Escrow Arrangements in Cross-Border Indian Deals: RBI Rules

Why Escrow Matters in Cross-Border Indian Deals

The RBI caps how much of a cross-border deal can be held back: no more than 25% of the total consideration may be subject to deferred payment, escrow, or indemnity arrangements without prior approval — beyond that, parties need the prior approval of the RBI (applied for through the AD bank). Each of those three mechanisms also carries an 18-month time ceiling, running from the date the SPA is executed for deferred consideration and escrow, or from the closing date for indemnity.

When a foreign company acquires shares in an Indian entity, or when an Indian company transfers equity to a non-resident, the transaction rarely closes in a single payment. Representations and warranties need backing, indemnity obligations require security, and deferred consideration demands a holding mechanism. This is where escrow arrangements enter the picture.

Under India's Foreign Exchange Management Act (FEMA), the Reserve Bank of India (RBI) regulates how escrow accounts operate in cross-border deals, with the operative provisions consolidated in the RBI Master Direction on Foreign Investment in India.

The Regulatory Framework: FEMA and RBI Master Direction

Core Legal Basis

The legal authority for escrow arrangements in cross-border deals comes from the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019, read with the RBI Master Direction on Foreign Investment in India (FED Master Direction No. 11/2017-18, as amended).

These regulations permit three distinct mechanisms in cross-border share transfer transactions:

• Deferred consideration: A portion of the purchase price is held back and paid later upon fulfillment of conditions
• Escrow arrangements: Funds are deposited with a neutral third party (an AD Category-I bank) pending completion of specified obligations
• Indemnity provisions: The seller provides a financial guarantee to cover post-closing liabilities

The 25% Cap Rule

The RBI imposes a hard limit: no more than 25% of the total consideration may be subject to deferred payment, escrow, or indemnity arrangements without prior approval. If a deal requires deferring more than 25%, the parties must seek the prior approval of the RBI through the AD bank — this is a transaction-specific RBI approval, distinct from the FDI government approval route.

The 25% limit is a single envelope across the three mechanisms — Rule 9(6) of the NDI Rules frames deferred payment, escrow settlement and indemnity as alternatives for "an amount not exceeding twenty-five per cent of the total consideration". Parties cannot stack a 25% deferred component on top of a separate 25% indemnity, and indemnity is available only where the buyer has paid the full consideration.

The 18-Month Time Limit

All three mechanisms are subject to an 18-month time ceiling, though the reference dates differ:

This distinction is critical. An escrow starts ticking from the SPA date, while an indemnity period starts from closing. In deals with gap between signing and closing, this can mean materially different effective protection periods.

Types of Escrow Accounts Under FEMA

INR Escrow Accounts

The standard escrow for cross-border deals is an Indian Rupee account maintained with an Authorized Dealer (AD) Category-I bank in India. The AD bank acts as the escrow agent, holding funds in trust until the release conditions specified in the escrow agreement are satisfied.

Key requirements for INR escrow accounts:

• Must be opened with a bank holding an AD Category-I authorisation from the RBI
• The escrow terms must form part of the SPA or transfer agreement, with the escrow agreement typically annexed to it
• All terms, conditions, and release triggers must be clearly documented
• The account can be funded through inward remittance via banking channels or by an AD bank guarantee

Non-Resident Escrow Accounts

Where the buyer is non-resident and the seller is also non-resident (common in secondary sales of FDI stakes), the escrow may be maintained outside India. FEMA pricing guidelines do not apply to a transfer between two non-residents, but the underlying investment must still comply with applicable sectoral caps and entry conditions.

Securities Escrow (Demat Account)

In addition to cash escrows, parties frequently use securities escrow accounts. Here, shares are held in escrow in a demat account with a SEBI-authorized depository participant. This is common in deals where shares are to be transferred in tranches or where the seller retains shares as security for indemnity obligations.

