India's startup landscape is thriving, with the country now home to 109 unicorns, placing it third globally, behind only the US and China, in terms of the number of unicorns. In the dynamic world of startups, unicorns—rare and exceptional ventures valued at over $1 billion—continue to captivate the business world with their remarkable achievements. With its dynamic entrepreneurial environment and thriving startup ecosystem, India has given rise to a host of unicorns that are transforming industries, redefining markets, and making waves on the global stage.
As per the 2024 Forbes report titled 'unicorns in India':
"As of May 2024, the Indian startup ecosystem, ranking third globally in terms of unicorn count, is collectively valued at $349.67 billion."1
In line with Modi government's vision of 'Viksit Bharat by 2047', the Ministry of Corporate Affairs ('MCA') which acts as a key player in advancing the ease of doing business and at the same time keeping a close check on suspicious transactions by corporate houses.
MCA has introduced the Companies (Compromises, Arrangements, and Amalgamations) Amendment Rules, 2024, which came into effect on September 17, 2024 ('Amendment'). The amendment lays down provision for enhanced regulatory regime in case of amalgamations between foreign holding companies and their wholly owned Indian subsidiaries.
Pursuant to the recent Amendment, the MCA has introduced a new sub-rule (5) under Rule 25A. The existing provisions of the Companies Act, 2013 (the 'Act') provide for a fast-track merger process for specified companies, including a merger transaction between holding companies and their wholly owned subsidiaries. Companies eligible for this fast-track provision are exempt from the time-consuming approval process of the National Company Law Tribunal ('NCLT'). This expedited route offers a streamlined process through the Regional Director, eliminating the need for court intervention.
However, prior to the Amendment, these fast-track provisions did not explicitly apply to mergers involving foreign holding companies and Indian subsidiaries. Consequently, the merger of an Indian holding or subsidiary company with a foreign company remained subject to the provisions of Section 234 of the Act.
Through the Amendment, the legislature has established a specific regulatory framework for mergers involving an Indian wholly owned subsidiary and its foreign holding counterpart which will now be eligible for the fast-track route.
Following the Amendment, an additional compliance has been imposed on holding and subsidiary companies, which now must obtain prior approval from the Reserve Bank of India ('RBI'). Previously, an exemption from obtaining RBI approval had been provided for the merger of a holding company into its subsidiary. This new compliance requirement is in addition to the existing regulatory framework under Section 233 of the Act. The Amendment streamlines the process for cross-border mergers while ensuring adherence to regulatory standards and the Act.
Rationale behind the Amendment
The Amendment traces its history from a noticeable trend of startups flipping, where Indian companies externalized their holding structures to foreign jurisdictions with an intent of incorporating a holding company in a favourable jurisdiction which subsequently becomes the holding company of the subsidiary in India. This was driven by various factors that attracted investors to India's rapidly growing startup ecosystem. Favourable government policies and incentives encouraged entrepreneurs to expand globally, relocating their holding companies to countries like Singapore, the United States, the United Kingdom, and the Netherlands.
"Flipping" generally refers to the process of moving ownership of an Indian entity to a foreign company, including key assets like intellectual property. While most of the market presence, workforce, and founders remain in India, the Indian entity becomes a wholly owned subsidiary of the foreign entity, with daily operations continuing in India.
Among various hidden benefits of flipping, the major one lies in gaining easier access to international financing, enter regulated markets, adopt corporate structures familiar to private equity investors, and enable listings on foreign stock exchanges. Flipping often took place during the early stages of startups, influenced by the commercial, tax, and personal preferences of founders and investors.
The rationale behind this Amendment is to facilitate reverse flipping, which is a key step towards reducing the practice of flipping. In the past, the government has implemented various measures, including establishing GIFT City to attract offshore investment, reducing the corporate tax rate, and abolishing the angel tax and dividend distribution tax. This Amendment is a key development in streamlining the process of establishing a holding company structure in India.
Regulatory Landscape for Cross-Border Merger in India
In India, cross-border mergers are primarily governed by the Act, in conjunction with Rule 25A of the Companies (Compromises, Arrangements, and Amalgamations) Rules, 2016, and the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 ("Cross Border Regulations"). The existing Cross-Border Regulations provide for a deemed approval from the RBI for schemes of amalgamation involving cross-border transactions, provided these schemes comply with the conditions specified in the Cross-Border Rules.
Understanding the Impact of the MCA Amendment on Current Corporate Structures
The MCA's Amendment to Rule 25A introduces significant changes, particularly for mergers involving foreign holding companies and their Indian subsidiaries.
The impact of Amendment is that the companies involved in the cross-border merger are no longer required to obtain approval from the NCLT. The scheme shall be filed before the Regional Director thereby reducing the time required for approval and thereby fast-tracking the cross-border transactions.
