The article analyses the changes to Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, and the potential issues that may arise as a result.

An inbound merger, or ‘reverse flipping’ allows a foreign company to merge into its Indian subsidiary, with the Indian subsidiary as the surviving company. This enables the transfer of the foreign company’s assets and operations to its Indian subsidiary, with its shareholders gaining ownership in the Indian subsidiary. In the past decade, many Indian startups with significant operations have established holding companies abroad to benefit from easier business regulations and favourable tax policies.

Several companies, that include PhonePe, Groww, Razorpay, Pepperfry, Flipkart, Meesho and Pine Labs, are either exploring or have begun inbound mergers. This is a shift driven by relaxed regulations, tax incentives, a thriving IPO market, and growing confidence within the start-up ecosystem. Over the last five years, sectors such as manufacturing, retail, IT and healthcare have led this trend. Recently, Zepto secured the National Company Law Tribunal (NCLT) approval for its inbound merger through the traditional route rather than the fast-track process.

Developing regulatory regime

Inbound mergers in India are regulated by:

  1. The Companies Act, 2013 (Act) along with the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 (CAA Rules); and
  2. The Foreign Exchange Management Act, 1999, along with the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (Cross Border Regulations).

A recent amendment introduced sub-rule (5) in Rule 25A of the CAA Rules which allows a foreign holding company to merge with its wholly owned Indian subsidiary via the fast-track route under Section 233 of the Act. This process is subject to:

(i) Prior approval from the Reserve Bank of India (RBI);

(ii) Compliance with Section 233 of the Act; and

(iii) Application to the regional director for merger approval under Section 233 of the Act and Rule 25 of the CAA Rules (which are required to be accompanied with a declaration in Form CAA-16 where the holding company is incorporated in countries sharing a land border with India).

This amendment eliminates the need for NCLT approval, significantly reducing merger timelines. While this is a positive development for inbound mergers in India, it also raises certain challenges.

Has the ‘fast-track route’ become mandatory?

The language used in the amendment to the CAA Rules suggests that the Indian subsidiary is mandated to avail the fast-track route for the merger under Section 233 of the Act. However, Section 233 of the Act itself allows companies to avail the traditional route legislated under Section 232 of the Act.

In our view, the amendment does not eliminate the option for Indian subsidiaries to pursue the traditional route, as:  

  1. The CAA Rules, being delegated legislation, cannot supersede the principal legislation; and
  2.  Established legal principles dictate that when two interpretations are possible, the one which does not reduce a legislation to futility should be preferred.

Is RBI approval mandatory?

For cross-border inbound mergers under the fast-track route, sub-rule (5) in Rule 25A of the CAA Rules requires both the foreign holding company and the Indian subsidiary to secure prior RBI approval. However, under Regulation 9(1) of the Cross Border Regulations, mergers that meet the prescribed regulatory conditions are automatically deemed approved by the RBI, eliminating the need for separate approval under Rule 25A.

The CAA Rules do not explicitly clarify whether the deemed RBI approval under the Cross Border Regulations also applies to fast-track inbound mergers. However, since Regulation 9(1) states that deemed approval is granted “…as required under Rule 25A…”, it can be reasonably inferred that separate RBI approval is unnecessary for fast-track inbound mergers, provided they comply with the Cross Border Regulations. These requirements include, among other things, adherence to sectoral caps and pricing guidelines.

Taxation of Inbound Mergers

For inbound mergers, the tax implications must be assessed in both the foreign holding company’s jurisdiction and India. In India, capital gains tax exemption applies only if the merger qualifies as an “amalgamation” under Section 47 of the Income Tax Act, 1961 (IT Act).

Furthermore, the carry forward of accumulated losses and unabsorbed depreciation from the foreign holding company to the Indian subsidiary is permitted only when:

(i) The foreign holding company qualifies as an ‘industrial undertaking’ under Section 72A of the IT Act, which excludes purely investment holding entities; and

(ii) Atleast 51% of the shareholding remains unchanged post-merger, as required under Section 79 of the IT Act.

These restrictions, however, do not apply if the Indian company is classified as an ‘eligible start-up’ under the IT Act.  

What’s the way forward?

India is currently witnessing a slowdown in inward foreign investments. In this context, the amendment to the CAA Rules is a positive development, likely to encourage inbound mergers, boost foreign investment, and enhance value creation for entrepreneurs. Additionally, inbound mergers could strengthen Indian capital markets, as many are aligned with proposed listings.

Bharucha & Partners – Mita Sood, Harshit Kumar and Muskaan Aggarwal