How Escrow Works in Practice: Step-by-Step

Step 1: Structuring the SPA

The share purchase agreement must explicitly reference the escrow arrangement, including the escrow amount (up to 25% of total consideration), release conditions, time periods, and dispute resolution mechanism. The NDI Rules require the deferral, escrow or indemnity terms to be part of the transfer agreement itself — not left to side letters.

Step 2: Selecting the Escrow Agent

The escrow agent must be an AD Category-I bank. AD Category-I banks that act as escrow agents include large Indian private-sector banks such as HDFC Bank, ICICI Bank and Axis Bank, and the Indian branches of international banks such as Citibank, HSBC and Standard Chartered.

Escrow agents charge a setup fee and annual maintenance charges that vary with deal size and the complexity of the release conditions; request the AD bank's escrow fee schedule early in the transaction.

Step 3: Funding the Escrow

For inbound FDI deals (foreign buyer acquiring Indian shares), the escrow is typically funded through inward remittance. The foreign buyer remits the escrow amount in foreign currency, which the AD bank converts to INR and credits to the escrow account. The remittance must be accompanied by the purpose code and Form FC-TRS reporting details (FC-GPR applies instead where the escrow funds a fresh issuance of shares).

Alternatively, the escrow can be backed by a bank guarantee issued by the AD bank or an overseas bank acceptable to the AD bank.

Step 4: Holding Period and Compliance

During the escrow period, the AD bank monitors the account for compliance with FEMA regulations. Interest earned on the escrow amount is typically addressed in the escrow agreement. The RBI does not mandate specific interest treatment, but the escrow agreement should specify whether interest accrues to the depositor, the beneficiary, or is distributed per a formula.

Step 5: Release or Forfeiture

Upon satisfaction of the release conditions (e.g., no indemnity claims within the specified period, achievement of earn-out targets, or completion of regulatory approvals), the AD bank releases the escrow funds to the designated party. If the transaction falls through, the AD bank may allow repatriation of the escrow amount at the prevailing exchange rate, subject to verification of bonafides.

Escrow in Different Deal Structures

Acquisition of an Indian Subsidiary

When a foreign company acquires 100% of an Indian wholly owned subsidiary from another foreign entity, the escrow typically covers post-closing indemnity for undisclosed liabilities, tax claims, and litigation. A portion of the deal value — within the 25% cap — is typically held in escrow for a period inside the 18-month window. The transfer pricing implications of the deal must also be addressed.

Joint Venture Exits

In JV dissolution or buyout scenarios, escrow accounts protect the buying partner against contingent liabilities that may surface after the selling partner exits. This is particularly important in sectors like FDI-regulated industries where regulatory approvals may be pending at closing.

Startup Acquisitions

In the Indian startup ecosystem, acqui-hires and asset purchases frequently use escrow for employee retention bonuses, IP transfer warranties, and earn-out mechanisms. The 18-month FEMA limit can be constraining for deals with multi-year earn-outs, requiring careful structuring or RBI approval.

Private Equity Exits and Secondary Sales

When a PE fund exits its Indian investment by selling shares to another foreign investor, escrow arrangements protect both parties. The selling PE fund typically places part of the exit proceeds in escrow to cover post-closing adjustments, tax indemnities, and representation breaches. Since both buyer and seller are non-residents, the escrow may be structured offshore, and FEMA pricing guidelines do not apply to a transfer between two non-residents — but the investment must still respect applicable sectoral caps and entry conditions.

Convertible Instruments and SAFE Notes

Foreign investors using SAFE notes or convertible instruments in Indian startup investments face additional escrow considerations. The conversion of these instruments into equity triggers FEMA compliance obligations, and any deferred or contingent payment held in escrow must still fit within the 25%/18-month envelope measured from the relevant transfer agreement — which can create tight timelines for multi-round deals.

