Start-up India Action Plan – Devil is the detailing – Part III

This post deals with the various initiatives and measures taken by the Ministry of Corporate Affairs (“MCA”) and the Reserve Bank of India (“RBI”) towards the Start up India Action Plan,

Aimed at easing the hurdles that start-ups face and ensuring that the start-up culture in the country gets a boost, many amendments to key legislations and polices are being formulated and are concurrently being implemented to bring the requisite changes in the regulations.

Please find below a series of such key amendments / policies / schemes that have been initiated:

Issuance of sweat equity shares and ESOPs

Vide notification dated 19 July 2016, the MCA has notified the Companies (Share Capital and Debentures) Third Amendment Rules, 2016 to amend the Companies (Share Capital and Debentures) Rules, 2014 and has provided relaxation to start-ups towards issuing sweat equity shares and ESOPs.

Under Rule 8 (4), a new proviso has been inserted stating that a start-up company as defined under the DIPP Notification may issue sweat equity shares not exceeding 50 (fifty) per cent of its paid up capital for upto 5 (five) years from the date of its incorporation or registration.

Further, under Rule 12 (1) (c) (ii), a new proviso has been inserted stating that in case of a start-up company as defined under the DIPP Notification, the conditions mentioned in Rule 12 sub-clause (1) (c) (i) and sub-clause (1) (c) (ii) shall not apply upto 5 (five) years from the date of its incorporation or registration.

The sub-clause (1) (c) (i) and sub-clause (1) (c) (ii) provides for the exclusion of promoter or a person belonging to the promoter group and a director (who either himself or through his relative or through any body corporate, directly or indirectly, holds more than 10 (ten) percent of outstanding equity shares) from the ambit of the term ‘Employees’ while issuing ESOPs. The amendment has done away with the application of the aforementioned sub-clauses for start-ups for upto five years from the date of its incorporation or registration.

Revisions in deposit rules to provide flexibility to start-ups in raising funds

Vide notification dated 29 June 2016, the MCA has notified “Companies (Acceptance of Deposits) Amendment Rules, 2016” to amend the “Companies (Acceptance of Deposits) Rules, 2014”, whereby a major amendment has been put into place to provide more flexibility to the start-ups in raising funds.

Under Rule 2 (1) (C), the definition of ‘deposits’ has been amended to include a new exemption, sub-clause (xvii), to the definition of deposits – an amount of INR 25 Lacs or more received by a start-up company, by way of a convertible note[1] (convertible into equity shares or repayable within a period not exceeding five years from the date of issue) in a single tranche, from a person.

Opening of foreign currency account with bank outside India

Vide notification dated 1 June 2016, RBI has notified the Foreign Exchange Management (Foreign Currency Accounts by a person resident in India) (Amendment) Regulations, 2016. It has been notified as under:

  • An Indian start-up or any other entity as may be notified by the RBI in consultation with the Central Government, having an overseas subsidiary, may open a foreign currency account with a bank outside India for the purpose of crediting to it foreign exchange earnings out of exports/ sales made by the said entity and/ or the receivables, arising out of exports/ sales, of its overseas subsidiary. However, the balances in the account shall be repatriated to India within the period prescribed in Foreign Exchange Management (Export of Goods and Services) Regulations, 2015 dated 12 January 2016, as amended from time to time, for realization of export proceeds.
  • A person resident in India may credit to the Exchange Earner’s Foreign Currency Account with an Authorised Dealer in India, 100 (hundred) percent of the foreign exchange earnings received by an Indian start-up or any other entity as may be notified by the RBI in consultation with the Central Government, arising out of exports/ sales made by the said entity or its overseas subsidiaries, if any.

Deferred consideration

In keeping with GOI’s initiatives to promote the ease of doing business and contribute to an eco-system conducive for growth of entrepreneurship, vide notification dated 20 May 2016, RBI has permitted under the automatic route, deferment of purchase consideration and escrow mechanism in share purchase transactions involving foreign investment.

Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 has been amended and after Regulation 10, a new Regulation 10A has been inserted by the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Seventh Amendment) Regulations, 2016, stating that:

  • In case of transfer of shares between a resident buyer and a non-resident seller or vice-versa, not more than 25 (twenty-five) per cent of the total consideration can be paid by the buyer on a deferred basis within a period not exceeding 18 (eighteen) months from the date of the transfer agreement.
  • For this purpose, if so agreed between the buyer and the seller, an escrow arrangement may be made between them for depositing the deferred consideration and the escrow amount shall not be more than 25 (twenty-five) per cent of the total consideration and such an arrangement shall not exceed a time period of eighteen months from the date of the transfer agreement
  • If the total consideration is paid by the buyer to the seller, the seller may furnish an indemnity for an amount not more than 25 (twenty-five) per cent of the total consideration for a period not exceeding 18 (eighteen) months from the date of the payment of the full consideration.
  • The total consideration finally paid for the shares must be compliant with the applicable pricing guidelines.

Devil is in the detail: It is pertinent to note that commencement date for the 18 (eighteen) month period for deferred consideration and escrow arrangement is the date of the transfer agreement and not the date of payment of the full consideration as in the case of the indemnity that may be furnished by the seller to the buyer.

Foreign Venture Capital Investment in Start-ups

Vide notification dated 28 April 2016 (“Notification”), RBI has permitted foreign venture capital investors to invest in start-ups.

The Notification has notified the definition of start-up as mentioned below:

‘startup’ shall mean an entity, incorporated or registered in India not prior to five years, with an annual turnover not exceeding INR 25 Crores in any preceding financial year, working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property,

Provided that such entity is not formed by splitting up, or reconstruction of a business already in existence. 

For this purpose,

  • ‘entity’ shall mean a private limited company (as defined in the Companies Act, 2013), or a registered partnership firm (registered under section 59 of the Partnership Act, 1932) or a limited liability partnership (under the Limited Liability Partnership Act, 2008).
  • the expression ‘turnover’ shall have the same meaning as assigned to it under the Companies Act, 2013.
  • An entity is considered to be working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property if it aims to develop and commercialize (a) a new product or service or process; or (b) a significantly improved existing product or service or process that will create or add value for customers or workflow

 Provided that it will not include the mere act of developing (a) products or services or processes which do not have potential for commercialization; or (b) undifferentiated products or services or processes or (c) products or services or processes with no or limited incremental value for customers or workflow.

The Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Third Amendment) Regulations, 2016 provided that:

A Foreign Venture Capital Investor (FVCI) registered under SEBI (FVCI) Regulations, 2000, may purchase equity Linked instruments or debts instruments issued by a start-up irrespective of the sector in which the start-up is engaged. It will make investment in the manner and subject to the terms and conditions specified in Schedule 6.”

Schedule 6 provides in relation to start up investments that:

A Foreign Venture Capital Investor (FVCI) registered under the SEBI (FVCI) Regulations, 2000, may purchase equity or equity linked instruments or debt instruments issued by a start-up, irrespective of the sector in which it is engaged.

To enhance the economy of the country it is vital to ensure that there is an efficient trade and commerce practice established with foreign countries. In todays globalized world, it is crucial to establish favourable trade and commerce practices to ensure foreign investment in India.

With the Foreign Venture Capital Investors being allowed to invest in start-ups, it will attract huge sums for such entities which would create favourable conditions in the Indian economy. This would also lead to an increase in the number of innovative start-ups in the country.

Devil is in the detail: The definition mentioned above is not clear of ambiguity and it is matter of doubt if the regulators have managed to create an unquestionable definition of the start-ups. Although there are certain tests laid down in order to identify what is ‘working toward innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property. These tests are largely subjective.

Online submission of Form A2 for outward remittance

Towards further promoting the ease of doing business in India, vide Circular No. 50 dated 11 February 2016, RBI has notified clarifications relating to online submission of Form A2 by the remitter. It has been clarified that with a view to facilitating miscellaneous remittances and reducing paperwork associated with payment transactions, Authorised Dealer banks, offering internet banking facilities to their customers have been permitted to allow online submission of Form A2.

