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INTRODUCTION
Special Purpose Vehicles (“SPVs”) as organized in India are distinct legal entities, typically structured as private limited companies under the Companies Act, 2013 (“Companies Act”), though they are occasionally formed as trusts or limited liability partnerships. SPVs are primarily used to isolate financial and operational risks for the sponsors or stakeholders participating in the vehicle. These kinds of structures typically serve as pivotal mechanism in infrastructure development, public-private partnerships (“PPPs”) and asset securitization. In sectors such as highways, metro rails, and smart cities, government bodies often establish SPVs to pool resources from public and private stakeholders while ring-fencing the broader assets of the participants.
In the Indian corporate landscape, businesses typically set up SPVs to execute specific projects. Participating entities, whether investors, governments, or consortium partners, enter into joint venture or shareholders’ agreements that define their roles, contributions, and profit-sharing terms. This structure limits the liability of the SPV to its own assets, thereby ensuring that the parent entities and their assets are not subject to severe exposure. The SPV’s compliance obligations are usually ring-fenced, and their inherent structure allows for operational independence from the parent entities.
The Foreign Exchange Regulatory Framework
Foreign investment into India is primarily governed by the Foreign Exchange Management Act, 1999 (“FEMA“), read with the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules“) and the consolidated Foreign Direct Investment Policy issued by the Department for Promotion of Industry and Internal Trade (“DPIIT“). Foreign direct investment (“FDI“) is permitted either under the automatic route or with prior government approval, depending on the sector. While key sectors like manufacturing and technology enjoy liberalized norms, sensitive areas such as defense and media, require scrutiny and prior approval from the Government of India.
Downstream Investments and Indirect Foreign Investments
As corporate structures grow more complex, the intersection of Special Purpose Vehicles and foreign investment regulations become significant legal issue. Rule 23 of the NDI Rules governs the regulatory framework for downstream investments in India. As per Rule 23(7)(g) read with the Explanation after sub-rule (7) of Rule 23 of the NDI Rules, “downstream investment” means the investment made by an Indian entity which has total foreign investment in it, or an Investment Vehicle, in the capital instruments or the capital, as the case may be, of another Indian entity.
Further, Explanation (i) to Rule 23 of the NDI Rules defines “indirect foreign investment” as a downstream investment received by an Indian entity from another Indian entity which has received foreign investment which is neither owned nor controlled by resident Indian citizens, and is rather owned or controlled by persons resident outside India. Similar conditions apply to downstream investments by investment vehicles whose sponsors or managers are foreign-owned or controlled.
Interplay of Downstream Investment and Control Test
Rule 23 of the NDI Rules introduces the Foreign Owned or Controlled Companies (“FOCCs”) test, to determine whether an Indian company is owned and controlled by any person residing outside India. As per the NDI Rules, an Indian company qualifies as an FOCC when more than 50% of its equity instruments are beneficially held by persons resident outside India, or where such persons resident outside India can exercise control over its management or policy decisions.
Under the NDI Rules, the FOCC test operates through two distinct limbs:
- Corporate/LLP: If an Indian company or Limited Liability Partnership (“LLP”) has received FDI, then, any investment made by such Indian company or LLP will be treated as an indirect foreign investment irrespective of the fact that such Indian company or LLP is not owned and controlled by resident Indians or if it is owned and controlled by non-residents;
- Pooled investment vehicle route: In the case of investment vehicles such as Alternative Investment Funds, Real Estate Investment Trusts, and Infrastructure Investment Trusts, where the sponsor, manager, or investment manager of such investment vehicle is not owned and controlled by resident Indian, or is owned and controlled by persons resident outside India, any downstream investment made by such investment vehicle into an Indian company will be treated as indirect foreign investment.
The distinction between entities that are “owned” and “controlled” by persons resident in India versus those outside India is important to note. As mentioned above, ownership means the beneficial holding of more than fifty percent of the equity instruments in a company. Control, as defined in Rule 2(d) of the NDI Rules (which incorporates the definition in Section 2(27) of the Companies Act, 2013), refers to the right to appoint a majority of the directors or to control the management or policy decisions of the company. Control can be exercised by virtue of shareholding rights, shareholding agreements, or voting agreements.
