Flip Structure Transactions: Regulatory Implications in India

[Divyansh Nayar is a 5th Year B.A.LL.B student and Arth Singhal a 4th Year B.A.LL.B student, both at National Law University Odisha]

Over the last decade, the concept of a “flip” has gained popularity in the venture capital circles, especially amongst Indian startups seeking support from foreign investors. A “flip” transaction is one where an Indian company incorporates a company in a favourable jurisdiction which is then made the holding company of the subsidiary in India. Such a jurisdiction is chosen for being investment friendly and more conducive for incorporation of a company in terms of legal compliances and regulations. Some of these jurisdictions include the United States (US), the United Kingdom (UK) and Singapore.

One of the methods for implementing a ‘flip’ transaction is through a share swap. Under this exercise, after the Indian promoters have incorporated an international holding company the shares held by the shareholders of the domestic company are swapped with the shares of the overseas holding company. As a consequence, the shareholders of the domestic company become shareholders of the overseas holding company. In place of a share swap, a flip structure can also be executed when the shareholders of the Indian company acquire shares of the overseas holding company and the holding company acquires all the shares of the Indian company from its shareholders.

Historically, US venture capitalists have invested in start-ups from other countries only if they agree to “flip” their corporate structure, wherein a US parent company is created. Over the years, even though US investors have found the tax dynamics to weigh in favour of investing directly in start-ups in the companies’ own jurisdiction, the trend shows that start-ups still prefer to go for a “flip” to ensure foreign funding and better access to foreign markets.

A flip helps in expansion of the company’s market presence in the other jurisdiction where the flip is being carried out. Apart from increasing the traction in other markets, a flip also helps in scalability, as the company not only benefits from the active venture capital presence, but also gets access to the larger public capital markets in the other jurisdiction. Thus, executing a flip has significant advantages for Indian start-up companies to attract larger US and Singapore investors and gain traction in those markets. However, various factors like tax implications, overall transaction cost, regulatory approvals and intellectual property transfers need to be taken into consideration while restructuring through a flip transaction. Through this post, the authors seek to lay out an overview of these multitude of factors affecting a flip transaction.

Foreign Investment Implications

When one considers flip restructuring in the Indian context, both overseas direct investment (ODI) and foreign direct investment (FDI) is involved. In the first stage, the money is taken out of India to set up the holding company in a foreign jurisdiction and then the investment comes back into the subsidiary in India. This exercise may be beneficial for the companies in terms of portraying illusionary growth and obtaining tax benefits, but this round tripping produces no net economic substance. When domestic funds come back into the country in form of FDI, but without any actual incremental flow of funds, it gives rise to various issues surrounding round tripping.

Apart from the existing complexities with regard to ODI and FDI investments, the Reserve Bank of India had, until recently, prohibited an Indian entity from setting up an Indian subsidiary through an offshore company in which the Indian entity is a shareholder. This was to avoid round tripping, which in turn created a problem for bona fide corporate structures which included flip structures. However, the Reserve Bank of India (RBI) later relaxed this prohibition and modified its FAQ and allowed Indian companies to set up such Indian subsidiaries with prior approval by the RBI.

The Government of India set up a High-Level Advisory Committee (HLAC) chaired by Mr. Surjit Bhalla to suggest changes in foreign investment rules to enable legitimate flip structures. The committee issued its report in 2019, wherein it noted that a blanket prohibition on transfer of funds might affect legitimate business activities in India. It found that investments in India by offshore holding companies through a genuine banking channel involving legitimate funds must be allowed through the automatic route. It also recommended that investment by a foreign entity whose total value of existing FDI does not exceed 25% of its consolidated net worth must not be categorized as “round-tripping” or a violation of the ODI regulations.

Automatic RBI approval in legitimate cases would speed up the regulatory process and would attract more legitimate businesses towards flip structure transactions. However, until the time the suggestions given by the HLAC gets implemented, government approval is required. Thus, the RBI’s approach towards approving legitimate externalization structures will be crucial.

