Everything You Need to Know About Overseas Direct Investment

The growing economy of India led to more global expansion of Indian business. In this, overseas direct investment (ODI) plays a key role. It can be defined as the investment made by Indian entities in a foreign country. The overseas investments are regulated by the Foreign Exchange Management Act (FEMA), 1999. Further, for a growing economy like India, these dynamics are vital as they not only boost the economic growth of the nation but also, on the global stage, improve its presence.

Considering this, this blog aims to provide a comprehensive guide for investors, businesses, and policymakers on how overseas direct investment helps in enhancing their global footprint. Additionally, assist in the long-term economic growth of the country. So read on and gather all the information.

What is Overseas Direct Investment?

Overseas Direct Investment (ODI) refers to investments made by Indian businesses, companies, residents, or entities into a foreign country. In the ODI, Indian residents and companies can have their Wholly-Owned Subsidiary (WOS) or enter into a joint venture (JV) in a foreign nation. These investments are not like portfolio investments that are limited to passive shareholding. Considering this, ODI generally includes subscribing to equity capital, acquiring a control stake, providing guarantees to overseas entities, or extending loans.

Additionally, ODI is governed under the FEMA framework, and the guidelines are stated by the Reserve Bank of India (RBI). All capital account transactions associated with foreign exchange, including overseas investment is regulated by FEMA. The regulatory system ensures that remittances made outside the country are transparent, compliant, and fit with the macroeconomic stability objectives of India.

Further, overseas direct investment is not merely about capital deployment. It is a strategic mechanism for expansion. Businesses use it to acquire technology, access new markets, establish global footprints, and diversify income streams. Considering this, for Indian businesses, it has become an important instrument for globalization, specifically in sectors such as manufacturing, IT, pharmaceuticals, fintech, and renewable energy.

Moreover, let's know the benefits of ODI:

• ODI is made with the aim of an Indian entity to diversify its current business in a foreign country.
• For Indian entrepreneurs, ODI is considered a vital avenue for promoting global reach.
• It allows the transfer of technology, enables the sharing of skills, and results of R&D.
• ODI is used as a bridge to the global market and to improve the image of a company overseas.
• Through Indian exports, ODI is a vital tool for foreign trade. They are a source of foreign exchange income by way of royalty, dividends, technical know-how fess and other titles.

This was all about overseas direct investment (ODI). Moving ahead, let's know the regulatory framework for ODI.

Regulatory Framework for Overseas Direct Investment

The legal foundation of overseas direct investment (ODI) depends on:

• Foreign Exchange Management Act (FEMA),1999
• RBI circulars and master directions
• As amended, overseas investment rules and regulations
• Notifications issued by the Ministry of Finance

Additionally, you can achieve ODI through two routes:

Automatic Route

In this mode, an Indian company or business can invest overseas without approval from the RBI if the investments are made within 400% of the net worth of the entity. It applies to all overseas direct investment made by the entity, including guarantees and loans.

Under this investment route, investors, if they meet specific conditions stated by the RBI through an authorized dealer (AD) bank, can make financial commitments to WOS or JVs. Additionally, to report the investment details file Form ODI to its authorized dealer bank. Apart from this, to track the performance of the overseas investment, making an annual performance report (APR) is mandatory.

Further, this investment route is beneficial for businesses that are well-established in sectors like IT, automotive manufacturing, and pharmaceutical which frequently look for the global market.

Approval Route

If an overseas direct investment does not qualify under the automatic route, it comes under the approval route, where, before investment, approval from the RBI is necessary. Considering this, key scenarios where ODI RBI approval includes:

• According to the latest audited balance sheet, investments are more than 400% of the net worth of the Indian business.
• Investments in areas that are restricted under the automatic route, for instance, banking, real estate, and more.
• Investments made in countries stated as "non-cooperative" by the FATF or under sanctions levied by the government of India.
• Investments made by unregistered partnership firms and proprietorship concerns that need prior approval from the RBI.
• Investment in a foreign entity involved in currency swaps or non-deliverable derivative contracts.
• Closure or disinvestment of the foreign entity results in a write-off that is more than the permissible limits.

Further, to justify the need for approval, through the AD banks, entities need to submit a formal request. Based on the nature of the business, investment purpose, profitability, and impact of the foreign exchange reserve in the country, the RBI evaluates approval. Additionally, the RBI approves on a case-by-case basis, generally including business plans, scrutiny of financial information, and valuation reports for the investment.

This was all about the regulatory framework for overseas direct investment. Moving further, let's know about the eligibility and permissible investments.

Eligibility and Permissible Overseas Direct Investments

The following entities are eligible to make overseas direct investment:

• Companies incorporated in India
• Limited Liability Partnerships (LLPs)
• Partnership firms registered under the Indian Partnership Act, 1932
• Bodies created under an Act of Parliament
• Registered Trusts and Societies are stated under restricted conditions and with RBI approval

Financial Obligations

The total financial commitment, including loans, equity, and guarantees by an Indian entity in all its overseas WOS/ JV, should not be more than 400% of the net worth of the entity according to the last audited balance sheet. Additionally, remittances to ODI should be routed through the authorized dealer (AD) bank of India. It ensures that remittance follows the FEMA and ODI guidelines.

Forms of Investment

Permissible overseas direct investments of Indian entities are as follows:

• Equity investments
• Debt instruments
• Investment in startups
• Financial services
• Guarantees
• Investment by resident individuals

However, investments in certain sectors like gambling, real estate, or activities prohibited by Indian law are restricted. Further subject to the annual remittance ceiling, residents invited are eligible to invest under the Liberalised Remittance Scheme (LRS). It allows remittances up to USD 250,000 per financial year. In foreign companies, you can use it for both equity and debt investments.

