Round-Tripping in Indian Foreign Exchange Law: Regulatory Suspicion Without Statutory Prohibition
Introduction: The Popular Narrative
Round-tripping is a popular practice, which involves domestic companies investing in foreign entities which in turn invest back into the domestic company, creating a circular flow of funds. In the Indian context, when entities route funds to an overseas subsidiary or an overseas intermediary organization that will then reinvest the money back in India as foreign direct investment (FDI).
This has been a major concern for various regulatory authorities such as RBI and Enforcement Directorate (ED) as the practice is often equated with illegality as the major intent of the companies behind this is to obscure the true origin of funds, facilitate regulatory arbitrage, or enable tax avoidance.
Although there is a lack of trust in this practice, there is a lot of confusion regarding the legal status of round-tripping in India. Neither the Foreign Exchange Management Act, 1999 (FEMA) and the regulations developed under it specifically state or prohibit round-tripping as an independent offence. Rather, Indian regulatory system only deals with these transactions indirectly through regulations of overseas investment, foreign direct investment, beneficial ownership disclosure and pricing regulations.
The article challenges the popular assumption that Indian Law explicitly prohibits round-tripping and argues that it is regulated through a combination of enforcement scrutiny and policy restrictions rather than a strict statutory prohibition.
Understanding Round-Tripping in Global Financial Practice
Round-tripping is not an Indian phenomenon and is practised in various jurisdictions where businesses are interested in maximising cross-border investment structures. The domestic money is usually routed to a foreign jurisdiction, usually one with favourable tax regimes, investment agreements, or regulatory leniency, and repatriated back as foreign capital.
Companies adopt such structures for several reasons. First, the foreign investment can have regulatory or tax benefits not enjoyed by the domestic capital. Second, international financial structures offer more access to international investors and capital markets. Third, the offshore structures can provide more flexibility and protection to corporate and dispute resolutions, especially where investment treaties are at play.
Historically, common jurisdictions in India as destinations of such investment were Mauritius and Singapore, which had favourable Double Taxation Avoidance Agreements (DTAAs) with India. These were set up to enable the foreign investors to enjoy capital gains tax exemptions, which consequently brought into question whether the domestic capital would be channelled through offshore jurisdictions and brought back as foreign investment. However, just the fact that there is a circular investment structure does not necessarily make a transaction illegal; its compliance with applicable regulatory and disclosure requirements matters
Absence of Explicit Prohibition under FEMA
The fact that India does not have a statutory definition of round tripping is one of the most striking aspects of the foreign exchange regime in India. The Foreign Exchange Management Act, 1999, that regulates cross-border capital flows, does not specifically state or forbid round-tripping transactions.
FEMA adopts a rather liberal approach than its predecessor, the Foreign Exchange Regulation Act (FERA) and is aimed mainly to facilitate external trade and payments. Section 6 of FEMA specifically empowers the Reserve Bank to regulate capital account transactions. This provision serves as the statutory basis for all ODI regulations. Nevertheless, the circular investment structures are not mentioned directly in the statute.
Instead, the regulatory control happens through subordinate legislation and policy frameworks. Regulatory oversight is instead exercised through subordinate legislation such as the Foreign Exchange Management (Overseas Investment) Rules and Regulations, 2022, which impose structural limitations on overseas investments that may result in circular capital flows lacking genuine commercial substance.
Notably, the regulatory framework does not emphasise the formal framework of a transaction but on the content and economic intent of the transaction. Regulators may question transactions which seem to be designed purely to avoid foreign exchange laws or restrictions on investments. The lack of a specific statutory prohibition however, suggests that the law does not consider all such cases of capital leaving then returning to India as being unlawful in nature.
Indirect Regulation through FDI and ODI Framework
In practice, the regulation of round-tripping in India relies less on explicit statutory prohibition and more on regulatory scrutiny and enforcement discretion.
The important change in this respect is the introduction of Foreign Exchange Management (Overseas Investment) Rules, 2022, and the Foreign Exchange Management (Overseas Investment) Regulations, 2022 and the RBI Master Directions on Overseas Investment (amended 2024). All these measures came to replace the previous regime and put in place more systematic protection of potentially abusive cross-border investment arrangements.
Amongst the most important is Rule 19(3) of the Overseas Investment Rules, 2022 which limits any Indian residents to be financially committed in a foreign entity that has been investing in India at one time or another and would lead to a multi-layered structure of subsidiaries. The RBI’s Overseas Investment (OI) Master Directions reaffirm this rule by restricting Indian entities from adding any additional layer and increasing the complexity if they already have a two-layer structure. Therefore, these structural limitations effectively target circular investments designed to leverage regulatory arbitrage.
In addition to the overseas investment framework, the FDI policy also acts as an indirect regulatory tool. Foreign investment in India, considered foreign capital, must comply with relevant sector-specific limits, entry requirements, and ownership rules. Pricing and valuation regulations play an important role as well.
The offshore investment structures have also been recognised as legitimate by judicial interpretation. In the Vodafone International Holdings BV v Union of India (2012) case, the Supreme Court pointed out that valid tax planning and corporate structuring could not be ignored just because of the tax benefits. The “look at” test of the Court emphasised the fact that the commercial content of the cross-border transactions should be considered, without necessarily presuming that the transactions were illegal based on its form.
Taken together, these regulatory tools reflect a substance-over-form approach. No statute explicitly makes the practice illegal but it is controlled and regulated indirectly through regulation of capital valuation, ownership disclosures and enforcement mechanisms in accordance with their economic substance approach rather than formal structure.
Regulatory Ambiguities and the Continuing Policy Dilemma
Regardless of the protections implemented in the framework of the Overseas Investment Rules, the round-tripping regulation remains characterised by the considerable difficulty of interpretation. The two-layer subsidiary restriction of Rule 19(3) brings about one area of uncertainty. With complicated international corporate arrangements, whether subsidiary levels are to be measured in terms of parent country perspective or foreign intermediate country perspective is not always apparent, a fact that provides the regulatory compliance test with ambiguity.
The problems are further complicated by the fact that the concept of control is widely defined within the context of the overseas investment regime, which can be enforced either in the form of shareholding, voting rights or management. These ambiguities point to the bigger policy issue that regulators are grappling with, which is how to strike the appropriate balance between preventing regulatory arbitrage and disguised inflows of capital, on the one hand, and providing Indian firms with the necessary flexibility to design genuine international investments, on the other.
Conclusion: Rethinking the Narrative
A careful examination of Indian law concludes that the belief that round tripping is strictly prohibited has no foundation in the law. Neither FEMA nor any other framework expressly state that Circular investment is prohibited, but it is controlled and regulated indirectly through regulation of capital valuation, ownership disclosures and enforcement mechanisms in accordance with their Economic Substance approach rather than Formal Structure.
The current lack of clear and concise statutory guidelines has resulted in a great deal of uncertainty among investors. While discretionary enforcement allows regulators to pursue and sanction abusive round-tripping, it has also created a confusing compliance environment for those legitimately investing in India.
The need of the hour is not an outright prohibition, but a balanced approach which includes clear regulation for potential risks and permissible structures, this would clear out the misconceptions and align enforcement with policy objectives. As India continue to develop relationships as global financial markets, it must also develop its regulatory approach towards round tripping.
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