Acquisition By An FOCC Of An Indian Company: Pricing Conditions For Resident And Non-resident Shareholders

INTRODUCTION

Foreign Owned and Controlled Companies (“FOCC”)

A FOCC refers to an Indian entity that has received foreign investment and is ultimately owned or controlled by persons resident outside India. Although incorporated in India under the Companies Act, such entities are treated differently from domestically owned and controlled Indian companies for the purposes of foreign investment regulation and downstream investment structuring. Consequently, an FOCC, despite being an Indian incorporated entity, is subject to regulatory conditions applicable to foreign investment while undertaking investments into other Indian entities.

The relevance of FOCCs has increased considerably in India’s investment landscape, particularly in private equity, venture capital, and strategic investment structures where foreign investors commonly route investments through Indian holding companies or intermediate entities. Such structures provide commercial flexibility, operational convenience, and tax and governance efficiencies. However, they also give rise to complex regulatory considerations, especially in relation to downstream investments, sectoral caps, pricing guidelines, reporting obligations, and compliance with foreign investment conditions.

The Pricing Conundrum: Differential Treatment Based on Seller Category

The complexity in FOCC acquisitions arises from the differential regulatory treatment accorded to transactions based on the residential status of the selling shareholder. When an FOCC acquires shares of an Indian company, the applicability of pricing guidelines and reporting requirements varies significantly depending on whether the seller is:

1. A person resident in India (Indian resident shareholder)
2. A person resident outside India (“PROI” or non-resident shareholder)
3. Another FOCC

This differential treatment creates practical challenges in structuring acquisitions, particularly in scenarios where FOCC simultaneously acquires shares from multiple categories of sellers. The regulatory framework's asymmetric approach to pricing for acquisitions versus transfers has led to considerable ambiguity, necessitating careful navigation of FEMA regulations and reliance on evolving industry practice guided by informal clarifications from Authorised Dealer (“AD”) banks.

LEGAL FRAMEWORK GOVERNING FOCC ACQUISITIONS

The regulatory framework applicable to acquisitions by FOCCs is primarily governed by the Foreign Exchange Management Act, 1999 (“FEMA”) and its subordinate legislation. The principal regulations include:

1. Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”): These Rules comprehensively regulate foreign investment in equity instruments and capital of Indian entities, including downstream investments by FOCCs.

2. Master Direction on Foreign Investment in India: Issued by the Reserve Bank of India (“RBI”), this Master Direction consolidates and clarifies various aspects of foreign investment policy, including specific provisions for FOCC transactions. The most recent update was issued on January 20, 2025.

3. Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019: These Regulations prescribe the manner and mode of payment and reporting requirements for investment in non-debt instruments.

The guiding principle underlying all these regulations, as articulated in Rule 23(1) of the NDI Rules, mandates that an Indian entity which has received indirect foreign investment shall comply with the entry route, sectoral caps, pricing guidelines, and other attendant conditions as applicable for foreign investment.

PRICING GUIDELINES UNDER THE NDI RULES

1.              Rule 21: General Pricing Framework

Rule 21 of the NDI Rules establishes the foundational pricing framework for transfer of equity instruments between residents and non-residents. The Rule prescribes different pricing methodologies based on whether the Indian company is listed or unlisted, and whether the transfer is from a person resident in India to a person resident outside India or vice versa.

The pricing framework most relevant to private company transactions stipulates that equity instruments of an unlisted Indian company transferred from a person resident in India to a person resident outside India shall not be at a price less than the fair value worked out as per any internationally accepted pricing methodology for valuation of shares on an arm's length basis, duly certified by a Chartered Accountant, a SEBI registered Merchant Banker, or a practicing Cost Accountant.

Conversely, when equity instruments are transferred from a non-resident to a resident, the price shall not be more than the fair market value determined using the same internationally accepted methodologies. This creates a pricing band where resident-to-non-resident transfers must occur at or above fair market value (“FMV”), while non-resident-to-resident transfers must occur at or below FMV.

