According to Moin Ladha, partner, Khaitan & Co, “Leaner investment ticket size and lower level of compliance filings could be some of the reasons leading many Indian resident investors to consider instruments like SAFE as portfolio investment. However, SAFEs are mere ‘rights’ for the future and not permitted under the current regime as they do not qualify as overseas direct investment (ODI) or portfolio investment (OPI) in terms of the new OI rules. Ideally, corrective measures should be taken by investors to regularise any such existing investment to avoid regulatory action.”
Rules allow resident individuals to invest up to $250,000 a year abroad in securities and properties under the RBI’s liberalised remittance scheme (LRS). Some have invested undeployed money lying in overseas accounts in SAFE (instead of bringing back idle funds as per RBI’s new regulations) – probably under the belief the authorities in India would never come to know of it. Those remitting funds from India under LRS into SAFE are simply giving misdeclaration or stating the fund end-use as ‘portfolio investment’.
SAFE is a promise to let an investor hold stocks or preference shares some years later when the startup achieves certain milestones. Unlike plain vanilla convertibles, a SAFE note is not necessarily converted into equity, and may well remain a debt in the startup’s books. Besides easier compliance, firms prefer SAFE to avoid immediate dilution while investors like the simplicity of the instrument that allows them to receive favourable conversion terms yet sometimes retaining the flexibility to exit by receiving repayment under specified liquidity events.
“Indians can invest under OPI only in regulated entities abroad. SAFE offers uncertain returns and does not provide any legal remedies in case of default by the company. Hence, RBI does not allow such investment. Nonetheless, many Indians are being approached by overseas funds and companies to invest in SAFE even though SAFE is not permitted under RBI’s OI rules,” said Rajesh P Shah, partner at Jayantilal Thakkar & Company, a CA firm specialising in matters related to Foreign Exchange Management Act and income tax.
Though there is no provision for compulsory conversion, in many cases, investors and banks are considering SAFE as exposure to unlisted equity (which is allowed under LRS unlike unlisted debt) as eventually the investor would receive shares. In a few cases banks allowed remittance after the SAFE terms were changed to ‘compulsory conversion into equity’. In the absence of any specific prohibition by RBI and the central bank’s FAQ on OI regulations leaving a raft of issues unclear, there are differing interpretations.
SAFE notes are usually favoured in early-stage startups because of difficulty in assigning a valuation to the company in absence of established measurable metrics, said Harshal Bhuta, partner at the CA firm PR Bhuta & Co.
“SAFEs are hybrid instruments by nature, whereas investment in an unlisted foreign company can be made under OI rules of FEMA only if it is into equity shares or instruments that are fully and compulsorily convertible in nature. Therefore, overseas investment in SAFE notes is prohibited under FEMA,” said Bhuta. However, counting on chances of outsized capital gains, some of the local wealthy investors are naive enough to take the risk of being penalised later – little realising that such fines, computed on the market value prevailing at the time of regularisation, could largely neutralise the profits.
Given the government and RBI’s recent concerns over flight of capital, most professionals think there is little room for any creative interpretation of regulations linked to FEMA and taxation. But amid tempting investment opportunities, there is a proclivity among HNIs to play around the grey areas in rules. The revived interest in SAFE bears this out.
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