Issue of Overseas Convertible Securities - Process, Procedure and Compliance

Issue of Overseas Convertible Securities  - Process, Procedure and Compliance . With an influx of foreign direct investment in India, various routes of receiving investments in a company are opening up. One of the offshore debt funding options are overseas convertible securities. This form of regulated funding from abroad is a hybrid instrument between debt and equity and requires compliance with SEBI and RBI guidelines. In this post, Compliance Calendar simplifies the processes and procedures around using overseas convertible securities for funding your business.
Overseas Convertible Securities - What are they?
Debt as a form of investment is preferable over equity for its several distinct advantages. This includes direct funding to the final borrowers, higher tax efficiency and retention of control of the original investors in the company. Convertible debentures are a category of debt instruments that mature into equity. In case of compulsorily convertible debentures, these are mandatorily converted to equity after lapse of a designated time period. They gained popularity after India amended its tax treaties with several countries after 2017.
Why should a business consider convertible securities?
There are several advantages of utilizing convertible securities as a way of raising funds. These are-

Delayed equity financing - Issuing convertible securities can help a corporation secure equity financing in a consistent way spread over time, as securities will be converted to equity at a future date. This offers an advantage of delayed dilution of the common stock.

Higher earnings per share - Since the conversion of debt into equity can be spread across ten years, a higher earnings per share can be maintained. This can be especially advantageous when an early stage company wants to preserve its equity and offer higher returns to initial investors.

Lower coupon rate - Companies can sell convertible securities at a lower coupon rate than standard debt issuances because of the conversion option. This may also be more financially viable than other forms of borrowing, such as through banks.

Stable operating income - Convertible security holders only receive interest, resulting in more operating income available for equity stockholders until the securities are converted to equity. A predetermined rate of interest also helps make better assessments and projections due to their consistent cost.

Provisions of the Companies Act, 2013 applicable to Convertible Debentures

The section 71 of the Companies Act, 2013 along with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 deal with debentures. Section 71(1) permits companies to issue debentures with an option to convert such debenture into shares, either wholly or partly at the time of redemption, provided that it shall be approved by a special resolution passed at a general meeting.

Companies can issue CCDs through a private placement offer under section 42 of the Companies Act, 2013.

As per the Companies Act, the maximum time period for issue of convertible debentures is ten years.

Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000
The foreign exchange regulations treat overseas convertible debentures as “equity” for the purpose of reporting to the Reserve Bank of India. Non-convertible/ optionally convertible/ partially convertible instruments, for which funds have been received on or after May 1, 2007, shall be treated as debt and shall conform to External Commercial Borrowing (ECB) guidelines. Issue of convertible debentures abroad also requires a Loan Registration Number.
Compliance Requirements
The Indian company issuing the securities on repatriation basis should within 30 days of receipt of application money and also within 30 days of issue of shares / debentures submit various details to the Reserve Bank of India briefly stated herein:

Name and address of the NRI investor

Amount of investment

Share of NRI participation

Name and Addresses of banks through which the funds have been received and other relevant facts about the investor

Name and address of the Company - its business, authorized capital, paid-up capital, share of NRI participation

Present value of shares as per specified guidelines and other relevant facts about the company

Certificates of audit from a professional chartered accountant

The above information is not required to be submitted if the shares / debentures are issued on non-repatriation basis.
Conditions for issue of overseas convertible debentures

Provisions notified by Ministry of Commerce - The issue of overseas convertible debentures is subject to compliance with provisions notified by the Secretariat for Industrial Assistance, Ministry of Commerce and Industry, Government of India.

Not requiring industrial license - It is relevant to note that the company's activity should not require any industrial license under the Industries (Development Regulation) Act, 1951 or Industrial Policy of 1991.

Cannot be used to acquire shares of an Indian company- The issue should also not be made for acquiring existing shares of other Indian companies.

Comply with permissible limits of Foreign Investment: Additionally, companies in certain industries that require approval from the government of India for foreign investments may do so, only after such approval is obtained. Certain sectors are prohibited from receiving foreign investment (such as Gambling, Chit Funds, Cigarettes, atomic energy etc). Consequently, industries operational in those sectors are also prohibited from issuing overseas convertible securities. A list of such industries is available as part of the Consolidated FDI Policy, released by the FDI Division, Ministry of Commerce.

Pricing of compulsorily convertible debentures
For listed companies, the price point for compulsorily convertible debentures has to conform to SEBI guidelines for valuation.
However, for unlisted Indian companies, the price valuation of capital instruments, such as compulsorily convertible debentures can be done as per any internationally accepted pricing methodology for valuation on an arm’s length basis. This must also be duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing Cost Accountant.
As per recent SEBI rules, the pricing formula for equity shares can also be decided at a later stage, after the issue of the debentures is completed.
SEBI Issue of Capital and Disclosure Regulations, 2009 - Conversion of debt into equity
As per Rule 22, conversion of optionally convertible debt instruments into equity share capital can be done subject to the following conditions:

An issuer should not convert its optionally convertible debt instruments into equity shares unless the holders of such convertible debt instruments have sent their positive consent to the issuer.

