Round Tripping under FEMA: What is Permitted, Risks, Compliance

Round tripping under FEMA is not illegal. That statement, repeated across every legal commentary on the subject, is accurate but incomplete. What it omits is that a round-trip structure that passes the FEMA two-layer test and the beneficial ownership screen under Press Note 2 of 2026 can still attract income tax scrutiny under the Place of Effective Management (POEM) rules, transfer pricing enforcement on intercompany flows, and Enforcement Directorate proceedings under the Prevention of Money Laundering Act, 2002 (PMLA) if the structure lacks commercial substance. The FEMA clearance is the entry gate. The income tax and PMLA risks run the length of the corridor.

Is round tripping under FEMA legal in India?

Round tripping (where an Indian resident invests in a foreign entity that then invests back into India) is not prohibited under FEMA, 1999 as a standalone offence. Rule 19(3) of the Foreign Exchange Management (Overseas Investment) Rules, 2022 expressly permits such structures, provided the resulting chain does not produce more than two layers of subsidiaries. From 02 May 2026, any inbound leg of the round-trip must also satisfy the PMLA-aligned beneficial ownership test under the FEMA (NDI) Amendment Rules, 2026, requiring government approval if the beneficial owner holds 10% or more in a land-border country entity within the structure. Passing these FEMA tests does not eliminate income tax or PMLA exposure, which are independent regulatory tracks that apply to the same structures.

The regulatory baseline: FEMA does not define round tripping

Section 6 of the Foreign Exchange Management Act, 1999 gives the Reserve Bank of India (RBI) power to regulate capital account transactions. That authority is exercised through subordinate legislation, primarily the Foreign Exchange Management (Overseas Investment) Rules, 2022 and the Foreign Exchange Management (Non-debt Instruments) Rules, 2019. Neither the statute nor any of its rules defines “round tripping” as a category of prohibited transaction.

What existed before 2022 was a FAQ-based prohibition under FEMA 120, which said in broad terms that Indian entities could not invest in foreign entities that had already invested into India. The language was intent-driven, poorly bounded, and gave authorised dealer (AD) banks wide discretion, which they often exercised by refusing to process structures that looked circular regardless of commercial substance.

The Foreign Exchange Management (Overseas Investment) Rules, 2022 replaced that framework. They did not introduce a blanket ban. They introduced a structural limit: two layers. That is the boundary the law now enforces. The 2021 draft rules had included an express bar on round-tripping designed for tax avoidance. The Ministry of Finance dropped that language in the final 2022 text, making the rule structural and quantitative rather than intent-based.

What Rule 19(3) of the OI Rules, 2022 permits and restricts

Rule 19(3) of the Foreign Exchange Management (Overseas Investment) Rules, 2022 reads:

“No person resident in India shall make financial commitment in a foreign entity that has invested or invests into India, at the time of making such financial commitment or at any time thereafter, resulting in a structure with more than two layers of subsidiaries.”

If the structure stays within two layers, the financial commitment is permitted on the automatic route without requiring specific RBI approval. The proviso preserves an approval path for structures that would otherwise exceed the limit.

Table 1: Permitted vs restricted round-trip structures under Rule 19(3)

Structure	Foreign layers above Indian Sub	Rule 19(3) outcome
Indian Co > Foreign Holdco > Indian Sub receives FDI	1 (Foreign Holdco)	Permitted, automatic route
Indian individual > Foreign Co > Indian Co receives FDI	1 (Foreign Co)	Permitted, automatic route
Indian Co > Foreign Holdco > Foreign Sub > Indian Sub receives FDI	2 (Holdco + Sub)	Prohibited; RBI approval needed
Indian Co > Foreign Holdco > Foreign JV (50:50) > Indian Sub	Depends on control	Scrutinised; control-based analysis required

The layer count runs from the Indian resident downward through each foreign entity in the chain. The Indian entity receiving the inbound FDI at the end of the chain is the terminal point and is not counted as a layer for Rule 19(3) purposes. Foreign Holdco is Layer 1; a foreign subsidiary of that holdco is Layer 2. Adding an Indian subsidiary below that foreign subsidiary is what the rule prohibits.

