The Corporate & Commercial Law Society Blog, HNLU

Author: HNLU CCLS

  • Navigating RBI’s Revised Framework for Downstream Investments by FOCCs

    Navigating RBI’s Revised Framework for Downstream Investments by FOCCs

    BY PURNIMA RATHI, FOURTH-YEAR STUDENT AT SYBIOSIS LAW SCHOOL, PUNE

    On January 20, 2025, the Reserve Bank of India (‘RBI’) released a comprehensive revision of the Master Direction on Foreign Investment in India (‘Master Direction’). The update represents a landmark regulatory revision, particularly for Foreign Owned and/or Controlled Companies (‘FOCCs’) pursuing downstream investments. The updated Master Direction has attempted to resolve a number of ambiguities, align regulatory treatment with the Consolidated Foreign Direct Investment (‘FDI’) Policy, 2020 and the Foreign Exchange (Non- Debt_ Instruments) Rules, 2019 (‘NDI Rules’) and thus, stream lining the compliance requirements for both investors and companies.

    The blog shall analyse key regulatory changes made through the Master Direction and its effects on downstream investments made by FOCCs. This analysis is made by comparing the recent update to the earlier versions of the Master Direction.

    WHAT ARE FOCCs AND DOWNSTREAM INVESTMENTS ?

    To understand the significance of the Master Direction, it is first necessary to understand the meaning and the context in which FOCCs and downstream investments operate. A FOCC is defined in the Foreign Exchange Management Act, 1999 (‘FEMA’) and the NDI Rules as an Indian entity that is:

    •  Owned by non-resident entities (more than 50% shareholding); or

    •  Controlled by non-residents (in the sense of a non-resident entity or person is empowered to appoint a majority of directors or is empowered to influence decisions which are deemed to be strategic business decisions).

    Downstream investment is defined collectively, in this context, as an investment in capital instruments (equity shares, compulsorily convertible preference shares, etc.) made by said FOCC in another Indian entity. It is essentially an investment made by a company already partly or wholly owned by foreign investors, into another Indian entity.

    Analysis of Key Changes

    The updated Master Direction has important amendments which are aimed at reducing compliance complexities, providing legal clarity, and allowing flexibility with transaction structures. Analysed below are the key revisions from the Master Direction:

    1. Consistency with General FDI Norms

    The most important change is the explicit consistency of downstream investments by FOCCs with general FDI norms. Downstream investments are treated as a different investment category and require separate compliance obligations.  However, now it requires that FOCCs must comply with the same entry routes (automatic or government), sectoral restrictions, price restrictions, and reporting requirements as any direct foreign investment investor. The guiding principle of “what cannot be done directly, shall not be done indirectly” has the intention to place downstream investments on an equal level with FDI.

    This is particularly advantageous in sectors where the automatic route is available and removes unnecessary bureaucratic hurdles. For example, if a FOCC is investing in an Indian startup that provides services to the technology sector, they may now invest and treat it the same as a direct foreign investment provided that the sector cap and conditions are adhered to.

    2. Share Swaps Approved

    Another important change is the recognition of share swap transactions by FOCCs. Before the recent change, it was unclear whether share swaps were permitted for FOCCs at all, and companies tended to either seek informal clarifications or err on the side of caution.

    The updated direction explicitly provides that FOCCs can issue or acquire shares in lieu of shares of another company (either Indian or foreign) subject to pricing guidelines and sectoral limitations. This is an important facilitative measure for cross-border mergers, joint ventures, and acquisition deals where share swaps are the predominant form of consideration.

    This reform enhances transactional flexibility, encourages capital growth and will reduce friction in structuring deals between Indian FOCCs and foreign entities, thereby promoting greater integration with global capital market. 

    3. Permissibility of Deferred Consideration

    The RBI now formally recognizes deferred consideration structures such as milestone-triggered payments, escrows, or holdbacks. However, they are still governed by the ’18-25 Rule’, which allows 25% of total consideration to be deferred, which must be paid within 18 months of execution of the agreement. This represents a pragmatic acceptance of the commercial acknowledgment that not all transactions are settled upon completion.

    RBI shall have to give additional clarifications as the Master Direction still does not specify the extent to which provisions are applicable to downstream investments in comparison to the FDIs.

