Foreign Venture Capital Investors in India – A Study Report by MUDS

Globalization has made the world shrink and easily accessible to everyone. None of the previous generations have had such opportunities, as we now have, to build a kind of economy that leaves no one behind. The field of trade and communication in our country is no different. It has led to a hike in the tide of offshore investments.

There has been an immense increment in the venture capital investments made by foreign countries in India. To encourage more of it, the government has also made favorable amendments in the rules to enhance effective trade relationships with foreign countries.

The foreign country investing in our country is referred to as Foreign Venture Capital Investors (FVCI). They invest in Indian Venture Capital Undertakings (VCU) and Venture Capital Funds under the regulation of the Foreign Exchange Management and the Securities Exchange Board of India (SEBI) regulations.

Foreign Venture Capital Investors

According to SEBI regulations, “Foreign Venture Capital Investors” can be as:

“An Investor of foreign incorporation or establishment registered under the FVCI regulations and investing in venture capital fund or venture capital undertakings in India.”

It is mandatory for a foreign investor to get itself registered with SEBI before it can invest in India.

Requirements for FVCI

There are three requirements that a foreign investor needs to satisfy before it can start making investments in the venture capital companies in India:

1. It should be incorporated or established in any country outside of India.
2. It should be registered with SEBI as a Foreign Venture Capital Investor.
3. It should work in accordance with SEBI regulations while making investments in VCFs or VCUs in India.
4. After registration with SEBI, further approval of RBI under FEMA regulations is required to make investments in India.

FVCI can be in the form of a company, a body corporate, or a trust.

Eligibility Criteria for FVCI Certificate from SEBI

For obtaining a certificate of recognition as FVCI from SEBI, a foreign investor has to satisfy certain eligibility criteria such as:

• The track record of the applicant
• The professional competence of the applicant
• Integrity and fairness of the applicant
• Its financial soundness
• Experience of market
• Necessary approvals from RBI, etc.

Once the SEBI is satisfied and assured that the applicant fulfills all conditions, it grants registration to the applicant as FVCI which allows him to make investments in the Indian market in accordance to the SEBI rules and regulations. However, SEBI can impose some terms and conditions upon the applicant which can limit its scope of investments in India.

Types of Investments by Foreign Investors

There are two types of investments that a foreign investor can engage in India:

Indian Venture Capital Undertaking (VCU)

VCU is a company incorporated in India but the shares are not listed on India’s recognized stock exchange. But the company should not be engaged in any activity specified under the negative list given by the SEBI. VCUs are generally a newborn private company that is still not established and needs funds, advice and support.

Venture Capital Fund (VCF)

VCF is a fund established as a trust or a company registered with the SEBI. It has a dedicated pool of capital and invests in accordance with the regulations.

A Foreign Venture Capital Investor that is registered with SEBI and has permission from RBI can make investments in both VCU or VCF. Investment can be made by purchasing equity, equity-linked instruments (instruments that are convertible into equity shares or share warrants like convertible preference shares or debentures), debt instruments or debentures.

Investment Limits

A Foreign Venture Capital Investor is permitted to make investments in the following manner:

• An FVCI can invest its 100% funds in a VCF registered under SEBI.
• It is mandatory for it to invest at least 66.67% of its funds in unlisted equity shares or equity-linked instruments of VCUs.

It can invest only 33.33% of the funds by:

• Subscribing to initial public offer of an adventure capital undertaking which has proposed listing for its shares.
• Investing in debt or debt instruments of VCU if it has already invested in the equity of such a VCU.
• Investment in equity shares of a listed company
• Investment in the equity of a financially weak listed company.
• Investment in special purpose vehicles.

In India, an FVCI has a fixed life cycle that has to be mandatorily be disclosed before making any investment. All the investment strategies are also needed to be disclosed prior to making any investments in India.

Obligations and Responsibilities of FVCI

The FVCI needs to follow some general obligations and responsibilities when investing in India. Some of them are:

• They need to maintain books of accounts, records, and documents for a period of eight years which gives a true and fair view of the state of affairs.
• The SEBI needs to be informed in writing about the place where the books, records, and documents will be maintained.
• The SEBI has the power to call for any information regarding any of its activities.
• The query of SEBI should be answered within the time specified by the board.
• The investor needs to enter into an agreement with a domestic custodian for the security of investments made by him.
• A non-resident rupee account or a foreign currency denominated accounts need to be opened in a bank approved by the RBI.

Top 3 Benefits for FVCI

FVCI enjoys some regulatory relaxations from SEBI and RBI if they register under the FVCI regulations (optional). Some of them are:

• Benefit #1: Exemption from the entry as well as the exit pricing norms.
• Benefit #2: Exemption from the lock-in period required when the company becomes public. In other words, FVCIs are allowed to exit the investment immediately after the investee company is listed.
• Benefit #3: Exemption from take-over code in respect of the shares sold by the FVCI to the promoters of the company after it has gone public. This code mandates acquirer to make an open offer on the acquisition of shares beyond prescribed threshold limits.