Notably, the Supreme Court of India, in the case of ArcelorMittal India Private Limited v. Satish Kumar Gupta & Ors (2018), though decided in the context of Section 29A of the Insolvency and Bankruptcy Code, 2016, laid out a test for “control” that has been treated as the authoritative law in the context of FEMA. This test contains both de jure control (the right to appoint a majority of directors) and de facto control (the right to control management or policy decisions). Indian companies that trigger these ownership or control thresholds by non-residents are classified as FOCCs.
Legal Conditions for Downstream Investments
Indian entities that have received indirect foreign investment are required under Rule 23(1) of the NDI Rules to comply with the same entry routes, sectoral caps, pricing guidelines, and other conditions, as applicable to direct foreign investment. This is an integral part of the FEMA philosophy, which states that “what cannot be done directly cannot be done indirectly“. Accordingly, whenever an Indian entity that has received foreign investment acquires equity instruments of another Indian company, the transaction is a downstream investment. Where the investor entity qualifies as an FOCC, that downstream investment gives rise to indirect foreign investment in the investee company.
Downstream investments that are classified as indirect foreign investment must also satisfy specific operational conditions under the NDI Rules. First, as required under Rule 23(2) of the NDI Rules, the downstream investment must be approved by the Board of Directors of the investing entity; and where a Shareholders’ Agreement is in place, such investment must be in accordance with that agreement. Second, when an Indian entity that has received foreign investment makes a downstream investment, it must ensure that the funds used are brought in from abroad or sourced from internal accruals (i.e., profits transferred to reserves and retained earnings after payment of taxes). It is strictly prohibited from using funds borrowed in the domestic market. Additionally, under recent RBI clarifications, such investments may also be structured via equity instrument swaps.
Furthermore, corporate structuring via SPVs is subject to statutory layering restrictions. Indian companies, including foreign-owned subsidiaries, are generally restricted from having more than two layers of subsidiaries under Section 2(87) read with Section 186 of the Companies Act and the Companies (Restriction on Number of Layers) Rules, 2017, subject to specified exemptions. This framework has been introduced to prevent complex multi-layered structures designed to facilitate tax evasion, round-tripping, or the flouting of sectoral caps under the FDI policy.
Under the current calculation methodology, where an investing Indian company is owned or controlled by persons resident outside India, the entire downstream investment it makes is treated as indirect foreign investment in the investee entity, subject to limited exceptions. For example, if an FOCC acquires 50% of the equity of a downstream company, the entire 50% is treated as indirect foreign investment for the purposes of sectoral-cap monitoring and reporting. Conversely, where the investing company has no foreign ownership or control, its downstream investment does not give rise to indirect foreign investment.
Reporting of Downstream Investments through SPVs
The Reserve Bank of India (“RBI“) is responsible for ensuring compliance with reporting timelines, and delays often trigger compounding proceedings. As per the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 (“Reporting Regulations“), an FOCC making a downstream investment must fulfill certain reporting requirements based on the nature of the transaction.
In the case of a primary investment, the FOCC must satisfy two obligations. First, it must notify the Secretariat for Industrial Assistance, DPIIT, within 30 days of making such downstream investment, even if the equity instruments have not yet been allotted. Second, the FOCC must file Form DI with the RBI within 30 days from the date of allotment of such equity instruments.
In the case of a secondary investment, the requirements depend on the residency of the seller. If the FOCC purchases shares from a non-resident, it must file Form FC-TRS within 60 days from the date of transfer of equity instruments or receipt of consideration, whichever is earlier. Additionally, it must file Form DI within 30 days from the date of acquisition of the equity instruments and intimate the DPIIT within 30 days from the date of the investment. If the FOCC purchases shares from a resident, it is required to file Form DI within 30 days from the date of acquisition and make the necessary intimation to the DPIIT within the same 30-day window.
