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Kartik Mehta and Jatin Yadav*
I. INTRODUCTION
PineLabs, a major fintech company, recently started the process of ‘internalization’ or ‘reverse-flipping’ through which it aims to re-domicile itself as an Indian company. This comes amidst the ongoing trend wherein many major companies such as PhonePe, Groww, and Pepperfry have announced their plans to shift operations back to India. India's startup ecosystem has emerged as a formidable engine of innovation and economic growth, increasingly compelling companies to reconsider their international operational strategies and return to their domestic roots. The previously prevalent practice of “flipping,” wherein Indian companies transferred their ownership and operations to foreign jurisdictions to capitalize on benefits such as access to global investment pools, favorable regulatory frameworks, and enhanced market valuations, is now witnessing a strategic reversal. This phenomenon, referred to as "reverse flipping" or "internalization," involves the repatriation of legal headquarters and ownership back to India. This shift is reflective of India's evolving economic landscape, characterized by improved regulatory conditions, a burgeoning domestic market, and the promise of higher valuations within the national context. Additionally, other significant players, including Razorpay, PineLabs, Meesho, UrbanLadder, Livspace, and Zepto, are in various stages of reestablishing their legal and operational bases in India. This article seeks to critically analyze the drivers behind the increasing trend of reverse flipping and to evaluate its broader implications for the Indian startup ecosystem. Through a thorough examination of the strategic motivations and outcomes associated with this process, the paper aims to elucidate the shifting dynamics of global business ownership and the renewed positioning of India as a central hub for entrepreneurial activity and value creation.
II. UNDERSTANDING THE HOMECOMING: 'FROM FLIPPING' TO 'REVERSE FLIPPING'
In recent years, numerous Indian companies have relocated their ownership structures abroad, driven by various strategic factors. These include but are not limited to the pursuit of overseas listings, access to global capital markets, the benefit of more robust intellectual property (IP) protections, the ability to attract talent in foreign jurisdictions, and the tax advantages provided by these offshore locations. However, the process of externalization has presented its own set of challenges. Companies have encountered rising operational costs and the potential risk of their foreign entities being classified as managed and controlled from India, leading to significant tax consequences. Additionally, in a rapidly changing global environment where international capital markets have become less appealing, there has been a growing interest in listing within India. The complexities of managing an externalized structure have also led to tax disputes. Moreover, the implementation of multilateral agreements and amendments to double taxation treaties have introduced further tax complications for these offshore structures. In response to these challenges, the Indian government has introduced various measures to encourage companies to repatriate their ownership structures back to India. These initiatives include tax incentives in GIFT City and proposals to create a more investor-friendly tax environment, such as the proposed exemption from angel tax for certain non-resident investors and startups.
Industrial experts cite the potential of the Indian market to offer high valuation to the concerned companies and the improved ease of doing business as the main reasons behind this emerging trend. Experts score that while the jurisdictions such as USA and Singapore help in terms of scaling business operations, Indian markets seem to poise more beneficial gains to the business giants.
A. The Reasons Behind the Rise in 'Return to Home'
The Economic Survey 2022-23 highlights a favorable environment for the rising trend of internalization among Indian companies, driven by a series of government initiatives, reforms, and schemes aimed at supporting startups. This supportive ecosystem, combined with increase in access to capital through venture capital and private equity, the maturing Indian markets, and recent regulatory changes regarding round-tripping, has created strong incentives for companies to bring their operations back to India. Key government programs, such as “The National Initiative for Developing and Harnessing Innovations (NIDHI)”, “The Fund of Funds for Startups (FFS)”, and “The Atal Innovation Mission (AIM)”, are instrumental in promoting the development of indigenous products and providing early-stage financial support to startups. Specifically, through NIDHI, the government has managed to support more than 12,000 startups and generate more than 130,000 jobs. These reforms have not only simplified the ease of doing business in India but have also renewed foreign institutional investors' confidence in the country’s economic prospects. A crucial driver behind this trend is the shifting perspective of founders and management teams, who increasingly recognize the capacity of Indian Market for value creation. This includes increased investment interest, stronger brand relationships, and a growing customer base, all of which enhance the appeal of a near-term exit through an initial public offering (IPO). One such company is Zepto, which is eyeing to get the benefit of Indian Stock Market’s bullish phase and widening investor base.
Companies are being compelled to revisit and re-strategize their business models to prioritize organic growth and customer focus. For businesses whose core value lies within India, returning operations to the country can offer significant advantages, including operational efficiency and positive market perception. Internalization also reduces administrative and managerial complexities by confining operations to a single jurisdiction.
B. Procedure and Compliances: Structuring the Flip
A critical component of the internalization process is identifying a suitable structure that aligns with the regulatory, legal and tax frameworks of the relevant jurisdictions. The two approaches that are mainly employed are:
1. Inbound Merger: Wherein a foreign entity merges into an Indian entity. In this structure, the assets and operations of the foreign entity are ultimately controlled by the Indian entity, and the shareholders of the foreign entity receive shares in the Indian entity as consideration. This method is often considered the simplest form of internalization. Groww followed this particular approach. In such transactions, shareholders can claim exemption from capital gain tax if the transaction qualifies as ‘amalgamation’.
