2023 (9) TMI 1570 - AT - FEMA

Offence under FEMA - Contravention of Sections 6 (3) (a) and (h) of FEMA - fact of the purchase by the SDS-2 of the residential real estate in UK, make the purpose of the direct investment by R-1 in the WOS as not being bona fide - Whether the declarations and the procedural requirements met by R-1 are invalidated in view of the aforementioned purchase of the residential real estate in UK by the SDS-2 - Whether the purchase of the residential real estate in UK by the SDS-2 located in BVI was actually by R-1, the Indian Party, which is a company resident in India? HELD THAT - The word bona fide has not been defined under FEMA, however, as mentioned in the impugned AO, bona fide means in good faith; without fraud or deception; honestly, as distinguished from bad faith; openly; sincerely . Regulation 6 (2) (ii) of the ODI Regulations reads as, The direct investment is made in an overseas Joint Venture or Wholly Owned Subsidiary engaged in a bona fide business activity. Obviously, if the business activity involves illegal activities say either narcotic trafficking or money laundering such business activity cannot be regarded as bona fide. From such an obvious example it appears that the requirement that the business activity is to be bona fide cannot be restricted to that of the WOS but will also apply to the business activities of the SDS-1 and of the SDS-2. No Indian Party shall make any direct investment in a foreign entity engaged in real estate business or banking business is what is stipulated under Regulation 5 (2) of the ODI Regulations. The definition of Direct Investment outside India under Regulation 2 (e) of the ODI Regulations is investment by way of contribution to the capital or subscription to the Memorandum of Association of a foreign entity or by way of purchase of existing shares of a foreign entity either by market purchase or private placement or through stock exchange, but does not include portfolio investment. Regulation 2 (q) of the ODI Regulations defines Wholly Owned Subsidiary to mean a foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country, whose entire capital is held by the Indian Party. Regulation 13 of the ODI Regulations is enabling provision for setting up of a step down subsidiary by a wholly owned subsidiary provided the Indian Party reports about this to RBI in the Annual Performance Report. Reporting through APRs is an obligation cast upon the Indian Party in addition to its obligations which have been cast upon it for setting up a wholly owned subsidiary. In the present case the SDS-2 is wholly owned subsidiary of the SDS-1, which is wholly owned subsidiary of the WOS wherein 100 per cent Direct Investment has been made by R-1. In view of this factual matrix a step down subsidiary also need to have bona fide business as stipulated under Regulation 5 (2) of the ODI Regulations. The argument of the learned counsel for the respondents that the provisions of the ODI Regulations are not applicable to step down subsidiaries and can only be applied to a Wholly Owned Subsidiary cannot be sustained as the ODI Regulations are to be read as a whole. The requirement of having bona fide business activity will also need to be complied by the step down subsidiaries as well. There is nothing on record to show that the WOS and the SDS-1 indulged in real estate business. No allegation has also been made to this effect. The entire controversy relates to the purchase of the residential real estate in UK by the SDS-2. It is true that out of US 5.5 million paid for the purchase of the said property, US 1.6 million was the fund which came from the SDS-1 and the WOS wherein direct investment was made by R-1. The charge made against R-1 is that the Indian Party in contravention of Section 6 (3) (h) of FEMA r/w Regulations 5 and 6 (2) (ii) of the ODI Regulations was not engaged in bona fide business activity. Respondent argued that the single transaction of only buying a residential real estate in UK is not covered under the definition of real estate business - Any activity in order to constitute business must be systematic and continuous. The Appellant has failed to produce any evidence as to show that the solitary purchase of the real estate abroad by the SDS-2 was not merely the only one in the dealing of real estate by the SDS-2. The Respondents have maintained that the real estate abroad was purchased to use as a Guest House for facilitating their business of trade. The Appellant has argued that the respondent has not produced evidence to show that the property was being used as a Guest House. Such insistence is not warranted in view of the fact that a solitary purchase of real estate abroad does not constitute business. In fact, the respondents have submitted evidence for trade transactions of the SDS-2 which have also been relied upon by the Appellant in the documents enclosed with the Appeal. Since, the SDS-2 did not indulge in the real estate