2.              Rule 23: Downstream Investment by FOCCs

Rule 23 of the NDI Rules specifically addresses downstream investments, which are defined as investments made by an Indian entity or investment vehicle having total foreign investment, in the equity instruments or capital of another Indian entity.

3.                 Rule 23(1): Downstream Investment by FOCCs

Rule 23(1) of the NDI Rules governs downstream investments by an Indian entity which has received indirect foreign investment. It provides that an investment made by such Indian entity into the equity instruments or capital of another Indian entity shall be regarded as indirect foreign investment for the investee entity and shall be required to comply with the entry routes, sectoral caps, pricing guidelines, and other attendant conditions applicable to foreign investment.

4.              Rule 23(5) - Pricing and Reporting Matrix

This sub-rule creates a critical framework for understanding when pricing guidelines and reporting requirements apply to FOCC transactions. For this purpose, it addresses equity instruments of an Indian company held by another Indian company, which has received foreign investment and is not owned and not

controlled by resident Indian citizens or is owned or controlled by persons resident outside India (commonly referred to in practice as an FOCC). It expressly provides for three scenarios involving the transfer of equity instruments by an FOCC:

1. Transfer from FOCC to Person Resident Outside India : Only reporting requirements apply; pricing guidelines do not apply.
2. Transfer from FOCC to Person Resident in India: Only pricing guidelines apply; no reporting requirements apply.
3. Transfer from one FOCC to another FOCC: Neither pricing guidelines nor reporting requirements

APPLICATION OF PRICING GUIDELINES TO FOCC ACQUISITIONS

Acquisition from Resident Shareholders

When an FOCC acquires shares of an unlisted Indian company from a resident shareholder, pricing guidelines mandatorily apply. The acquisition price must be a negotiated price that is not less than the fair value determined as per any internationally accepted pricing methodology for valuation on an arm's length basis. This valuation must be duly certified by a Chartered Accountant or a SEBI registered Merchant Banker.

The rationale for this requirement aligns with the general FEMA principle that prevents value leakage from India. When a resident transfers shares to what is essentially treated as a foreign-controlled entity, the transaction must ensure that the resident receives at least fair market value for the shares.

From a reporting perspective, on the basis of the current NDI Rules and Master Direction framework, such transactions are generally treated as downstream investments between two persons resident in India (the resident seller and the FOCC), with reporting obligations flowing through the downstream investment reporting (such as Form DI) rather than being characterised as a resident-to-non-resident transfer for Form FC-TRS purposes. In practice, however, AD bank approaches may differ and are often confirmed on a transaction-specific basis.

Acquisition from Non-Resident Shareholders: The Regulatory Gap

The NDI Rules expressly clarify that where an FOCC transfers equity instruments of an Indian company to a person resident outside India, such transfer is subject only to reporting requirements, and not to pricing guidelines. However, the NDI Rules do not expressly address the reverse scenario where an FOCC acquires equity instruments from a non-resident, thereby leaving ambiguity on the applicability of pricing guidelines to such acquisition. Applying the principle of symmetry, pricing guidelines should not apply to such transfers. However, AD banks have historically taken differing positions on this issue. Some banks have exempted such transfers from pricing guidelines, treating the FOCC as equivalent to a non-resident for pricing purposes. However, others have required compliance with pricing norms, viewing the FOCC as a resident Indian entity making payment to a non-resident, which ideally should not exceed fair market value. FC-TRS must be filed within 60 days of transfer of equity instruments or receipt/remittance of funds (whichever is earlier) where the transaction is treated as a reportable transfer between a resident and a non-resident.

Acquisition from Another FOCC

When an FOCC acquires equity instruments from another FOCC, the transaction is treated as purely domestic under the current downstream investment framework, with neither pricing guidelines nor reporting requirements applying. This reflects the regulatory position that such transfers involve no cross-border element and are essentially restructuring transactions between Indian entities.

