Land Border Approval: Implications of the 22nd April 2020 Amendment on ESOP.

July 4, 2024

Introduction:

The Central Government in exercise of the powers conferred by clauses (aa) and (ab) of sub-section (2) of section 46 of the Foreign Exchange Management Act, 1999 (42 of 1999) (Hereinafter referred to as “FEMA 1999”) notified the Foreign Exchange Management (Non-debt instruments) Rules, 2019 [NDI Rules 2019] in supersession of the Foreign Exchange Management (Transfer or issue of security by a Person Resident Outside India ) Regulations 2017 and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018.

In this article we are trying to understand the impact of 22^nd April 2020 amendment to the NDI Rules 2019. The major condition was inserted for investments from land boarder countries entities or beneficial owners. In this context we need to check whether the equity shares allotted due to exercise of the options issued pursuant to Employee Stock Option schemes by the employees situated or citizen of such countries are also under approval route. Following is the gist of amendments to the NDI Rules 2019:-

Till today the NDI Rules 2019 were amended as follows :-

Date of Notification	Key amendments
5^th December, 2019	Clarificatory amendment
22 April 2020	Major amendment for Land Border approval of Government
27 April 2020	Renunciation in case of Rights conditions, Insurance Sector in Schedule I got amended, Schedule II amendment
27 July 2020	RBI to administer rules, Amendment to AIR Transport in Schedule I
8^th December, 2020	increase in the sectoral cap for foreign direct investment (FDI) in the defence sector to 74%; and issued certain clarifications on the present policy on investments from countries sharing land borders with India. (clarify one aspect that multilateral banks or funds, of which India is a member, shall not be subject to restrictions brought by PN3 irrespective of bordering nations also holding such memberships)
9^th August, 2021	An explanation is added to definition of indirect foreign investment stating that investment made by Indian entity which is owned and controlled by NRI on re-patriation basis not be considered for calculation
19^thAugust, 2021	Allow 74% Foreign Investment In Indian Insurance Companies
5^th October, 2021	Amendment to Schedule I, pertaining to petroleum and natural gas sector
12^th October, 2021	Permitted 100 per cent foreign direct investment (FDI) under the automatic route in the telecom services sector subject to certain conditions
12^th April 2022	Convertible Notes: The period for which a convertible note can be issued by a start-up company has been extended from five years to ten years. Equity Instruments: The definition of equity instruments was expanded to include partly paid equity shares and clarified the terms for convertible debentures and preference shares. Foreign Investment: The rules around counting investments as foreign investment were clarified, especially in cases where a declaration of beneficial interest by a person resident outside India is made. Indian Company Definition: The definition of an ‘Indian company’ was updated to include companies defined under the Companies Act, 2013, or any body corporate established under any Central or State Act and incorporated in India. Share Based Employee Benefits [Rule 2(ama)] – newly inserted to cover different forms of employee benefit. Amendment to Schedule I, Certain activities will not be considered as real estate business Sectoral cap for LIC inserted Rule 19(1) which specify “Merger or de-merger or amalgamation of Indian Companies” has been modified to include scheme of compromise
24^th January, 2024	Introduces international exchanges – enabling direct listing of equity shares by public Indian companies on the International Exchanges at IFSC.
14^th March, 2024	Explanation to definition of unit added stating unit shall include unit that has been partly paid up permitted under SEBI regulations
16^th April, 2024	prescribes new entry routes for foreign investment in activities under the space sector.

B] The first amendment :-

As discussed earlier, till now there were thirteen amendments, but the second amendment made major impact on the Foreign Direct investments in India. The said amendment effective from 22^nd April 2020 was as follows :-

Short title and commencement.— (1) These rules may be called the Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2020. (2) They shall come into force on the date of their publication in the Official Gazette. 2. In the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, in rule 6, in clause (a), for the provisos, the following provisos shall be substituted namely:-

“Provided that an entity of a country, which shares land border with India or the beneficial owner of an investment into India who is situated in or is a citizen of any such country, shall invest only with the Government approval:

Provided further that, a citizen of Pakistan or an entity incorporated in Pakistan shall invest only under the Government route, in sectors or activities other than defence, space, atomic energy and such other sectors or activities prohibited for foreign investment:

Provided also that in the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction or purview of the above provisos, such subsequent change in beneficial ownership shall also require government approval”.

