Funding of Indian Subsidiaries – A FEMA perspective

Funding of Indian Subsidiaries – A FEMA perspective

Over the years since, 1991, foreign investment in India is on the rise and is a highly regulated field. Foreign businesses see India as a highly lucrative and ever-emerging market for growing their business operations across the globe. As Indian operations grow, foreign shareholders grapple with the best ways to finance these operations and repatriate some of the profits – partly due to the Indian regulatory system, which strictly regulates capital account transactions. This article examines some key ways of financing the Indian operations of foreign shareholders from a lens of Foreign Exchange Management Act, 1999 (‘FEMA’) regulations. But it will depend on the specific circumstances in each case to determine which option is best suited for a particular Indian subsidiary.

Categories of financing

The categories of financing routes can be broadly classified as under:

  1. Financing through equity instruments
  2. External Commercial borrowings / Non-convertible debentures
  3. Business arrangements

 1. Financing through equity instruments

  • Equity financing can be done in either of the three ways viz. issue of equity shares, issue of compulsorily convertible preference shares (‘CCPs’), or issue of compulsorily convertible debentures (‘CCDs’).
  • The shares can be issued under the above three methods by following the pricing guidelines formulated under the FEMA.
  • The issue of shares is restricted by the Foreign Direct Investment (‘FDI’) policy applicable to the respective type of business. Further, it is restricted by the entry route applicable to the foreign shareholder i.e. automatic route or RBI/government approval route.
  • Indian companies can freely issue equity shares subject to prescribed valuation norms and if the investment is in automatic route as per FDI policy. Initial investment in an Indian company can be done at face value. The valuation for further issue of equity shares will need to comply with the valuation guidelines prescribed under the FEMA regulations which are as follows:
  • For unlisted companies, the value of shares shall not be less than the fair value determined by a SEBI registered Category – I – Merchant Banker or a Chartered Accountant as per any internationally accepted methodology on arm’s length basis
  • Stamp duty to be paid on the value (including premium) at which shares are issued
  • The consideration for equity shares shall be paid by way of inward remittance through normal banking channels from abroad and the shares shall be issued within 60 days from the date of receipt of inward remittance.
  • Reporting requirements i.e. filing of Form FC-GPR (SMF) under the FEMA regulations needs to be complied with by Indian company.
  • No end-use restrictions apply on utilization of funds received by Indian company from issue of equity shares
  • In case of CCPs and CCDs, the pricing needs to be determined upfront based on the conversion formula which has to be fixed up-front, however, the price at the time of conversion should not be less than the fair value worked out, at the time of issuance of these CCPs / CCDs, in accordance with the FEMA regulations.
  • CCPS are required to be converted into equity shares within 20 years.
  • CCDs are required to be mandatorily converted into equity shares after a specified period of time in conformity with the terms of issue of CCDs.

2. External Commercial borrowings (‘ECB’) / Non-convertible debentures

  • ECBs refers to commercial loans including borrowings in the form of bank loans, buyers’ credit, suppliers’ credit; securitized instruments (e.g. floating rate notes and fixed rate bonds, non-convertible, optionally convertible or partially Preference shares and debentures) availed by permitted resident entities from recognized non-resident lenders.
  • ECB can be issued by the non-resident to Indian company with a Minimum Average Maturity Period (‘MAMP’) of 3 years. However, if ECB is raised from foreign equity holder and utilized for working capital purpose, general corporate purpose, then MAMP would be 5 years.
  • ECBs can be availed only by eligible borrowers from recognized lenders subject to end use restrictions. Other conditions in relation to maturity period, rate of interest, etc. Further, ECB can be raised either under automatic route or approval quote.
  • An eligible borrower is an entity eligible to receive FDI.
  • ECB can be raised up to USD 750 Million or equivalent during one financial year under the automatic route. Additional ECB can be raised through the approval route and would require RBI approval.
  • If ECB is raised (above USD 5 million or equivalent) through foreign equity investor, the equity-debt ratio of 1:7 is to be maintained by Indian company.
  • A recognized lender should be a resident of Financial Action Task Force (‘FATF’) or International Organisation of Securities Commission’s (‘IOSCO’) compliant country.
  • The reporting requirements for Indian company in order to raise fund under ECB framework are as follows:
  • Filing duly certified form ECB with the AD Category I Bank
  • Obtaining Loan Registration Number (‘LRN’)
  • Monthly reporting of actual ECB transaction through Form ECB 2 Return through AD Category I Bank
  • All in cost ceiling:
  • ECB with MAM of 3, 5 and 10 years – 6 months LIBOR + 500 basis points per annum or applicable benchmark for the respective currency.
  • Benchmark rate in case of Rupee denominated ECB (INR ECB) will be prevailing yield of the Government of India securities of corresponding maturity + 450 basis points per annum.
  • Penal interest, if any, for default or breach of covenants should not be more than 2% over and above the contracted rate of interest
  • End-use restrictions:

The negative list, for which the ECB proceeds cannot be utilized, would inter-alia include the following:

  • Real Estate Activities, investment in capital markets and domestic equity investment
  • Working capital purposes, general corporate purposes or for repayment of Rupee loans except (1) raised from Foreign Equity Holders for MAM of 5 years; and (2) from others raised for working capital purposes / general corporate purposes for MAM of 10 years
  • On-lending to entities for the above activities except by NBFCs


3.Business arrangements

  • In this case, the Indian companies shall receive the funds from their foreign shareholders by way of business arrangements whereby the Indian company agree to render services / goods to the foreign shareholder in exchange of funds.
  • The law does not stipulate a cap on funds received from a foreign shareholder as part of a service contract between the Indian subsidiary and the foreign shareholder. However, the same shall be subject to transfer pricing regulations under the Income-tax law.


MASD’s offerings

  • Assess overseas and domestic funding options available to your Indian subsidiary, and provide structuring support.
  • Provide tailored advice based on your requirements including sector of operations, quantum of funding, timeline and costs involved, tax implications, repatriation, exit considerations etc.



Karan Vakharia

Partner   |   Email:|   LinkedIn Profile

Nishika Acharya

Associate Consultant ||LinkedIn profile

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