    4. Limitations on the Utilisation of Domestic Borrowings

    In an effort to safeguard the integrity of foreign investment channels and to deter round-tripping, or indirect foreign investment through Indian funds, the RBI continues to restrict FOCCs from utilising domestic borrowings for downstream investment. This implies that FOCCs can only downstream invest with foreign funds introduced through equity investments or through internal accruals. The restriction aims that downstream investments are made through genuine foreign capital introduced in the country through abroad, rather than through domestic borrowings.

    Practically this means that if the FOCC receives a USD 5 million injection from the parent organization abroad, then they can utilize such funds for downstream investment, but not if they were to borrow the same amount in INR through a loan from an Indian financial institution. This maintains investor confidence and enhances transparency in capital flows.

    5. Modified Pricing Guidelines for Transactions

    The revised framework reiterated pricing guidelines in accordance with the different types of company:

    •  For listed companies: The pricing must comply with the Securities and Exchange Board of India (‘SEBI’) guidelines,

    •  By unlisted companies: The price cannot be lower than the fair market value determined by internationally accepted pricing methodologies.

    Additionally, in all rights issues involving non-residents, if the allotment is greater than the investor’s allotted entitlement, price has to comply with these guidelines. In this case, the rights issue would protect minority shareholders and mitigate the dilution that would occur by no listings from unlisted companies.

    6. Reporting and Compliance via Form DI

    An excellent innovation is the new compliance requirement of filing on Form DI within 30 days of the date an Indian company becomes a FOCC or makes a downstream investment. This will assist the RBI in maintaining regulatory visibility and better tracking of foreign investment in India. Companies will have to implement stricter internal compliance mechanisms and timely reporting as failure to do so could result in penalties under FEMA. The RBI’s emphasis on transparency reflects a continuing trend toward digitization and live reporting of capital flows by Indian regulators.

    7. Clearer Application of the Reporting Forms (FC-GPR, FC-TRS, DI)

    In addition, the RBI has further clarified the documents to use the following forms:

    • Form FC-GPR: is for reporting the issuance of shares by an Indian entity to a FOCC. • Form FC-TRS: is for any transfer of shares involving FOCC as the non-resident and between residents and non-residents.

    • Form DI: is for downstream investments made by FOCC into any other Indian entity.

    This clarity will help eliminate confusion around these procedures and synchronize the reporting regime of the RBI with the reporting systems of the Ministry of Corporate Affairs (‘MCA’) and SEBI. FOCC should implement strong internal controls to monitor and track when these filings will become due.

    8. Classification of FOCCs based on Share Movement

    The new regulations will also provide clarity on how the status of a FOCC will influence a regulatory classification. Specifically:

    •  if a FOCC receives shares from an Indian entity, it will be treated as a ‘Person Resident Outside India’; and

    •  if it transfers shares to an Indian entity, it will be deemed to be domestic in nature but needs to comply with the repatriation norms.

    These classifications have an important bearing on the route and pricing of transactions especially in exits or complex internal restructuring transactions. Through these classifications, RBI intends to clarify the confusion from mischaracterizing transactions and reducing risk for the investors in the event of any enforcement action.

    Conclusion

    The amendments to the Master Direction represent a measured and thoughtful change in the foreign investment regulatory framework in India. The RBI has set the tone in favour of enabling policy predictability and investor confidence by clarifying FOCC structures’ downstream investment norms to be consistent with FDI, allowing for more sophisticated structures like share-swap transactions and deferred consideration, and imposing effective operational compliance requirements. Going forward, these refinements have set the foundation for deeper capital integration and increased investor trust in India’s FDI regime.