business, question a) raised in paragraph 30 is answered in favour of the respondents. In view of the aforementioned the charge of the contravention of Section 6 (3) (h) FEMA r/w Regulations 5 and 6 (2) (ii) of the ODI Regulations does not hold good. The declarations filed by R-1 with the Authorised Dealer include ODI Forms. As discussed in paragraph 27, R-1 made direct investment of US 2.4 million as equity contribution in the WOS registered in Singapore. The investment was made in three tranches. For each of the tranche, Form ODI was filed with the Authorised Dealer. The ODI Form has declaration to the effect that the purpose of forming wholly owned subsidiary in Singapore is to have a Special Purpose Vehicle to make down stream investment in trading activities. Moreover, the ODI Form for the third tranche was filed in the revised format as prescribed. This Form ODI has information not only on the WOS but also on the SDS-1 and the SDS-2. The Activity Code for the SDS-2 has been declared as 820.3 which has been explained as lessor of real property. This Form also has the declaration that a step down subsidiary called Rhizen Pharmaceuticals Ltd. in Switzerland has been formed by the SDS-1. Besides the aforementioned ODI Forms, R-1 has filed Annual Performance Reports for the relevant years of 2015-16 and 2016-17 with the RBI through the Authorised Dealer, which substantiate the earlier filings in the three Forms ODI. The evidence on record thus substantiates the contention that the SDS-2 was doing trading activities. It is pertinent to mention the admitted fact that the SDS-2 had taken loan of US 3.9 million from M/s. Silverwood Enterprises which was the main source of fund to purchase the residential real estate in London. It is also significant to note that the declarations made in the Forms ODI and the APRs were not questioned by the Authorised Dealer and the RBI. In fact, the SDS-2 does not even appear to have indulged in the activity relating to lessor of real property in spite of declaration to that effect made in third Form ODI and APRs. Thus, the SDS-2 has not contravened the declarations made by R-1 to the Authorised Dealer about the purposes for which the foreign exchange was acquired. In view of these discussions, the answer to question b) raised is that these declarations and other procedural requirements met by R-1 do not get invalidated because of the purchase of the residential real estate in UK by the SDS-2. Therefore, the charge of contravention of Section 10(6) of FEMA invoked against the respondents is not proved. Contravention of Section 4 of FEMA - charge is based on the allegation that R-1 by creating paper subsidiaries in Singapore, UAE and BVI transferred US 1.6 million for purchase of the immovable property 46 Campden Hill in London UK - There is no documentary evidence to corroborate that either de jure control and power, or de facto control and power was with R-1 with regard to conduct of the affairs of the SDS-2. In fact, there is documentary evidence on record that the SDS-2 is registered in the British Virgin Island and has Board of Directors which demonstrate that the de-jure control and power was with the SDS-2. The Bank account statement of the SDS-2 showing debits and credits relating to trading business in Annexure VII to the present Appeal, the list of items traded by the SDS-2 with the names of parties and the value of such items, and the statement of R-2 listing transactions relating to trading business in oil and gas equipment without any intervention by R-1 go on to show that the de-facto control and power was with the SDS-2. The evidence about the circumstances under which the solitary purchase of the immovable property in UK was made, as discussed in paragraph 39, does not lead to conclusion that the SDS-2 was under the control of R-1. Appellant has also invoked the principle of lifting of the corporate veil. Since, it is admitted fact that the direct investment by R-1 flowed through the WOS and the SDS-1 to the SDS-2 which has also been declared to the Authorised Dealer, the principle of lifting of the corporate veil is not applicable as the factual status of each of the entity has been made patent. In view of the aforementioned discussions question c) raised in paragraph 30 is to be answered in negative. Therefore, there is no contravention of Section 4 by the respondents. In view of the aforementioned findings the seizure of mutual funds valued at Rs. 10,35,20,000/- cannot be sustained. None of the charges of contravention invoked under FEMA and Regulation is established against the three Respondents (R-1, R-2 R-3), the issue raised in paragraph 25 with regard to the fourth Noticee to the SCN Shri Chirayu Amin, also gets closed. Since, the learned AA has dropped the charges against the fourth Noticee to the SCN in the impugned AO and the Appellant has chosen not to make the fourth Noticee as a Respondent to the present Appeal, the impugned AO has assumed finality for him.