2. Share Swap: A share swap arrangement can be employed, where shareholders of the foreign entity exchange their shares in the foreign entity for shares in the Indian entity. This approach offers another viable option for internalization, catering to specific strategic or financial objectives. PhonePe employed this method for their reverse flipping. In cases of reverse flipping through share swaps, capital gains tax is levied on the difference between the value of the Indian entity’s shares at the time of the reverse flip and the acquisition cost of the foreign entity's shares. However, the determination of acquisition costs and the valuation of the Indian entity are often points of contention between businesses and tax authorities. The Vodafone case serves as a crucial example of the significant legal and financial risks businesses face while navigating India’s tax regime, especially in the context of cross-border transactions.
C. Regulatory Compliance
The whole process of ‘reverse flip’ requires regulatory compliance with various Indian Laws. The tax and regulatory considerations for ‘reverse flipping’ thorough inbound merger and share swap has been discussed below:
1. Inbound Merger:
To initiate an inbound merger, one is required to obtain RBI approval and a valuation report from a registered valuer which has to be in accordance with internationally recognized principles of valuation[1]. Thereafter, the concerned company shall approach the National Company Law Tribunal to file an application for approval. Such approval is subject to meeting of creditors and members of the concerned company and any intervention by statutory bodies.
Furthermore, one must also look out for compliance with the relevant provisions under The Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (‘Merger Regulations’) and Foreign Exchange Management (Non-debt Instruments) Rules, 2019. When the Indian entity, assumes the outstanding guarantees and borrowings of foreign merged company from overseas sources, such liabilities must comply with the External Commercial Borrowing (ECB) norms and the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018, within two years of the transfer, excluding end-use restrictions.
2. Share Swap:
In case of a Share swap, the Indian company needs to adhere to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, The Foreign Exchange Management (Overseas Investment) Rules, 2022, Income Tax Act and rules and regulation framed therein, among many other considerations such as DPIIT’s Press Note 3.
D. The Tax Implications
If a reverse flip is executed through an inbound merger, shareholders of the foreign amalgamating entity could claim capital gains tax exemptions, but only if the transaction meets the specific conditions for an ‘amalgamation’ under the Indian Income Tax Act, 1961 (IT Act). This caveat is crucial, as the IT Act broadly defines "transfer" to include not only the sale but also the extinguishment or relinquishment of capital assets, signaling the complexity of navigating India’s tax regime. In cases where a cross-border merger fails to meet the exemption criteria under the IT Act, the cancellation of the foreign entity’s shares becomes a taxable event, which could significantly increase the tax burden on the foreign entity. This tax exposure raises concerns about whether the benefits of internalization truly outweigh the costs for investors.
Moreover, a reverse flip structured through a share swap brings its own set of challenges. Foreign shareholders will face taxation in India on the difference between the value of the Indian entity’s shares at the time of the flip and the original acquisition cost of their foreign shares. This tax obligation, as seen in the case of PhonePe, where capital gains taxes amounted to nearly INR 8,000 crores, demonstrates the heavy financial toll that shareholders may bear. Consequently, investors are likely to push for robust exit provisions, such as a quick IPO, to recoup their investments, amplifying the pressure on the Indian entity’s near-term performance. This focus on short-term exit strategies may, however, compromise the company’s ability to take a long-term strategic view, potentially affecting its growth trajectory and market positioning.
The IT Act’s indirect transfer tax provisions also introduce another layer of complexity. Income from the transfer of shares in a foreign entity is taxable in India if the value of those shares is substantially derived from Indian assets. This provision applies even in cases of share swaps, adding further tax risk for foreign shareholders, which could deter some investors from supporting the reverse flip process. These regulatory intricacies raise the question of whether India’s current tax framework is adequately structured to accommodate the growing trend of reverse flipping without disproportionately penalizing foreign investors. From a broader perspective, the tax challenges faced by foreign shareholders underscore deeper concerns about India's tax regime. While India has made progress in signing Double Taxation Avoidance Agreements (DTAAs) with several countries, these treaties may not always protect foreign investors from the full brunt of India's tax laws. For instance, the expiration of favorable capital gains tax treatment for Singaporean investors in Indian entities after April 1, 2017, highlights the limitations of DTAAs in providing long-term tax certainty. Such unpredictability can erode investor confidence, making India a less attractive jurisdiction for reverse flips.
Finally, there is the issue of accumulated losses, which may be rendered unusable post-flip if shareholding thresholds are breached. This could undermine the financial health of the Indian entity at a time when it most needs stability to manage the complexities of internalization and maintain investor confidence. Overall, the tax and regulatory hurdles that come with reverse flipping not only complicate the decision-making process for companies and investors but also call for more streamlined and predictable tax reforms to better align India’s policy framework with its aspirations of becoming a global startup hub.