Common Pitfalls and How to Avoid Them

Pitfall 1: Exceeding the 25% Cap Without RBI Approval

Some deal structures attempt to split the deferred component across multiple mechanisms to stay within the cap. The RBI takes a substance-over-form approach. If the total deferred or contingent component exceeds 25%, prior approval is required regardless of how it is labeled in the agreement.

Pitfall 2: Misunderstanding the 18-Month Start Date

The escrow clock starts from the SPA execution date, not the closing date. In deals with extended regulatory approval timelines (e.g., CCI approval, SEBI open offer), the effective escrow protection period post-closing may be significantly shorter than 18 months. Factor this into your deal timeline.

Pitfall 3: Using Non-AD Bank Escrow Agents

Only AD Category-I banks can serve as escrow agents for FEMA-regulated transactions. Using a law firm's client account, a non-banking financial company, or an offshore escrow service will render the arrangement non-compliant. The FEMA compliance consequences can include penalties under Section 13 of FEMA.

Pitfall 4: Inadequate Documentation

The NDI Rules require that escrow arrangements be captured in the share transfer agreement with all key details. Separate escrow agreements that are not referenced in the SPA may face scrutiny during AD bank compliance reviews.

Pitfall 5: Ignoring Tax Implications

Escrow releases may trigger withholding tax obligations under section 393(2) of the Income-tax Act, 2025 (Table, Sl. No. 17; section 195 of the Income-tax Act, 1961). The payer must deduct TDS at the time of credit or payment, whichever is earlier. For cross-border deals, the applicable rate depends on the DTAA between India and the investor's home country. File Form 145 and, where required, a Form 146 CA certificate (formerly Forms 15CA and 15CB) before remitting escrow funds abroad.

Recent Developments and Common Misconceptions (2025-2026)

Downstream Investments: The Arrangement Travels, the FEMA Escrow Account Does Not

Rule 9(6) of the NDI Rules — and paragraph 7.9.1 of the RBI Master Direction on Foreign Investment in India, which recites it — is written for transfers of equity instruments between a person resident in India and a person resident outside India. The extension to downstream investment comes from a different place in the same Master Direction: the Note inserted in the preamble to paragraph 9 (Downstream Investment) by the update of January 20, 2025, which records that the arrangements available for direct investment under the NDI Rules, including "payment arrangements/mechanism as per Rule 9(6) of the Rules", "shall also be available for the purpose of downstream investment" — provided the transaction does not circumvent Rule 23 of the NDI Rules, including the restrictions on use of borrowed funds for downstream investment. A downstream acquisition by a foreign-owned and controlled company (FOCC) can therefore carry a deferred, escrowed or indemnified component on Rule 9(6) terms.

Two things travel with it. First, the borrowed-funds bar: paragraph 9.3.6 of the Master Direction requires the Indian entity making a downstream investment that is treated as indirect foreign investment for the investee to bring in the requisite funds from abroad and not to use funds borrowed in the domestic markets, so a deferred structure funded or serviced out of a domestic rupee borrowing falls outside the Note. Second, and cutting the other way, the escrow account does not travel at all. Paragraph 7.10.1 permits a person resident outside India to open an escrow account in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016; a downstream acquisition is a transfer between two residents, so there is no non-resident to open one. The Note makes the escrow arrangement available; it does not give a domestic buyer a FEMA escrow account, and in practice the escrow is an ordinary domestic one.

Reporting differs too. A downstream investment treated as indirect foreign investment is reported in Form DI, not Form FC-TRS — the Master Direction on Reporting under FEMA, 1999 requires the Indian entity or investment vehicle making it to file Form DI with the Reserve Bank within 30 days from the date of allotment of equity instruments. That trigger is worded for allotment rather than for a secondary transfer, and the Reporting Master Direction prescribes no per-tranche Form DI obligation for deferred downstream consideration — do not assume one exists. Settle the reporting mechanics with the AD bank before signing.

