A foreign investor’s lawyers will ask for your FEMA file in the first week of due diligence. They want every FC-GPR acknowledgment, every valuation certificate and every FLA return since the first rupee of foreign money came in. If a filing is missing or a share was priced below fair value, the deal slows down. Sometimes the price changes. Sometimes the investor walks.
A FEMA audit done before diligence starts lets you find those gaps first. You get time to file what’s late, compound what can’t be cured by a late fee, and explain the rest on your terms. This guide sets out what a buyer’s counsel will check under the Foreign Exchange Management Act, 1999 and the FEMA (Non-Debt Instruments) Rules, 2019, and how to clean up each issue before it reaches the data room.
What a FEMA Audit Covers Before a Deal
A FEMA audit is a review of every cross-border transaction your company has done, tested against the rule that applied on the date of the transaction. For most Indian companies with foreign shareholders, that means the NDI Rules for equity, the Overseas Investment Rules, 2022 for money sent abroad, and the ECB framework for foreign loans.
The audit looks back to incorporation, or to the first foreign investment, whichever came first. A buyer won’t accept “the old management handled it”. Contraventions stay with the company, and so does the exposure.
Why Buyers and Investors Run FEMA Due Diligence
Penalties under Section 13 of FEMA can reach three times the sum involved where the amount is quantifiable, plus a further amount for each day the contravention continues. A buyer acquiring shares inherits that risk. Lenders and future investors will ask the same questions again, so an unresolved FEMA issue also affects the next round.
FEMA problems also block exits. A foreign investor who later sells to an Indian resident has to file Form FC-TRS, and the AD bank will look at whether the original investment was reported correctly. Gaps from five years ago surface at the point of sale.
Expect counsel to ask for indemnities covering any pre-closing FEMA breach, a specific escrow, or a condition precedent requiring compounding before closing.
The FEMA Audit Checklist
Work through these in order. Each item lists what the buyer will ask for and where problems usually hide.
1. Inflow of funds and allotment timelines
- Was every foreign remittance received through an AD Category-I bank, through normal banking channels?
- Were shares or convertible instruments allotted within 60 days of receiving the money?
- If allotment didn’t happen in 60 days, was the money refunded within the next 15 days?
- Do you hold the FIRC and KYC report from the bank for each inflow?
Money parked beyond 60 days without allotment or refund is one of the most common findings in a FEMA audit.
2. FC-GPR and FC-TRS reporting
- Was Form FC-GPR filed on the FIRMS portal within 30 days of each allotment?
- Was Form FC-TRS filed within 60 days for every transfer between a resident and a non-resident, including secondary sales by founders?
- Do the acknowledgments and RBI approval references match the share register?
- Were ESOP allotments to non-resident employees reported (Form ESOP)?
Buyers will reconcile your FIRMS filings against the register of members line by line. Any share held by a non-resident that has no matching filing becomes a question.
3. Pricing under the NDI Rules
- For each issue to a non-resident, was the price at or above fair value under an internationally accepted pricing methodology?
- Is there a valuation certificate from a chartered accountant, SEBI-registered merchant banker or practising cost accountant, dated close to the transaction?
- For transfers from residents to non-residents, was the price at or above fair value? For transfers from non-residents to residents, at or below?
- If any consideration was deferred, did it stay within 25% of the total and get paid within 18 months?
Old valuation reports, or reports that use a method other than the one stated in the FEMA rule, are an easy point for a buyer to raise.
4. Instrument structure
- Are all preference shares and debentures held by non-residents fully and mandatorily convertible? Optionally convertible instruments are treated as ECB, not equity.
- Was the conversion formula fixed upfront?
- Do the shareholders’ agreement and articles give any foreign investor an assured return on exit? Optionality clauses are allowed, but a guaranteed return is not.
5. Sectoral caps, entry route and Press Note 3
- Did the company’s activity fall under the automatic route on the date of each investment?
- If the sector needed government approval, is the approval on file and were its conditions met?
- Is any investor, or the beneficial owner of any investor, from a country sharing a land border with India? Since April 2020, these investments need government approval regardless of sector.
