Authored By: Bala Nivetha S
SASTRA UNIVERSITY
ABSTRACT:
In the era of globalisation, corporate growth strategies have evolved from cash-based transactions to equity-based exchanges. Cross-border equity swaps have emerged as a preferred instrument for international mergers, acquisitions, and strategic partnerships.[1] However, in India, such transactions have historically been burdened by procedural hurdles under the Foreign Exchange Management Act (FEMA), requiring prior government approvals and complex compliance formalities.[2] The 2024 amendment to FEMA marks a significant shift in this regulatory landscape. By introducing clearer definitions, simplifying registration processes, and streamlining reporting requirements—particularly for automatic-route sectors—the amendment has created a more enabling environment.[3] This is especially consequential for unlisted Indian companies and startups seeking overseas investments. This article examines the corporate legal dimensions of the 2024 amendment, analyses its alignment with RBI, SEBI, and tax laws, and critically evaluates its impact. The article contends that while the amendment represents a progressive step towards liberalisation, its effectiveness depends on proper coordination among regulatory bodies and practical application.
Keywords: FEMA, Cross-Border Equity Swaps, FDI-ODI Swap, Non-Debt Instruments Rules, Startup Investment, Automatic Route.
INTRODUCTION
In August 2024, the Indian government notified a pivotal amendment to the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019.[4] This amendment addressed a long-standing regulatory lacuna by expressly permitting secondary transfers of shares through cross-border equity swaps, effectively eliminating the prior approval requirement for transactions falling under the automatic route. This reform marked a paradigm shift from a regime of restriction to one of facilitation, aligning India’s foreign investment framework with global best practices.[5]
The evolution from cash-based to equity-based deal-making reflects broader trends of globalisation and financial innovation. Cross-border equity swaps—where shares of an Indian company are exchanged for equity capital of a foreign entity—are indispensable tools for modern mergers and acquisitions (M&A).[6] Yet, in India, such transactions have historically navigated a complex regulatory labyrinth under the Foreign Exchange Management Act, 1999 (FEMA), often requiring prior governmental approvals and cumbersome procedural formalities.[7]
The 2024 amendment to the FEMA Non-Debt Instruments Rules represents a watershed moment. By introducing Rule 9A, the amendment expressly permits both primary issuances and secondary transfers of equity instruments by way of swap of equity instruments or swap of equity capital of a foreign company.[8]This FDI-ODI swap mechanism eliminates the prior approval requirement that had long been a significant impediment to such transactions.
This article examines the corporate legal dimensions of the 2024 FEMA amendment. It analyses the amendment’s alignment with RBI regulations, SEBI rules, and tax laws, while critically evaluating its impact on business growth and outbound investment.[9] The article contends that while the amendment represents a significant step towards liberalisation, its effectiveness ultimately depends on proper coordination among regulatory bodies. Part II sets out the pre-2024 legal framework. Part III analyses the key changes introduced by the amendment. Part IV examines alignment with other regulatory regimes. Part V offers a critical evaluation and Part VI concludes with recommendations.
THE PRE-2024 LEGAL FRAMEWORK: RESTRICTIONS AND AMBIGUITIES
The Regulatory Architecture
The regulation of cross-border equity swaps in India has historically been governed by a complex interplay of statutes. The foundational statute, the Foreign Exchange Management Act, 1999, empowers the Reserve Bank of India (RBI) and the Central Government to regulate capital account transactions.[10] Under FEMA, any cross-border financial transaction not expressly permitted may only be undertaken with prior RBI approval.[11]
The specific rules governing foreign investment were consolidated in the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI Rules). Prior to the 2024 amendment, the NDI Rules permitted Indian companies to issue equity instruments to persons resident outside India against a swap of equity instruments, provided the issuer company was engaged in a sector under the automatic route.[12] However, this permission was strictly limited to primary issuances; the NDI Rules were notably silent on secondary transfers of equity instruments through share swaps.[13]
The Secondary Transfer Conundrum
The absence of express permission for secondary share swaps created significant uncertainty. Under FEMA’s framework, capital account transactions may only be undertaken if expressly permitted; in the absence of such permission, prior RBI approval was required.[14] Consequently, secondary share swap transactions required prior approval, a process that was often time-consuming and unpredictable.
Moreover, while the Foreign Exchange Management (Overseas Investment) Rules, 2022 (OI Rules) permitted swaps of equity capital of a foreign entity, this provision was not mirrored in the NDI Rules, creating a regulatory asymmetry.[15] This regulatory gap meant that an Indian resident could, under the OI Rules, swap their equity in an overseas entity for shares of an overseas acquirer, but the corresponding provision for inbound swaps was absent from the NDI Rules.
