This article is a discussion on the key highlights of the Foreign Exchange Management (Cross Border Merger) Regulations, 2018. The article is co-authored by Abhimanyu Sharma (National Law University, Jodhpur – 5th year student) and, Saumya S. Jaju (National Law University, Jodhpur – 5th year student).
Foreign Exchange Management (Cross Border Merger) Regulations, 2018
In the month of April last year, a major step was taken by the Ministry of Corporate Affairs when it finally notified Section 234 of the Companies Act, 2013. This provision deals with the mechanism of cross border mergers in the Indian scenario. The notification of this Section assumed relevance taking into account the stark changes that it introduced as compared to Section 394 of the erstwhile Companies Act of 1956 (hereinafter “1956 Act”).
Section 394 of the 1956 Act dealt with cross border mergers. However, the scope of the Section was limited to the extent that it only permitted inbound cross border mergers, i.e. merger of a foreign Company with an Indian Company when the resultant Company is Indian. The Statute was completely silent on the procedure and permissibility of outbound mergers under the Act, i.e. when the resultant Company subsequent to merger is a foreign Company.
Based on the recommendation of an expert committee under the chairmanship of Dr. Jamshed J. Irani, this shortcoming under the 1956 Act was sought to be remedied by enactment and subsequent notification of Section 234 of the Companies Act, 2013. This provision permitted merger of an Indian Company with a foreign Company and vice versa in relation to countries as notified by the Central Government from time to time. By permitting outbound mergers, new gateways were opened for Indian Companies such as creating international holding companies, providing strategic exit to the investors and even consolidation of holdings.
In furtherance of Section 234, the Central Bank of India had formulated draft regulations which finally saw the daylight as they were notified this year in the month of March. These Regulations provide an elaborate framework for regulation of both inbound and outbound mergers and other regulatory requirements for its implementation. This short research paper aims at analysing the FEM (Cross Border Merger) Regulation, 2018 [hereinafter “Regulations”], elaborating on the procedure envisaged under the Regulation and ambiguities and positive steps undertaken to enhance the mergers and acquisition system within the country.
A general overview of the Regulation
The FEM (Cross Border Merger) Regulation comes as a significant move as it would spur the foreign direct investment within the country with the reformulation and tweaking of the pre-existing laws and enactment of certain new key provisions. The Regulations have broadly been demarcated under two heads namely, inbound and outbound mergers, specifying the regulatory regime for such mergers, which will be discussed in Part-II and Part-III of this paper, respectively.
This part of the paper takes a brief look at some of the other key procedural provisions under the Regulations, while analysing their impact and possible fallacies.
- Definition of Cross Border Merger:
The Regulations define cross border mergers as ‘any’ merger, amalgamation or arrangement between an Indian Company and a foreign Company in compliance with Companies Act, 2013 read with the Relevant Rules. This definition is of a wider import compared to the one covered under the Companies Act which restricts such transactions to mergers and amalgamations alone and does not include arrangements. Arrangement covers instances of reorganization of Company’s share capital by means of either consolidation of shares or division of Company’s share.
This gives rise to certain ambiguities as to the purview of such cross border transactions due to variance in the definition. Up till now no amendment has been carried out either in the Companies Act or Companies (Compromise, Arrangement and Amalgamation) Rules, 2016 thus not clarifying the intention of the legislators towards such a change. This may very well be a drafting error which may be rectified by the Ministry of Corporate Affair subsequently.
- Provision Concerning Deemed Approval:
Regulation 9 of the FEM Cross Border Regulation provides for deemed approval of RBI to transactions involving cross border merger if undertaken in accordance with the said Regulation. Though, there is a requirement of submission of certificate from MD or Whole Time Director or Company Secretary of compliance to the Regulation but the same is not mandatory which is implicit from the use of word “if available”
The introduction of the concept of deemed approval of RBI comes as a departure from the earlier approach of the Ministry of Corporate Affairs which required a mandatory approval of RBI before approaching NCLT for sanctioning of such a Scheme. The rationale behind such a requirement was the change in ownership and liabilities which is accompanied subsequent to such a transaction. However, such a requirement is less appealing to a foreign investor who apart from having to obtain an approval from NCLT and other sectoral regulators would also have to approach the RBI. This had a direct impact on the timelines for undertaking such a merger transaction.
