How to Issue Shares for Services to Foreign Consultants in India: FEMA Rules

A Comprehensive Guide to Non-Cash Allotments, Shares for Services, and Regulatory Compliance

The global investment landscape has increasingly recognized India as a primary destination for long-term sustainable capital, a sentiment underscored by the nation achieving the historic milestone of receiving USD 1 trillion in cumulative Foreign Direct Investment (FDI) since April 2000. This influx is not merely a testament to market size but reflects a sophisticated regulatory evolution from the restrictive Foreign Exchange Regulation Act (FERA) to the facilitative Foreign Exchange Management Act (FEMA), 1999. Central to this contemporary framework is the ability of Indian enterprises to engage in complex capital structures, including the issuance of equity instruments for considerations other than cash—a mechanism vital for acquiring global technical know-how, compensating foreign consultants, and facilitating cross-border corporate restructuring. The governance of these transactions is anchored in the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, and the Master Direction on Foreign Investment in India, which provide the statutory basis for balancing economic growth with stringent oversight of foreign exchange flows.  

The Macro-Economic and Regulatory Genesis of the Indian FDI Framework

The Indian government's intent behind its FDI policy is to supplement domestic capital, technology, and skills to accelerate economic growth. Unlike Foreign Portfolio Investment (FPI), which often seeks short-term gains through secondary market transactions, FDI is characterized by a "lasting interest" in a resident enterprise. This lasting interest is legally codified through the 10% threshold in listed companies and any investment in unlisted entities. The transition to the current regime was catalyzed by the 2011 FDI policy update, which first introduced formal guidelines for issuing shares against non-cash considerations such as trade payables and the import of capital goods. Prior to this, the automatic route was restricted almost exclusively to cash considerations, with narrow exceptions for external commercial borrowings (ECBs) and technical fees.  

The modern regulatory architecture is governed by the Department for Promotion of Industry and Internal Trade (DPIIT) and the Reserve Bank of India (RBI). The DPIIT formulates the Consolidated FDI Policy, while the RBI administers the operational aspects through the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 (FEMA 395). This dual-track governance ensures that while policy intent remains expansionary, the execution remains compliant with national security and monetary stability requirements. In January 2025, the framework further matured to accommodate the complexities of global supply chains, clarifying that foreign-owned and controlled companies (FOCCs) can utilize share swaps, escrows, and deferred consideration on par with other international investors.  

Legal Anatomy of Equity Instruments and Investor Categorization

A nuanced understanding of non-cash allotment begins with the legal definition of "Equity Instruments." Under the NDI Rules 2019, these include equity shares, fully and mandatorily convertible debentures (CCDs), fully and mandatorily convertible preference shares (CCPS), and share warrants. Any instrument that is not fully and mandatorily convertible is treated as a debt instrument and must comply with the more restrictive External Commercial Borrowing (ECB) guidelines. This distinction is critical because equity instruments fall under the non-debt instrument (NDI) rules, which offer more flexible entry routes and higher sectoral caps compared to debt-based financing.  

The classification of the investor determines the applicable compliance pathway. The regulations distinguish between several categories of non-resident investors, each governed by specific schedules under the NDI Rules.  

The status of the investee entity also impacts the issuance of shares for services or assets. For instance, a "Startup Company" is defined as a private company incorporated under the Companies Act, 2013, and recognized by the DPIIT. Startups enjoy unique flexibility, such as the ability to issue "Convertible Notes," which are debt instruments that can convert into equity within ten years, providing a bridge for foreign consultants to eventually hold a stake in the company.  

The Intricacies of Non-Cash Consideration: Legal Mechanisms and Commercial Realities

The issuance of shares without the immediate inward remittance of foreign currency is an exception to the general rule of cash consideration. The rationale for this restriction is the government's desire to ensure that FDI results in an actual inflow of foreign exchange. However, the DIPP recognizes that certain intangible contributions—such as technology transfer, professional expertise, and pre-operative expenditures—carry significant economic value that warrants capitalization.  