Impact on Startups and Unlisted Companies
For startups and unlisted companies, which often have limited cash reserves and rely on equity as a primary currency for growth, these restrictions were particularly burdensome.[16] The inability to execute secondary share swaps under the automatic route meant that many startups seeking to expand internationally through all-stock deals were forced to seek regulatory approvals, adding months to transaction timelines and creating deal uncertainty. Furthermore, definitional ambiguities regarding ‘control’ and ‘startup company’ created inconsistencies across different regulatory frameworks, confusing investors and increasing compliance costs.[17]
III. THE 2024 AMENDMENT: KEY CHANGES AND LIBERALISATION
Introduction of Rule 9A: The FDI-ODI Swap Mechanism
The most significant change introduced by the Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules, 2024, is the insertion of Rule 9A.[18] This new provision expressly permits the transfer of equity instruments of an Indian company between a person resident in India and a person resident outside India by way of swap of (i) equity instruments of an Indian company; or (ii) equity capital of a foreign company.[19]
For the first time, this enables what industry practitioners term the ‘FDI-ODI’ swap—the swap of shares of an Indian company against the shares of a foreign company.[20] Such swaps are permitted both in cases where the transaction falls under the automatic route and where government approval is applicable.[21]
Primary and Secondary Transfers
Prior to the amendment, the NDI Rules did not permit a secondary transfer of equity instruments of an Indian company against a share swap. The 2024 amendment addresses this gap comprehensively. Indian companies may now issue equity instruments to a person resident outside India against swap of equity capital of a foreign company.[22]Further, the amendment now also permits transfer of equity instruments of Indian companies between residents and non-residents against swap of equity instruments issued by Indian or foreign companies.[23]Consequently, secondary share swaps for companies operating in automatic route sectors can now be undertaken swiftly without prior approval.[24]
Harmonisation of Definitions
Beyond the share swap provisions, the 2024 amendment introduced several definitional harmonisations that enhance regulatory clarity. The definition of ‘control’ under the Companies Act, 2013, has now been adopted in the NDI Rules, ensuring harmonisation in legislative interpretation across various statutes, including those pertaining to SEBI.[25]The amendment has also updated the definition of ‘startup company’ to align it with the DPIIT Notification G.S.R. 127(E) dated 19 February 2019, increasing the recognition period to up to 10 years.[26] This ensures that the regulatory benefits available to startups under FEMA are consistent with those available under other regulatory frameworks.
ALIGNMENT WITH RBI, SEBI, AND TAX REGULATIONS
Alignment with RBI Regulations
The 2024 amendment has been complemented by corresponding updates to the RBI’s regulatory framework. The RBI updated its Master Direction on Foreign Investment in India to incorporate the changes introduced by the Amendment Rules, covering transfers by way of swap of securities and investment by OCIs on a non-repatriable basis.[27] The alignment between the NDI Rules and the OI Rules is particularly significant, ensuring that inbound and outbound equity swaps are governed by consistent principles.[28]
Alignment with SEBI Regulations
The amendment’s adoption of the Companies Act definition of ‘control’ is particularly relevant for SEBI-regulated transactions.[29]Under SEBI regulations, including the Takeover Code and the ICDR Regulations, the determination of ‘control’ has significant implications for disclosure obligations and pricing norms.[30] The harmonisation ensures consistency in regulatory treatment and reduces the compliance burden on companies. However, challenges remain regarding the interaction between FEMA’s liberalised swap provisions and SEBI’s stringent pricing norms for preferential allotments where swaps involve listed securities.[31]
Tax Implications
The tax treatment of cross-border equity swaps raises several complex questions under the Income Tax Act, 1961. The swap of equity shares may constitute a ‘transfer’ under Section 2(47), triggering capital gains tax.[32] For non-residents, the implications depend on the applicable Double Taxation Avoidance Agreement (DTAA). The amendment does not directly address the tax treatment, and the complexity of these issues, particularly regarding valuation and withholding tax under Section 195, continues to pose challenges.[33] The absence of specific guidance may discourage some parties from utilising these structures despite the regulatory liberalisation.
CRITICAL EVALUATION: IMPACT AND REMAINING CHALLENGES
Positive Impact on Business Growth
The 2024 amendment has several positive implications for business growth and cross-border investment in India. By eliminating the requirement for prior approval for secondary share swaps, it significantly reduces regulatory burden and aligns with the government’s broader ‘Ease of Doing Business’ agenda.[34] For startups and unlisted companies, the ability to execute cross-border equity swaps under the automatic route enables international expansion and strategic acquisitions without depleting cash reserves.[35] The FDI-ODI swap also allows for varied structuring options, providing companies with greater flexibility.[36]
Remaining Challenges and Gaps
Despite the significant progress, several challenges and gaps remain. First, proper coordination among regulatory bodies, including the RBI, SEBI, and the CBDT, is essential for the reform to be effective.[37] Differences in regulatory approaches may continue to create compliance challenges. Second, despite the clarity introduced, certain ambiguities remain regarding the treatment of transfers involving investors from restricted countries under Press Note 3 (PN3).[38] Third, the practical implementation of the liberalised provisions may face challenges as operational procedures for reporting have not been fully updated.[39]
Furthermore, the tax treatment of equity swaps remains uncertain. The characterisation of the swap for capital gains purposes, the determination of fair market value, and the applicability of withholding tax obligations raise complex questions that have not been fully resolved.[40] Finally, Indian LLPs are currently kept outside the scope of the swap provisions, creating a differential treatment that may not be justified by policy considerations.[41]
CONCLUSION
The 2024 amendment to the FEMA Non-Debt Instruments Rules represents a significant milestone in India’s regulatory evolution. By introducing Rule 9A and expressly permitting both primary issuances and secondary transfers through share swaps, the amendment has addressed a long-standing gap.[42] The impact is particularly significant for startups and unlisted companies, which can now pursue international expansion through all-stock transactions without the burden of prior regulatory approvals.[43]
However, the effectiveness of the reform ultimately depends on proper coordination among regulatory bodies and practical implementation. The interaction between FEMA’s provisions and SEBI’s disclosure requirements, as well as the tax treatment of equity swaps, requires careful navigation.[44] The comparative experience of other jurisdictions demonstrates that reform is achievable without compromising regulatory integrity. India, as a major player in the global economy, has the opportunity to continue refining its framework to support cross-border investment and business growth.[45] The fintech startup that inspired this analysis would, under the amended framework, be able to execute its acquisition through a secondary share swap without the delays that once plagued such transactions.