A structure used widely from 2011 onward (Indian founders incorporate a Singapore or Delaware holdco; the holdco becomes parent of the Indian entity; then receives external capital and routes it into India as FDI) sits within one foreign layer and is permitted under the 2022 framework. What is not permitted is adding a Cayman fund layer above Singapore, with Singapore then investing into India, because that produces two foreign layers before the Indian entity.

How the two-layer limit is counted: where the ambiguity sits

The rule is structural but produces three genuine uncertainties at the margins.

Uncertainty 1: JVs versus subsidiaries

Rule 19(3) speaks of “more than two layers of subsidiaries.” Whether a foreign entity in which the Indian investor holds a minority stake, without control rights, constitutes a “subsidiary” for layer-counting purposes is not definitively answered in the OI Rules or the RBI Master Directions. The working position among practitioners is that control-based arrangements trigger layer counting; passive minority investments without board representation or veto rights are outside the rule’s scope. This requires case-specific legal review. Do not assume a minority stake is outside Rule 19(3) without verifying the control analysis.

Uncertainty 2: Divergence between Companies Act and FEMA layer counting

The Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 exempt wholly owned subsidiaries and entities required by applicable foreign law from layer counting. No equivalent exemption exists in the FEMA OI Rules. A structure that is two layers under the Companies Act framework may still be three layers under Rule 19(3). These are parallel rule-sets under different statutes, and the FEMA position governs for ODI compliance.

Uncertainty 3: Post-investment structural evolution

Rule 19(3) applies “at the time of making such financial commitment or at any time thereafter.” A structure that was within two layers when the ODI was made can breach the rule if the foreign entity later incorporates a step-down subsidiary that invests into India. Annual Performance Reports (APRs), due 31 December each year, should include a layer-count review for each overseas entity chain as part of standard compliance.

How the three FEMA NDI amendments of 2026 changed the beneficial ownership test

The beneficial ownership framework for inbound FDI underwent its most significant reform in three stages between March and June 2026.

Stage 1: Press Note 2 of 2026 (15 March 2026)

The Department for Promotion of Industry and Internal Trade (DPIIT) issued Press Note 2 of 2026, replacing the blunt geographic restriction of Press Note 3 of 2020. The old framework required government approval for any investment from a land-border country (LBC), regardless of stake size. The new framework shifted the test from country of registration to beneficial ownership and control.

Stage 2: FEMA (NDI) (First Amendment) Rules, 2026 (02 May 2026, S.O. 2174(E))

The Ministry of Finance codified PN2 into FEMA law by substituting Rule 6(a) of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019. For the first time, the definition of “beneficial owner” was formally enshrined in the primary FEMA instrument, cross-referenced to Section 2(1)(fa) of the Prevention of Money Laundering Act, 2002 and Rule 9(3) of the Prevention of Money Laundering (Maintenance of Records) Rules, 2005.

Under Rule 9(3) of the PML (Maintenance of Records) Rules, 2005, a natural person is a beneficial owner of a company if they hold more than 10% of shares, capital, or profits, or have the ability to exercise control through other means.

Stage 3: FEMA (NDI) (Third Amendment) Rules, 2026 (12 June 2026, S.O. 3030(E))

The Third Amendment extended the LBC framework into portfolio investment routes, introduced harmonised BO determination across different foreign investment vehicles, replaced references to “NRI or OCI” with “individual” in Rule 9 to widen the eligible investor base, and added prior government approval requirements in Rules 12 and 13 where investment or transfer results in ownership or beneficial ownership by an LBC citizen or entity in listed Indian companies.

Table 2: Beneficial ownership threshold and FDI route under PN2 and the 2026 NDI Amendments

LBC beneficial ownership in the foreign investor entity	Applicable FDI route
Below 10%, no control rights over investor or Indian entity	Automatic route
At or above 10%, no control over investor or Indian entity	Government route required
Any LBC beneficial ownership with control over Indian entity	Government route required
Direct investment by LBC citizen or entity	Government route required
Pakistan or Afghanistan-linked investment, sensitive sectors	Restricted regardless of route

Land-border countries (LBCs) are China, Pakistan, Bangladesh, Nepal, Bhutan, Myanmar, and Afghanistan.

