Press Note 3 (2020) and the Indirect-Shareholding Question
Press Note 3 of 2020 introduced a prior-government-approval requirement for any FDI from an entity of a country sharing a land border with India, or where the beneficial owner of the investment is situated in or is a citizen of any such country. The indirect-shareholding question is where the framework gets complicated.
The framework
The Government of India introduced Press Note 3 of 2020 ("PN3") in April 2020, amending Paragraph 3.1.1 of the Consolidated FDI Policy. The amendment requires prior Government of India approval for any FDI from an entity of a country which shares a land border with India, or where the beneficial owner of the investment is situated in or is a citizen of any such country.
The land-bordering countries are: Afghanistan, Bangladesh, Bhutan, China, Myanmar, Nepal and Pakistan. The Press Note has since been embodied in the FEMA NDI Rules, 2019 (Rule 6) through the FEM (NDI) Amendment Rules, 2020.
Direct shareholding is the easy case
Where the foreign investor is incorporated in or a citizen of a land-bordering country, PN3 applies. Government approval is required before the investment is made, before the share allotment, and before any reporting under Form FC-GPR. There is no de minimis threshold.
Indirect shareholding is the complicated case
The complication arises in indirect-shareholding scenarios — where the immediate foreign investor is incorporated in a non-bordering country (Singapore, Mauritius, Netherlands, etc.) but the upstream beneficial ownership traces to a land-bordering country.
The PN3 framework looks through the immediate shareholder to the "beneficial owner". The 2020 amendment imported, in substance, the beneficial-ownership concept from the Companies Act, 2013 and the PMLA Rules — though without explicitly cross-referencing either statute.
What constitutes "beneficial ownership"
The Press Note itself does not define beneficial ownership. In practice, three working tests have emerged:
- The 10% test. Drawing from PMLA Rule 9 and the Companies (Significant Beneficial Owners) Rules, 2018, beneficial ownership is typically asserted where a person holds 10% or more (directly or indirectly) of the shares or voting rights of the entity. This is the most commonly applied threshold in practice.
- The control test. Beneficial ownership extends to persons exercising control over the entity, regardless of shareholding — including through arrangements such as veto rights, board-appointment rights or contractual control.
- The nominee test. Where the nominal shareholder is shown to be holding for the benefit of another person, that other person is treated as the beneficial owner.
The structuring question
For Indian enterprises receiving foreign capital, the working question is: how to determine whether PN3 applies to a proposed investment from a non-bordering-country investor.
The protocol that has developed in practice is a two-stage diligence:
- Stage 1 — corporate diligence. A trace through the corporate ownership chain from the immediate shareholder to the ultimate beneficial owner, with documentary evidence at each level (registry filings, shareholder agreements, declarations).
- Stage 2 — declarations. Beneficial-ownership declarations from each tier of the ownership chain, plus a top-level declaration from the ultimate beneficial owner that no land-bordering-country nexus exists.
The PN3 framework is structured around presumptions: the absence of disclosed land-bordering-country nexus is not conclusive of compliance; the burden of demonstrating absence falls on the investor and the investee.
Approval procedure
Where PN3 applies, prior approval must be obtained from the competent administrative ministry — typically through the relevant ministry's online FDI portal. The approval timeline varies considerably by sector and by the nature of the investor.
Approval is granted on a transaction-by-transaction basis, not as a blanket clearance. Subsequent share allotments, follow-on rounds and exit transactions involving the same investor each require fresh approval.
Working observations
The PN3 framework has been applied with significant rigour since its introduction. Filings have been rejected where the beneficial-ownership trace was incomplete, where the ultimate beneficial owner was not satisfactorily identified, or where the investor's connection to a land-bordering country was found at an upstream level despite the immediate investor being incorporated in a non-bordering jurisdiction.
For Indian enterprises, the practical takeaway is unambiguous: the diligence on the investor's beneficial ownership must be conducted before the term sheet, not after the share allotment. A non-compliant investment cannot be regularised after the fact through ex-post approval — the contravention crystallises at the point of share allotment.