Authorized Dealers may also enable uploading/submission of documents, if and as may be necessary, to establish the permissibility of the remittances under the extant rules or regulations framed under the Foreign Exchange Management Act, 1999 (FEMA).

Remittances that do not require any documentation (e.g. certain transactions under the LRS) may be put through on the basis of the Form A2 alone. Remittances on the basis of online submission alone will be available for transactions with an upper limit of USD 25,000 (or its equivalent) for individuals and USD 100,000 (or its equivalent) for corporates. However, remittance will be subject to satisfaction of the Authorised Dealer banks as laid down in Section 10 (5) of FEMA.

RBI clarifications relating to acceptance of payments on behalf of overseas subsidiaries

Vide Circular No. 51 dated 11 February 2016, RBI has notified clarifications relating to acceptance of payments on behalf of overseas subsidiaries. It has been clarified as under:

  • Indian start-ups having overseas subsidiaries are allowed to open and maintain foreign currency account abroad to collect and pool foreign currency earning against exports/sales.
  • In the said account, the overseas subsidiaries shall be permitted to pool its receivables arising from the transactions with residents in India as well as with non-residents abroad.
  • Balances in the said account shall be repatriated to India within the prescribed time limits of realisation of export dues.
  • Start-ups are also permitted to use Online Payments Gateway Service Providers (OPGSPs) for realization of overseas payments against export/sales with a maximum limit of USD 10,000.
  • Contractual arrangements to facilitate the above said transaction should be in place between Indian Start-ups, their overseas subsidiaries and customers.
  • A dedicated mailbox has been created by the RBI to provide assistance and guidance to the start-up sector. Electronic reporting of investment and subsequent transactions will be made on e-Biz platform only and submission of physical forms has been discontinued with effect from February 8, 2016.

RBI clarifications relating to issue of shares

Vide Circular No. 52 dated 11 February 2016, RBI has notified clarifications relating to issue of shares. It has been clarified as under:

  1. Indian companies have been permitted to issue sweat equity, subject to conditions, inter-alia, that the scheme has been drawn either in terms of regulations issued under the Securities Exchange Board of India Act, 1992 in respect of listed companies or the Companies (Share Capital and Debentures) Rules, 2014 notified by the Central Government under the Companies Act 2013 in respect of other companies.
  2. Indian companies have also been permitted to issue equity shares against any other funds payable by the investee company remittance of which does not require prior permission of the Government of India or Reserve Bank of India under FEMA, 1999 subject to conditions relating to adherence to FDI policy including sectoral caps, pricing guidelines, etc. and applicable tax laws.

Further, there are many more policy reforms that are being contemplated to give further wings to the Action Plan and we can look forward to the same:

Keeping with the Action Plan, the Reserve Bank of India (“RBI”) has in its Sixth Bi-monthly Policy Statement, 2015-2016 dated 2 February 2016 highlighted the steps that it shall take to keep with the Action Plan and contribute to an ecosystem conducive for growth of entrepreneurship, particularly with respect to start-ups. In this regard, vide Press Release dated 2 February 2016, RBI had proposed to make in consultation with the government, certain regulatory changes for easing cross-border transactions, particularly relating to the operations of the start-up enterprises. Many of the proposed changes have already been implemented, however, following proposals are still under consideration:

  1. Simplifying the process for dealing with delayed reporting of Foreign Direct Investment (FDI) related transaction by building a penalty structure into the regulations itself;
  2. Permitting start-up enterprises to access rupee loans under External Commercial Borrowing (ECB) framework with relaxations in respect of eligible lenders, etc.; and
  3. Issuance of innovative FDI instruments like convertible notes by start-up enterprises.

[This is the third of a series of 6 posts that seeks to consolidate all the benefits and policy directives directed towards promoting Start-ups in India.]

[1] A ‘convertible bond’ or ‘convertible note’ or ‘convertible debt’ (or a ‘convertible debenture’ if it has a maturity of greater than 10 years) is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company (typically in conjunction with a future round of funding).

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