[By Adeeb Bakhtavar]
The author is a student of Dr. B.R. Ambedkar National Law University, Sonepat.
Introduction
Early 2025 saw the ‘reverse flip’ of RazorPay from its US-based holding company to an indian parent entity after receiving the nod from the Ministry of Corporate Affairs. Zepto, a quick commerce startup, also received formal approvals from both the Singapore court and India’s National Company Law Tribunal to execute its cross-border merger, thereby becoming an Indian parent entity. According to a recent white paper published by Bay Capital shows that the value of India’s publicly listed digital-first firms is $90 million. While headlines celebrated it as a win for the startups and indian markets, what remained unsaid was that, how such structural shifts like these can cloak opaque capital arrangements under the guise of regulatory compliance? Reverse mergers that were once deployed as alternative IPO routes, are now being strategically used to embed shadow capital, exploit jurisdictional leniencies, and bypass regulatory gatekeeping. This blog will examine how the entities are leveraging the gaps in Indian corporate and securities law to channel shadow capital via reverse mergers.
Conceptual Prelude: Reverse Mergers & Shadow Capital
Reverse mergers, traditionally used as listing shortcuts (also known as reverse takeovers, RTOs) can be referred to as transactions where a private company acquires a publicly listed shell company. It allows the private company to bypass lengthy regulatory scrutiny and gain access to capital markets through corporate restructuring. According to the OECD Shadow Banking Report, “Shadow Capital” refers to the opaque, non-traditional sources of private capital that are not regulated, are often outside the regulated fund structure, and mimic institutional capital but are under grey zones. Shadow capital lacks fiduciary supervision as the investors may not be bound by LPAs (Limited Partner Agreements) or SEBI audit rules, which can be used to bypass the disclosures regarding the beneficial ownership or voting rights to SEBI, MCA, or the exchanges. The National Company Law Tribunal’s 2024 ruling in Hologram Holdings Private Limited v. NCLT introduced what is now referred to as the “Substantive Business Purpose Test” under Section 232 of the Companies Act, 2013. Moving beyond the formalities of statutory compliance, the Tribunal held that merger schemes must demonstrate a genuine business rationale or contribute meaningfully to the public interest. The court concluded that such arrangements constituted “merely accommodation entries or paper transactions” designed to “artificially increase the share prices and use the merged company as a vehicle of tax evasion and money laundering”
2025 Regulatory Framework Landscape
The Stock Exchange Board of India (SEBI) amended the Issue of Capital and Disclosure Requirements (ICDR) regulations in March 2025, which marked the most significant regulatory evolution in reverse merger oversight since the original framework was established. As per the technical analysis of these amendments, the regulations struggle to be comprehensive yet contain some fundamental structural deficiencies that continue to enable sophisticated shadow capital deployment. The amended pre IPO transaction reporting framework, that is the regulation 58B(1):
“(1) Every issuer shall, within twenty-four hours of such transaction, disclose to the recognised stock exchange(s) and simultaneously on its website, all pre-issuance placements of equity or convertible securities which aggregate to an amount in excess of ₹25 crore”
Mandates all pre-IPO transactions exceeding ₹25 crore to must be reported to stock exchanges within 24 hours, despite this regulatory framework shadow capital operators can exploit the regulations through the method called “cascade structure” method, according to which a private entity involves structuring a transaction through multiple sub-₹25 crore tranches across different entities throughout a 12-month period in order to inject shadow capital into a listed shell company. While each transaction on its own is below the requirement for reporting threshold, the total amount of shadow capital deployed is significant. Such structured transactions are not recognised by SEBI’s current monitoring systems simply because of their lack in real-time aggregation capabilities. This is the concept of “connected transactions,” that very crucial in determining shadow capital but is not defined in ICDR regulations, and is not included by amended Regulation 58B(1).
The subsidiary companies can subsequently merge with their parent company through simplified merger procedures under Section 233 of the Companies Act 2013, which can effectively infuse substantial shadow capital without triggering enhanced disclosure obligations. The enhanced materiality thresholds under the regulation 32A(4) introduce tiered materiality thresholds which includes ₹10 crore or 2% of net worth (whichever is lower) for companies with net worth below ₹500 crore, and ₹25 crore or 1% of net worth for companies with net worth exceeding ₹500 crore. In contrast, the U.S. Securities and Exchange Commission’s Aggregation Rule under Section 13(d) of the Securities Exchange Act codified in 17 C.F.R. § 240.13d‑3(c) mandates the disclosure of beneficial ownership by aggregating holdings across related entities and coordinated investors, while the European Union’s transparency regime under the Shareholder Rights Directive and Disclosure Regulation (EU 2017/1129) requires consolidated reporting of financial exposures, thereby preventing circumvention through fragmented sub-threshold structures, a safeguard currently absent in India’s regulatory framework. As per the subsidiary parking strategy, for example, any XYZ Limited, a listed shell company with net worth of ₹450 crore, can create multiple wholly-owned subsidiaries. Then, shadow capital is injected through transactions of ₹9.5 crore each into different subsidiaries over a 18-month period. Each transaction remains below the 2% materiality threshold, avoiding consolidated disclosure requirements. This successfully infuses shadow capital through reverse mergers, without triggering SEBI regulations.
