The Reserve Bank of India (RBI) has introduced a new framework that allows Foreign Portfolio Investors (FPIs) to convert their investments into Foreign Direct Investment (FDI) if their holdings exceed the 10% equity threshold in Indian companies. This move is designed to streamline the process, making it easier for FPIs to align with FDI guidelines, provided they have the necessary government and company approvals. The new rules, effective from November 11, 2024, offer FPIs the option to reclassify excess shares within five trading days, ensuring compliance with the Foreign Exchange Management Act (FEMA) and sectoral FDI caps.
Key Changes in FPI to FDI Conversion
Previous Restrictions and New Flexibility
Previously, FPIs holding more than 10% in a company were required to either sell off the excess stake or reclassify it as FDI. Now, the RBI framework allows FPIs to retain the excess shares by converting them into FDI, with approval from both the Indian government and the investee company.
Steps for Reclassification
Compliance Reporting: FPIs must report to SEBI and transfer shares from FPI demat accounts to FDI accounts.
Custodian Notification: The custodian must notify SEBI, and no further equity purchases are allowed until the reclassification is complete.
Timeframe: Reclassification must be done within five trading days of exceeding the 10% limit.
Alignment with SEBI Guidelines and Restrictions
The RBI’s notification complements SEBI’s guidelines, which also came into effect in May 2024. These guidelines require custodians to notify SEBI and halt further transactions until the reclassification process is completed. The new system is designed to help FPIs expand their stakes beyond the limit while adhering to FDI norms. However, reclassification is restricted in sectors where FDI is not permitted, such as industries with entry barriers for foreign investment.
Government and Tax Implications
FPIs must seek government approval for investments that exceed the 10% threshold, especially for sectors with specific FDI restrictions. The tax treatment of these reclassified investments may also change, with the possibility of tax deducted at source (TDS) being applicable when selling post-reclassification.
Expert Views
Experts have hailed the move as a “welcome” change, offering more flexibility to FPIs while boosting long-term foreign investment in Indian companies. The RBI and SEBI’s coordinated approach ensures a more transparent and structured pathway for FPIs to transition their investments into FDI, enhancing the overall investment climate in India.
Key Points: FPI to FDI Conversion
Reason for Conversion: FPIs exceeding the 10% equity cap in an Indian company can convert the excess into Foreign Direct Investment (FDI).
Timeline: The conversion must happen within 5 trading days of surpassing the 10% threshold.
Approval Required: The conversion requires approval from the Indian government and the investee company.
Compliance: FPIs must report to SEBI and cease additional equity purchases until reclassification is complete.
Sectoral Restrictions: Conversion is not allowed in sectors with FDI restrictions.
Custodian Role: Custodians must notify SEBI and transfer the shares to an FDI-designated demat account after ensuring compliance.
FPI vs. FDI: FPI is a short-term market investment, whereas FDI is a long-term, direct investment requiring government approvals.
Tax Implications: Reclassified investments may be subject to different tax treatments (e.g., TDS).
Summery of the News
| Why in News | Key Points |
|---|
| RBI Introduces Framework for Converting FPI to FDI | Date: November 11, 2024. RBI introduced a streamlined framework allowing FPIs to convert excess holdings (above 10%) into FDI in Indian companies. |
| FPI Ownership Limit | Previous Cap: FPIs were restricted to 10% of a company’s paid-up equity. New Framework: FPIs can reclassify the excess stake as FDI within 5 trading days with approval from the Indian government and the company. |
| Reclassification Process | Steps: FPIs must report to SEBI, halt equity purchases, and transfer shares to an FDI demat account. |
| SEBI Guidelines | SEBI requires custodians to notify and suspend FPI equity purchases beyond the 10% limit until reclassification. |
| Sectoral Restrictions | Reclassification is restricted in sectors with FDI caps or prohibitions. |
| FPI vs. FDI | FPI: Short-term investments through stock markets. FDI: Long-term equity investment with direct government approval. |
| Government Approval | FPIs must seek approval for reclassification in specific cases, especially in sensitive sectors or with land-bordering countries. |
| Tax Implications | Once reclassified as FDI, investments may be subject to different tax rules, including TDS on the sale of reclassified investments. |
| Custodian’s Role | Custodians must report to SEBI and facilitate the transfer of shares for reclassification after completing compliance. |
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