The importance of foreign-owned or controlled companies in India and the need for a more lucid regulatory framework to govern them

Tuesday 14 May 2024

Anshuman Mozumdar
Khaitan & Co, Mumbai

Anshita Agrawal
Khaitan & Co, Mumbai

The significance of foreign-owned or controlled companies (FOCCs)

India is likely to become one of the preferred investment destinations for global investors, with an expected average gross domestic product of 6.7 per cent or more over the next decade.[1]

Several key factors (including the liberalisation of foreign investment policies since 1991), have facilitated the growth in investments by multinational corporations (MNCs) that have wanted to capitalise on the ‘India growth story’ and tap into a large potential customer base (especially in fast-moving consumer goods, automobiles, pharmaceuticals and healthcare sectors), or set up cost-effective offshore outsourcing centres (such as in information technology (IT) and IT-enabled services).[2]

The infusion of private capital into India has also grown manifold, with an average annual investment volume of approximately $40bn over the last five years,[3] owing to the abundance of dry powder with regard to global asset managers, the China Plus One strategy followed by global investors and the maturing market in India. Several large private equity (PE) funds have been operating as buyout funds (with buyout funds accounting for about 19 per cent of investments in 2022[4]). PE funds are also pivoting to a platform strategy to create more value for investors, rather than depending solely on Indian promoters to grow the business and generate value.

A common theme that connects strategic MNCs, buyout funds and PE platforms operating in India is the use or involvement of FOCCs in their investments into India. MNCs use FOCCs to initially set up a presence in India (which is a relatively more efficient method from a tax efficient perspective of setting up a presence in India as compared to alternative means, such as setting up branch offices and liaison offices). FOCCs have similar operational flexibility to carry out business as that available to other Indian resident companies. FOCCs owned by MNCs make further strategic investments in downstream entities either through greenfield projects or through inorganic bolt-on acquisitions, to develop synergies in line with their business strategies. Having a first-level FOCC vehicle in India helps the MNC consolidate its investments across the relevant product/market segment and develop internal synergies.

On the other hand, buyout funds and private equity-owned platforms make follow-on investments into other portfolio companies through their platforms (which are essentially FOCCs), to consolidate their investments and facilitate greater value creation for their stakeholders.

With the quantum of investments by MNCs and buyout funds slated to increase in the near future, it is necessary to have complete clarity and certainty in regard to the interpretation of the exchange control regulations, especially in the context of investments and exits by FOCCs.

The exchange control regulations governing FOCCs

Foreign direct investment (FDI) into India has to adhere to certain norms (the exchange control regulations) dictated by the Indian government and administered by the Reserve Bank of India (RBI). Key norms include compliance with entry routes (that determine whether investments can be made with or without the government’s approval), pricing guidelines (a price floor and price cap for investments and divestments by foreign investors) and sectoral caps (a maximum level of foreign investments permitted in companies operating in certain sensitive sectors).

In order to tackle instances of foreign investors misusing FOCCs to sidesteps the aforesaid norms, in 2009, the Indian government introduced the concept of FOCCs and ‘downstream investments’ (ie, investments made in other Indian companies by FOCCs). These measures sought to regulate certain aspects of FOCCs’ behaviour, by applying the aforementioned foreign investment-related norms that are otherwise applicable to non-residents. This approach started off as a mere codification of the principle that what cannot be done directly, should not be achieved indirectly.

The exchange control regulations state that investments by an FOCC in an Indian company must comply with ‘entry route, sectoral caps, pricing guidelines, and other attendant conditions as applicable for foreign investment’.[5] However, since the inherent nature of an FOCC is that of a company that is resident and domiciled in India, the same exchange control regulations continue to treat FOCCs as residents for all other purposes. This dual treatment of FOCCs creates regulatory inconsistencies and practical hurdles, in the absence of adequate clarifications in the law. Some of these key concerns are outlined below.

Inconsistencies in the application of the pricing guidelines

A key compliance requirement for foreign investors undertaking the acquisition or disposal of investments in India, is the applicability of pricing guidelines to such transactions. Rule 21 of the Foreign Exchange Management (Non-Debt Instruments) Rules 2019 (‘NDI Rules’) states that the pricing guidelines shall be applicable to the transfer of shares in an Indian company, from a non-resident to a resident, and vice versa.

Such pricing guidelines state that when the seller of the shares of an Indian company is a non-resident and the buyer is a resident, the contracted price cannot exceed the fair market value (FMV) determined as per internationally accepted valuation methodologies and at arm’s length. Conversely, when the seller is a resident and the buyer is a non-resident, the contracted purchase price cannot be less than the FMV. Share transfers between two non-residents are exempted from the applicability of the pricing guidelines.