INR Settlement Push

The RBI has been actively promoting INR settlement for cross-border transactions. The Foreign Exchange Management (Deposit) (Fifth Amendment) Regulations, 2025 (January 2025) allow foreign investors to use Special Non-Resident Rupee (SNRR) accounts for permissible current and capital account transactions with residents, expanding the options beyond the traditional NRE, FCNR(B), and escrow accounts. The previous 7-year limit on SNRR account tenure has been removed — the tenure now simply runs concurrent with the underlying contract or business of the account holder.

Cross-Border Payment Aggregator Framework

The RBI's cross-border payment aggregator framework imposes separate escrow-style collection account requirements for the inward (import) and outward (export) legs of cross-border payment flows. While primarily aimed at fintech and e-commerce, these rules impact foreign companies with payment processing operations in India.

FEMA Pricing Guidelines and Escrow Interaction

A critical consideration that many foreign investors overlook is the interaction between escrow mechanisms and FEMA pricing guidelines. Under FEMA, the price at which shares of an Indian company are transferred to a non-resident must not be less than the fair market value determined by an internationally accepted pricing methodology. Conversely, when shares are transferred by a non-resident to a resident, the price must not exceed the fair market value.

Impact on Escrow Structuring

The total consideration, including the deferred or escrowed portion, must comply with these pricing guidelines at the time of the SPA execution. This means the valuation report prepared by the registered valuer or chartered accountant must factor in the full deal value, not just the immediate payment. If the escrow release is contingent on earn-out targets, the maximum earn-out amount must still fall within the valuation parameters established at signing.

Currency Risk in Escrow

For foreign investors, the escrow period introduces currency risk. The escrow account is denominated in INR, but the foreign investor's reference currency is typically USD, EUR, or GBP. During the 18-month escrow period, INR depreciation against the investor's home currency can erode the effective value of the escrow amount. Some sophisticated deal structures include currency hedging provisions within the escrow agreement, though this adds complexity and cost.

RBI Reporting During Escrow

The escrow-linked transaction must be reported through the AD bank — Form FC-TRS for share transfers (FC-GPR for fresh issuances) — and reflected in the Indian company's annual FLA return. The reporting obligation continues throughout the escrow period, not just at the time of opening. Any release, partial release, or forfeiture from the escrow must be reported to the RBI within the prescribed timelines. Failure to report can attract penalties under FEMA, even if the underlying transaction is compliant.

Escrow Costs and Practical Considerations

Budget for several cost lines: the escrow agent's setup fee and annual maintenance charges, per-release transaction charges, bank guarantee commission where the escrow is guarantee-backed, legal fees for negotiating the escrow agreement, and the CA certificate for Forms 145 and 146 on outbound releases. Fee levels vary widely with deal size, the bank, and the complexity of the release conditions — obtain written fee quotes from the AD bank before signing the escrow agreement.

Key Takeaways

• Escrow arrangements in cross-border Indian deals are governed by FEMA and the RBI Master Direction, with a hard cap of 25% of total consideration and an 18-month time limit under the automatic route
• Only AD Category-I banks can act as escrow agents; using any other intermediary makes the arrangement non-compliant
• The 18-month clock for escrow starts from SPA execution, not closing. Factor regulatory approval timelines into your deal structure to maximize post-closing protection
• The 25%/18-month deferral, escrow and indemnity arrangements are also available for downstream investment by foreign-owned and controlled Indian companies (FOCCs), under the Note inserted in the preamble to paragraph 9 of the RBI Master Direction on January 20, 2025 — subject to the proviso that the transaction must not circumvent Rule 23 of the NDI Rules, including the bar on funding downstream investment with domestically borrowed money. The escrow account of paragraph 7.10.1 does not travel with it: that account is for a person resident outside India, so a FOCC uses an ordinary domestic escrow, and reports in Form DI rather than FC-TRS
• Always file Form 145, with a Form 146 certificate where Part C applies (a taxable remittance above INR 5 lakh without an Assessing Officer's certificate), and apply the correct DTAA rate before releasing escrow funds abroad to avoid withholding tax penalties