The Department for Promotion of Industry & Internal Trade, Government of India (DPIIT) in April 2020, issued the Press Note 3 (PN3) to amend the FDI Policy of India with an intent to curb opportunistic takeovers / acquisitions of Indian companies.


The PN3 provided that an entity of a country sharing land border with India or where the beneficial owner of an investment is an entity of such country sharing border can invest only under Government route (i.e., with prior approval of Government of India). Further, in the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the aforesaid restriction, such subsequent change in beneficial ownership will also require Government approval.


Therefore, in any given case, whether a particular investment will trigger a prior PN3 Government approval, a two-fold assessment would need to be made – (i) whether the investing entity in India is organized or incorporated in any Land Bordering Country; and (ii) whether the ‘beneficial owner’ of investing entity in India is from any Land Bordering Country.


Land Bordering Countries


Although the PN3 or FDI Policy do not prescribe a list of countries sharing land border with India or define the expression ‘countries sharing land border with India’, since the notification of PN3, the position as to what all countries / jurisdictions are covered under PN3 Rules has now been crystallised. For the purposes of PN3, the following countries are regarded as country sharing land border with India – Pakistan, Afghanistan, China (including Hong Kong and Macau), Nepal, Bhutan, Bangladesh and Myanmar (Land Bordering Countries). Earlier, there was some ambiguity about the treatment of Taiwan for PN3 purposes. However, the position in this regard has been crystalized and Taiwan is not regarded as a Land Bordering Country for PN3 purposes. Accordingly, if the investor entity that is seeking to make an investment in India is situated / incorporated in any Land Bordering Country, a PN3 approval from Government of India will be required for such foreign investment.


Issue of ‘beneficial ownership’ under PN3


The FDI Policy, PN3 and Indian foreign exchange laws do not define the expression ‘beneficial owner’ and neither any guidance has been provided on any particular shareholding threshold that should be applied for assessing ‘beneficial owner’ for the purposes of PN3.


Ever since PN3 has been introduced, this lack of clarity has resulted in certain challenges for even those blue chip European and US based Private Equity/ Venture Capital (PE/VC) funds who may have miniscule participation and ownership at an indirect level from the investors/limited partners of Land Bordering Country. This is especially because in a typical PE/VC fund structure, no limited partner individually has any say in management or affairs of the overarching PE/VC fund and the over-all decision qua the investments remain in the hands of the ‘general partners’ (GPs) – who are not generally controlled by residents/citizens from Land Bordering Countries.


Now, given the absence of any definition/guidance in this regard and in view of settled principles of statutory interpretation, various legal practitioners in the market have applied the test/shareholding thresholds prescribed in other regulations.


In July 2020, the Government issued GFR Order which provided certain restrictions in context of bidders from Land Bordering Country. This GFR Order while defining ‘beneficial owner’ linked the concept of beneficial ownership to a threshold of 25% shares or capital or profits of the company. On the other hand, the Indian anti-money laundering laws define ‘beneficial owner’ by prescribing a threshold of 10% of the shares or capital or profits of the company. In the same vein, the KYC Directions issued by the Reserve Bank of India (“RBI”) also pegged the shareholding threshold while defining beneficial ownership to 10%. Similarly, the Indian company law also link the beneficial ownership threshold to 10%.


Therefore, with the only exception of GFR Order, all other notifications / rules- the anti-money laundering laws, RBI KYC Directions, Indian company laws are aligned on the threshold for determining the beneficial ownership (i.e. a 10% threshold). Accordingly, given the lack of clarity and specific guidance from the Government, thus far, various legal practitioners having been taking views that, the relevant threshold for determining beneficial ownership should be linked to a holding (directly or indirectly) 10% of the shares or capital, voting rights, or right to participate/receive dividends/distributions or profits of the company. Until now, the authorized dealer banks in India have also been generally processing FDI transactions in automatic route (i.e., without prior Government approval) by taking a declaration from foreign investor that ownership / shareholding interest from Land Bordering, on a look through basis, is less than 10%.


DPIIT FDI Approval SOP & its implications on determination of beneficial ownership under PN3


A few months back, in August 2023, the DPIIT amended its Standard Operating Procedure (SOP) for Processing Foreign Direct Investment (FDI) Proposals (FDI Approval SOP). The FDI Approval SOP generally governs how FDI approval applications are to be processed (including PN 3 approval applications) and also prescribes the documentation requirements for filing approval applications with the Government.


While in the latest round of amendments to FDI Approval SOP, the Government has still not defined the term ‘beneficial ownership’, some of these amendments have caused ambiguity and are likely to have bearing on how beneficial ownership is to be understood for PN3 purposes. In cases involving a PN3 approval, the Government is now seeking extensive information in respect of the concerned investor including inter alia – details of shareholders, directors, investment committee members, general partners, limited partners, key managerial personnel of all the upstream entities (till the ultimate beneficial owner) of the concerned investor.


On the other hand, with respect to those FDI approval applications which do not fall under purview of PN3 and instead requires approval on account of specific activities of Indian investee company, the FDI Approval SOP now requires an applicant to submit a very broad declaration stating that none of the investors/shareholders of the Indian investee company and the foreign investor(s) including their respective beneficial owners (having any percentage of shareholding) are situated in or are citizen(s) of Land Bordering Country. While the Government has not gone into defining ‘beneficial ownership’, the language of the instant declaration is ambiguous and this could also lead to multiple interpretations as to what is intended to be captured by virtue of this declaration.


This amendment is also significant especially considering that there are also some arguments in the market that since there is no precise definition from Government in context of PN 3, even a single share or contribution of single dollar from any Land Bordering Country at an indirect level could constitute beneficial ownership thereby requiring a PN3 approval.


The impact of these recent amendments in FDI Approval SOP (particularly, the wide scope of the declaration) remains to be seen and the intent behind such change by the Government would also need to be understood. If it is intended that even a single share/dollar from Land Bordering Country could trigger a PN 3 approval, several blue chip European and US based investors (particularly, private equity and venture capital funds as well as overseas listed companies) who may have miniscule participation and ownership at an indirect level from the investors/limited partners of Land Bordering Country (despite general partner/fund manager being from non-Land Bordering Country), could face challenges and difficulties when they are looking to make investments in India.