The Enforcement Directorate (ED) has reportedly questioned several high-net-worth individuals (HNIs) in recent weeks over their investments in overseas funds that indirectly invest in Indian equities, raising concerns of potential violations of foreign exchange and securities regulations. According to a report by The Economic Times, these investors have bypassed India’s Securities and Exchange Board (SEBI)-registered Foreign Portfolio Investors (FPIs), opting instead to invest through offshore vehicles that contribute to the funds managed by FPIs with substantial exposure to Indian stock markets.
While regulations permit Indian residents to invest abroad under the Reserve Bank of India’s (RBI) Liberalised Remittance Scheme (LRS), the scheme restricts investments in instruments issued by Indian entities. These individuals, however, have invested in offshore funds with significant Indian stock holdings—an activity that could be deemed as an indirect way of circumventing Indian laws, the ET report added.
Moneycontrol could not independently verify the report.
Legal experts are raising alarms over the potential violation of foreign exchange regulations, particularly the Foreign Exchange Management Act (FEMA). Moin Ladha, a partner at law firm Khaitan & Co, told ET, "Investing in India-focused funds through an offshore vehicle can be seen as a violation of the LRS rules, which explicitly restrict investments in Indian-issued instruments."
Investors might be drawn to such routes to gain currency appreciation or benefit from tax arbitrage. Rajesh P. Shah, partner at CA firm Jayantilal Thakkar & Company, told ET that some investors are enticed by foreign bank representatives who pitch the opportunity of investing in India-focused funds through the LRS route. "However, the LRS is intended for outbound investments, not for routing funds back into India via overseas vehicles," Shah added.
The ED is likely to take action against investors who fail to justify their investments or those found violating the law, the ET report further adds. Penalties under FEMA could include hefty fines, with individuals facing the prospect of paying three times the amount of their investment, as well as forfeiting any profits made.
While the route of investing in FPIs is open to non-resident Indians (NRIs), there are stringent caps on their participation. A single NRI cannot own more than 25% of an FPI, and a group of NRIs cannot collectively exceed a 50% stake. However, capital market regulators have made provisions for 100% NRIs in FPIs based in the GIFT City financial hub, though these measures have yet to gain traction.
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