Reference(S):
[1] See generally K. Zweigert & H. Kötz, An Introduction to Comparative Law (Tony Weir tr, 3rd edn, OUP 1998).
[2] Foreign Exchange Management Act 1999, s 6(3).
[3] Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules 2024, Notification No. S.O. 3492(E), dated 16 August 2024.
[4] Ibid, inserting Rule 9A.
[5] Delano Furtado, Saumya Kakar and Pranika Correa, ‘India Eases Foreign Investment Norms: Key Amendments to the Non-debt Instruments Rules, 2019’ (Trilegal, 27 August 2024).
[6] See generally Ryan Abbott, The Reasonable Robot: Artificial Intelligence and the Law (CUP 2020) 45.
[7] Foreign Exchange Management Act 1999, s 6(3)(a).
[8] Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules 2024 (n 3) r 9A(1).
[9] Reserve Bank of India, Master Direction on Foreign Investment in India, RBI/FED/2017-18/60 FED Master Direction No. 11/2017-18 (updated up to 8 August 2024) para 4.2.
[10] Foreign Exchange Management Act 1999, s 6.
[11] Ibid s 6(3)(b).
[12] Foreign Exchange Management (Non-Debt Instruments) Rules 2019, r 9 (pre-amendment).
[13] Tanushree Bhuwalka & Althea Pereira, ‘Amendments to FEMA Rules — Facilitating Ease of Business’ (Khaitan & Co, 9 December 2024).
[14] Foreign Exchange Management Act 1999 (n 10) s 6(2).
[15] Foreign Exchange Management (Overseas Investment) Rules 2022, r 7.
[16] See generally Manish Gupta, Rashi Singh and Ananya Vajpey, ‘Cross-Border Share Swaps Home and Free’ (Shardul Amarchand Mangaldas & Co, 14 November 2024).
[17] Companies Act 2013, s 2(27).
[18] Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules 2024 (n 3).
[19] Ibid r 9A(1)(i).
[20] Ministry of Finance, Press Release, ‘Department of Economic Affairs Amends Foreign Exchange Management (Non-debt Instruments) Rules, 2019’ (16 August 2024).
[21] Ibid.
[22] Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules 2024 (n 3) r 9A(2).
[23] Ibid r 9A(1)(ii).
[24] PwC, ‘Foreign Investment Rules Amended to Include Transfer of Shares by Swap of Securities’ (Regulatory Insights, 22 August 2024).
[25] Companies Act 2013, s 2(27).
[26] DPIIT Notification No. G.S.R. 127(E), dated 19 February 2019
[27] Reserve Bank of India, Master Direction on Foreign Investment in India (n 9) para 5.2.
[28] Foreign Exchange Management (Overseas Investment) Rules 2022 (n 15).
[29] SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018, reg 2(1)(c).
[30] SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011, reg 2(1)(e).
[31] Ibid reg 10(3).
[32] Income Tax Act 1961, s 2(47).
[33] Income Tax Act 1961, s 195.
[34] ‘Securing India’s Growth Story: A Look at India’s Foreign Investment Regulatory Framework’ (AZB & Partners, 20 January 2025).
[35] ‘Permissibility of Cross-Border Share Swap’ (Lexology, 23 November 2024).
[36] Furtado, Kakar and Correa (n 5).
[37] See generally ‘Securing India’s Growth Story’ (n 34).
[38] Press Note No. 3 (2020 Series), Government of India, Department for Promotion of Industry and Internal Trade.
[39] Bhuwalka & Pereira (n 13).
[40] Income Tax Act 1961 (n 32).
[41] Foreign Exchange Management (Non-Debt Instruments) Rules 2019, r 9A (restricted to ‘companies’).
[42] Reserve Bank of India, Master Direction on Foreign Investment in India (n 9) para 6.1.
[43] Gupta, Singh and Vajpey (n 16).
[44] SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (n 29).
[45] Abbott (n 6) 210.
