The Regulatory Framework
Inbound investments into Indian companies are governed by the Foreign Exchange Management Act, 1999 and the Foreign Direct Investment Policy issued by DPIIT. Understanding the interplay between these regulations is critical for structuring any cross-border transaction.
The framework appears straightforward on paper but reveals considerable complexity in practice. Sectoral caps, downstream investment restrictions, pricing requirements, and reporting obligations create a compliance matrix that demands careful navigation. A misstep at any stage can delay transactions, attract regulatory scrutiny, or in extreme cases, render the investment void.
Automatic Route versus Government Approval
Most sectors permit FDI under the automatic route up to specified limits. This means no prior government approval is required, though compliance reporting remains mandatory. The automatic route covers sectors from manufacturing to information technology, from pharmaceuticals to financial services, each with its own conditions and caps.
However, certain sectors require prior government approval through the Foreign Investment Facilitation Portal. Defence beyond 74 per cent, broadcasting, multi-brand retail, and several others fall into this category. The approval process can take several months and involves inter-ministerial consultations. Transaction timelines must account for this reality.
The distinction between automatic and approval routes is not always clear-cut. A company operating in an automatic route sector may trigger approval requirements if it engages in activities that cross sectoral boundaries. Due diligence must examine not just the target company's primary business but its entire spectrum of activities.
Pricing Guidelines
The pricing of shares in inbound investments must comply with fair market value determined as per internationally accepted pricing methodologies. For listed companies, the floor price is the average of weekly high and low prices on the recognised stock exchange for the preceding 26 weeks or 2 weeks, whichever is higher.
For unlisted companies, the fair market value must be determined by a SEBI-registered merchant banker or a chartered accountant using the discounted free cash flow method. This valuation becomes the floor price for the transaction. Pricing below this floor is not permitted and can result in the transaction being declared void.
Documentation Requirements
Every FDI transaction requires compliance reporting within 30 days through the FC-GPR form for fresh issuance or FC-TRS for transfer of existing shares. These are not mere formalities. Delays in reporting attract compounding fees that can significantly impact transaction costs.
The documentation requirements extend beyond the reporting forms. Valuation certificates, board resolutions, shareholder agreements, KYC documents for foreign investors, and source of funds declarations must all be in order. Any discrepancy can trigger queries from the AD bank, delaying the allotment of shares or transfer of consideration.
Recent Developments
The Press Note 3 restrictions on investments from countries sharing land borders with India continue to apply with full force. Any investment from entities beneficially owned by citizens of these countries requires government approval, regardless of the sector. This has particular implications for private equity structures with diverse investor bases.
The beneficial ownership test has created challenges for fund structures. A fund incorporated in Singapore or Mauritius may trigger Press Note 3 if any of its limited partners are from restricted countries. The compliance burden has increased significantly, requiring detailed investor analysis before any Indian investment.
Practical Considerations
Successful cross-border M&A requires early engagement with regulatory requirements. We recommend conducting FEMA due diligence in parallel with commercial negotiations to identify potential deal breakers early. The time required for government approvals, where applicable, should be factored into transaction timelines from the outset.
The consequences of FEMA non-compliance are severe. Beyond penalties, transactions can be unwound, creating commercial chaos. The reputational damage to all parties involved can be lasting. Prevention through proper structuring is always preferable to cure through compounding applications.