  • Taxing the Non-existent: Transfer Pricing of AMP Expenses

    Taxing the Non-existent: Transfer Pricing of AMP Expenses

    BY YARABHAM AKSHIT REDDY, THIRD- YEAR STUDENT AT HNLU, RAIPUR
    Introduction

    The treatment of Advertising, Marketing and Promotion (‘AMP‘) expenditure has been a contentious issue under the Transfer Pricing (TP) Regulations as outlined in sections 92 to 92F of the Income Tax Act, 1961 (‘ITA‘). The debate centers on whether such expenses constitute transactions between Associated Enterprises (AEs) requiring compensation or qualify as ordinary business expenses. Recently, in the case of PCIT v Beam Global Spirits & Wine (India) Pvt Ltd, the Delhi High Court ruled that the existence of an International Transaction must be established before proceeding with the benchmarking analysis of AMP expenses and rejected the application of Bright Line Test (‘BLT‘) for inferring the International Transaction. As per section 92B (1) of ITA, an International Transaction is “a transaction entered into between two or more AE where at least one of them is a non-resident by way of agreement, arrangement or action – whether formalized in writing or otherwise. Since, there is no statutory framework governing the AMP expenses, the concept has evolved through a series of judicial pronouncements. This ruling came as a relief to the taxpayers who are engaged in marketing intangibles and could claim deductions for such expenses under section 37 of ITA.

    In light of the above, the article critically analyzes the judgement in two prongs, viz, firstly, by understanding the concept of the BLT for determining the existence of International Transactions, and Secondly, through exploring the alternatives in determining the TP adjustments of AMP expenses and prevent unfair tax assessments by revenue authorities.

    Behind the Judgement: Key Legal Takeaways

    In the present case, the assessee (Beam India Holding Ltd) is one of the companies of Beam Global Group which is engaged in the manufacture, sale, marketing and trading of Indian Made Foreign Liquor (‘IMFL‘). This IMFL is sold under the brand name and license given by Fortune Brands which is stated to be the ultimate parent company. The core issue before the Transfer Pricing Officer (‘TPO‘) was whether AMP expenses incurred by the assessee constitute an International Transaction as per section 92B of ITA.

    The TPO applied the BLT and determined that the excessive expenditure constitutes an International Transaction as the same has benefited the legal owner as a result of brand building and commenced benchmarking analysis. As a result, the assessee filed an appeal before the Income Tax Appellate Tribunal (‘ITAT‘) which ruled in his favour by establishing that before initiating a TP Adjustment, the TPO must establish the presence of an International Transaction with tangible and concrete evidence. Aggrieved by the same, the revenue authorities challenged the decision before the Delhi High Court (HC).

    The Delhi HC upheld the decision given by ITAT by stating that a mere relationship between two AEs cannot be satisfactory evidence for the presence of an International Transaction and relied on Maruti Suzuki India Pvt Ltd v. CIT, which established that mere rendering of service by one party to another would not constitute a transaction unless the same is based on mutual arrangement or agreement as per Section 92B (1) of ITA. Further, the court relied on Sony Ericsson Mobile Communication India Private Limited v. CIT (‘Sony Ericsson‘) and rejected the BLT as an objective criterion for establishing AMP expenses as International Transactions.

    From Acceptance to Rejection: Tracing the path of BLT

    The concept of BLT originated in the case of DHL Corporation & Subsidiaries v. Commissioner of Internal Revenue before the US Tax Court. According to this test, if a subsidiary AE incurs significant costs in the exploitation of an intangible brand name and that expenses exceed the bright line limit of routine expenditure (costs incurred by the other comparable entities), then such entity is deemed to have economic ownership over that brand name. It then becomes an obligation for the parent AE to reimburse the subsidiary AE for non-routine expenditures incurred in brand building. In the absence of any statutory provision to compensate the subsidiary AE for the benefits drawn by foreign AE, the need for transfer pricing adjustment arises. The revenue authorities apply this test in determining the arms’ length price of this perceived transaction.

    In the Indian Context, the test was first applied in the case of Maruti Suzuki India Ltd v ACIT wherein the Delhi HC determined that AMP Expenses would constitute an International Transaction if they exceed the expenses incurred by comparable independent entities placed in similar circumstances. Further, in LG Electronics India Private Limited vs. ACIT (‘LG Electronics‘), the ITAT ruled that proportionately higher expenses incurred in the creation of marketing intangibles would constitute an International Transaction.

    Subsequently, LG Electronics was overruled to the extent that excessive AMP expenses incurred by domestic AEs would constitute an International Transaction in Sony Ericsson case. The court held that BLT would not be an appropriate method as it lacks statutory mandate and was not envisioned in ITA or Income Tax Rules. Moreover, the Supreme Court has dismissed the Special Leave Petition challenging the Delhi HC judgment in CIT v. Whirlpool of India Ltd which invalidated the BLT test, thereby establishing it as a binding precedent.

