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India Investment Restrictions Take Effect

Tuesday, April 13, 2010

Indian government changes to foreign direct investment rules have taken effect from April 1, 2010. The new rules require foreign venture capital funds to obtain prior approval for investment in Indian venture funds, and investment in unregistered trusts is no longer permitted.

The rules were issued by the Department of Industrial Policy and Promotion, which is responsible for foreign direct investment policy. The changes are reported to be motivated by the desire to curb money-laundering through trusts, since they are not as tightly regulated as companies.

Foreign inward investment through venture capital funds has been regulated since 2007 when a huge rise in venture capital investments swamped real-estate markets. Measures put in place included restricting tax benefits to certain sectors and tightening registration procedures to regulate the flow of funds from these entities.

When foreign VC funds were required to undertake to the Reserve Bank of India not to invest in the property sector, some of the offshore VCs, especially those registered in Mauritius, sidestepped the regulations by investing in local funds. A Securities and Exchange Board-registered (SEBI) foreign venture capital investor was permitted to invest without prior approval in a domestic venture capital fund registered with the SEBI until the new regulations kicked in.

Domestic venture funds may be structured either as a company or as a trust and can accept foreign investment from a foreign venture capital investor after permission has been obtained. The absence of any grandfathering provisions for foreign investors registered prior to April 1, 2010, and those that had invested in domestic funds registered before this date, has created an element of uncertainty, and it is not yet clear whether such investments will require any further approval from the government.