Reverse Flipping – An Overview of the Legal, Tax and Regulatory Regime in India
The once-common practice of ‘flipping’, wherein companies incorporated their operations abroad to tap into specific benefits such as overseas listing, access to international capital markets, a more protective intellectual property environment, and tax concessions offered by offshore jurisdictions, is now paving the way amongst Indian- origin start-ups for a phenomenon known as ‘reverse flipping’ or ‘internalisation’. “Reverse flipping” is the strategic integration of ownership of a foreign parent entity into its Indian subsidiary.
Notable examples of successful internalisation include start-ups such as Pepperfry, Groww, PhonePe, PineLabs and Zepto whilst the move for companies such as Razorpay, Meesho, UrbanLadder and Livspace is still in the pipeline. The factors contributing to “reverse flipping” gaining momentum, are fuelled by India’s growing consumer base, simplified regulatory compliances, stable investment conditions including viable exit strategies driven by public offerings.
Structuring the flip: In this article, we have examined 2 (two) structures for achieving a ‘reverse flip’ and the attendant legal, regulatory and tax implications thereof.
- INBOUND MERGER
In this structure, a foreign entity merges with an Indian entity, and the foreign entity’s shareholders are issued shares of the Indian entity, resulting in the Indian entity also owning and controlling the business and operations outside India.
Legal, Regulatory and Foreign Exchange considerations
Section 234 of the Companies Act, 2013 (“Companies Act”) read along with Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 (“CAA Rules”), governs the process of inbound mergers in India. The CAA Rules are supplemented by the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (“Cross Border Merger Regulations”) issued by the Reserve Bank of India (“RBI”).
With the aim to simplify the process for inbound mergers, the Ministry of Corporate Affairs issued a Notification on 09 September 2024 (click here), introducing an amendment to the CAA Rules, whereby inbound mergers between a foreign holding company and its Indian wholly owned subsidiary (“WOS”) would now be covered under the fast-track merger mechanism within the scheme of Section 233 of the Companies Act and meet with its criteria, thus eliminating the requirement of obtaining an approval from the National Company Law Tribunal. Additionally, the following conditions would also be required to be adhered to:
- RBI Approval: The transferor foreign company incorporated outside India, being a holding company and the transferee Indian company, being the WOS would have to obtain the prior approval of the RBI for entering into the merger, thereby eliminating the deemed RBI approval process.
- Application to Central Government: The Indian WOS would have to make an application to the Central Government under the provisions of Section 233 of the Companies Act, read with Rule 25 of the CAA Rules.
- Declaration Requirement: A declaration in Form CAA 16 must be filed by the Indian WOS, if the foreign company has been incorporated in a country which shares land border with India at the stage of making the application under fast-track merger route under Section 233 of the Companies Act. This declaration requires the Indian WOS to specify whether prior approval is required under the Foreign Exchange Management (Non-debt Instruments) Rules (“NDI Rules”) for the proposed merger.
In addition to complying with the aforesaid conditions, cross-border inbound mergers must comply with pricing guidelines, sectoral caps, entry routes restrictions, and reporting obligations as per the provisions of the NDI Rules. Further, the relevant legal, exchange control, and tax laws of the jurisdiction to which the foreign holding company belongs would also required to be specifically analysed to understand their implications on the merger.
Tax considerations
Under the provisions of the Income-tax Act, 1961 (IT Act), transfer of a capital asset by the amalgamating company to the amalgamated company is not chargeable to income-tax. Similarly, transfer by a shareholder of a capital asset being shares held in the amalgamating company is also not chargeable to income-tax. Such non-taxability is subject to the condition that the merger meets the conditions of “amalgamation” under the IT Act and the amalgamated company is an Indian company.
- SHARE SWAP TRANSACTION
In a share swap transaction, the investors of the foreign holding company would swap their shares in the holding company with the shares of the Indian company. As a result, the investors of the foreign holding company will directly hold shares in the Indian company; and the Indian company would become the holding company of the foreign company.
Regulatory and Foreign Exchange considerations
The issuance of equity instruments by an Indian company to persons resident outside India against a swap of equity instruments of a foreign company, are permitted in accordance with provisions of the NDI Rules. Accordingly share swap transactions will be subject to pricing guidelines, sectoral caps, entry routes restrictions and reporting obligations as per the provisions NDI Rules and relevant RBI notifications released from time to time.
In addition, since the erstwhile Indian WOS would become the holding company of the foreign entity, the provisions of the Foreign Exchange Management (Overseas Investment) Rules, 2022; Foreign Exchange Management (Overseas Investment) Regulations, 2022; and Foreign Exchange Management (Overseas Investment) Directions, 2022 would be applicable.
Further, in the event that, an entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only after obtaining specific approval from the Government of India as per Press Note 3 dated 17 April 2020,(“Press Note 3”)It is pertinent to note that the applicability of Press Note 3 is relevant not only to inbound mergers but also for cross border share swap transactions.
Tax implications
For taxation purposes, a swap of a holding company’s shares with an Indian company’s shares would be termed as an “exchange” and hence would come under the purview of a transfer for the purposes of the IT Act. As the shareholders are transferring the shares of a foreign company, implications under the indirect transfer provisions under the IT Act would be required to be evaluated. At the same time, provisions under the relevant double taxation avoidance agreements would also required to be evaluated to determine whether taxability is in the hands of the shareholders, being non-residents in India.
In conclusion, “reverse flipping” in India represents a significant shift in the business landscape, as companies recognize the long-term benefits of returning to their home base. With India’s regulatory and tax frameworks becoming increasingly favourable, and the push towards a self-reliant economy, businesses are finding more incentives to re-establish their roots domestically.
The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.