Thus, the step undertaken by the Central Bank comes as a welcome step as it would directly impact the efficacy of the process of cross border mergers. It would reduce the time taken for undertaking such transactions and thus, this move complies with India’s move to liberalise the inflow of Foreign Direct Investment within the Country.
- Valuation of the Companies
Another measure undertaken under the Regulation to ensure transparency and good governance is incorporation of the requirement of valuation of the Companies involved in the transaction. Such a valuation is required to be done in accordance with the recently notified provision of Companies (Compromise, Arrangement and Amalgamation) Rules, namely Rule 25A.
Valuation to be undertaken under Rule 25A has to be; (i) done by valuers who are members of recognised professional body in the jurisdiction of transferee Company; and (ii) in accordance with internationally accepted principles on accounting and valuation. Such a requirement seems to have been included to ensure the protection of shareholders and creditors by making valuation reports readily available to them. This requirement would also ensure that the shareholders are not deceived in cases of exit option being provided to them and correct exit price is afforded.
The Regulation also provides for regular reporting by Companies involved in cross border merger as prescribed by RBI in consultation with the Central Government, from time to time. The reporting requirement seems to be a measure undertaken to evaluate and track the functioning of the resultant Company post the merger scheme. It may also be used to check the any market abuse or possible market abuse by the resultant Company.
Provisions Concerning Outbound Merger
The FEM Cross Border Regulations contains substantive provisions governing inbound and outbound mergers enshrined under Regulation 4 and 5, respectively. This part of the paper will analyse the provisions governing outbound mergers their efficacy and any added perils so introduced under the Regulations.
- Permissibility to acquire securities of foreign Company
The Regulations permit a person resident in India, to subscribe to securities issued by the foreign Company in terms of Foreign Exchange Management (Transfer or Issue of Foreign Security) Regulations, 2004. The valuation of shares issued to such persons resident in India has to meet the limit prescribed under the Liberalised Remittance Scheme [hereinafter “LRS”]. Currently, the LRS permits authorised dealers to remit up to USD 2,50,000 per financial year by resident individuals.
- Status of Office in India pursuant to Outbound Merger
In case of an outbound merger, the resultant Company having an office in India is to be treated as branch office of the foreign Company (resultant Company) in India in accordance with FEM (Establishment in India of a branch office or a liaison office or a project office or any other place of business), Regulations, 2016 [hereinafter “LOBOPO Regulation”]. Thus, such recognised branch office in India will have to conform to transactions mentioned in the Regulations.
Generally a foreign Company seeking to setup a branch office in India has to apply to authorized bank to obtain approval. However, the procedure envisaged under the Regulations provide for deemed approval subject to compliance to requirements enumerated under the LOBOPO Regulation. Such a branch office has limited permissible operations including (i) export/import of goods; (ii) providing professional consultancy services; (iii) research on resultant Company’s business; among others.
Certain tax considerations also come into effect with the Indian offices being deemed as branch office of foreign company, which may in turn be treated as Permanent Establishment under the Income Tax Act, 1961. Thus, the profits attributable to the activities carried out by the branch office would directly be taxable under the Income Tax Act.
This aspect might be a bone of contention as one hand capital gains tax pursuant to an inbound merger are exempted or tax neutral but a significant tax may be collected from activities pursuant to outbound mergers. On one hand, this may be productive for the tax authorities as it would serve as a source of revenue but on the other hand this may also dissuade the foreign investors or Companies to invest in India due to heavy tax burden. Such a move may directly impact the inflow of foreign direct investment within the country a stance completely contradictory to liberalization policy adopted by the Government.
- Outstanding Guarantees and Borrowings
Under the Regulations subsequent to a successful outbound merger, the guarantees and outstanding liabilities of resultant Company is required to be repaid as per the Scheme devised by the NCLT. However, the resultant Company shall not incur any liability towards a lender in India in Rupees not in conformity with the provisions of the Act or Rules or Regulations, subject to a no-objection certificate obtained to this effect.
Such a requirement of obtaining a no-objection certificate might create unnecessary hurdles for the foreign resultant entity and unnecessarily enhance the timelines and increase the burden on the foreign entity with respect to lending.
- Permission to hold assets in India & Opening Bank Account in India
Regulation 5(5) acts a general provision which permits the resultant Company to hold and transfer assets which it is permitted to acquire subject to compliance with the Act, Rules and Regulation. In case, holding of such assets or securities outside India is not permitted under Foreign Exchange Management Act, 1999 [hereinafter “FEMA”] a time period of 2 years has been given to sell off such assets subsequent to sanction of merger by NCLT.