RBI MASTER DIRECTION UPDATED ON JANUARY 20, 2025

On January 20, 2025, the Reserve Bank of India issued an updated Master Direction on Foreign Investment in India, addressing several longstanding ambiguities in the regulatory framework for downstream investments by FOCCs. This update was particularly significant as it aligned downstream investment regulations more closely with direct foreign investment provisions, thereby providing much-needed clarity on structuring options available to FOCCs.

The updates were driven by practical challenges faced by market participants and repeated requests from the industry for clarification on whether certain flexibilities available for direct foreign investments could be extended to downstream investments by FOCCs.

One of the most significant clarifications introduced by the updated Master Direction pertains to investment by way of swap of equity instruments. Paragraph 9 of the Updated Master Direction expressly clarifies that investment by way of swap of equity instruments is permitted for downstream investment, provided that the transaction does not circumvent other provisions of the NDI Rules relating to downstream investment, including restrictions on use of borrowed funds.

This clarification enables FOCCs to structure acquisitions of Indian companies through share exchange transactions, subject to compliance with sectoral limits, valuation requirements, pricing regulations, and reporting obligations. The ability to undertake share swaps significantly enhances the flexibility available to FOCCs in structuring complex acquisition transactions and corporate restructurings.

Deferred Payment Mechanism for Downstream Investments

The updated Master Direction provides critical clarity on the availability of deferred payment arrangements for downstream investments. It explicitly states that the deferred payment arrangements permitted under Rule 9(6) of the NDI Rules for transfer of equity instruments between an Indian entity and a foreign entity are now also available for downstream investments by FOCCs.

Under this framework, an FOCC may acquire equity shares with up to 25% of the total consideration deferred for a period not exceeding 18 months from the execution of the transfer agreement (commonly referred to as the 18-25 rule). This provision significantly enhances deal structuring flexibility, particularly in acquisitions involving earn-out provisions, escrow arrangements, or working capital adjustments.

Reaffirmation of Guiding Principles

The updated Master Direction reaffirms the fundamental guiding principle for downstream investments: what cannot be done directly must not be done indirectly. This principle ensures that downstream investments by FOCCs are subject to the same entry routes, sectoral caps, pricing guidelines, and other attendant conditions applicable to direct foreign investment.

The clarifications provided in the January 2025 update explicitly confirm that permissions and prohibitions applicable to direct foreign investment under the NDI Rules extend equally to indirect foreign investment through FOCCs.

REGULATORY AMBIGUITY ON PROI TO FOCC TRANSFERS

The Interpretational Challenge

Despite the clarifications provided in the updated Master Direction, a significant regulatory ambiguity persists regarding the applicability of pricing guidelines when a person resident outside India (PROI) transfers shares to an FOCC. The NDI Rules expressly provide for pricing exemption only for transfers from an FOCC to a PROI but remain silent on the reverse scenario.

This silence has created two conflicting interpretational approaches:

1. The Symmetry Argument: Proponents of this view argue that if pricing guidelines do not apply when an FOCC transfers shares to a PROI, the same exemption should logically apply to the reverse Under this interpretation, an FOCC acquiring from a PROI should be treated as equivalent to a transaction between two non-residents for pricing purposes.

2. The Residency-Based Argument: The contrary view emphasizes that an FOCC is, by definition, an entity incorporated in India and therefore constitutes a person resident in India under When such a resident entity makes payment to a non-resident for acquiring shares, the transaction should ideally not exceed fair market value, necessitating application of pricing guidelines to prevent value outflow from India.

The practical approach adopted by market participants has evolved significantly over recent years, largely driven by informal guidance from AD banks based on their consultations with the RBI. While some AD banks have historically been amenable to exempting PROI-to-FOCC transfers from pricing guidelines, the industry practice has been migrating toward requiring compliance with pricing norms.

This shift reflects a more conservative regulatory interpretation, with many AD banks now taking the position that pricing guidelines are applicable for such transfers, requiring that the acquisition price does not exceed the fair market value. This evolving practice creates additional compliance burden and uncertainty for transaction structuring.