What the beneficial ownership test means for round-trip structures

The FEMA structural test (Rule 19(3)) and the beneficial ownership test (PN2 + NDI Amendments) are independent inquiries. Both must be satisfied for a round-trip structure to proceed on the automatic route.

The practical consequence is that an Indian founder who has flipped their company into a Singapore or Delaware holdco, and whose foreign entity then invests back into India as FDI, must trace the beneficial ownership of that foreign entity back to any LBC national before filing each FC-GPR.

Common scenarios:

Scenario 1: Singapore fund with Chinese LP. A Singapore-registered fund has a Chinese limited partner holding 13% of the fund’s capital. The fund invests into a Delaware holdco, which then invests into an Indian company. Because the Chinese LP holds more than 10% of the fund, the entire investment chain into India requires government route approval. The structure is within two layers (Rule 19(3) compliant) but fails the PN2 BO test without prior approval. Post-02 May 2026, the Indian investee company faces FEMA contravention risk if it accepted the FDI on the automatic route.

Scenario 2: Delaware holdco with Chinese co-founder. An Indian company flips to a Delaware C-Corp. One co-founder is a Chinese national holding 15% of the Delaware entity. The Delaware entity then invests into the Indian subsidiary as FDI. Government route approval is required. The Indian investee company, not just the foreign investor, bears FEMA contravention risk if the BO analysis was not done before the transaction.

Scenario 3: Clean structure from US fund. A Singapore entity funded entirely by a US VC firm (no LBC beneficial owners above 10%) invests into an Indian company. This remains on the automatic route. No change from the pre-PN2 position, but the Indian company must now document the BO analysis and maintain LP composition certificates from the investor on file.

The obligation to conduct the BO analysis sits with the Indian investee company, not the foreign investor. A fund’s side letter representation or a “PN3 compliance” certificate is insufficient. Post-PN2, every FC-GPR filing should be supported by a three-limb BO test record: (a) no LBC natural person holds 10% or more of the investing entity, (b) no LBC natural person can exercise control over the investor through other means, and (c) no LBC natural person holds ultimate effective control over the Indian company in any manner.

What income tax risks apply to a FEMA-compliant round-trip structure?

Passing the FEMA tests does not close the income tax file. Round-trip structures face scrutiny from the Central Board of Direct Taxes (CBDT) and the Income Tax department on three independent grounds, each of which can apply even where the structure is fully FEMA-compliant.

POEM: when the foreign holdco becomes an Indian tax resident

The Place of Effective Management (POEM) test under Section 6(3) of the Income Tax Act, 1961, now reorganised under the Income Tax Act, 2025, determines the tax residency of a foreign company. A foreign company is treated as Indian tax-resident for a financial year if its POEM is in India during that year, meaning the key management and commercial decisions necessary for the conduct of the business as a whole are, in substance, made from India.

For a round-trip structure, the POEM risk is direct: if the Delaware C-Corp or Singapore Pte Ltd that functions as the foreign holdco is actually managed by India-based founders, with all key decisions made from Indian offices, the holdco becomes an Indian tax resident. An Indian tax-resident company is taxed on its worldwide income, not just India-sourced income.

The CBDT’s POEM guidelines (Circular No. 6/2017) use the Active Business Outside India (ABOI) test as a first filter. A company satisfies ABOI if less than 50% of its total employees are resident in India, less than 50% of its total assets are situated in India, less than 50% of its total income is paid or payable to Indian residents, and less than 50% of its board members are Indian residents. A single-purpose holdco that has no genuine employees, income, or assets outside India typically fails this test on multiple counts.

For founders who structured a flip between 2019 and 2022, and who have since run their entire business from India with a nominee director in Singapore, POEM is not a theoretical risk. Tax authorities in 2026 are sharper at identifying single-purpose holdcos without substance, and the consequences of a POEM finding (worldwide income taxed in India, plus penalties for prior years) are material.

What genuine substance looks like in practice

RBI and CBDT both apply a substance-over-form test. For a foreign holdco in a round-trip structure to withstand both tests, it should have: independent directors who actively participate in board decisions and are physically present in the foreign jurisdiction for meetings; a local bank account through which treasury functions are genuinely exercised; at least one full-time employee or contracted resource in the jurisdiction; third-party revenue or investment relationships independent of the Indian entity; and board minutes that document substantive deliberation, not rubber-stamping of India-side decisions.