    It is contended that the application of the BLT method would risk undermining statutory framework of ITA. Such an approach would introduce a novel concept that lacks any formal recognition, thereby creating interpretative inconsistencies and potential conflicts with the established methodologies. section 92C of ITA outlines an exhaustive list of methods for the computation of AMP and must not lay down any other guidelines. The existence of International Transactions must be established based on actual or concrete evidence and such a qualitative determination cannot serve as the basis for their recognition. Despite subsequent High Court rulings rejecting BLT, Revenue Authorities are increasingly relying on BLT for a regressive analysis of AMP expenses to determine an International Transaction.

    Critical Analysis
    • Prima Facie establishment of International Transaction:

    The judgement is a step in the right direction as it places the burden of proof on the revenue authorities to prove the existence of International Transactions based on tangible or concrete evidence between the domestic AE and its foreign AE. This position has been affirmed in CIT v EKL Appliance Enterprise Ltd, wherein the TPO has been directed to “examine the International Transaction as he finds it and not to make its existence a matter of surmises.” This would reduce arbitrary assessments faced by Indian AEs and force the Revenue authorities to reassess their approach towards transfer pricing of AMP Expenses.

    • BLT cannot be an appropriate method for AMP Expenses:

    The level and nature of AMP spending depend on a variety of business factors like market share, market environment, contractual mechanisms, management policies, etc. It varies across industries and also differs within the same industry as it could be company-specific. In the absence of a clear statutory scheme, reliance cannot be placed on BLT to decide AMP expenses by mere comparison with other similarly situated entities. Such fact-specific cases necessitate careful consideration of multiple factors- whether the AE operates a licensed manufacturer, distributor or marketing agent, the duration of contracts whether long-term or short-term, extent of risk undertaken. The Delhi ITAT in BMW Motors India Pvt. Ltd v. DCIT, established that there is no straightjacket formula to determine transfer pricing matters of AMP expenses and such a fact-extensive exercise requires a detailed Functional Analysis to characterize transactions appropriately and understand the business models.

    Avoiding TP Adjustment of AMP Expenses: Assessing the Possible Alternatives

    Until the legislature lays down clear guidelines for determining International Transactions or the Supreme Court resolves the ambiguity, BLT cannot be used as it is inherently susceptible to arbitrariness and operational challenges. In due time, revenue authorities must mandate Indian entities and their foreign AEs to maintain detailed documentation of Functions performed, assets employed and risk undertaken (‘FAR Analysis’) while performing AMP functions. This would help in keeping track of purposes for which expenditure is undertaken, reasons for excessive expenses and the existence of any implicit arrangement or agreement.

    OECD and the Australian Tax Office (‘ATO’) also lay down guidelines for preventing profit shifting due to excessive AMP expenditure. It prescribes that any assessment undertaken by the revenue authorities must look for reduced product/service prices or lower royalty rates paid by domestic AE to foreign AE, profit splitting agreements between them and any provision for compensation for excessive AMP by foreign AE. Since, these guidelines concern distributors or marketers, any legislature enacting these rules must also lay down for licensed manufacturers.

    Another alternative would be Advance Pricing Agreements (‘APAs’). These are pre-negotiated agreements between revenue authorities and the assessee, providing for fixed methods of transfer pricing over a specific period and decides the ALP. These APAs will determine what kind of transactions will be covered by them and what methods would be used for TP Adjustments. AMP Expenses could be covered under these APAs which would help in reducing tax litigations and boost foreign investments in India. Since this issue requires a thorough analysis of fact-specific cases, it must be carried out with a fixed/standardized methods for a fair and accurate determination.

    Conclusion

    This judgement reinforces that excessive AMP expenses incurred by the assessee could not qualify as International Transaction as the creation of marketing intangibles increases his own sales and benefits his business. The burden of proof is on revenue authorities to prove the presence of International Transactions with tangible or concrete evidence. Rejection of BLT emphasizes the need for a more objective/ standardized methods to ensure fair TP Assessments, thereby protecting companies from arbitrary and unwarranted tax adjustments. Until legislative clarity is provided in this regard, proper and detailed documentation, APAs and FAR Analysis could bring clarity and consistency in handling AMP-related TP issues. Such a fair and balanced approach will go a long way in reducing litigations and create a predictable tax environment in India.