Practical Implications for Simultaneous Acquisitions

The regulatory ambiguity creates particularly acute challenges in transactions where an FOCC simultaneously acquires shares from both resident and non-resident shareholders of an unlisted Indian company. In such scenarios, the FOCC potentially faces conflicting pricing requirements:

1. Shares acquired from residents: Must be priced at or above fair market value (floor pricing);
2. Shares acquired from non-residents: Depending on the AD bank's interpretation, may need to be priced at or below fair market value (ceiling pricing).

While both requirements theoretically converge at fair market value, the existence of different pricing constraints for different categories of sellers creates documentation complexity, valuation challenges, and potential disputes regarding the applicable fair market value.

The Need for Express Clarification

The lack of express regulatory clarification on PROI-to-FOCC transfers creates several practical challenges:

1. Inconsistent Application: Different AD banks may adopt different interpretations, leading to inconsistent treatment of similar transactions.
2. Transaction Delays: The need to seek advance clarity from AD banks on pricing applicability can delay time-sensitive transactions.
3. Increased Compliance Costs: Conservative structuring to comply with both possible interpretations increases transaction costs.
4. Regulatory Risk: Uncertainty regarding the correct interpretation creates potential non-compliance

Industry stakeholders have consistently advocated for an express amendment to the NDI Rules or a clarification in the Master Direction to definitively address whether pricing guidelines apply to PROI-to-FOCC transfers.

ADDITIONAL REGULATORY CONSIDERATIONS

Sectoral Caps and Entry Routes

Beyond pricing considerations, downstream investment by an FOCC must comply with applicable sectoral caps and entry routes (automatic route or government approval route) for the sector in which the target Indian company operates. The total foreign investment in the target company, including indirect foreign investment through FOCC shareholding, must not exceed the sectoral cap prescribed under the Consolidated Foreign Direct Investment (“FDI”) Policy and reflected in the RBI Master Direction.

Source of Funds Restrictions

An FOCC making downstream investment is required to bring in requisite funds from abroad and cannot utilize funds borrowed in the domestic markets for such investment. However, downstream investments may be funded through internal accruals, defined as profits transferred to reserve account after payment of taxes.

CONCLUSION

The regulatory framework governing acquisitions by FOCCs of unlisted Indian companies presents a complex matrix of pricing guidelines, reporting requirements, and compliance obligations that vary significantly based on the residential status of the selling shareholder. While the NDI Rules and the RBI's Master Direction provide a foundational framework, significant ambiguities persist, particularly regarding pricing applicability for PROI to FOCC transfers.

The January 2025 update to the Master Direction represents a meaningful step forward in aligning downstream investment regulations with direct FDI provisions, particularly through the clarifications on share swaps and deferred payment mechanisms. These clarifications enhance transaction structuring flexibility and bring much needed regulatory certainty to certain aspects of FOCC acquisitions.

However, the continuing ambiguity on PROI to FOCC transfer pricing creates practical challenges and compliance uncertainties. The evolving industry practice, characterized by increasing conservatism among AD banks, suggests a trend toward requiring pricing guideline compliance even where not expressly mandated. This evolution underscores the importance of obtaining advance clarity from the concerned AD bank before structuring FOCC acquisition transactions.

Looking forward, express regulatory clarification on the applicability of pricing guidelines to PROI to FOCC transfers would significantly enhance regulatory certainty and facilitate efficient structuring of FOCC acquisitions. Until such clarification is provided, market participants must navigate the existing ambiguity through careful transaction structuring, proactive engagement with AD banks, and conservative compliance practices.

The FOCC framework represents an important balancing act in India's foreign investment regime, enabling operational flexibility for foreign investors while ensuring compliance with sectoral caps and pricing norms designed to protect India's economic interests. As India's investment landscape continues to evolve, further refinements to the regulatory framework will be essential to provide the clarity and certainty necessary for efficient capital flows while maintaining appropriate regulatory oversight.

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