Following table shall give clear understanding of what was changed by 22^nd April 2020 amendment:-

6(a) Before amendment of 22 April 2020	6(a) After amendment of 22 April 2020
6. Investments by person resident outside India: – A person resident outside India may make investment as under:- (a) may subscribe, purchase or sell equity instruments of an Indian company in the manner and subject to the terms and conditions specified in Schedule I:	6. Investments by person resident outside India: – A person resident outside India may make investment as under:- (a) may subscribe, purchase or sell equity instruments of an Indian company in the manner and subject to the terms and conditions specified in Schedule I:
Not there earlier	“Provided that an entity of a country, which shares land border with India or the beneficial owner of an investment into India who is situated in or is a citizen of any such country, shall invest only with the Government approval:
Provided that a person who is a citizen of Bangladesh or Pakistan or is an entity incorporated in Bangladesh or Pakistan cannot purchase equity instruments without the prior government approval:	Not there now as it is covered in above proviso.
Provided further that a citizen of Pakistan or an entity incorporated in Pakistan cannot invest in defence, space, atomic energy and sectors or activities prohibited for foreign investment even through the government route.	Provided further that, a citizen of Pakistan or an entity incorporated in Pakistan shall invest only under the Government route, in sectors or activities other than defence, space, atomic energy and such other sectors or activities prohibited for foreign investment:
Not there earlier	Provided also that in the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction or purview of the above provisos, such subsequent change in beneficial ownership shall also require government approval”

Lets also understand rule relating to Issue of Employees Stock Options and sweat equity shares to persons resident outside India.-

Rule 8 of NDI Rules, 2019 contains the provisions relating to issue of ESOP.

An Indian company may issue “employees’ stock option” and/ or “sweat equity shares” to its employees or directors or employees or directors of its holding company or joint venture or wholly owned overseas subsidiary or subsidiaries who are resident outside India:

Provided that. –

(a) the scheme has been drawn either in terms of regulations issued under the Securities and Exchange Board of India Act, 1992 or the Companies (Share Capital and Debentures) Rules, 2014, as the case may be;

(b) the “employee’s stock option” or “sweat equity shares” so issued under the rules or regulations are in compliance with the sectoral cap applicable to the said company;

(c) the issue of “employee’s stock option” or “sweat equity shares” in a company where investment by a person resident outside India is under the approval route shall require prior government approval and issue of “employee’s stock option” or “sweat equity shares” to a citizen of Bangladesh or Pakistan shall require prior government approval:

Provided further that an individual who is a person resident outside India exercising an option which was issued when he or she was a person resident in India shall hold the shares so acquired on exercising the option on a non- repatriation basis.

C] Impact of the First Amendment :-

The first amendment to NDI Rules, clearly shows intention of the Government to control investments from land border countries. Let’s analyse one by one.