- Has the business changed activity since the investment in a way that moves it into a capped or restricted sector?
Press Note 3 is now one of the first things buyers check, because beneficial ownership often sits several layers up.
6. Downstream investment
- If the company is owned or controlled by non-residents, has every investment it made into another Indian company been reported in Form DI within 30 days?
- Did each downstream investment follow the sectoral conditions that apply to the investee?
- Were downstream investments funded from foreign inflows or internal accruals, and not from domestic borrowings?
7. Annual returns
- Was the FLA return filed by 15 July every year since the first foreign investment or overseas investment?
- Do the FLA figures reconcile with the audited balance sheet?
Missed FLA returns are common in startups that raised money early and then stopped tracking compliance.
8. Overseas investment and foreign borrowing
- For any foreign subsidiary or joint venture, were Form ODI and the Annual Performance Report (due 31 December) filed?
- For any ECB, was the Loan Registration Number obtained and the ECB-2 return filed every month?
- Were end-use restrictions on ECB proceeds respected?
Red Flags That Stall a Deal
Some findings are routine and close with a late fee. Others hold up signing. In our experience, these are the ones that cause delays:
- Shares held by a non-resident with no FC-GPR or FC-TRS filing at all
- Issue price below fair value with no supporting valuation
- Investment from a land-border country without government approval
- Optionally convertible instruments treated as equity
- Downstream investments never reported
Each of these needs a remedy plan before the buyer’s counsel writes their report.
Fixing Gaps: Late Submission Fee or FEMA Compounding
Not every lapse needs compounding. RBI allows a Late Submission Fee for reporting delays such as late FC-GPR, FC-TRS or Form DI filings, within the time window RBI has set. Paying the fee regularises the delay without a compounding application.
Substantive contraventions, and reporting delays outside the LSF window, go through compounding under the Foreign Exchange (Compounding Proceedings) Rules, 2024. The company applies to RBI, admits the contravention, and pays a compounding amount set by RBI. Once compounded, the matter is closed and can’t be reopened for the same breach.
For a deal, the sequence matters. File the pending forms first, pay LSF where it applies, and file compounding applications for the rest. A buyer will usually accept a pending compounding application backed by a specific indemnity. An unidentified breach found by their own counsel is much harder to negotiate.
How Long a Pre-Diligence FEMA Audit Takes
For a company with two or three funding rounds, a FEMA audit typically takes two to four weeks, depending on how complete the records are. Start before you sign a term sheet. Late filings and compounding can take several months, and you’ll want that work underway before the buyer’s checklist arrives.
A Agarwalla & Co.’s FEMA lawyers in Delhi carry out pre-transaction FEMA audits, prepare compounding applications and work with deal counsel during diligence. If your company is preparing for an investment or acquisition, our FDI team can review your foreign investment file and set out what needs fixing.
FAQs
What is a FEMA audit?
A FEMA audit is a review of a company's foreign exchange transactions and filings to check compliance with the Foreign Exchange Management Act, 1999, the NDI Rules and RBI directions. It covers foreign investment, transfers of shares, overseas investment, foreign loans and annual returns.
Is a FEMA audit mandatory before an acquisition in India?
No law requires it. In practice, any buyer or investor dealing with a company that has foreign shareholders will run FEMA due diligence, so an internal audit beforehand lets the company find and fix problems first.
What happens if FC-GPR was filed late?
A late FC-GPR can usually be regularised by paying a Late Submission Fee, if the delay falls within the period RBI allows. Outside that window, the company will need to apply for compounding.
Can FEMA violations be fixed before a deal closes?
Most can. Reporting delays are cured through a late fee, and other contraventions through compounding with RBI. Where compounding is still pending at closing, buyers commonly rely on a specific indemnity or escrow.
What do investors check under the FEMA Non-Debt Instruments Rules?
Investors check pricing against fair value, instrument structure, sectoral caps and entry route, Press Note 3 compliance, allotment timelines, and whether every issue and transfer was reported on the FIRMS portal.