Section 194N Exemption for Foreign Representations: Key Highlights of the New Income-Tax Notification

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  On 28th November 2024 , the Ministry of Finance issued Notification No. 123/2024 , bringing clarity to the applicability of Section 194N of the Income-tax Act, 1961. The notification exempts specified foreign representations from the provisions of this section, reinforcing India's commitment to international diplomatic norms and global cooperation. Effective from 1st December 2024 , this move comes after due consultation with the Reserve Bank of India (RBI) and aligns with international protocols such as the Vienna Convention and the United Nations Privileges and Immunities Act . Understanding Section 194N of the Income-tax Act Section 194N mandates tax deduction at source (TDS) on cash withdrawals exceeding ₹1 crore in a financial year . The provision applies to withdrawals from banks, co-operative banks, and post offices, aiming to curb cash usage and promote digital transactions. Fifth Proviso to Section 194N The fifth proviso grants the Central Government the authority ...
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RBI’s New Operational Framework for Reclassifying Foreign Portfolio Investment (FPI) to Foreign Direct Investment (FDI)

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On November 11, 2024, the Reserve Bank of India (RBI) introduced a streamlined operational framework for the reclassification of Foreign Portfolio Investment (FPI) holdings to Foreign Direct Investment (FDI). This new directive, outlined in Circular No. 19 (A.P. DIR Series), is applicable to all Category-I Authorized Dealer Banks. It aims to provide a structured and transparent process for FPIs when their holdings exceed the regulatory threshold of 10% in any Indian company’s equity. This blog discusses RBI’s latest circular, breaking down the operational requirements, necessary approvals, and implications for FPIs, Indian companies, and authorized banks.

Background: The FPI and FDI Distinction in India

In India, foreign investments are regulated based on their nature—FPI (short-term, portfolio-based investments) and FDI (longer-term, direct investments). Under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI Rules), an FPI’s investment in a single Indian company must remain below 10% of the company’s total paid-up equity capital on a fully diluted basis. Exceeding this threshold mandates the reclassification of FPI holdings as FDI, bringing the investment under FDI regulations, which involve more stringent sectoral and compliance requirements.

Objective of RBI’s New Framework for FPI to FDI Reclassification

RBI’s circular establishes a clear, systematic process for FPIs that exceed the 10% threshold to either divest their holdings or reclassify them as FDI. This operational framework aims to:

  1. Ensure Regulatory Compliance: By setting structured guidelines, RBI ensures that foreign investments align with the compliance and reporting requirements of both FPI and FDI categories.
  2. Enhance Clarity for Stakeholders: The circular clarifies the steps, timelines, and responsibilities for FPIs, authorized dealer banks, and custodians in the reclassification process.
  3. Protect Indian Markets: The reclassification framework supports regulatory oversight, especially in sectors with restrictions on foreign ownership.

Key Provisions of RBI’s Circular on Reclassification of FPI to FDI

1. Threshold and Conditions for Reclassification

  • FPIs must maintain their holdings below 10% of an Indian company’s total paid-up capital (fully diluted basis).
  • Upon breaching this threshold, FPIs can either divest the excess holdings or reclassify the investment as FDI within five trading days from the date of trade settlement causing the breach.

2. Reclassification Restrictions in FDI-Prohibited Sectors

  • Reclassification is not permitted in sectors where FDI is prohibited. FPIs are required to divest any excess holdings if they cross the 10% threshold in these restricted sectors.

3. Approvals and Concurrence Required for Reclassification

To proceed with reclassification, the FPI must obtain:

  • Government Approvals: For investments from restricted countries or in sectors with specific FDI requirements, the FPI must obtain prior approvals from relevant government bodies.
  • Indian Company Concurrence: The FPI must secure the Indian company’s concurrence to ensure the company’s compliance with sectoral caps, entry routes, pricing guidelines, and other conditions under FDI regulations.

Step-by-Step Reclassification Procedure

The RBI’s circular provides a comprehensive process for FPIs that choose to reclassify their holdings to FDI.

1. Intent and Notification

  • Intent to Reclassify: The FPI must formally declare its intent to convert its holdings from FPI to FDI to its custodian.
  • Freeze on Transactions: Following the intent declaration, the custodian freezes further purchase transactions by the FPI in that company’s equity instruments until reclassification is complete.

2. Divestment in Absence of Approvals

  • If the required approvals and concurrence from the government or Indian company are not obtained, the FPI must divest its excess holdings within five trading days.

3. Reporting Requirements

The RBI mandates strict reporting guidelines based on the source of the FPI’s excess holdings:

  • FC-GPR Form: If the breach occurs due to new issuance of equity by the Indian company, the company must file an FC-GPR (Foreign Currency – Gross Provisional Return) form.
  • FC-TRS Form: If the excess holdings result from a secondary market acquisition, the FPI must file an FC-TRS (Foreign Currency – Transfer of Shares) form.
  • LEC (FII) Reporting by AD Bank: Authorized Dealer (AD) banks must report the reclassified investment as a divestment in the LEC (FII) reporting format.

4. Transfer and Completion of Reclassification

  • Once reporting is complete, the FPI must request its custodian to transfer the equity instruments from its FPI demat account to its FDI demat account.
  • Custodian Action: After confirming compliance with all reporting requirements, the custodian will unfreeze the equity instruments and facilitate the transfer. The date of the initial breach will be considered the official date of reclassification.

After reclassification, the FPI’s entire investment in the company will be considered FDI, regardless of future percentage changes in ownership.

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