulations, 2019, B has to inform the Secretariat
for Industrial Assistance , DPIIT within 30 days of such investment. B shall also file Form DI in FIRMS portal
within 30 days from the date of allotment of equity instruments.
Note: Filing of Form FC-GPR would not be applicable as the issue of shares are to Company B, an Indian Company, even
though there is indirect increase in foreign investment

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