Further, if the value of the convertible portion of the debt exceeds ?50 lacs, and an issuer has not determined the conversion price at the time of issue of security, the holders must be given the option to not convert the convertible portion into equity. However, where the upper limit on the price has been disclosed to investors, there is no requirement of giving an option to convert the convertible portion into equity share capital.

Who are eligible investors for purchasing convertible debentures?
The following classes of investors can purchase convertible debentures in India:

Indian citizens

Foreign citizens of Indian origin resident outside India, other than citizens of Bangladesh or Pakistan

An entity incorporated outside India, other than entities in Bangladesh or Pakistan

Modes of investment in overseas convertible debentures
Funds for the process of investment in convertible debentures can be used from Non Resident External Accounts (NRE), Foreign Currency Non Resident Account (FCNR) and Foreign Exchange Remittances from abroad. These modes also require Know Your
Customer (KYC) certificates from the Indian bank, and the same may also be required from foreign banks remitting the funds.
Transfer and Repatriation of sale proceeds

A person resident outside India may transfer by way of sale or gift, the shares or convertible debentures to any person resident outside India (including NRIs).

The transfer can also be made via gift or selling the shares and convertible debentures of an Indian company on a recognized Stock Exchange in India through a stock broker registered with stock exchange or a merchant banker registered with SEBI.

Reporting of transfer of shares between residents and non-residents
Reporting of transfer of shares is to be done in Form FC-TRS. The Form FC-TRS should be submitted to the AD Category – I bank, within 60 days from the date of receipt of the amount of consideration. The onus of submission of the Form FC-TRS within the given timeframe would be on the transferor / transferee, resident in India. The AD Category – I bank, would forward the same to its link office. The link office would consolidate the Form FC-TRS and submit a monthly report to the Reserve Bank.
The net sale value, after payment of taxes, can be repatriated out of India and credited to NRE, FCNR or NRO account, if purchased on repatriation basis. The amount invested in convertible debentures on non-repatriation basis normally cannot be transferred abroad. However, under the Liberalized Remittance Scheme, the balance held in the NRO account may be repatriated abroad up to USD 1 million per financial year.
Financial planning for funding can help your business not just save money but also reduce the risk of non-compliance at a later stage. Consult with our qualified tax professionals and chartered accountants at Compliance Calendar to get specific advice on the suitability, tax implications and filing process for issuing overseas convertible debentures for your business.

With an influx of foreign direct investment in India, various routes of receiving investments in a company are opening up. One of the offshore debt funding options are overseas convertible securities. This form of regulated funding from abroad is a hybrid instrument between debt and equity and requires compliance with SEBI and RBI guidelines. In this post, Compliance Calendar simplifies the processes and procedures around using overseas convertible securities for funding your business.

Overseas Convertible Securities - What are they?

Debt as a form of investment is preferable over equity for its several distinct advantages. This includes direct funding to the final borrowers, higher tax efficiency and retention of control of the original investors in the company. Convertible debentures are a category of debt instruments that mature into equity. In case of compulsorily convertible debentures, these are mandatorily converted to equity after lapse of a designated time period. They gained popularity after India amended its tax treaties with several countries after 2017.

Why should a business consider convertible securities?

There are several advantages of utilizing convertible securities as a way of raising funds. These are-

Delayed equity financing - Issuing convertible securities can help a corporation secure equity financing in a consistent way spread over time, as securities will be converted to equity at a future date. This offers an advantage of delayed dilution of the common stock.
Higher earnings per share - Since the conversion of debt into equity can be spread across ten years, a higher earnings per share can be maintained. This can be especially advantageous when an early stage company wants to preserve its equity and offer higher returns to initial investors.
Lower coupon rate - Companies can sell convertible securities at a lower coupon rate than standard debt issuances because of the conversion option. This may also be more financially viable than other forms of borrowing, such as through banks.
Stable operating income - Convertible security holders only receive interest, resulting in more operating income available for equity stockholders until the securities are converted to equity. A predetermined rate of interest also helps make better assessments and projections due to their consistent cost.

Provisions of the Companies Act, 2013 applicable to Convertible Debentures

The section 71 of the Companies Act, 2013 along with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 deal with debentures. Section 71(1) permits companies to issue debentures with an option to convert such debenture into shares, either wholly or partly at the time of redemption, provided that it shall be approved by a special resolution passed at a general meeting.
Companies can issue CCDs through a private placement offer under section 42 of the Companies Act, 2013.
As per the Companies Act, the maximum time period for issue of convertible debentures is ten years.

Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000

The foreign exchange regulations treat overseas convertible debentures as “equity” for the purpose of reporting to the Reserve Bank of India. Non-convertible/ optionally convertible/ partially convertible instruments, for which funds have been received on or after May 1, 2007, shall be treated as debt and shall conform to External Commercial Borrowing (ECB) guidelines. Issue of convertible debentures abroad also requires a Loan Registration Number.