Transfer pricing: intercompany transactions between the Indian entity and the foreign holdco

Once the round-trip structure is in place, every transaction between the Indian operating entity and the foreign holdco is an international transaction subject to arm’s-length pricing under Chapter 10 of the Income Tax Act, 2025 (previously Sections 92 to 92F of the Income Tax Act, 1961).

The transactions that attract Transfer Pricing Officer scrutiny include: management fees charged by the holdco to the Indian entity; royalties or brand fees for use of IP held by the holdco; intercompany loans at above-market or below-market interest rates; cost-sharing arrangements; and intragroup service fees for technology, HR, or legal support.

If the Indian entity pays a management fee to its Singapore holdco at 10% of revenue, and comparable independent transactions price such services at 3-5%, the Transfer Pricing Officer will adjust the deduction downward to the arm’s-length rate and add back the difference to the Indian entity’s taxable income. The adjustment also affects FEMA: if the actual payment was above ALP, the excess remittance abroad may be a FEMA contravention as an outward remittance without adequate consideration.

The Income Tax Act, 2025 expanded the associated enterprise definition and broadened the scope of international transactions. Structures that were outside transfer pricing applicability under Sections 92A of the 1961 Act may now be inside the expanded framework under the 2025 Act. Groups with pre-2025 intercompany arrangements should revisit their pricing policies.

TDS on intercompany flows: equity infusion versus interest payments

When the foreign holdco routes money into the Indian entity as equity (FDI), there is no TDS. When the same money is routed as an intercompany loan, and the Indian entity pays interest to the holdco, Section 195 of the Income Tax Act, 2025 (TDS on payments to non-residents) triggers. The applicable TDS rate depends on whether a Double Taxation Avoidance Agreement (DTAA) applies between India and the holdco’s jurisdiction.

Under the India-Singapore DTAA, interest is taxable at 15% unless the Singapore entity satisfies the Principal Purposes Test (PPT), which requires the arrangement not to have tax avoidance as a principal purpose. A round-trip structure where funds cycle from India to Singapore and back to India as a loan, with the Indian entity paying 10% interest to the Singapore holdco, faces a direct PPT challenge: the Singapore entity’s primary purpose may be characterised as obtaining a DTAA benefit rather than conducting a genuine business.

The choice between equity infusion (FDI) and intercompany lending in a round-trip structure is not just a financial preference. It determines TDS liability, transfer pricing exposure, and DTAA treaty risk. These need to be assessed together before the transaction structure is finalised.

What separates a FEMA compounding proceeding from an ED investigation?

Not all FEMA violations involving round-trip structures are treated equally. There is a meaningful gradient between a compounding proceeding before the RBI and an Enforcement Directorate (ED) investigation under the PMLA.

Compounding under Section 15 of FEMA

The RBI’s compounding mechanism under Section 15 of FEMA allows a person who has committed a contravention under Section 13 to approach the RBI voluntarily, acknowledge the violation, and pay a compounding amount. This closes the matter. The compounding authority’s rank within the RBI corresponds to the quantum involved: contraventions above ₹100 lakhs require Chief General Manager or Executive Director level approval.

Compounding is available for inadvertent, technical, or non-wilful violations: delayed Form FC filing, missed APRs, a round-trip structure that exceeds two layers because a step-down subsidiary was added without prior review, or FDI received on the automatic route where government approval was technically required but the BO analysis was not done. RBI investigations in FY 2025-26 reached 4,308 cases. The April 2025 amendments (Master Direction FED No. 04/2025-26) capped compounding amounts at ₹2 lakh for specified technical non-reporting violations, but that cap does not apply to substantive route violations (receiving FDI without government approval where it was required) or to violations involving quantifiable amounts where the 3x penalty formula applies.

ED referral and PMLA proceedings

The ED’s FEMA enforcement powers and its PMLA powers are legally distinct but operationally connected. A FEMA contravention that is serious, structured, or involves concealment of ownership (rather than inadvertent non-filing) is referred from RBI to the ED. Section 37A of FEMA additionally empowers the ED to attach assets (Indian and overseas) where the aggregate value of foreign exchange, foreign security, or immovable property outside India exceeds ₹1 crore.