Capitalization of Technical Know-How Fees and Royalties

One of the most effective ways for Indian companies to climb the value chain is the acquisition of foreign intellectual property and technical expertise. The FDI policy permits the issuance of equity instruments against lump-sum technical know-how fees and royalties due to a foreign entity. This mechanism is particularly beneficial for manufacturing and technology-intensive sectors where the upfront cost of acquiring IP is prohibitive.  

Under the automatic route, an Indian company may issue shares against these payables if its primary business activity is eligible for 100% FDI under the automatic route and it has no FDI-linked performance conditions. The process requires the fee to be determined at an arm's length price, substantiated by an independent valuation certificate from a Chartered Accountant or a SEBI-registered Merchant Banker. A critical compliance nuance is that the conversion to equity must be net of applicable taxes. This means the Indian company must fulfill its withholding tax obligations under Section 195 of the Income Tax Act, essentially paying the tax in cash to the government while issuing shares for the remaining value of the services or royalty.  

Equity Issuance for Pre-incorporation and Pre-operative Expenses

The establishment of a wholly owned subsidiary (WOS) in India often involves a significant temporal gap between the initial conceptualization and the activation of a domestic bank account. During this period, foreign promoters often pay for legal fees, rent, and administrative setup from their headquarters. To relieve the financial burden on the parent entity, the RBI allows these pre-incorporation and pre-operative expenses to be capitalized into equity.  

This pathway is restricted to subsidiaries operating in sectors under the 100% automatic route. The capitalization is capped at the lower of 5% of the Indian company's authorized capital or USD 500,000. The regulatory oversight for this process is rigorous: the Indian entity must report the transaction in Form FC-GPR within 30 days of issuance, and the statutory auditor must certify that the expenses were incurred for bona fide purposes relating to incorporation or the commencement of operations.  

Shares for Services: Compensating Foreign Consultants and Service Providers

The "Shares for Services" model is a specialized non-cash allotment strategy where an Indian company compensates external foreign consultants, advisors, or material providers with equity instead of cash. While the NDI Rules do not categorize this under a single umbrella term, it is legally executed through the provision for "issuance of equity instruments against funds payable".  

For a consultant to receive shares for services, the Indian company must demonstrate that the payment of such fees is permitted under the Current Account Rules or has received prior RBI approval. This is distinct from "Sweat Equity," which is specifically governed by Section 54 of the Companies Act, 2013, and is restricted to the company's own employees or directors. Sweat equity is issued at a discount for providing know-how or intellectual property rights. In contrast, shares for services issued to independent foreign consultants must adhere to the standard pricing guidelines, meaning the consultant cannot receive shares at a discount to the fair market value.  

The commercial implication of this model is significant for the Indian startup ecosystem. It allows cash-strapped firms to attract top-tier global talent by offering long-term upside in the form of equity. However, the complexity of valuation and the immediate cash requirement for tax withholding (TDS) often act as a barrier to implementation.  

The Valuation Paradigm: Methods, Professionals, and Precision

The integrity of the Indian FDI regime rests on the "Pricing Guidelines," which mandate that any issuance or transfer of shares between a resident and a non-resident must occur at a price not less than the fair market value. This prevents the artificial dilution of Indian assets and ensures that capital enters the country at realistic valuations.  

Authorized Professionals and Statutory Validity

The choice of the valuer is determined by the nature of the transaction and the legal framework under which it is conducted. For FEMA compliance, the valuation must be performed by one of the following:

• A Chartered Accountant (CA) in practice.
• A SEBI-registered Category I Merchant Banker.  
• A Practicing Cost Accountant.  
• A Registered Valuer under the Companies Act (primarily for domestic requirements or when mandated by the AD Bank).  

While CAs are permitted for simpler unlisted share issuances, any transaction involving the Discounted Cash Flow (DCF) method or complex cross-border structures—such as share swaps or outbound direct investments (ODI)—increasingly necessitates the involvement of a Merchant Banker to ensure high regulatory acceptance. The valuation report is valid for only 90 days from the date of the investment, requiring meticulous synchronization between the valuer and the corporate legal team.  