Compliance Requirements

The Indian company issuing the securities on repatriation basis should within 30 days of receipt of application money and also within 30 days of issue of shares / debentures submit various details to the Reserve Bank of India briefly stated herein:

Name and address of the NRI investor
Amount of investment
Share of NRI participation
Name and Addresses of banks through which the funds have been received and other relevant facts about the investor
Name and address of the Company - its business, authorized capital, paid-up capital, share of NRI participation
Present value of shares as per specified guidelines and other relevant facts about the company
Certificates of audit from a professional chartered accountant

The above information is not required to be submitted if the shares / debentures are issued on non-repatriation basis.

Conditions for issue of overseas convertible debentures

Provisions notified by Ministry of Commerce - The issue of overseas convertible debentures is subject to compliance with provisions notified by the Secretariat for Industrial Assistance, Ministry of Commerce and Industry, Government of India.
Not requiring industrial license - It is relevant to note that the company's activity should not require any industrial license under the Industries (Development Regulation) Act, 1951 or Industrial Policy of 1991.
Cannot be used to acquire shares of an Indian company- The issue should also not be made for acquiring existing shares of other Indian companies.
Comply with permissible limits of Foreign Investment: Additionally, companies in certain industries that require approval from the government of India for foreign investments may do so, only after such approval is obtained. Certain sectors are prohibited from receiving foreign investment (such as Gambling, Chit Funds, Cigarettes, atomic energy etc). Consequently, industries operational in those sectors are also prohibited from issuing overseas convertible securities. A list of such industries is available as part of the Consolidated FDI Policy, released by the FDI Division, Ministry of Commerce.

Pricing of compulsorily convertible debentures

For listed companies, the price point for compulsorily convertible debentures has to conform to SEBI guidelines for valuation.

However, for unlisted Indian companies, the price valuation of capital instruments, such as compulsorily convertible debentures can be done as per any internationally accepted pricing methodology for valuation on an arm’s length basis. This must also be duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing Cost Accountant.

As per recent SEBI rules, the pricing formula for equity shares can also be decided at a later stage, after the issue of the debentures is completed.

SEBI Issue of Capital and Disclosure Regulations, 2009 - Conversion of debt into equity

As per Rule 22, conversion of optionally convertible debt instruments into equity share capital can be done subject to the following conditions:

An issuer should not convert its optionally convertible debt instruments into equity shares unless the holders of such convertible debt instruments have sent their positive consent to the issuer.
Further, if the value of the convertible portion of the debt exceeds ?50 lacs, and an issuer has not determined the conversion price at the time of issue of security, the holders must be given the option to not convert the convertible portion into equity. However, where the upper limit on the price has been disclosed to investors, there is no requirement of giving an option to convert the convertible portion into equity share capital.

Who are eligible investors for purchasing convertible debentures?

The following classes of investors can purchase convertible debentures in India:

Indian citizens
Foreign citizens of Indian origin resident outside India, other than citizens of Bangladesh or Pakistan
An entity incorporated outside India, other than entities in Bangladesh or Pakistan

Modes of investment in overseas convertible debentures

Funds for the process of investment in convertible debentures can be used from Non Resident External Accounts (NRE), Foreign Currency Non Resident Account (FCNR) and Foreign Exchange Remittances from abroad. These modes also require Know Your

Customer (KYC) certificates from the Indian bank, and the same may also be required from foreign banks remitting the funds.

Transfer and Repatriation of sale proceeds

A person resident outside India may transfer by way of sale or gift, the shares or convertible debentures to any person resident outside India (including NRIs).
The transfer can also be made via gift or selling the shares and convertible debentures of an Indian company on a recognized Stock Exchange in India through a stock broker registered with stock exchange or a merchant banker registered with SEBI.

Reporting of transfer of shares between residents and non-residents

Reporting of transfer of shares is to be done in Form FC-TRS. The Form FC-TRS should be submitted to the AD Category – I bank, within 60 days from the date of receipt of the amount of consideration. The onus of submission of the Form FC-TRS within the given timeframe would be on the transferor / transferee, resident in India. The AD Category – I bank, would forward the same to its link office. The link office would consolidate the Form FC-TRS and submit a monthly report to the Reserve Bank.

The net sale value, after payment of taxes, can be repatriated out of India and credited to NRE, FCNR or NRO account, if purchased on repatriation basis. The amount invested in convertible debentures on non-repatriation basis normally cannot be transferred abroad. However, under the Liberalized Remittance Scheme, the balance held in the NRO account may be repatriated abroad up to USD 1 million per financial year.

Financial planning for funding can help your business not just save money but also reduce the risk of non-compliance at a later stage. Consult with our qualified tax professionals and chartered accountants at Compliance Calendar to get specific advice on the suitability, tax implications and filing process for issuing overseas convertible debentures for your business.