A PMLA investigation requires a “predicate offence,” which is a criminal case for an offence listed in the PMLA Schedule. Fraud, cheating, and criminal breach of trust under the Bharatiya Nyaya Sanhita are scheduled offences. A round-trip structure that was set up to disguise the true origin of funds, avoid sectoral FDI caps, or artificially inflate valuation involves elements that can constitute predicate offences under the Schedule. The PMLA consequence is not a monetary compounding: it is asset freezing, prosecution before a Special Court, and, on conviction, up to seven years imprisonment.

What determines which track applies

Four factors distinguish compounding territory from ED territory: commercial substance (does the foreign entity have genuine operations, employees, and third-party relationships?), documentation (was the structure disclosed to the AD bank and reported correctly, or was it actively concealed?), intent (did the violation result from a structuring decision made without legal advice, or from a deliberate scheme?), and quantum (is the undisclosed foreign exchange or property above ₹1 crore?). A founder who structured a two-layer flip, forgot to file APRs for two years, and voluntarily disclosed when discovered is in compounding territory. A founder who set up a chain of offshore entities to disguise Chinese promoter investment, received FDI on the automatic route, and failed to disclose the beneficial ownership chain is in ED territory.

The FDI-ODI swap route: a clean alternative for circular structuring

The 2024 Union Budget introduced an amendment to the FEMA (Non-debt Instruments) Rules, 2019 permitting FDI-ODI swaps. This allows an Indian company to acquire shares in a foreign entity by issuing its own equity shares to the foreign company, rather than remitting cash abroad. The Indian company becomes the new holding company of the foreign entity without a cash outflow.

For round-trip planning, this is directly relevant. A founder who wants the Indian entity to hold the foreign operating entity (rather than the other way around) can use the swap route to restructure an existing inverted holdco structure without triggering a cash remittance under ODI. The FDI leg (foreign company receiving Indian shares) and the ODI leg (Indian company acquiring foreign shares) are treated as simultaneous. Both legs require separate FEMA reporting, and both must be valued at fair market value under RBI’s prescribed methodology.

Related reading: Treelife’s FDI-ODI Swap guide walks through the mechanics of swap transactions and when they are commercially appropriate.

Reverse flipping: when it makes sense to unwind

Reverse flipping (restructuring from a foreign holdco back to an Indian parent company) is the operational opposite of a round-trip structure. Several Indian-origin companies completed reverse flips back to India between 2022 and 2024, driven by India’s maturing IPO market, the regulatory friction of maintaining overseas holding structures, and the POEM and transfer pricing compliance burden of running a substance-lite Singapore or Cayman holdco.

The FEMA mechanism for a reverse flip is governed by Rule 25A(5) of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, which streamlines cross-border mergers. The foreign holdco merges into the Indian entity, shareholders of the foreign holdco receive Indian shares, and the Indian entity becomes the surviving entity.

For a founder running a round-trip structure, reverse flipping makes sense when: the foreign holdco has no genuine substance outside India, creating ongoing POEM and transfer pricing risk; the group’s target exit market is an Indian exchange rather than a US or Singapore listing; the regulatory cost of maintaining FEMA ODI compliance (annual APRs, FLA returns, AD bank oversight) exceeds the benefit; and the investment jurisdiction (Cayman, BVI) no longer offers treaty protection after post-BEPS treaty renegotiations.

A reverse flip is itself a FEMA transaction (the Indian entity receives shares from foreign shareholders in exchange for its own shares, which is inbound FDI) and must be reported under FC-GPR. Capital gains tax in the hands of foreign shareholders is determined at fair market value under the Income Tax Act, 2025.

Common mistakes that create FEMA exposure in round-trip structures

Mistake 1: Not re-testing Rule 19(3) after the foreign entity adds a step-down subsidiary

Rule 19(3) applies “at any time thereafter.” Many founders test the structure at setup and never review it again. When the Singapore holdco acquires a UK sales entity in year three, the structure may suddenly have two foreign layers above an Indian investing entity, breaching Rule 19(3). APR filings should include an annual layer-count review.