E. Other Key Sectorial Considerations
In addition to adhering to DPIIT’s Press Note 3, various other regulatory and sectorial approvals may be necessary, depending on the industry of the entity. For example, if the internalized entity operates in a sector that requires prior approval under the Consolidated Foreign Direct Investment (FDI) Policy of India[2], approvals from the Government of India or the Reserve Bank of India (RBI) may be needed. Furthermore, the nature of the business and the licenses held by the entities involved might trigger additional approvals.[3] For instance, the RBI requires prior approval for any "change in control" involving non-banking financial companies[4] and housing finance companies.[5] Since the reverse flip involves dissolving the foreign entity and integrating its shareholders into the Indian entity, this results in a change in control, ownership, shareholding, and potentially management, necessitating all relevant approvals related to these changes. Similarly, payment aggregators must inform the RBI of any changes in control or management, and the RBI may impose restrictions based on its review[6].
It is also important to assess whether the Competition Commission of India (CCI) needs to be notified or grant approval for the transaction. This assessment involves determining if the internalization results in an acquisition of control and reviewing the deal value, asset size, and turnover of the involved entities. Depending on the final structure, a notification under the Competition Act, 2002, may be required to be submitted to the CCI by both the entities and the foreign investors[7].
Therefore, a thorough evaluation of all regulatory and sectorial approvals required in India, as well as in the foreign entity’s host country, is essential for effectively planning the internalization process and managing associated timelines.
III. HURDLES AND THE RECENT AMENDMENT
The hurdles that a company faces while reverse flipping are majorly the regulatory ones. As detailed above, a company needs to comply with a plethora of rules and regulations in order to ensure proper internalization. One significant challenge is the complexity of India's tax regulations, particularly concerning the repatriation of assets and the potential for dual taxation. Companies moving back to India must navigate intricate processes related to capital gains, transfer pricing, and compliance with the Goods and Services Tax (GST). Moreover, while the government has introduced tax incentives, such as those in GIFT City, further reforms are needed to address concerns around corporate governance, regulatory approvals, and cross-border merger regulations. Further compounding these challenges are the commercial complexities tied to shareholder agreements and stock options. Reverse flipping often necessitates amending shareholder agreements and reissuing stock options to employees, which can trigger dissatisfaction among employees. The cancellation of foreign stock options and their replacement with new options that comply with Indian laws could lead to feelings of disenfranchisement, particularly if the Indian stock options are perceived as less favorable. This poses a risk to employee retention, especially in a startup ecosystem where talent is a key driver of success. Companies must, therefore, manage these transitions strategically to avoid attrition and maintain workforce stability. Compliance with these various laws and regulations can be highly time-consuming. That is why the government has recently introduced a amendment in Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 to make the homecoming of IPO-bound startups more time efficient. The amendment waives off the requirement of securing NCLT approval, which would approximately reduce the time for the whole process by more than half.
IV. CONCLUSION
As this paper illustrates, the motivations driving this trend are multifaceted. On one hand, companies are compelled by the burgeoning opportunities in India's growing economy, enhanced regulatory frameworks, and a more favorable investment climate. On the other hand, the rising operational costs, tax implications, and complexities of maintaining foreign ownership structures have diminished the appeal of offshore domiciliation. Key government initiatives, such as tax incentives, reforms in GIFT City, and the introduction of programs aimed at fostering startup growth, have further bolstered India’s attractiveness as a business hub. Companies like PhonePe, Groww, and Pine Labs are examples of how internalization not only aligns with these policy shifts but also enables them to tap into higher valuations, improved operational efficiency, and stronger domestic brand loyalty. This trend towards internalization is expected to yield significant economic benefits for India, including the creation of new job opportunities. However, the complexity inherent in managing operations and shareholders across multiple jurisdictions demands a meticulous assessment of various interrelated factors. such as the tax implication which can, and which have been a point of confrontation between the corporations and the government in the past. It is essential to assess and align these considerations comprehensively to ensure that the benefits of internalization outweigh the challenges and complexities involved.
[1] “Section 234 of the Companies Act, 2013”.
[2] Government of India, ‘Consolidated FDI Policy’ <https://dpiit.gov.in/sites/default/files/FDI-PolicyCircular-2020-29October2020_0.pdf.> accessed 23 August 2024.
[4]Direction 3, Non-Banking Financial Companies (Approval of Acquisition or Transfer of Control) Directions, 2015.
[5] Direction 45, Non-Banking Financial Company – Housing Finance Company (Reserve Bank) Directions, 2021.
[6] Guideline 5.2, Guidelines on Regulation of Payment Aggregators and Payment Gateways, Reserve Bank of India”.
[7] Section 6(2), Competition Act, 2002.
*Kartik Mehta and Jatin Yadav are fourth-year B.A.LL.B. (Hons.) students at Hidayatullah National Law University, Raipur.
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