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Investment into corporate groups and ‘indirect’ investment

A large corporate group or a conglomerate often operates through a holding company. The holding company usually does not carry out business activities independently – it will merely possess majority shares in its ‘subsidiaries’ which operate in different business sectors. Rarely, the holding company may itself engage in business activities in a particular sector, apart from having investments in its subsidiaries. As a group grows larger, it may operate through a chain of holding companies.

For example, consider the following structure:

Foreign investment can also be raised at the group level, that is, in one of the holding companies, or directly in one of the subsidiaries. Imagine that an Indian company operates in three different sectors - bio-technology, insurance and software. It has 3 operating companies held through a common holding company. In such cases, a foreign investor may either acquire a stake in one of the operating companies, or, it can take exposure to all of the company’s businesses, by investing directly into the holding company.

In the latter instance, the foreign investor is considered to have invested ‘indirectly’ in the operating companies as well, although it directly holds shares only of the holding company. If it invests in the holding company, the subsidiaries of the holding company will also be considered to have foreign investment (indirectly), and will be required to comply with the same requirements as though the foreigner had directly invested into the company.

However, investment at the group level is usually requires an FIPB approval and may also involve tax leakages, which is the reason foreigners prefer directly investing into the operating company, unless there is an overarching strategic reason. 

Strategic reasons for investment in holding company

Imagine a private equity investor which wants to invest in a listed subsidiary of an Indian company – the obvious route is for it to make a direct investment (either on the stock market or purchase a bulk of the shares of the listed company outside the market). However, note that private equity investors like to take certain additional rights to protect their investment, in comparison to ordinary shareholders, which is not possible if the investment is directly made into the listed company. However, if the investment is made into the holding company, taking some of these rights at the level of the holding company may achieve a similar effect.

The amount of indirect foreign investment (that is foreign investment in operating companies, when the FDI has been made into a higher level holding company) can be calculated as per the mechanism given below. 



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