FDI in real estate: rules need further clarification

In India, foreign direct investment (FDI) of up to 100% is permitted under the automatic route in township, housing and construction projects, subject to certain conditions in the Department of Industrial Policy and Promotion’s (DIPP’s) press note 2 of 2005.

(i) Minimum development: the minimum land area to be developed for serviced housing plots is 10 hectares (50,000 square metres for construction development projects); (ii) Minimum capitalization: for a wholly owned subsidiary, the minimum capitalization is US$10 million (US$5 million for a joint venture), which must be brought in within six months of the commencement of business; (iii) Lock-in requirement: the original investment may not be repatriated within three years of the minimum capitalization, except by prior approval of the Foreign Investment Promotion Board (FIPB).

Additional rules: at least 50% of the project must be developed within five years of obtaining all statutory clearances (the foreign investor being responsible for obtaining such clearances); the investor may not sell undeveloped plots; and the project must comply with land use requirements, the provisions of applicable building control regulations and other standard local, municipal and state government rules.

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Press note 2 of 2005 provides increased foreign investment opportunities in the Indian real estate sector, but retains ambiguities which require further clarification by the DIPP. Firstly, the term “built-up area” remains unclear. The DIPP has informally indicated that the term should be construed in relation to applicable state land and building by-laws, but this approach may result in inconsistencies in how the minimum built-up area is determined.

In relation to the minimum capitalization requirement, the term “commencement of business” has not been specified.

Similarly, in relation to the requirement for a lock-in period before repatriation of investment, the term “original investment” is not defined. It was previously understood to mean the specified minimum capitalization, and so the view was generally taken that foreign investors may repatriate amounts in excess of the minimum capitalization during the three year lock-in period. However, in July the DIPP informally clarified that “original investment means the entire investment”, which some construe as meaning that the entire foreign investment is subject to the three year lock-in.

Again in relation to the lock-in requirement, one view was that the transfer of securities in a real estate development company from one non-resident investor to another during the lock-in period should be allowed, as it would not result in any repatriation of funds. However, in February the FIPB rejected an application by ICP Investments (Mauritius), a non-resident entity, to acquire the shares of an Indian real estate development company held by another non-resident entity during the lock-in period. According to press reports, the application was rejected because the lock-in restriction applied in respect of the foreign investor, and not just the foreign investment. The lock-in issue also impacts other types of capital-raising activities. For example, if foreign investment in an offering is considered FDI, the FIIs subscribing to shares of a real estate development company in that case may be subject to a three year lock-in, which would make the offering unmarketable to FIIs.

In relation to the need for compliance with land use requirements, the usual practice of real estate development companies is to acquire agricultural land and subsequently apply to the relevant authorities for permission to change the land use. FDI is largely prohibited in the agricultural sector. While it may be argued that real estate development companies acquiring agricultural land do not actually engage in agriculture, the DIPP has informally clarified that any such company that has received FDI cannot own agricultural land. A related question is whether a company with non FDI-compliant projects is permitted to receive FDI at all. There is a view that this should be allowed as long as the FDI is used only for FDI-compliant projects. However, in January the FIPB rejected an application by Vatika, an Indian real estate development company, to retain non-FDI compliant projects after the company had received FDI.

Two final ambiguities – both concerning how press note 2 of 2005 should apply to an Indian real estate development investee company into which downstream investment is received from another Indian company – have been raised by the recently issued press notes 2 and 4 of 2009. These concern the calculation of foreign investment in Indian companies and downstream investments by Indian companies.

Press note 4 of 2009 applies FDI rules to downstream investments by Indian companies that are owned or controlled by foreign entities, but it is unclear whether the minimum capitalization and lock-in requirements specified in press note 2 of 2005 need to be fulfilled in relation to the investee company also.

In addition, press note 2 of 2009 states that foreign investment through an Indian resident-owned and controlled company will not be considered in the calculation of indirect foreign investment. Thus it could be argued that a foreign investor may indirectly invest in a real estate development company via an Indian resident-owned and controlled company without having to comply with press note 2 of 2005.

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Juhi Singh is a partner at S&R Associates, a New Delhi-based law firm.