The first change which they brought in revised version of 6(a) is as follows :- “Provided that an entity of a country, which shares land border with India or the beneficial owner of an investment into India who is situated in or is a citizen of any such country, shall invest only with the Government approval:”
The first proviso was newly inserted by the Central Government, which states that :-
1. An entity of a country, which shares land border with India ; or
2. The beneficial owner of an investment into India who is situated in or is a citizen of any such country – Shall invest only with the Government approval.
Here, the intention seems much beyond citizenship of a person. They state two types of persons here first is “entity” and second is “beneficial owner”.
Lets us see if these terms are defined in the Rules. The NDI rules have defined the term “Indian entity” in Rule 2(aa) Indian Entity shall mean an Indian Company or a LLP. The term beneficial owner is not defined in the NDI Rules.
Rule 2(2) states that the words and expressions used but not defined in these rules shall have the same meaning respectively assigned to them in the Act, Rules and Regulations.
The FEMA 1999 also does not define these terms. Hence we need to check it under any other relevant act or rules or regulations.
As per Law Lexicon – “Entity” means A real being; existence. An organization or being that possesses separate existence for tax purposes. Examples would be corporations, partnerships, estates and trusts. The accounting entity for which accounting statements are prepared may not be the same as the entity defined by law. “Entity” includes corporation and foreign corporation, not-for-profit corporation; profit and not-for-profit unincorporated association; business trust, estate, partnership, trust, and two or more persons having a joint or common economic interest; and state, United States, and foreign government. An existence apart, such as a corporation in relation to its stockholders. Entity includes person, estate, trust, governmental unit. Something that has a real existence.
The term “Beneficial Owner” as per the Blacks Law means One recognized in equity as the owner of something because use and title belong to that person, even though legal title may belong to someone else; esp., one for whom property is held in trust. Also termed equitable owner. [Caser Trusts 139.] 2. A corporate shareholder who has the power to buy or sell the shares, but who is not registered on the corporation’s books as the owner. [Cases: Corporations 135.] 3. Intellectual property A person or entity who is entitled to enjoy the rights in a patent, trademark, or copyright even though legal title is vested in someone else. The beneficial owner has standing to sue for infringement. A corporation is typically a beneficial owner if it has a contractual right to the assignment of the patent but the employee who owns the patent has failed to assign it. Similarly, a patent or copyright owner who has transferred title as collateral to secure a loan would be a beneficial owner entitled to sue for infringement.
Further they have used the words who is “situated in or is a citizen of” what is situated in or citizen of means?
- The word situated is used in Transfer of Property Act, 1982 -Situated. explanation I to Section 3 uses word “situated”. Lexicon explains the meaning of this word as “located”.
- The word citizen , as per Blacks Law is “A person who, by either birth or naturalization, is a member of a political community, owing allegiance to the community and being entitled to enjoy all its civil rights and protections; a member of the civil state, entitled to all its privileges. Cf. RESIDENT; DOMICILIARY. [Cases: Aliens, Immigration, and Citizenship 652.
We understand from the above that the words’ “Situated” and “Citizen” are not the same. Situated doesn’t mean citizenship and citizenship does not mean situated always. It clearly means the Government wants to control the investments into India made by any entity of such countries or beneficial owner situated in or citizen of such countries. If the Government wanted to restrict it to only citizen, they would have mentioned only citizen. But the Government also want to restrict investments from beneficial owners who may not be citizens but situated in those countries.
As per principles of interpretation of statute, if the precise words used are plain and unambiguous, we are bound to construe them in their ordinary sense and give them full effect. The argument of inconvenience and hardship is dangerous one and is only admissible in construction where the meaning of the statute is obscure and there are alternative methods of construction. Where the language is explicit its consequences are for Parliament, and not for the courts, to consider.[1]
Further, while interpreting the provisions of a Statute, it can neither add, nor subtract even a single word. The legal Maxim “A verbis legis non est recedendum” meaning , “from the words of law, there must be no departure”.
It is a cardinal principle of interpretation that the words of a statute must be understood in their natural, ordinary or popular sense and construed according to their grammatical meaning, unless such consideration leads to some absurdity or unless there is something in the context or in the object of the statute to the contrary. The golden rule is that the words of a statute must prima facie be given their ordinary meaning. It is yet another rule of construction that when the words of the statute are clear, plain and unambiguous, then the courts are bound to give effect to that meaning, irrespective of the consequences. It is said that the words themselves best declare the intention of the law giver. The courts have adhered to the principle that efforts should be made to give meaning to each and every word used by the legislature and it is not sound principle of construction to brush aside words in a statue being in apposite surpluses, if they can have a proper application in circumstances conceivable within the contemplation of the statute.[2]
As discussed above, the first proviso which was inserted vide amendment to NDI Rules 2019 dated 22^nd April 2020 repeated for the purpose of easy reading as follows:- “Provided that an entity of a country, which shares land border with India or the beneficial owner of an investment into India who is situated in or is a citizen of any such country, shall invest only with the Government approval:”
It means that any entity of a country or beneficial owner situated or citizen of any such country means “country which shares land border with India” cannot invest under Foreign Direct Investment without government approval.
As per Rule 6 of the NDI Rules, 2019 “Investments by person resident outside India: – A person resident outside India may make investment as under…” should be as per Schedule I and conditions provided in provisos to clause (a) of Rule 6 of the NDI Rules, 2019.
Now, the question is whether the word Investment by a person resident outside India covers even equity shares issued on exercise of ESOP ?
The word investment is defined under clause (ac) of Rule 2 of the NDI Rules:- “investment” means to subscribe, acquire, hold or transfer any security or unit issued by a person resident in India; Explanation:-
- Investment shall include to acquire, hold or transfer depository receipts issued outside India, the underlying of which is a security issued by a person resident in India;
- for the purpose of LLP, investment shall mean capital contribution or acquisition or transfer of profit shares;
Investment means subscribe, acquire, hold or transfer any “security” or unit issued by a person resident in India. Here we need to understand whether the word security includes equity shares issued by converting esop?
Definition of ‘ESOP’ means ‘Employees’ stock option’ as defined under the Companies Act, 2013 and issued in accordance with the Companies Act, 2013 and SEBI regulations, as applicable. [ 2.1.13 of Consolidated FDI Policy 2020]
The word Security is defined under the Foreign Exchange Management Act, 1999, Section 2 clause (za) “security” means shares, stocks, bonds and debentures, Government securities as defined in the Public Debt Act, 1944 (18 of 1944), savings certificates to which the Government Savings Certificates Act, 1959 (46 of 1959) applies, deposit receipts in respect of deposits of securities and units of the Unit Trust of India established under sub-section (1) of section 3 of the Unit Trust of India Act, 1963 (52 of 1963)* or of any mutual fund and includes certificates of title to securities, but does not include bills of exchange or promissory notes other than Government promissory notes or any other instruments which may be notified by the Reserve Bank as security for the purposes of this Act.
Equity instrument is defined under clause (k) of Rule 2 of the NDI Rules, 2019, “equity instruments” means equity shares, convertible debentures, preference shares and share warrants issued by an Indian company;