Mistake 2: Treating PN2 as a one-time check at investment close

The beneficial ownership of a fund changes as LPs buy and sell secondary units. A Chinese LP that held 8% at time of investment may later cross 10% through secondary acquisition. There is no automatic FEMA notification mechanism for this. The Indian company must build contractual protections (BO representation and warranty in the investment agreement, plus notification obligations on the investor if LBC beneficial ownership changes) and verify at each subsequent funding round.

Mistake 3: Failing to cross-check ODI disclosures with FC-GPR filings

The outbound ODI (Form FC with the AD bank) and the inbound FDI (Form FC-GPR on the FIRMS portal within 30 days of allotment) are filed by different parties but must be consistent. Where a promoter holds 20% of the foreign holdco and 60% of the Indian entity, both filings need to reflect this. Mismatch is a common ED trigger in group restructuring.

Mistake 4: Using a nominee director to satisfy substance requirements

A nominee director who rubber-stamps decisions made in India does not create substance for POEM or RBI purposes. CBDT Circular No. 6/2017 requires that board meetings be held outside India with substantive deliberation by directors physically present in the foreign jurisdiction. A nominee signing resolutions by email from an Indian address does not satisfy this. Neither does a single meeting per year in Singapore if all operational decisions are made in India throughout the year.

Mistake 5: Assuming compounding covers any round-trip violation

The ₹2 lakh compounding cap (April 2025 amendments, FED Master Direction No. 04/2025-26) applies only to specified technical and non-reporting violations. Receiving FDI on the automatic route when government approval was required, or creating a structure that exceeds two layers without prior RBI approval, involves a quantifiable contravention. The compounding formula runs on the full amount involved, with a potential maximum of three times the contravention amount.

Mistake 6: Not maintaining intercompany pricing documentation before the financial year end

Transfer Pricing documentation (Local File and Master File under Chapter 10 of the Income Tax Act, 2025) must be contemporaneous, meaning it must exist before the financial year in which the international transactions took place ends. Many founders prepare this retrospectively at the time of assessment. The Income Tax Act, 2025 introduced stricter documentation requirements, and the Transfer Pricing Officer can reject retrospective documentation prepared after the fact.

FAQs

Q: Is round tripping under FEMA legal in India?
A: It is not defined or categorically prohibited under FEMA, 1999 or the OI Rules, 2022. Rule 19(3) expressly permits round-trip structures that stay within two layers of foreign subsidiaries above the Indian entity. Beyond two foreign layers, prior RBI approval is needed.

Q: What does the two-layer rule under Rule 19(3) actually mean?
A: An Indian resident cannot make a financial commitment in a foreign entity if that foreign entity has invested (or will invest) into India and the resulting chain produces more than two foreign layers above the Indian entity receiving the FDI. One foreign holdco above the Indian entity is one layer and is permitted on the automatic route.

Q: From what date did the PN2 beneficial ownership test become operative as FEMA law?
A: Press Note 2 of 2026 was issued on 15 March 2026. It became operative as FEMA law through the FEMA (NDI) (First Amendment) Rules, 2026, notified on 02 May 2026. The FEMA (NDI) (Third Amendment) Rules, 2026, notified on 12 June 2026, extended the framework to portfolio investment routes and listed company transactions.

Q: What is the beneficial ownership threshold under PN2?
A: A person is a beneficial owner under PN2 if they hold more than 10% of shares, capital, or profits in the investing entity, per Rule 9(3) of the PML (Maintenance of Records) Rules, 2005. If an LBC natural person crosses this threshold in any entity in the investment chain, the inbound FDI requires government route approval.

Q: Which countries are land-border countries under PN2?
A: China, Pakistan, Bangladesh, Nepal, Bhutan, Myanmar, and Afghanistan. Pakistan and Afghanistan-linked investment faces additional restrictions in sensitive sectors regardless of beneficial ownership percentage.

Q: Who conducts the BO analysis: the foreign investor or the Indian company?
A: Both have obligations, but the Indian investee company bears direct FEMA contravention risk under PN2. The obligation to analyse whether any LBC natural person holds 10% or more in the foreign investor entity sits with the Indian company receiving the FDI. A fund’s representation is helpful but does not discharge the Indian company’s own obligation.