Practitioners frequently rely on a compliance matrix derived from Rule 23(5) of the NDI Rules, the RBI Master Direction on Foreign Investment, and prevailing Authorized Dealer (“AD“) bank practice. This practice applies the “assumed residency principle,” wherein FOCCs are treated as non-residents for pricing purposes but as residents for reporting purposes. The requirements in different scenarios involving an FOCC are outlined below:
- Transfer from FOCC to Indian resident: Where an FOCC transfers its equity instruments to an Indian resident, the pricing guidelines under the NDI Rules will apply. However, no reporting is mandated under the Reporting Regulations;
- Transfer from Indian resident to FOCC: Where an Indian resident transfers its equity instruments to an FOCC, the pricing guidelines under the NDI Rules along with the filing of Form DI and intimation to the DPIIT is required;
- Transfer from FOCC to a person resident outside India: Where an FOCC transfers its equity instruments to a person resident outside India, the pricing guidelines under the NDI Rules will not apply. However, the filing of Form- TRS will be required under the Reporting Regulations;
- Transfer from person resident outside India to a FOCC: Where a person resident outside India transfers its equity instruments to a FOCC, then pricing guidelines under the NDI Rules will apply along with the intimation to the DPIIT and filing of Form FC-TRS and Form DI;
- Transfer from a FOCC to a FOCC: Where a FOCC transfers its equity instruments to another FOCC, then, by application of the principle of “assumed residency”, both the FOCCs will be treated as persons resident outside India and accordingly, the pricing guidelines under the NDI Rules may apply. Further, the NDI Rules and the Reporting Regulations do not expressly mandate reporting for transfers between two FOCCs. However, AD banks often take a conservative approach and may require the filing of Form DI by acquiring FOCC as a matter of prudential practice.
Use of SPVs to Centralize FEMA Compliance
The deployment of SPVs allows foreign investors to centralize and front-load their cross-border funding mechanics at the point when capital is initially injected into the Indian entity. While subsequent downstream investments into other Indian companies continue to be governed by Rule 23 of the NDI Rules, the SPV structure provides operational flexibility. Once the SPV is capitalized, each subsequent downstream investment no longer requires a separate cross-border remittance; the Foreign Owned or Controlled Company (FOCC) can deploy funds already brought into India or utilize its internal accruals (i.e., post-tax profits transferred to reserves) to execute transactions domestically.
However, it is a critical misconception that establishing an Indian SPV eliminates FEMA pricing and compliance friction at the downstream level. Under the assumed residency principle embedded in Rule 23(1) of the NDI Rules, an FOCC is treated on par with a non-resident. Therefore, if an FOCC invests in an Indian startup, that transaction must strictly adhere to FEMA pricing guidelines, requiring the investee company to obtain a valuation report using an internationally accepted pricing methodology (typically certified by a Merchant Banker or Chartered Accountant), just as if a foreign investor were investing directly[1]. The compliance burden rests firmly on the SPV; the first-level FOCC is statutorily responsible for ensuring that its downstream investments comply with entry routes, sectoral caps, and pricing norms, and must obtain an annual statutory auditor certificate confirming this compliance.
Where SPVs truly streamline compliance is in the pooling of investments and the management of sectoral FDI limits. For sectors subject to FDI caps, downstream investments made by an FOCC are treated in their entirety as indirect foreign investment. Rule 23 dictates that this indirect foreign investment must not breach the applicable sectoral ceiling of the target company. Using this method, foreign funds and strategic investors can monitor their aggregate portfolio holdings against these prescribed thresholds, creating greater value creation while avoiding flouting of FDI Norms.
Conclusion
The utility of SPVs in India extends well beyond their traditional role in ring-fencing financial risk. For foreign investors, structuring transactions through an Indian SPV offers a practical pathway to navigate the regulatory maze of FEMA. Rather than engaging in fragmented, deal-by-deal reporting and pricing certifications across multiple downstream entities, investors can centralize compliance obligations at the initial point of entry.
However, this structural efficiency is not a loophole. The NDI Rules are certain: what cannot be done directly cannot be done indirectly. Downstream investments remain strictly tethered to FEMA’s sectoral caps and pricing guidelines. Therefore, while an SPV can insulate a foreign investor from repetitive cross-border administrative burdens, it demands rigorous governance at the board level to avoid triggering compounding proceedings. When structured correctly, an SPV balances commercial flexibility with strict regulatory adherence and provides a stable and compliant foundation for deploying foreign capital in India.
[1] Under Section 247 of the Companies Act, 2013, the valuation of shares must be conducted by a valuer registered with the Insolvency and Bankruptcy Board of India (IBBI). Similarly, Rule 21 of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 mandates that for unlisted Indian companies, the valuation must be determined via an internationally accepted pricing methodology for valuation on an arm’s length basis, duly certified by a Chartered Accountant, a practicing Cost Accountant, or a Merchant Banker registered with the Securities and Exchange Board of India (SEBI).
Authored by Mr. Jyoti K Chowdhury, Senior Partner and Mr. Shubham Tripathi, Principal Associate