Schrodinger’s FOCC: FEMA’s Grey Area on Determining Position of FOCC in Buyback of Shares

[Jahanvi and Kritika are students at Gandhinagar National Law University.]

In today’s rapidly evolving markets, buyback of shares is a common mechanism through which companies can restructure their capital. At its core, a buy-back allows a company to repurchase its own shares from the market, a move that can enhance shareholder value, and provides an exit route to the investors. However, buy-backs are far from a simple, risk-free tactic. Their use is not always permitted, nor are they meant to be deployed at will. The law strictly prohibited companies from buying back their own securities; exceptions are allowed only in extraordinary scenarios with comprehensive compliance requirements provided in Section 68 of the Companies Act 2013. It is designed to prevent abuse and protect shareholder interests.  These transactions get even more complex when foreign owned and controlled company (FOCC) are involved. The  Foreign Exchange Management Act 1999 (FEMA) does not clarify the status of FOCCs, when it undertakes a buyback from a Indian resident. This gap in the law creates legal ambiguity and compliance risks. 

The Identity Crisis: Dual nature of FOCCs

When it comes to buy-backs, the stakes and the complexities rise sharply if a company is an FOCC. FOCCs are, at first glance, ordinary Indian companies: they are incorporated under Indian law, governed by the Companies Act 2013, and hence, categorized as a ‘resident entity’ for most statutory and compliance obligations. Yet, by virtue of its majority ownership or effective control resting with foreign entities or individuals, it is simultaneously tied to the ‘non-resident’ status. Although operationally a FOCC is an Indian company for most compliance and disclosure purposes, it is nevertheless viewed through a different lens under foreign exchange laws. 

This regulatory dichotomy leads to a lot of practical challenges. For transactional matters such as pricing, valuation, and capital account flows governed by FEMA and the Foreign Exchange Management (Non-Debt Instruments) Rules 2019 (NDI Rules); an FOCC triggers separate, and sometimes conflicting, requirements compared to ordinary Indian-owned companies.  

Hence, the unique character of FOCCs is their defining feature and also the primary source of uncertainty when it comes to strategic corporate actions. This duality makes any transaction involving fund flows or buy-backs especially uncertain, highlighting the need for a defined nature for FOCC. 

Buy-Backs: the Grey Zone 

FOCC can be described as an Indian entity that is receiving foreign investment and is controlled or owned by a person resident outside of India. FOCCs are unique because such companies are incorporated in India, but their control and ownership lie outside of India. The NDI Rules govern transactions by regulating and enforcing pricing norms involved in the transactions involving FOCCs.  

Under the NDI Rules, downstream investment means any investment made by an Indian entity, which already has foreign investment, into the capital instruments or capital of another Indian entity. The purpose behind this regime is to ensure that indirect foreign investments, layered through Indian companies, remain subject to the same sectoral caps, entry routes, and conditionalities as direct FDI. In essence, down-streaming prevents foreign investors from bypassing India’s regulatory thresholds by routing funds indirectly through domestic intermediaries like FOCCs. 

However, while the NDI Rules speak clearly on downstream investments, they remain silent on other capital transactions that an FOCC might undertake; such as a buy-back of shares from its Indian shareholders. This omission leaves a fundamental question unanswered: Should a buy-back by a FOCC be treated like a transaction between two Indian residents (thus exempt from certain pricing and reporting norms) or as a cross-border transaction attracting the same scrutiny as direct foreign investments? The answer has significant regulatory and tax implications. 

Rule 23(5) of the NDI Rules provides that FOCC investing in Indian company needs to comply with where the pricing guidelines and reporting requirements as specified by the Reserve Bank. Pricing guidelines ensures that equity instruments are transferred and issued between resident and non-resident are on fair market value.  This is to prevent round tripping of funds or potential capital loss. However, the said rules only apply in the scenario for when the shares of FOCC are sold to a person resident within India or Person resident outside of India. They remain silent on what are the requirements to be followed when FOCC is purchasing equity instrument from an Indian entity.  

Firstly, this creates ambiguity in the scenarios where FOCC is undertaking buy-back of its shares from an Indian resident. It remains unclear whether such transaction should be considered resident to resident transactions, or whether the FOCC should be treated as a non-resident and therefore necessitating FEMA guidelines compliance. 

Secondly, downstream investments cannot be equated with buy-backs of share. The explanation to Rule 23 of the NDI Rules defines down-streaming as an investment made by an Indian entity which has received investment from foreign entity or which is an investment vehicle in the equity instruments or the capital, as the case may be, of another Indian entity. Whereas buyback of shares is capital restructuring, where company buys its own shares. Both cannot be treated as on par with each other. 

The definition of 'resident' under Section 2(v) of FEMA includes ‘any person or body corporate registered or incorporated in India’, and by that definition, FOCC qualifies as resident under FEMA. Accordingly, buyback of shares by FOCC would be considered a transaction between two residents. In this scenario, there is no foreign exchange occurring between parties and funds are within India. It may be contended that, based on the this interpretation, such transactions will not come under the scope of FEMA.

Judicial Position on the Matter

In Re Panama Wind Energy Godawari Private Limited (Panama Godawari), this issue was before National Company Law Tribunal, Mumbai bench, where the petitioner made application for reduction of share capital by cancelling its preference shares of some of its resident shareholder. As per the petition, Panama Godawari is a wholly-owned subsidiary of O2 Power SG Pte. Ltd situated in Singapore. One of the questions before the bench raised by RD was whether FEMA and guidelines will be applicable on this transaction. The petitioner argued that the transaction does not trigger FEMA, as both transacting parties, the FOCC and the shareholders, are residents. Mr Tushar Wagh, the counsel representing the Regional Director stated that the explanation provided above was satisfactory and held no further objections. The NCLT bench also did not raise any objections to this interpretation, thereby implying tacit acceptance of the FOCC’s status as a resident for the purposes of the transaction. 

There appears to be very few judgments and orders that address the legal position of FOCCs when they are undertaking buy back of shares from Indian residents. While the legislative framework is silent on this issue, the lack of judicial scrutiny has further contributed to the uncertainty. There appears to be no conclusive judgements or detailed interpretative analysis of the position FOCCs in transaction involving buy-backs and capital reduction with residents.  

Conclusion  

In sum, the regulatory ambiguity surrounding buy-back transactions by FOCCs exposes significant gaps in India’s capital market governance. While the Companies Act 2013 clearly governs buy-backs, the silence of the NDI Rules on FOCC buy-backs invites conflicting interpretations. The limited judicial insight, as seen in Panama Godawari, suggests a resident status for such transactions, yet no authoritative precedent exists. Until clearer legislative or regulatory guidance emerges, FOCCs and their stakeholders must tread carefully as the dual identity of FOCCs will continue to blur the lines of resident and non-resident treatment in capital transactions. Any legislative clarification will remove the ambiguity and create a stable, transparent investment environment.