Q: What is the POEM risk for a single-purpose foreign holdco in a round-trip structure?
A: If the holdco has no employees, no third-party revenue, no local bank account, and all key decisions are made by India-based founders, the holdco fails the Active Business Outside India test under CBDT Circular No. 6/2017. A POEM finding makes the holdco an Indian tax resident, taxable in India on its worldwide income, with penalties for prior years. This is independent of FEMA compliance.

Q: What is the penalty for receiving FDI on the automatic route when government approval was required?
A: Under Section 13 of FEMA, 1999, the penalty can be up to three times the amount involved. For a ₹50 crore FDI, the theoretical maximum is ₹150 crore. The ₹2 lakh compounding cap (April 2025 amendments) does not apply to substantive route violations of this kind.

Q: What separates a FEMA compounding proceeding from an ED PMLA investigation?
A: Compounding under Section 15 covers inadvertent, non-wilful violations that are voluntarily disclosed. ED referral under PMLA applies where the violation is deliberate, involves concealment of beneficial ownership, or where the aggregate value of undisclosed foreign exchange or assets exceeds ₹1 crore (the Section 37A FEMA threshold for asset attachment). PMLA proceedings can result in asset freezing and criminal prosecution, not just a monetary penalty.

Q: Does a DPIIT-recognised startup face different round-tripping rules?
A: No. DPIIT recognition and the Section 80-IAC tax exemption are unaffected by the use of a foreign holdco structure. The two-layer rule, PN2 BO test, POEM risk, and transfer pricing obligations apply equally to DPIIT-recognised entities.

Q: Was there a one-year window restriction in the old rules that no longer exists?
A: Yes. The FAQ-based framework under FEMA 120 contained a one-year window restriction prohibiting an Indian entity from investing in a foreign entity that had recently invested into India. Rule 19(3) of the OI Rules, 2022 removed the time-based bar and replaced it with the structural two-layer limit. The current rule says the structure cannot produce more than two layers at any time (past, present, or future). There is no time window.

Q: What is a pre-2022 structure’s status under the new framework?
A: The 2022 framework applies prospectively to new financial commitments. A structure that was technically non-compliant under the FAQ-based FEMA 120 prohibition (for example, an Indian entity that invested in a foreign entity that had invested into India, with prior RBI approval obtained under the old framework) is not automatically regularised by the 2022 rules. Its compliance status needs to be assessed against both the old and new frameworks for the relevant periods. Founders with pre-2022 structures that relied on the old FAQ-based position should obtain a current legal opinion before making any further financial commitments in the same structure.

Q: How does the APR obligation interact with a round-trip structure?
A: The APR must be filed for each foreign entity in which the Indian entity has an ODI, by 31 December each year. For a round-trip structure, the APR must disclose investments made by the foreign entity back into India. AD banks use APR data to identify circular structures that have evolved. Missing or incorrect APRs are the most common compounding trigger in ODI compliance and, under the August 2025 RBI directive, block all further overseas investment until regularised.

Q: Can the FDI-ODI swap route eliminate round-tripping exposure?
A: The swap route (introduced via the 2024 Budget amendment to the FEMA NDI Rules) allows an Indian company to acquire shares in a foreign entity by issuing its own equity, rather than remitting cash. This is a permitted alternative to a conventional round-trip cash flow and may be structurally cleaner for founders who want the Indian entity to hold the foreign operating entity. It does not eliminate POEM or transfer pricing risk, which are independent of cash flow direction.

Regulatory references:

• Foreign Exchange Management Act, 1999: Sections 6, 13, 15, 37A
• Foreign Exchange Management (Overseas Investment) Rules, 2022: Rule 19(3)
• Foreign Exchange Management (Non-debt Instruments) Rules, 2019: Rule 6(a) as substituted by FEMA (NDI) (Amendment) Rules, 2026, S.O. 2174(E) dated 02 May 2026
• Foreign Exchange Management (Non-debt Instruments) (Third Amendment) Rules, 2026, S.O. 3030(E) dated 12 June 2026
• Press Note 2 of 2026 (Series), DPIIT, dated 15 March 2026
• Prevention of Money Laundering Act, 2002: Section 2(1)(fa), Section 3