Valuation Methodologies and the DCF Standard

For unlisted companies, the RBI mandates valuation as per "any internationally accepted pricing methodology" on an arm's length basis. In practice, the DCF method is the gold standard because it projects future cash flows and discounts them to their present value, capturing the growth potential of the enterprise. For listed companies, the price is dictated by SEBI's pricing formulas based on the market price over a specific duration preceding the relevant date.  

Failure to comply with pricing guidelines leads to severe repercussions. If shares are allotted at a price below the FMV, the difference is taxable in the hands of the non-resident investor as "income from other sources" under Section 56(2)(x). Additionally, the transaction may be categorized as a contravention of FEMA, attracting penalties of up to 300% of the sum involved.  

Sector-Specific Conditionalities and Performance Requirements

A critical component of FDI-related services in India is determining whether the target sector is under the "Automatic Route" or the "Government Route". While many sectors allow 100% FDI automatically, others have caps or performance-linked conditions that must be satisfied before shares can be issued, even for non-cash consideration.  

Sensitive Sectors: Defense, Insurance, and Banking

The regulatory evolution of 2024-2025 has significantly liberalized several sensitive sectors.

• Defense: FDI is now permitted up to 100%, with the automatic route covering up to 74%. Investment beyond 74% requires government approval, particularly where it results in access to modern technology.  

Insurance: The FDI cap has been raised from 74% to 100%, reflecting a major policy shift toward deeper integration with global insurance markets. However, the Chairperson and at least one of the MD/CEO/Principal Officer must be resident Indian citizens.  

Banking: In the private sector, FDI is capped at 74%, with the automatic route available up to 49%. For public sector banks, the cap remains at a restrictive 20% under the government route.  

Geopolitical Nuances and the Bordering Country Restriction (Press Note 3)

In 2020, the Indian government introduced a significant amendment to the FDI policy to prevent "opportunistic takeovers" of domestic firms during economic volatility. Known as Press Note 3, this rule mandates that any investment from an entity situated in a country sharing a land border with India—or where the beneficial owner is a citizen or resident of such a country—requires prior government approval.  

The bordering countries include Afghanistan, Bangladesh, Bhutan, China (including Hong Kong), Myanmar, Nepal, and Pakistan. There is no minimum ownership threshold for determining "beneficial ownership" under this rule, meaning even minor stakes or non-cash allotments to consultants from these jurisdictions trigger the approval requirement. In early 2025, an exception was introduced for Multilateral Banks or Funds (such as the ADB or New Development Bank) of which India is a member, allowing them to invest without being subject to these constraints.  

Taxation of Cross-Border Allotments: The Section 195 Compliance Burden

The issuance of shares to a non-resident for services or technology is fundamentally a payment of income from an Indian source, which triggers withholding tax (TDS) obligations under Section 195 of the Income Tax Act. The payer (the Indian company) is responsible for deducting the tax at the prescribed rates before the "payment" is made.  

Double Taxation Avoidance Agreements (DTAA) and TRCs

While the domestic withholding rate for royalties and technical fees is 20%, foreign entities can leverage India's extensive network of DTAAs to reduce this burden to 10% or 15%. To claim these benefits, the non-resident must provide a Tax Residency Certificate (TRC) from their home country and file Form 10F. If the non-resident does not have a Permanent Account Number (PAN) in India, the tax rate may be increased to 20% or higher.  

Procedural Requirements: Forms 15CA, 15CB, and 27Q

The compliance cycle for non-cash allotment involves multiple filings with the income tax department:

1. Form 15CB: A certificate from a Chartered Accountant certifying the nature of the payment, the applicability of the tax rate, and the deduction of the correct amount of tax.  
2. Form 15CA: An online declaration filed by the Indian company detailing the remittance and the tax withheld.  
3. Form 27Q: A quarterly TDS return that summarizes all payments made to non-residents during the quarter.  

The challenge in "Shares for Services" is that the consideration is not in cash, making it impossible to "deduct" tax from the shares themselves. The Indian company must therefore deposit the tax amount in cash from its own funds and then issue equity for the net-of-tax value. Failure to file these forms accurately can lead to penalties and interest for delayed payment under Section 201(1A).  