Tax Implications

From the perspective of a start-up company, any investment made by or in the company, entails numerous tax liabilities, depending on the jurisdiction where the company is situated. Externalization poses as a viable solution to reduce, if not entirely circumvent, these tax liabilities and makes the functioning of the company cost-effective.

Looking from an Indian tax perspective, the tightly regulated tax regime is one of the biggest factors that motivates Indian start-up companies to flip their structure into other favourable jurisdictions like the US, the UK or Singapore. India imposes numerous taxes at exorbitant rates, such as gift tax, capital gains tax, corporate tax, angel tax, minimum alternative tax and ESOP tax, some of which are also exclusive to India. For instance, while the corporate tax imposed by India on domestic companies ranges between 22-25%, exclusive of surcharges and cess, in the UK the corporate tax is fixed at 19%, thus making the UK tax regime more favourable for the ease of doing business.

Compliance with taxation laws also continues to pose hurdles in attracting foreign investors, despite the plethora of reforms brought through the Union Budget and other instruments. Recently, the Government exempted the Indian startup companies registered with the Department for Promotion of Industry and Internal Trade (DPIIT) from paying the exorbitant 30% angel tax as chargeable under section 56(2)(viib) of the Income Tax Act, 1961. However, this was closely followed by instances of complications arising in income tax returns due to non-resolution of angel tax related issues. The Government is viewed as going back on its word by charging such tax on these companies, despite fulfilling the requirements, thus making it difficult for such companies to prefer India over others where such issues do not persist.

Thus, when considering to externalize or flip any Indian start-up company, tax implications are key in deciding a cost-effective jurisdiction. First, the fair market value of shares to be transferred needs to be taken into consideration. Whenever any transfer of shares of an Indian company takes place, the Income Tax Act vests the tax authority with the power to deem the fair value as the taxable value, irrespective of the actual consideration paid. Thus, one needs to take this into consideration while the flip structuring process is underway.

Second, it is necessary to consider the commercial substance test under the General Anti-Avoidance Rules (GAAR). GAAR is a concept which empowers the Commissioner of Income Tax to deny tax benefit of transactions or arrangements which do not have any commercial substance and where the only purpose of such a transaction is achieving the tax benefit. It was introduced to keep a check on tax avoidance and ensure that the companies are taxed under the proper tax brackets. Thus, it poses an imminent threat to the scheme of flip structuring. Accordingly, a company conducting externalization should be conscious of these rules.

Last, the ‘place of effective management’ test, which was introduced a few years back to determine the residence of a foreign company for taxation purposes under the Income Tax Act would bear implications. This test was introduced in an attempt to align the domestic laws with the international standards and prevent the companies from avoiding tax liability despite being controlled and managed from India. Thus, the offshore holding company needs to keep a check on its functioning in order to prevent it from being taxed in India.

Intellectual Property Implications

While the transfer of intellectual property (IP) of an Indian company undergoing the flip structuring is allowed under various provisions of the Foreign Exchange Management Act, the different aspects pertaining to taxation as well as valuation need to be addressed adequately. From a transfer pricing point of view, the valuation has to be in accordance with the fair market value of the IP. Furthermore, the gains made on such transfer of the IP shall also be subjected to tax in India according to the provisions of the Income Tax Act. Overall, the timing of transfer as well as the basis of valuation of such IP assumes greater importance to make the process of externalisation cost-effective.


After the devastating effect of COVID-19 on the Indian economy, legislators are looking to strike a balance between some conflicting requirements such as creating an investor-friendly regime and at the same time reviving the economy through investment laws and regulations. In this background, Indian start-ups are considering externalization as a viable mode of expanding their companies. However, the decision of externalizing the company is taken only after factoring the regulatory and compliance implications extending across foreign investment norms, taxation laws, fair pricing mechanism and intellectual property amongst other concerns. A successful flip structuring factors all these implications and structures accordingly.

– Divyansh Nayar & Arth Singhal

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