The draft regulations had prescribed a time period of 180 days for selling off of assets which the resultant company was not permitted to hold. This had invited staunch opposition and criticism as failure to comply with this requirement would have resulted in levy of penalties, additional stamp duty and increased tax burdens on the resultant Company. Also, it was also considered that the period of 180 days would prove to be insufficient for the resultant company to comply with the requirements under FEMA. Thus, enhancing of the time period under Regulation 5(6) comes as a welcome step which would further encourage such outbound merger transactions.
Also under the Regulation certain relaxation has been carved out by permitting resultant Company to open an SNRR Account for a period of 2 years in India under FEMA (Deposit) Regulations, 2016. This time period of 2 years is in conformity with the Deposit Regulation which fixes the maximum time period for opening of an SNRR Account to seven years. Also, considering that balances under SNRR Account can be repatriated outside India would further incentives such transactions.
However, on the downside, balances in a SNRR account are subject to applicable tax rates which would create further burdens for foreign or resultant Company and would be a welcome step of Income Tax authorities.
Provisions Concerning Inbound Mergers
‘Inbound merger’ means a cross border merger where the resultant company which takes over the assets and liabilities of the companies involved in the cross-border merger is an Indian company. Unlike outbound mergers, Rule 25A of the Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 does not specify any jurisdictions for the purposes of an inbound merger.
- Issuance or transfer of security
Where the resultant company wishes to issue or transfer any security and/or a foreign security, as the case may be, to a person resident outside India, it has to be done in accordance with the pricing guidelines, entry routes, sectoral caps, attendant conditions and reporting requirements for foreign investment as laid down in Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017.
(i) where the foreign company involved in the merger is a joint venture (JV)/ wholly owned subsidiary (WOS) of the Indian company, it shall comply with the conditions prescribed for transfer of shares of such JV/ WOS by the Indian party as laid down in Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004.
(ii) where such an inbound merger of the JV/WOS results into acquisition of the step-down subsidiary of JV/ WOS of the Indian party by the resultant company, then such acquisition shall be required to be in compliance with Regulation 6 and 7 of Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004.
- Status of office outside India pursuant to Inbound Merger
An office outside India of the foreign company, pursuant to the sanction of the Scheme of cross border merger shall be deemed to be the branch/office outside India of the resultant company in accordance with the Foreign Exchange Management (Foreign Currency Account by a Person Resident in India) Regulations, 2015. Accordingly, the resultant company may undertake any transaction as permitted to a branch/office under the aforesaid Regulations. It is pertinent to note that the continuance of activities at such a branch or office in the foreign jurisdiction could mean a place of business outside India and have result in having a Permanent Establishment of the resultant company in that jurisdiction, therefore exposing it to tax liabilities as per their laws. 
- Guarantees or offshore liabilities of the foreign company
The guarantees or outstanding borrowings of the foreign company from overseas sources which become the borrowing of the resultant company or any borrowing from overseas sources entering into the books of resultant company shall conform, within a period of two years, to the External Commercial Borrowing norms or Trade Credit norms or other foreign borrowing norms, as laid down under Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000 or Foreign Exchange Management (Borrowing or Lending in Rupees) Regulations, 2000 or Foreign Exchange Management (Guarantee) Regulations, 2000, as applicable. These liabilities will be recorded in the books of the accounts of the resultant companies.
There is a prohibition on the remittance that can be made for the repayment of such liability from India in the period of two years.
Since the borrowings shall be treated as external commercial borrowings, it has been provided further that the various conditions/restrictions with respect to the end-uses mentioned under the External Commercial Borrowing norms shall not apply. This has been done as it shall otherwise be difficult to ensure compliance of the existing liabilities with the stringent extant norms for such overseas debt.
However, where any liability outside India is not permitted to be held by the resultant company, the same may be extinguished from the sale proceeds of such overseas assets within the period of two years.
- Assets and securities permitted to be held by the resultant company
The resultant company may acquire and hold any asset outside India which an Indian company is permitted to acquire under the provisions of the Foreign Exchange Management Act and rules or regulations framed thereunder. Such assets can be further transferred in any manner for undertaking a transaction permissible under the Act or rules or regulations framed thereunder.
However, where the asset or security outside India is not permitted to be acquired or held by the resultant company under the Act, rules or regulations, the resultant company shall sell such asset or security within a period of two years from the date of sanction of the Scheme by NCLT and the sale proceeds shall be repatriated to India immediately through banking channels.
