Friday, April 1, 2011

Changes to FDI Policy – Part II: Shares Against Non-Cash Consideration

The FDI policy allows issue of shares by Indian companies to foreign investors only against cash remittances received through normal banking channels. However, the only exceptions to this are conversion of external commercial borrowings outstanding as well as payment obligations towards lump sum fee or royalty for technical collaborations. Any other type of transaction involving an issue of shares to foreign investors for consideration other than cash requires approval of the Government of India through the Foreign Investment Promotion Board (FIPB). Although the Government had been initially hesitant in granting approvals for such transactions, it has adopted a more liberal stance lately.
In this background, and in order to provide more investment options, the Government issued a discussion paper in September 2010 considering additional methods of issue of shares for consideration other than cash. These included: Import of Capital Goods/ Machinery/ Equipment, Services, Import of Raw Material/ Trade Payables, Pre-operative/ Pre-incorporation Expenses, Share Swaps,
Intangible Assets (including franchisee rights), and One Time Extraordinary Payments (including arbitration awards).
In the new policy that the Government announced yesterday, only the following additional methods have been accepted for issue of shares for consideration other than cash (para. 3.4.6 of the Policy):
(a) import of capital goods/ machinery/ equipment (including second-hand machinery);
(b) pre-operative/ pre-incorporation expenses (including payments of rent, etc.).
The policy also specifies requirements for valuation and verification of expenditure.
The benefits of this change are that it enables Indian companies to procure equipment and services from foreign enterprises (particularly collaborators) when they are either unable to pay cash, or when a cash transaction is not desirable from a financing standpoint. It allows payment by Indian companies through issue of its own shares. Such a method also ensures that suppliers and collaborators have an interest in the success of the Indian company’s business by taking a stake in it (and thereby assuming risk).
From a policy perspective, this change may not be viewed as all that material. This is because such issue of shares for the purposes described above continues to be under the approval route thereby requiring parties to make an application to the Government and obtain permission before carrying out the transaction. In that sense, the current policy merely perpetuates the previous one, with the exception that it lends some certainty to parties that if they issue shares for the above two reasons, that would be within the policy thereby increasing the likelihood of obtaining the approval.
Finally, the new policy has not expressly adopted the other methods described in the September 2010 discussion paper. Of these, shares swaps constitute an important component. In the context of increasing outbound acquisitions by Indian companies, it is necessary to allow the use of shares as currency for such acquisitions. The current policy for outbound acquisitions is therefore heavily loaded in favour of cash acquisitions, thereby limiting the structuring options for Indian acquirers. Although there appears to be no discussion as to the reasons why share swaps were not included, the subsequent rounds of policy review must give this the required attention.

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