Summary

Issues Involved:

1. Contravention of Sections 6 (3) (a) and (h) of FEMA and related ODI Regulations.
2. Alleged contravention of Section 10 (6) of FEMA.
3. Alleged contravention of Section 4 of FEMA.
4. Validity of the procedural requirements and declarations made by the respondents.
5. Seizure of mutual funds under Section 37 A of FEMA.

Issue-wise Detailed Analysis:

1. Contravention of Sections 6 (3) (a) and (h) of FEMA and Related ODI Regulations:

The core issue was whether the direct investment by R-1 in its Wholly Owned Subsidiary (WOS) was in violation of the FEMA provisions. The Ld. Adjudicating Authority (AA) determined that the investment by R-1 into its WOS was in accordance with Regulation 5 of the ODI Regulations. The WOS was declared as a Special Purpose Vehicle to make downstream investments in trading activities, and it was not engaged in real estate business or any fraudulent activity. The purchase of a single residential property by the second step-down subsidiary (SDS-2) in the UK was not considered real estate business as per Regulation 2 (p) of the ODI Regulations. The Tribunal upheld these findings, emphasizing that the solitary purchase did not constitute a real estate business, thereby dismissing the charges under Sections 6 (3) (a) & (h) of FEMA.

2. Alleged Contravention of Section 10 (6) of FEMA:

The Tribunal examined whether R-1 contravened Section 10 (6) of FEMA by not adhering to the declared purpose of remittance. The Ld. AA found that R-1 had fully disclosed the purpose of remittance as equity contribution in the Form ODI and Annual Performance Reports, and the ultimate end use of foreign exchange is not required to conform to the declared purpose. The Tribunal agreed with this interpretation, noting that the SDS-2 engaged in trading activities, and the purchase of the real estate was not the primary business activity. Thus, the charge under Section 10 (6) was not sustained.

3. Alleged Contravention of Section 4 of FEMA:

The charge under Section 4 of FEMA was based on the allegation that R-1 indirectly acquired immovable property in the UK through its subsidiaries. The Tribunal found that the SDS-2, incorporated in the British Virgin Islands, was not a person resident in India, and the property purchase did not constitute a violation by R-1. The Tribunal emphasized that the SDS-2's purchase was independent, and there was no evidence of R-1's control over the SDS-2's decisions. Therefore, the charge under Section 4 was not established.

4. Validity of the Procedural Requirements and Declarations Made by the Respondents:

The Tribunal reviewed the procedural compliance by R-1, including the filing of Form ODI and Annual Performance Reports. The Tribunal noted that these documents were not questioned by the Authorised Dealer or the RBI, and the procedural requirements were met. The Tribunal concluded that the declarations made by R-1 were valid and did not get invalidated due to the SDS-2's purchase of real estate.

5. Seizure of Mutual Funds under Section 37 A of FEMA:

The seizure of mutual funds was based on the alleged contravention of Section 4 of FEMA. Since the Tribunal found no contravention of Section 4, the basis for the seizure was invalidated. The Tribunal upheld the Ld. AA's decision to revoke the seizure order and directed the release of the seized mutual funds.

In conclusion, the Tribunal dismissed the appeal, upholding the findings of the Ld. AA that none of the charges against the respondents were established. The procedural requirements were met, and the transactions did not contravene the provisions of FEMA. The appeal was disposed of, and the seized mutual funds were ordered to be released.