What does the current law provide for?

Before the Amendment Rules, subject to compliance with the pricing guidelines, sectoral caps, and other conditions prescribed by Reserve Bank of India (RBI), Indian companies were permitted to issue equity instruments to persons resident outside India against the swap of equity instruments^[1] strictly of another Indian company. Meaning, an Indian company could acquire equity instruments of another Indian company held by non-residents, and against which, it can issue its own equity instruments to non-residents. Since the word “issue” indicates the primary issuance of equity instruments by the company, the transfer of equity instruments of an Indian company between a resident and a non-resident against the swap of equity instruments held in another Indian company was not permitted under automatic route. Further, the recently liberalised Foreign Exchange Management (Overseas Investment) Rules, 2022 (OI Rules) permitted an Indian entity to make overseas direct investment against the swap of securities.

What do the Amendment Rules provide for?

In addition to the abovementioned permissibility of swapping of shares in case of a primary issuance, the Amendment Rules have now allowed an Indian company to issue its equity instruments to a person resident outside India by way of swap of equity capital of a foreign company, provided that it complies with the OI Rules.

The Amendment Rules further permitted the transfer of equity instruments of an Indian company between persons resident in India and persons resident outside India by way of swap of equity instruments of an Indian company or by way of swap of equity capital^[2] of a foreign company. That said, Government approval will be required for a share swap if the Indian investee company is engaged in business in a sector that falls under the Government route.

Implications and ambiguities

The Amendments Rules open new avenues for Indian companies and, will potentially aid them in expanding their global footprint, facilitate cross-border mergers and acquisitions (M&A), offshore holding structures, and managed to resolve certain inconsistencies by aligning the NDI Rules and OI Rules. It will also facilitate cashless cross-border M&A transactions, making the swap options more lucrative. However, it would be interesting to see the applicability of the Amendment Rules in a situation where a foreign-owned and/or controlled company is either the buyer or seller of the Indian equity instruments involving a transaction of share swap. Further, if a resident Indian individual would be eligible to avail the share swap option (to swap its shares as a resident to a non-resident in lieu of shares of a foreign company) under the NDI Rules considering the OI Rules do not permit such individual to make or hold overseas investment other than by way of swap of securities on account of a merger, demerger, amalgamation or liquidation.

While OI Rules permit the swap of equity capital of foreign entity even in case of a limited liability partnership (LLP) or limited liability company (LLC), the NDI Rules have always restricted the share swap option only to Indian companies. As such, Indian LLPs are kept outside the purview of the NDI Rules. Amended Rules have continued the same treatment for Indian LLPs, as it intends to cover only companies. Accordingly, only Indian companies can reap the benefits of relaxed share swap option.

Remarks

Although the Amendment Rules have simplified the share swap transactions and unlocked a range of restructuring possibilities, tax neutrality of these structures may remain a concern in making these options more palatable, since the taxability of these transactions depends on their structure and tax treaty benefits,. Also, there are different views amongst the authorised dealer banks as to whether a foreign-owned and/or controlled company can make a downstream investment through share swap under automatic route, and the popular view being this is not permitted without RBI’s prior approval.

Footnote

[1] Per Rule 2(k) of the NDI Rules, equity instruments means equity shares, convertible debentures, preference shares and share warrants issued by an Indian company

[2] Per Rule 2 (1) (e) of the OI Rules, equity capital means equity shares or perpetual capital or instruments that are irredeemable or contribution to non-debt capital of a foreign entity in the nature of fully and compulsorily convertible debentures.

This article was originally published in SCC Online on 23 November 2024 Co-written by: Inder Mohan Singh, Partner; Suraj Prasad Meher, Principal Associate. Click here for original article

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