Procedure for Registration as FVCI

For registering with SEBI as an FVCI, the applicant needs to file an application through Form A and deposit the prescribed fees. In the form details of the sponsor should be filled along with its group, details of registration, website details, etc. Details of the custodian and the bank are also to be filled in. Copy of income tax return and the certificate of incorporation in the home country are to be submitted along with the form.

In addition, some supporting documents are also required:

• Contact details like name, address, email address, etc.
• Details of the directors
• Copy of the Articles of Association and Memorandum of Association
• Proof that any director is not restricted by SEBI
• Documents supporting registration with SEBI or any other regulatory body in India
• Declaration about work experience, educational qualifications, etc of the major players of FVCI
• Detailed investment plan
• Declaration on compliance with SEBI regulations 2000
• A Declaration to prove that you are a fit and proper person

Taxation on FVCI

According to the Income Tax Act, a non-resident assessee can choose to be taxed either under the Indian Income Tax Act or under the Double Taxation Avoidance Agreement(DTAA), whichever is more beneficial.

According to the Income Tax Act, even the non-residents are taxable for the income received or deemed to be received in India, accrued or deemed to be accrued in India or arisen in India. This includes income generated whether directly or indirectly in India from any business connection.

The taxability of FVCI is determined under Section 10 and Section 115U of the Income Tax Act. But both the sections have to be considered simultaneously. FVCI is given the status of a pass-through entity under the Act. The aim of these sections of the Act is to make companies’ taxes and venture capital funds exempt and to provide taxation of the income of the investors when distributed to them.

In simple words, the taxation scheme is to exempt the income while providing for taxation in the hands of the investors. The venture capital company or fund is not taxed on any income that is earned from these investments. But when this income is distributed, it becomes taxable in the hands of the investors.

But this status of “pass-through” for the purpose of the tax treatment of the income depends on the nature of the income. The income in the form of a dividend is tax-free in the hands of shareholders. But, it is subject to a dividend distribution tax of 16.99% that is payable by the company distributing the dividend. Else, a capital gain tax is charged when the shares of the investee companies are sold. Thus, there is no specific tax redemption for FVCI technically.

However, the benefits of DTAA can be availed by the FVCI. With the help of its favorable tax treaty, Mauritius has become the most popular country investing in India. The India-Mauritius DTAA exempts tax in India on the capital gains earned by a Mauritius resident. According to the treaty signed between both companies, when a Mauritius resident transfers an Indian capital asset, such gains are considered taxable only in Mauritius.

Mauritius does not impose any tax on capital gains, thus the taxpayer is in an overall beneficial position. Using treaties like these, many investors have chosen this route to make investments in India as the tax is only payable in their country of residence. According to the rule, if the taxpayer has legitimately reduced his tax liability by taking advantage of such a treaty, the benefit cannot be denied to him on the ground of revenue loss.

Advantages of Foreign Venture Capital Investments

FVCI is important in our country for the promotion of innovation and the conversion of scientific technology and knowledge into commercial production. The recent improvement that has been seen in the area of information technology itself speaks for the potential for growth in knowledge-based industries.

This potential is not limited to information technology but is also applicable to fields like biotechnology, pharmaceuticals, agriculture, drugs, food processing, services, telecommunication, etc.

India has inherent strength by the way of its technology, cost-competitive labor, skilled manpower, environment, and policy support. With funds, it can use these strengths to achieve greater heights in the world economy. Foreign investments can fill this gap between the capital requirements and the funds available from traditional lenders like banks.

Along with the finances, FVCI also brings smart advice, hands-on management support, and skills that help entrepreneurial visions that make up promising marketable products.

Sectors Allowed for Investments

Foreign Venture Capital Investors are allowed to invest in the following sectors:

• IT (Software and hardware)
• Biotechnology
• Nanotechnology
• Seed Research and Development
• Research in pharmaceuticals
• Dairy Industries
• Poultry Industries
• Production of Biofuel
• Hospitality
• Infrastructure

Exit Strategy

The exit strategy is the process through which a foreign venture capital investor gets out of an investment that has been made in the past.

An FVCI can acquire or sell its Indian shares, convertible debt, convertible debentures, convertible preference shares or any other investments at a price that is mutually acceptable to both parties.

This implies that there is no entry or exit price restriction applicable to the FVCI. This is a very important benefit for them when they intend to cash out of the investments.

Conclusion

Foreign Venture Capital Investment is a high-risk activity but the rewards are worth the risk. The investments made yield high returns. The investors do not involve themselves in everyday management and they are generally managed by professionals. The funds used for investments are for a limited life and returns are distributed among the investors.

The growth that India’s economy has seen in recent years and the scope it reflects for future growth have made it a harbor for world-class foreign investors. The change in government policies in favor of global investors, increasing urbanization and rising spending capacity of people in the country also invite foreign investments.

“The trading environment in India attracts the foreign venture capital investors and this will keep getting better in the times to come.”
– Shweta Gupta (CEO, Muds Management Pvt Ltd)