On 1 April 2016, the Reserve Bank of India (RBI) has notified the Foreign Exchange Management (Deposit) Regulations 2016 (New Deposit Regulations) in suppression of the erstwhile Foreign Exchange Management (Deposit) Regulations 2000 (Old Deposit Regulations).
The New Deposit Regulations rationalise and consolidate the extant regulatory framework in relation to the acceptance of deposits and the various accounts that may be opened by non-residents in India.
The key changes introduced by the New Deposit Regulations and their likely impact are discussed below.
Escrow Arrangements: In 2007, the RBI permitted non-resident acquirers to open escrow accounts and special accounts for the acquisition of shares and convertible debentures through open offers, delisting/exit offers and buybacks in accordance with regulations issued by the Securities and Exchange Board of India. Subsequently, the RBI allowed resident and non-resident acquirers to open non-interest bearing escrow accounts for the facilitation of closings for transactions under the foreign direct investment (FDI) route, where consideration towards the issuance or transfer of shares of an Indian company could be held in escrow for a period of up to six months. Any escrow arrangements exceeding the above period required the prior approval of the RBI.
The New Deposit Regulations now permit escrow arrangements of up to 25% of the total sale consideration in respect of share transfers involving non-residents, for a period of up to 18 months from the date of the transfer agreement. This relaxation follows a press release issued by the RBI on 2 February 2016, which discusses the relaxations announced for start-ups in India, including a proposal to permit escrow arrangements for an extended period and deferred consideration in FDI transactions.
Definition of NRI and PIO: The Old Deposit Regulations defined a non-resident person (NRI) as a person resident outside India who is a citizen of India or a person of Indian origin (PIO). In January 2015, the Government of India merged the definition of PIOs with Overseas Citizens of India. The RBI subsequently amended the definition of NRI under the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) 2000 to exclude PIOs and include an ‘Overseas Citizen of India’ cardholder within its ambit.
The New Deposit Regulations attempts to align the definition of NRI. NRI has been defined to include a person resident outside India and who is a citizen of India and PIOs have been separately defined to include ‘Overseas Citizen of India’ cardholders. The rejigging of these definitions should not negatively impact PIOs, as all the benefits available to NRIs have been extended to PIOs.
Permissible Deposits: Minimal changes have been introduced to the key existing bank account schemes under which authorised dealer banks in India (AD Banks) and companies were permitted to accept deposits from NRIs and non-residents (such as the Foreign Currency Non-Resident (Bank) Account Scheme, Non-Resident (External) Rupee Account Scheme, and the Non-Resident Ordinary Rupee Account Scheme). However, the Non-Resident (Non-Repatriable) Rupee Deposit Scheme and Non-Resident (Special) Rupee Account Scheme have now been discontinued.
Further, unlike the Old Deposit Regulations, the New Deposit Regulations do not permit foreign portfolio investors (FPIs) and NRIs to open single non-interest bearing Indian Rupee accounts for routing certain investments into India (such as eligible portfolio investments by FPIs and on-market purchases of shares by NRIs).
A new bank account scheme for non-residents having a business interest in India has been permitted, namely the non-interest bearing Special Non-Resident Rupee Account (SNRR account). SNRR accounts may be used for effecting bona fide transactions in Indian Rupees. The debits and credits to the SNRR account must be specific or incidental to the business proposed to be undertaken by the non-resident account holder in India. Further, the tenure of the SNRR account must be concurrent with the tenure of the contract or period of business operation of the non-resident account holder, and in any event, must not exceed seven years. The balances are required to be commensurate with the business operations and are permitted to be repatriated outside India.
AD Banks have also been permitted to allow unincorporated joint ventures of non-residents to open and maintain non-interest bearing foreign currency accounts and SNRR accounts for purposes of undertaking transactions in the ordinary course of business. The debits and credits to such accounts should be incidental to the business requirement of the unincorporated joint venture and the tenure of such accounts must be concurrent to the tenure of the contract or period of operations in India.
The extension of the permissible escrow period from six months to 18 months under the New Deposit Regulations is a positive step towards permitting deferred consideration structures in FDI transactions (including holdback for indemnity claims). However, absent amendments to foreign exchange management regulations, deferral of purchase consideration through escrow arrangements will continue to require RBI approval regardless of the above extension.
Further, the extension of the escrow period applies to secondary investments only and will not benefit investors looking to make primary investments. As there is no rational basis to prescribe separate escrow conditions for primary and secondary investments, the RBI appears to have missed an opportunity to simplify and liberalise the existing regulatory framework on cross-border escrow arrangements.
We expect that FPIs and NRIs are likely to use SNRR accounts to route their Indian investments going forward. However, since the RBI has prescribed a seven year tenure for SNRR accounts, it is unclear how the investments will be routed after expiry of such period.
Besides codifying escrow accounts and relaxing the period of share transfer escrows, there are no material changes from the Old Deposit Regulations which will incentivise an increase in business activity by non-residents in India.