While the government’s intent was to extend these pricing guidelines to FOCCs, the ambiguities in the exchange control regulations have resulted in gaps in interpretation. In the context of FOCCs, Rule 23(5) of the NDI Rules states that the sale of investments in other Indian companies by FOCCs in favour of other residents cannot be made at a contracted price that is less than the FMV. The Master Direction on Foreign Investment (Master Direction) issued by the RBI further clarifies that pricing guidelines will not apply to the sale of shares by an FOCC to a non-resident. However, the NDI Rules are silent on the applicability of the pricing guidelines to the purchase of shares by FOCCs from residents and non-residents.

In the absence of such clarification, authorised dealers (ADs) (banks that have been delegated certain functions in regard to regulating and monitoring foreign investments in India) have refrained from assuming that the pricing guidelines do not apply to the purchase of shares by FOCCs from non-residents (though this would be a logical conclusion). Among several inconsistent views, prominent AD banks have taken the view that when FOCCs are purchasing shares from (1) residents, the contracted price should not be lower than the FMV; and (2) non-residents, the contracted price should not be higher than the FMV (though the logical extension of the principle of treating FOCCs on a par with non-residents for such purposes does not support this conclusion).

Moreover, in transactions involving the simultaneous acquisition of shares by FOCCs from Indian residents and non-resident shareholders of an Indian company, applying pricing norms to both legs of the transaction seem unreasonable. This would force the acquiring FOCC to purchase the shares exactly at the FMV (which is usually not the case and may be difficult to achieve practically), thus potentially jeopardising the commercial viability of the deal.

Deferment of the purchase consideration

Purchase consideration holdbacks and escrows are a key protectionist measure for buyers in M&A transactions. The Indian government recognised the need for such measures and introduced the ability for non-resident buyers to defer the payment of the sale consideration of shares of an Indian company, by up to 25 per cent and up to a duration of 18 months, without the need to seek any specific approvals. However, the exchange control regulations are silent on this aspect. This has led to a lot of ambiguity regarding the applicability of such deferred payment guidelines to acquisitions made by FOCCs. The RBI and various AD banks have provided different views on this subject. The RBI has reportedly, in some instances, suggested that since the law only allows non-residents and residents to enter into such arrangements, FOCCs, being fictional residents, cannot enter into such arrangements.[6] However, this interpretation would be absurd as it seeks to impose a stricter regulatory requirement than those that are applicable to non-residents. In the absence of a formal guidance, this matter continues to be a grey area.

The issuance of shares to FOCCs for consideration other than cash

Rule 23(4)(b) of the NDI Rules state that an FOCC can make a downstream investment from its internal accruals or requisite funds brought in from outside India. FOCCs are not permitted to use funds borrowed from the domestic Indian markets for onward downstream investments. However, since the NDI Rules omit the mention of other modes of investment (including share swaps or the issuance of shares for consideration other than cash), some AD banks have of late taken positions that an FOCC cannot be issued shares by the investee downstream entity, in lieu of amounts due from the downstream entity to the FOCC (eg, share swap transactions or the issuance of shares for consideration other than cash), even though the NDI Rules permit such share swaps in the context of pure non-resident investors.


While the aforementioned ambiguities are some of the key areas of concern surrounding the regulatory framework governing FOCCs, the government should work towards resolving such ambiguities (through amendments to the NDI Rules and Master Directions). This will increase the appeal of using FOCC-centric structures for M&A activity in India.

The views expressed in this article are the personal views of the authors.


[1] Hiren Dasani et al, Stronger for Longer: Investing in India’s Economic Ascent (Goldman Sachs, 10 April 2024), available at www.gsam.com/content/gsam/global/en/market-insights/gsam-insights/perspectives/2024/indias-economic-ascent.html

[2] Nikhil Prasad Ojha et al, The Steady Rise of MNCs (Mint, 20 May 2016), available at www.livemint.com/Companies/t6wKAx4HAhpl4MKwCY1lJL/The-steady-rise-of-MNCs.html

[3] Nils Rode et al, The India growth story- the role of private equity and the 3D reset (Schroders, 18 January 2024), available at www.schroders.com/en-ca/ca/professional/insights/the-india-growth-story-the-role-of-private-equity-and-the-3d-reset/

[4] Ibid.

[5] Rule 23 of the Foreign Exchange Management (Non-Debt Instruments) Rules 2019.

[6] Pavan Burugula, Share purchases by foreign-owned firms under RBI scanner (Mint, 5 September 2023), available at www.livemint.com/companies/news/share-purchases-by-foreign-owned-firms-under-rbi-scanner-11693938290186.html