"We'll just buy back the shares": What FEMA and the Companies Act actually require for foreign shareholder exits

Somewhere between term sheet and closing, almost every foreign investor in an Indian company asks the same question: how do I get my money back out? The answer that usually comes back — "the company will buy back your shares" — sounds simple, and it is the single most common source of stranded capital in Indian subsidiaries. A buyback is not a discretionary corporate decision in India. It is a capital-reduction event governed simultaneously by the Companies Act, 2013, by FEMA 1999 and the pricing rules made under it, and by Indian income tax. Get the sequencing wrong and the exit stalls for two years, or the remittance is blocked at the authorised dealer bank on the day you need it.

What the regulation actually says

Three separate regimes apply to a foreign shareholder exit, and they must all be satisfied at once.

Companies Act, 2013 — Section 68 (buyback). A company may buy back its own shares out of free reserves, the securities premium account, or the proceeds of a fresh issue of shares — but never out of the proceeds of an earlier issue of the same kind of shares. Section 68 imposes hard quantitative limits. Buyback in any financial year cannot exceed 25% of the aggregate of paid-up capital and free reserves. For equity shares specifically, the buyback in a financial year is capped at 25% of paid-up equity capital. Post-buyback, the debt-to-capital-and-free-reserves ratio must not exceed 2:1. A buyback authorised by board resolution alone is capped at 10% of paid-up equity capital and free reserves; anything above that requires a special resolution of shareholders and an explanatory statement. Critically, Section 68(8) creates a cooling-off period: no further buyback for one year from the closure of the previous one. Companies with unpaid deposits, defaulted debentures, or unpaid dividends are barred from buyback until the default is remedied for three years.

Companies Act, 2013 — Section 66 (capital reduction). Where the company has no free reserves — a common position for a subsidiary that has burned capital — buyback is unavailable, and the route is a selective capital reduction under Section 66. This is a tribunal-driven process: the company passes a special resolution and petitions the National Company Law Tribunal (NCLT), which issues notice to the Registrar of Companies, SEBI (if applicable), the income tax department, and creditors, each of whom has three months to object. The NCLT order is then filed with the RoC in Form INC-28. Realistically this is a six-to-twelve-month process, sometimes longer, and it cannot be compressed by commercial urgency.

FEMA 1999 and pricing. Both routes involve a capital account transaction with a non-resident and are therefore governed by FEMA. Under the FEMA (Non-Debt Instruments) Rules, 2019 — currently in force, with the RBI's draft FEMA (Foreign Investment) Rules, 2026 released on 21 July 2026 proposing to replace them, open for comment until 31 August 2026 — the operative pricing principle for an exit is that a non-resident may not receive more than the fair value of the shares, determined by a SEBI-registered merchant banker or a practising chartered accountant using an internationally accepted pricing methodology (typically DCF, on an arm's-length basis). This is the mirror image of the entry rule: on the way in, a non-resident may not pay less than fair value; on the way out, may not receive more. A buyback priced above the merchant banker's valuation will be refused by the AD bank.

Assured returns are void. This is the provision most foreign investors are blindsided by. FEMA does not permit an equity instrument to carry a guaranteed exit price or an assured return. Put options, exit puts on the promoter, and buyback obligations at a pre-agreed IRR are permissible in a shareholders' agreement only if the exit is at fair value at the time of exit — not at a formula-driven price fixed at investment. An "investor shall be entitled to a buyback at 2x cost" clause is, under FEMA, an unenforceable debt-like return dressed as equity, and re-characterises the instrument.

Tax. Since the amendments effective 1 October 2024, buyback proceeds received by a shareholder are taxed in the hands of the shareholder as deemed dividend under Section 2(22)(f), not as capital gains, and the company-level buyback distribution tax under Section 115QA has been withdrawn. For a foreign shareholder this shifts the analysis materially: the dividend article of the applicable DTAA now governs, withholding applies at treaty rate, and the shareholder's cost of acquisition becomes a capital loss available for set-off. Capital reduction under Section 66 is treated differently again — the portion attributable to accumulated profits is deemed dividend under Section 2(22)(d), and the balance is capital gains. The choice between buyback and reduction is therefore a tax choice as much as a corporate one, and should be modelled before the resolution is drafted.

Practical implications of getting this wrong

The failure modes are specific and expensive.