Explanation:-

Equity shares issued in accordance with the provisions of the Companies Act, 2013 shall include equity shares that have been partly paid. “Convertible debentures” means fully, compulsorily and mandatorily convertible debentures. “Preference shares” means fully, compulsorily and mandatorily convertible preference shares. Share Warrants are those issued by an Indian company in accordance with the regulations by the Securities and Exchange Board of India. Equity instruments can contain an optionality clause subject to a minimum lock-in period of one year or as prescribed for the specific sector, whichever is higher, but without any option or right to exit at an assured price.

Partly paid shares that have been issued to a person resident outside India shall be fully called-up within twelvemonths of such issue or as may be specified by the Reserve Bank from time to time. Twenty- five per cent of the total consideration amount (including share premium, if any) shall be received upfront.

In case of share warrants, at least twenty-five per cent of the consideration shall be received upfront and the balance amount within eighteen months of the issuance of share warrants.

D] Conclusion :-

Hence from the above discussion, it is clear that the word investment means investment in any security. The word Security is defined under FEMA Act 1999 which covers shares, stock bonds. Hence when the equity shares will be allotted pursuant to exercise of ESOP by the person resident outside India it has to comply with Rule 6 of NDI rules, 2019 as well.

In nutshell even if the employee of the Indian Entity is situated in country sharing land border with India, Equity instrument by converting ESOP cannot be allotted without prior permission of the Government.