Conversely, it also stipulates that both parties must obtain prior approval from the RBI, notwithstanding such schemes are in compliances with the Cross Border Regulations. The relevant extract of the Amendment is reproduced herein:
"(5) Where the transferor foreign company incorporated outside India being a holding company and the transferee Indian company being a wholly owned subsidiary company incorporated in India, enter into merger or amalgamation, –
- both the companies shall obtain the prior approval of the Reserve Bank of India;
- the transferee Indian company shall comply with the provisions of section 233;
- the application shall be made by the transferee Indian company to the Central Government under section 233 of the Act and provisions of rule 25 shall apply to such application; and
- the declaration referred to in sub-rule (4) shall be made at the stage of making application under section 233 of the Act."
Why Reverse Flipping is Becoming a Key Trend
Recently we have witnessed that numerous, startups relocated their holding companies to overseas jurisdictions for multiple reasons. However, those that initially underwent "flipping" are now considering "reverse flipping," returning their holding company to India. This trend has gained significant momentum among new-age startups, driven by more favourable valuations in Indian capital markets, strong government support, simplified regulatory frameworks, and improved access to capital. Now, after numerous reforms, the robustness and expansion of India's IPO market provide investors a reliable way to secure returns through an effective exit strategy.
Many companies initially established their structures in foreign countries for various reasons including foreign funding, but with recent reforms and growing awareness, India has become a more attractive option for such setups. As highlighted in the 2023-24 Annual Report of SEBI, the trends in fundraising are notable, and companies are increasingly aligning with this national trend.
"During 2023-24, fund raising through public issues increased by 15 per cent compared to 2022-23. The steady upsurge in fund mobilisation was supported by growing optimism in India's growth trajectory, resilience in domestic economic activities, healthy corporate earnings, rising investor participation etc. The number of newly listed companies rose to 272 in 2023- 24 as compared to 164 during 2022-23. Notably, the number of small and medium enterprises (SME) listings was the highest ever in 2023-24. The number of main board IPOs almost doubled, totalling 76 during 2023-24, with median size being 597 crore as compared to 635 crore during 2022-23".2
India's regulatory landscape, once lacking in robustness and investor protection, has seen significant improvements over time. Recent developments and proactive government initiatives, alongside a vast customer base of over 1.43 billion, present compelling reasons for companies to consider returning to India. Key factors driving this shift include:
- Evolved Startup Landscape: The Indian startup landscape has greatly developed, offering improved access to skilled talent and advanced technology.
- Untapped Local Investment Opportunities: A significant number of domestic retail investors are keen to invest in emerging companies with promising growth prospects.
- Government Backing: The Indian government has simplified the process for startups to go public, increasing the appeal of relocating operations back to India.
- Appealing Market Valuations: Despite the considerable tax implications of moving, companies are drawn to the favourable valuations present in the Indian markets.
Nexus between the Amendment and the Trend of Reverse Flipping
After several reforms, this latest Amendment facilitates the return of startups that had previously set up their headquarters abroad. It smooths the transition by streamlining the process, bypassing the lengthy procedures under Sections 230 to 232 of the Act. With this Amendment, companies can now apply directly to the central government for approval, navigating a time-bound process rather than a prolonged adjudication. Recent regulatory changes in India have made it easier for startups to bring their headquarters back to India, as part of a broader effort to encourage the repatriation of offshore funds. Now, with enhanced access to capital through India's dynamic private equity and venture capital landscape, along with regulatory adjustments addressing round-tripping concerns, the trend of flipping has slowed down. As a result, companies are increasingly considering "reverse flipping," relocating their holding structures back to India.
Conclusion
This Amendment reflects the MCA's proactive stance on aligning India's corporate framework with global best practices while ensuring that regulatory oversight remains robust. The emphasis on faster processing through the Regional Director rather than the NCLT is a pragmatic step. It responds to business concerns over delays, which is a significant pain point for companies navigating cross-border mergers. This shift enhances India's attractiveness as a business destination by creating an environment that allows foreign companies to expand operations in a timely and efficient manner.
India's status as a burgeoning global business leader is bolstered by its dynamic, tech-savvy, and entrepreneurial population, positioning it as a prime hub for both startups and established firms. The recent trend of reverse flipping, with companies such as Pepperfry, PhonePe, and Groww shifting their headquarters back to India, highlights the nation's growing appeal. Additionally, major fintech players like Pine Labs, Meesho, Flipkart, and Zepto are also considering this move. This Amendment is poised to accelerate such relocations by providing a more streamlined and simplified process, supporting India's ambition to become a $5 trillion economy.
In conclusion, while recent Amendments have made significant strides, further reforms are still needed at the ground level to fully support the return of Indian startups. The Economic Survey 2022-23 highlighted the need for additional measures to facilitate reverse flipping, including simplifying ESOP (Employee Stock Ownership Plan) taxation, streamlining tax processes, improving inter-ministerial board certification, and easing capital flow restrictions. It also stressed the importance of collaborating with startups to establish best practices and enhance India's startup incubation and funding ecosystem. By implementing these comprehensive steps, we can advance the vision of Prime Minister Narendra Modi for a robust and thriving Indian economy.
Footnotes
1. https://www.forbesindia.com/article/explainers/unicorns-india-list/85309/1
2. file:///C:/Users/hp/Downloads/Annual%20Report%202023-24.pdf
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