If the buyback price exceeds fair value, the AD bank will not process the outward remittance. The money sits in the company's account and the foreign shareholder remains on the register. Regularising this requires a compounding application to the RBI under Section 13 of FEMA, which carries a monetary penalty calculated on the amount and duration of the contravention, plus several months of delay.

If a buyback is executed without the Section 68 limits being met — most often the 25% cap or the 2:1 debt ratio — the transaction is void under the Companies Act and directors face liability. The company then cannot attempt a corrective buyback for one year under the Section 68(8) cooling-off rule, and the only remaining route is an NCLT capital reduction.

If the shareholders' agreement contains an assured-return exit clause, an Indian court or the RBI may treat the instrument as debt rather than equity. That triggers external commercial borrowing (ECB) analysis retrospectively — eligible lender tests, all-in-cost ceilings, minimum average maturity — none of which the original investment was structured to satisfy.

And where the Indian company has accumulated losses and no free reserves, buyback is simply not legally available. Founders who promised a buyback exit on a term sheet frequently discover this only at the point of exit, when the only route left is a twelve-month tribunal process.

Step-by-step: what to do

• Test buyback eligibility before promising it. Check free reserves, securities premium, the 25% cap, the 2:1 post-buyback debt ratio, and whether any buyback closed in the last twelve months. If free reserves are inadequate, plan for Section 66 capital reduction and budget the timeline honestly.
• Obtain the valuation first. Commission a fair-value certificate from a SEBI-registered merchant banker or a practising chartered accountant using DCF or another internationally accepted methodology. The buyback price must not exceed this. The certificate is dated and stale valuations are challenged — sequence it close to the transaction.
• Pass the correct resolution. Board resolution if the buyback is within 10% of paid-up equity capital and free reserves; special resolution with an explanatory statement under Section 102 if above that and up to 25%.
• File Form SH-8 (letter of offer) with the RoC, accompanied by a declaration of solvency in Form SH-9 signed by two directors, one of whom must be the managing director where one is appointed. Keep the register of buyback in Form SH-10.
• Open the offer, complete acceptances, and extinguish the shares within seven days of the last date of completion. File the return of buyback in Form SH-11 with the RoC within thirty days of completion, with a compliance certificate in Form SH-15.
• Route the remittance through your AD Category-I bank, providing the valuation certificate, board/shareholder resolutions, the SH-8/SH-9 filings, and the tax withholding evidence. Withhold tax at the applicable DTAA dividend rate and issue Form 15CA/15CB for the outward remittance.
• File FC-TRS where the exit is a transfer rather than a buyback. If the foreign shareholder sells to a resident buyer instead of the company redeeming, the transaction is a transfer and Form FC-TRS must be filed on the RBI FIRMS portal (firms.rbi.org.in) within 60 days of receipt of consideration. Buyback itself is a capital reduction and is reported through the AD bank rather than FC-TRS — confirm the reporting route with your AD bank before remitting, because misreporting is itself a contravention.
• For Section 66 capital reduction, pass the special resolution, file the NCLT petition with the audited position and creditor list, respond to RoC, SEBI, income tax and creditor representations during the three-month window, obtain the order, and file Form INC-28 with the RoC within thirty days.

FAQ

Can we write a guaranteed buyback price into the shareholders' agreement?
No. FEMA prohibits assured returns to non-residents on equity instruments. An exit right is permissible; a pre-agreed exit price or IRR is not. The price must be fair value determined at the time of exit.

We have losses and no free reserves. What is our exit route?
Buyback under Section 68 is unavailable. The options are a selective capital reduction under Section 66 via NCLT, a secondary sale to a resident or another non-resident buyer with FC-TRS filing, or a scheme of arrangement. Plan for six to twelve months on the NCLT route.

Is buyback still tax-efficient for a foreign shareholder after the 2024 amendment?
Less so than before. Proceeds are now deemed dividend taxed in the shareholder's hands at the applicable DTAA rate, and the cost of acquisition converts to a capital loss rather than reducing the taxable amount directly. Model buyback against a secondary sale — which remains capital gains — before choosing the route.

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See Also

• GIFT City is not a shortcut into the Indian market: What FEMA and the IFSCA framework actually allow
• Convertible notes are just SAFEs with Indian paperwork: What FEMA and the FDI Policy actually require
• ESOPs to your Indian team from a foreign parent: What FEMA and the Income-tax Act actually require

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