So, this was all about the eligibility and permissible overseas direct investment. Moving ahead, let's know the process for making overseas direct investments.

Process for Making Overseas Direct Investment

The overseas direct investment process of India includes several steps that business entities need to follow. To help you out, below is a simplified flowchart that states key procedural requirements of ODI.

1. Step: Document Submission to Authorized Dealer (AD) Bank
   • Entities initiating ODI should submit the requested documents to the AD bank. These generally include the Form ODI, financial statements, board resolutions, and any other papers to support the proposed investment.
2. Step: Inspection by AD Bank
   • To ensure the proposed investment qualifies under the automatic route, the submitted documents are reviewed and verified by the AD Bank. It means it does not require approval from the RBI.
3. Step: Generation of Unique Identification Number (UIN)
   • When making the first financial transaction with a foreign entity, a UIN is generated. For all subsequent financial transactions associated with the same foreign enitty this UIN serves as a reference.
4. Step: Outward Remittance Processing
   • Once the UIN is issued, the AD Bank is able to process the outward remittance. It allows Indian entities to transfer their funds overseas.
5. Step: Reporting for Subsequent Transactions
   • Using the same UIN number, the Indian entity for future transactions should report these activities. This certifies consistency and regulatory monitoring of all associated investments.
6. Step: Fulfillment of Compliance Obligations
   • Indian individuals and entities should follow ongoing obligations. It includes the filing of the APR and submission of share certificates to maintain compliance with the RBI. 

These are the procedural requirements of overseas direct investment. Moving forward, let's review the compliance and reporting requirements for ODI. 

Compliance and Reporting Requirements of Overseas Direct Investment

Once an Indian business makes an overseas direct investment, to ensure regulatory compliance with Indian laws, specifically under FEMA and RBI guidelines, it should meet several obligations. Considering this, the key reporting requirements are:

• Filing out Form FC (Financial Commitment)
• Submitting Annual Performance Report (APR)
• Reporting of disinvestment, restructuring, or write-offs
• Disclosure of guarantees invoked

Further, APR helps in getting the financial details of the overseas entity. It includes turnover, net worth, and profit/ loss. This also ensures ongoing regulatory oversight. Additionally, failure to file timely reports results in:

• Paying late submission fees
• Restrictions on further remittances
• Compounding proceedings under FEMA

Entities should maintain documentary evidence. It includes the audited financial statements of the foreign entity, share certificates, and confirmation of bank remittance. 

Regulatory compliance is a continuing obligation, not a one-time event. Moving further, let's look at the tax and financial implications of overseas direct investment.

Taxation and Financial Implications

Indian entities are liable to pay tax on their global income. It means any income they earn through foreign investments, such as capital gains, dividends, or profit/ loss from foreign WOS/ JV, is taxable in India. The profits of the overseas entity are also liable to pay taxes in the host country. It further leads to double taxation, unless a Double Taxation Avoidance Agreement (DTAA) helps with it.

Dividends and Repatriated Earnings

Dividends received from a foreign subsidiary in the hands of the Indian entity are taxed as income. Further, under certain DTAAs, to avoid double taxation, you can set off the foreign withholding tax on dividends against their Indian tax obligations. Considering this, Indian entities under the Foreign Tax Credit (FTC) are allowed to credit paid taxes in the foreign country, reducing the tax burden in India.

Capital Gains Tax

Capital gains taxes are triggered by the sale of overseas shares or disinvestment. Considering this, if an Indian entity sells shares in a foreign WOS/ JV, it is applicable both in India and the host country, unless there is a DTAA agreement. 

Withholding Tax

Indian entities may need to withhold taxes on payments made to foreign businesses. It includes interest, royalty, or fees based on DTAA provisions. 

Transfer Pricing

Transactions made between the Indian parent company and its foreign JV and subsidiary should follow transfer pricing regulations. It ensures that, to avoid tax avoidance, the transactions are at arm’s length, i.e., market value. Further, to substantiate the pricing of cross-border transactions, it is vital to make detailed transfer pricing documents.

Moreover, with proper tax planning, you can make your overseas direct investment more effective. Now, moving ahead, let’s know about the disinvestment and repatriation of funds. 

Disinvestment and Repatriation of Funds

Indian investors holding overseas direct investment in foreign entities should ensure the repatriation of:

• Amounts received upon liquidation of a foreign business
• Any dues pending from the overseas company
• Proceeds from the transfer or sale of shares or disinvestment

Further, within 90 days from the due date, the disinvestment, transfer date, or the date when the assets were distributed by the liquidator, the funds should be realized and transferred to India.

Additional Considerations

For specific events such as disinvestment from ODI, changes in the shareholding structure, or transfer of shares in a foreign company, you should do appropriate reporting. Additionally, within the given timeline, submit to the AD Bank. 

In specific cases, depending on the RBI guidelines and nature of the investment, you do not need to submit an APR.

Further, if an Indian entity has a Step Down Subsidiary (SDS) abroad, it should follow the applicable provision stated under FEMA. It includes mandatory documentation and reporting as per regulatory requirements.

Final Thoughts

Lastly, overseas direct investment for resident Indians and entities is a powerful tool for strategic capital allocation and expanding their business globally. It helps Indian businesses to integrate into global value chains, diversify sources of revenue, and access advanced technologies.

Further, a well-structured overseas direct investment strategy helps in balancing investment growth with regulatory prudence. If you need any help in managing your finances and choosing the right investment type, connect with Savetaxs. Our financial experts will help you select the correct investment as per your financial goals and risk appetite.