Reporting Requirements and the FIRMS SMF Portal

Transparency is maintained through the Foreign Investment Reporting and Management System (FIRMS), a centralized portal managed by the RBI. All FDI-related transactions must be reported through the Single Master Form (SMF), which replaces the previous fragmented reporting system.  

Form FC-GPR: Reporting New Issuances

When an Indian company allots shares to a non-resident, it must file Form Foreign Currency-Gross Provisional Return (FC-GPR) within 30 days of the allotment.  

• Registration Phase: The company must first register an "Entity User" to create the master profile and then a "Business User" to file the specific forms.  
• Documentation Checklist:

• FIRC/KYC: For cash transactions, the Foreign Inward Remittance Certificate is essential. For non-cash transactions, proof of the consideration (e.g., customs valuation or service agreement) is required.  
• Board/Special Resolution: Approving the subscription and authorizing the filing.
• Valuation Certificate: Not older than 90 days from the date of allotment.  
• CS Certificate: Attesting that the issuance complies with the Companies Act and FEMA.  

Form FC-TRS: Reporting Transfers

In scenarios involving the transfer of existing shares between a resident and a non-resident (such as a share swap), Form FC-TRS must be filed within 60 days of the transfer or the receipt/payment of funds. The onus of filing is on the resident party. For transfers on a recognized stock exchange, the non-resident investor is responsible for the reporting.  

Annual Compliance: Form FLA and Form DI

Indian entities with FDI must file the Annual Return on Foreign Liabilities and Assets (FLA) by July 15th each year, detailing the market value of foreign equity and any outstanding liabilities. Additionally, if an Indian entity with foreign investment makes a "Downstream Investment" in another Indian company, it must file Form DI within 30 days of the allotment of shares in the second-level entity.  

Compliance Timelines and the Consequences of Non-Adherence

The Indian regulatory environment is characterized by strict timelines, and delays often trigger financial penalties or the requirement for compounding.  

For quantifiable contraventions, the penalty can extend up to three times the sum involved. For technical or minor lapses, the "Compounding" process allows the entity to voluntarily disclose the error and pay a fine to regularize the transaction. The Enforcement Directorate (ED) has the authority to investigate more serious violations, including potential money laundering or the bypass of government approval routes through fictitious non-cash allotments.  

Future Horizons: 2025 and Beyond in the Indian FDI Ecosystem

As India positions itself as a $5 trillion economy, the FDI policy is trending toward greater parity and simplified procedures. The expansion of the "Automatic Route" to include almost all service-related activities—provided they are not in the few prohibited sectors—has reduced the time-to-market for international consultants and tech providers. The introduction of the "Fast-track Route" for inbound mergers in late 2024 further streamlines the process for foreign parents to consolidate their Indian operations.  

The trend toward digitalization, embodied by the FIRMS portal and the FLAIR system, has made compliance more transparent, but also more data-driven. For foreign consultants looking to accept equity for services, the key to success lies in early-stage tax planning and robust valuation documentation. By aligning with the arm's length principle and the Section 195 withholding norms, global experts can effectively partner with Indian growth stories without incurring regulatory drag.  

Nuanced Conclusions on Non-Cash Allotment Strategy

The issuance of shares for non-cash consideration, particularly the "Shares for Services" model, represents a sophisticated intersection of corporate law, foreign exchange policy, and tax strategy. While the regulatory barriers—such as the 60-day allotment window and the stringent DCF valuation standards—are formidable, they serve to protect the economic interests of both the investor and the host nation.

Third-order insights into this landscape reveal that non-cash allotments are becoming the preferred vehicle for high-tech industrial collaboration, as they allow for the seamless transfer of "intangible capital" which is often more valuable than liquid currency. However, the requirement to deposit TDS in cash remains a liquidity paradox for startups. Strategic investors must therefore view equity-based compensation not as a "free" alternative to cash, but as a long-term commitment that requires upfront fiscal coordination. In the final analysis, a successful FDI transaction in India is one that respects the spirit of "lasting interest" by building a foundation of transparency and regulatory rigor from the moment the first pre-incorporation expense is incurred.