Companies with multiple overseas holding structures face enhanced RBI scrutiny

Companies with multiple overseas holding structures face enhanced RBI scrutiny

Several companies with multiple holding structures for overseas subsidiaries are facing scrutiny from the Reserve Bank of India (RBI) for non-compliance with the mandatory two- layer overseas investment rule, sources with direct knowledge of the matter told Moneycontrol requesting anonymity.

“In the last few months, a growing number of companies have received directions from RBI to immediately amend existing overseas structures to comply with India’s outward remittance rules,” one of the persons cited above told Moneycontrol.

The list of companies that have received such communication includes one of the largest Information Technology(IT) companies in the country, a company that is part of one of the country's leading conglomerates, and a well known fintech company, among others, the people cited above added. Most of these structures were created during the period between 2016 and 2022.

At the crux of the matter is a provision in India’s Overseas Direct Investment (ODI) rules that says Indian entities are not permitted to invest in a foreign entity that has business operations in India through a structure with more than two layers of subsidiaries. For instance, in the case of the IT company, it had acquired a European company that also had business in India.

Analysts observed that in the past, it was a regular practice among companies to use multiple layers of subsidiaries based in tax neutral jurisdictions like the Netherlands, Mauritius, and Singapore for M&A activity and to retain control thereafter. For example, a prominent business conglomerate with presence in metals and cement owned several overseas companies through intermediate entities based in the Netherlands. This company recently eliminated the Dutch subsidiary and brought the foreign company directly under the Indian parent.

“Prior to the amendment in 2022, ODI structures were only permitted under the approval route. For existing structures, the prudent approach would be to seek a post facto approval and complete a compounding process. We have also seen past cases where notices requiring unwinding of the existing structure have been issued,” said Moin Ladha, partner, Khaitan & Co.

Also, until 2016, there was no requirement for Indian companies to disclose all their foreign subsidiaries. However, the rules were tweaked in 2016 to make it mandatory for all companies having outward remittances to provide a complete list of foreign subsidiaries along with details of their structures in annual filings.

This came after the RBI, in 2016, detected that entities with subsidiaries outside India were being using them for round tripping by providing inter-corporate loans to their subsidiaries. The central bank subsequently imposed a ban on the practice unless undertaken for legitimate purpose with its approval.

However, since the ban could also disincentive foreign investment by Indian entities due to compliance burden and cost, the central bank introduced the layering restriction in 2022 with automatic approval. .

“The RBI has been asking companies to clean up non-compliant structures. They are being asked to undo the non compliant structures and reduce the subsidiaries to two layers as prescribed in the rules,” said a person cited above. “After this, the company will have to compound the issue with RBI by paying a fine since such structures were not allowed in the first place,”

“There are a lot of legacy structures among Indian conglomerates that have overseas structures that still have five-six layers of subsidiaries, however they are all pre-2019 and back then there was no explicit prohibition on such structures,” said another person cited above. “The RBI has been informally encouraging them to rationalise the structures.”

In legal terms ‘compounding’ is a settlement scheme of RBI which allows participants to close any existing violation of foreign exchange management(FEMA) rules by paying a fee. To be sure, RBI has powers to decline such compounding applications if the violations are considered serious in nature.