- Bank account for the purposes of the abovementioned transactions
The resultant company may open a bank account in foreign currency in the overseas jurisdiction for the purpose of putting through transactions incidental to the cross border merger for a maximum period of two years from the date of sanction of the Scheme by NCLT.
The FEM Cross Border Regulation, 2018 comes as a positive step in accelerating the Government’s stance towards establishing India as an investor friendly country. This is evident from the liberalise procedure included within the Regulation, including provisions for deemed approval, deemed branch office status pursuant to cross border merger, permissibility to open SNRR account in India post an outbound merger among others.
However, the Regulations still suffer from some fallacies and ambiguities, which have been highlighted throughout the course of this research paper. It is pertinent that the issues concerning tax considerations which impose extra burden on resultant companies post an outbound merger. Such variation in taxation of branch offices in case of inbound or outbound merger need to be formalised otherwise it would only dissuade foreign investors and adversely impact the ease of doing business drive.
It almost took an year for the draft regulations to be see the light of day, various fallacies were removed in draft regulations however, there are still issues which need to be rectified and clarification be sought from the Ministry of Corporate Affairs.
 Foreign Exchange Management (Cross Border Merger) Regulation, 2018, Regulation 2(v) [hereinafter “FEM Cross Border Regulation”].
 Id, FEM Cross Border Regulation, Regulation 2(viii).
 Companies Act, 2013, § 234(1).
 Rajesh S. Athavale, Outbound Mergers- Yet Another Impetus for Buoyant M&A Market in India?, Taxsutra, available at: http://www.taxsutra.com/experts/column?sid=853.
 supra note 1, FEM Cross Border Regulation, Regulation 2(iii).
 Companies (Compromise, Arrangements and Amalgamation) Rules, 2016.
 supra note 3, § 234(1).
 Id, § 230(1) Explanation.
 supra note 1, FEM Cross Border Regulation, Regulation 9(2).
 Anubhav Pandey, All you need to know about Combination (Merger Control) Regulations, I-Pleaders, available at: https://blog.ipleaders.in/combination-merger-control/.
 supra note 1, FEM Cross Border Regulation, Regulation 6.
 Ministry of Corporate Affair, Notification, April 13, 2017, available at: http://www.mca.gov.in/Ministr y/pdf/CompaniesCompromises_14042017.pdf,
 supra note 6, Rule 25A.
 supra note 1, FEM Cross Border Regulation, Regulation 8.
 Master Direction- Liberalised Remittance Scheme (LRS), Reserve Bank of India, RBI/FED/2017-18/3 FED Master Direction No. 7/2015-16, available at: https://rbi.org.in/Scripts/NotificationUser.aspx?Id=10192&Mode =0.
 supra note 1, FEM Cross Border Regulation, Regulation 5(3).
 Foreign Exchange Management (Establishment in India of a branch office or a liaison office or a project office or any other place of business), Regulations, 2016, Regulation 4.
 supra note 1, FEM Cross Border Regulation, Regulation 5(3).
 supra note 1, FEM Cross Border Regulation, Regulation 5(6).
 Id, Regulation 5(7).
 Accounts in India by Non-Residents, Frequently Asked Questions, Reserve Bank of India (Aug 01, 2016), available at: https://www.rbi.org.in/scriptS/FAQView.aspx?Id=52#FQ6.
 supra note 1, FEM Cross Border Regulation, Regulation 2(v).
 supra note 1, FEM Cross Border Regulation, Regulation 4(1).
 supra note 1, FEM Cross Border Regulation, Regulation 4(1)(i) and 4(1)(ii).
 supra note 1, FEM Cross Border Regulation, Regulation 4(2).
 supra note 1, FEM Cross Border Regulation, Regulation 4(3).
 Master Direction- External Commercial Borrowings, Trade Credit, Borrowing And Lending In Foreign Currency By Authorised Dealers And Persons Other Than Authorised Dealer Reserve Bank Of India, Reserve Bank of India, available at: https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=10204.
 supra note 1, FEM Cross Border Regulation, Regulation 4(5).
 supra note 1, FEM Cross Border Regulation, Regulation 4(4).
 supra note 1, FEM Cross Border Regulation, Regulation 4(5).
 supra note 1, FEM Cross Border Regulation, Regulation 4(6).