Changed FDI Norms can make Foreign Investment Difficult

News Posted - 2010-04-13

Foreign venture capital funds will find it more difficult to invest in venture funds here with the government changing the foreign direct investment (FDI) rules. Experts fear this could dampen foreign investments into India. The new rules say foreign funds will now require prior approval for investment in Indian venture funds and they cannot invest in unregistered trusts. “This is a retrograde step. This is uncalled for, as no approval should be needed for FDI flows between two Sebi regulated entities,” said Punit Shah, financial services tax practice leader, KPMG.

The rules were issued by the department of industrial policy and promotion (Dipp), the key government body on foreign direct investment policy. While the move could be driven by the government’s efforts to curb money-laundering through trusts that are not as regulated as companies, the change could impact inflow. Foreign money coming in through the venture capital route has been under the regulatory scanner since 2007 when there was a surge in investments by these entities into real estate. Both the government and regulators cracked down on foreign venture capital funds and put in place several measures such as restricting tax benefits to select sectors and tightening registration procedures to regulate flow of funds from these entities.

Foreign VC funds entering India have to give an undertaking to the Reserve Bank of India that they will not invest in the property sector. Thus, some of the offshore VCs, registered in Mauritius, invested in local funds to sidestep regulations.

Till now, a Sebi registered foreign venture capital investor was allowed to invest under the automatic route (or without any prior approval) in a domestic venture capital fund registered with the Sebi. Domestic venture funds have the flexibility to structure themselves either as a company or as a trust and accept foreign investment from a foreign venture capital investor. “Rationale of such measure is not clear and this will act as dampener to free flow of FDI,” said Akil Hirani, managing partner, Majmudar & Co.

Experts also point out the absence of any grandfathering provision in the policy for the foreign investors registered prior to April 1, 2010 and those that had invested in domestic funds registered before this date. It is not clear if such investments will require any further approval from the government.

Source: Indianrealtynews 12/4/10