Transferring Wealth Overseas -Permitted Capital Account Transactions: Direct Investments & Portfolio Investments

Private Client Series

Series 1 | Article 7

When considering overseas investments by Resident Indians, the two primary modes are Direct Investments and Portfolio Investments. Each of these options falls under the broader category of capital account transactions, governed by the Foreign Exchange Management Act (FEMA), 1999, and its related regulations. This article explores the permitted transactions under these two categories, focusing on their legal framework, requirements, and implications.

1. Overseas Direct Investments (ODI)

Overseas Direct Investment (ODI) refers to investments made by Indian entities or resident individuals in equity, debt, or other financial instruments of foreign entities. This mode of investment is generally pursued for business expansion and can include the setting up of Joint Ventures (JVs) or Wholly Owned Subsidiaries (WOS) abroad.

Key Regulations:

• Eligibility: According to the Foreign Exchange Management (Overseas Investment) Regulations, 2022, an Indian entity is eligible to make an ODI if it meets specific criteria, including having a net worth and maintaining a track record of profitability. Resident individuals can also make such investments under the Liberalised Remittance Scheme (LRS), subject to the LRS limit​​.

• Permissible Investments: Investments may include acquiring shares of foreign entities, setting up or investing in JVs or WOS, and extending loans to these entities. However, investments must comply with the conditions set by the Reserve Bank of India (RBI), such as ensuring that the loan interest rate is on an arm's length basis and that guarantees are not open-ended​.

• Financial Commitment Limit: The total financial commitment made by an Indian entity, including equity investments, loans, and guarantees, must not exceed 400% of its net worth as on the last audited balance sheet. For individuals, the LRS limit of USD 250,000 per financial year applies to all capital account transactions​​.

• Reporting Requirements: Entities making ODIs must report their financial commitments and any subsequent changes (e.g., disinvestments, restructuring) to the RBI through the designated Authorised Dealer (AD) bank. Annual Performance Reports (APRs) are also mandatory​.

2. Overseas Portfolio Investments (OPI)

Overseas Portfolio Investment (OPI) refers to the purchase of securities, including shares and bonds, listed on foreign stock exchanges. Unlike ODIs, which involve significant control over the foreign entity, OPIs are passive investments.

Key Regulations:

• Eligibility and Limits: OPI is primarily available to resident individuals under the LRS, which allows investments up to USD 250,000 per financial year. The Foreign Exchange Management (Overseas Investment) Regulations, 2022, govern these transactions, ensuring that they are within the set financial limits and are made in compliant jurisdictions​​.

• Permissible Investments: Resident Indians can invest in listed shares, mutual funds, and debt instruments abroad. However, certain high-risk investments, such as those in companies involved in real estate or gambling, are prohibited​.

• Reporting and Compliance: Investors are required to report their portfolio investments within 60 days of the end of each half-year (March and September) through their AD bank. This ensures that all transactions are accounted for and are within the prescribed limits​.

3. Comparison and Strategic Considerations

• ODI vs. OPI: The choice between ODI and OPI largely depends on the investor's goals. ODI is suited for those looking to expand business operations internationally and gain significant control over foreign entities. In contrast, OPI is more suitable for individuals or entities seeking diversification and exposure to international markets without engaging in business management abroad.

• Risk and Compliance: While ODI involves higher risk due to the scale of investment and control, it also requires rigorous compliance with reporting and regulatory requirements. OPI, being passive, is less risky but still demands adherence to the financial limits and prohibited activities outlined by the RBI.

4. Conclusion

Both Direct and Portfolio Investments offer significant opportunities for Resident Indians to participate in the global economy. However, these investments are tightly regulated under FEMA and related rules to ensure that they align with India's economic policies and mitigate risks associated with international transactions. As such, individuals and entities must carefully consider the legal frameworks, financial commitments, and reporting obligations before venturing into overseas investments.

This article forms part of a broader series on transferring wealth overseas, providing crucial insights for Resident Indians looking to explore international financial opportunities.

About the Author

Pranay Mangharam is a founding member of MZD Legal Consultancy.  He leads the firm's private client; technology; and transaction advisory practices. Pranay advises high-net-worth individuals, closely held businesses, and family offices on a range of private matters including their investments, succession planning, transborder holdings, etc. He can be contacted at pranay@mzdlegal.in 

About MZD Legal Consultancy

MZD Legal Consultancy is a boutique law firm in Mumbai, India. The firm was established in 2011 and comprises professionally qualified lawyers with varied levels of experience and expertise in specific practice areas. To know more, click here www.mzdlegal.in