Furthermore, the amended LODR Regulation 27B Related Party Transaction (RPT) requires disclosure of all RPTs exceeding ₹1 crore on a consolidated basis, quarterly monitoring of cumulative RPT exposure, and an Independent director certification of arm’s length pricing. The current RPT disclosure requirements focus on individual transaction materiality rather than cumulative economic impact. For example, A sophisticated shadow capital scheme involving Entity A (shadow capital source) creating apparent arm’s length transactions with Entity B (reverse merger target) could include Entity A providing “consultancy services” to Entity B at inflated rates (₹95 lakh per quarter to remain below disclosure thresholds). Then, Entity B could lease assets from Entity A at below-market rates, creating an economic value transfer, following which the extended credit period will create shadow capital deployment through working capital support. This is called the circular transaction web, a sophisticated shadow capital scheme, in which the independent director lacks the technical expertise to evaluate complex shadow capital structures, making their certification process superficial.
Companies Act, 2013, Merger Provisions As Tools For Infusion Of Shadow Capital
As per Section 232(2)(h), reverse mergers involving listed transferor companies must comply with SEBI regulations regarding change in control, stock exchange listing agreement provisions, and enhanced disclosure requirements for unlisted transferee companies. Before the start of the NCLT proceedings, artificial creditors (entities controlled by shadow capital source) are created through inter-corporate loans, and then the voting rights of minority shareholders are diluted through preferential allotment to shadow capital-controlled entities. As a result, true economic fundamentals cannot be reflected by market prices, creating systematic mispricing that can cascade through interconnected market segments. To address these concerns, the NCLT introduced an “Objective Verification Test” by evaluating whether the merger aligned with the stated objectives and assessed the true intent and purpose behind the transaction. This scrutiny can uncover whether creditor claims are genuine or merely proxies for the shadow capital source, and whether preferential allotments unfairly dilute minority interests. This includes a detailed factual investigation of the facts and also a more informed analysis of the financial and strategic benefits proposed to be claimed by the applicant companies to assess whether the stated goals of a merger genuinely reflect the company’s financial and operational reality. In doing so, the Objective Verification Test helps restore transparency, uphold fair valuation, and mitigate the risk of systemic mispricing driven by manipulated fundamentals.
Indian companies can undertake cross-border mergers with foreign companies under Sections 234 to 240 of the Companies Act, 2013. Such transactions require approval from the Reserve Bank of India to ensure compliance with foreign exchange regulations, as well as clearance from the Central Government for investments in strategic sectors. Additionally, companies must adhere to applicable sectoral caps and follow the permitted entry routes under India’s foreign investment policy.
These provisions fail to recognise the jurisdiction Shopping Strategy as per which offshore vehicles are created through shadow capital in jurisdictions with weak beneficial ownership disclosure (e.g., British Virgin Islands, Cayman Islands). Even though Double Taxation Avoidance Agreements (DTAAs) include Limitation of Benefits (LoB) clauses meant to prevent treaty abuse, sophisticated structures still find ways to claim treaty benefits. Typically, shadow capital operators utilise multi-layered offshore vehicles to disguise beneficial ownership while maintaining DTAA benefits. The General Anti-Avoidance Rule (GAAR), implemented to prevent tax avoidance, proves inadequate against sophisticated shadow capital structures that maintain substance requirements while achieving regulatory arbitrage. In practice, the offshore Special Purpose Vehicle (SPV) sets up an Indian subsidiary with minimal capital investment. Once established, large amounts of funds or assets are transferred from the shadow capital source to this Indian subsidiary in a way that appears legitimate on paper. Finally, the Indian subsidiary merges with a listed shell company in India using the Section 234 cross-border merger provisions. This process allows shadow capital to enter Indian markets under the appearance of a compliant cross-border transaction, while avoiding genuine disclosure and regulatory oversight. Indian capital, routed through foreign jurisdictions and reintroduced as Foreign Direct Investment (FDI) or Foreign Portfolio Investment (FPI), represents a significant shadow capital channel. This process allows shadow capital to enter Indian markets under the appearance of a compliant cross-border transaction, while avoiding genuine disclosure and regulatory oversight.
Conclusion
It is suggested by indicators such as Gross Non-Performing Assets (GNPA) of 2.8% and Net Non-Performing Assets (NNPA) of 0.6% that there is banking resilience, but there’s an undercurrent of vulnerability. GNPA represents the proportion of total loans that are in default without deducting provisions, while NNPA accounts for these provisions, showing the actual potential loss to the bank. Low GNPA and NNPA ratios typically suggest sound asset quality and effective risk management. These numbers obscure a shadow financial layer that is built through reverse mergers and complex deal structures, that cannot be captured by conventional metrics. Shadow financial layers can artificially inflate valuations, disguise true ownership, and circumvent regulatory scrutiny. As a result, while headline asset quality numbers appear healthy, the system may remain exposed to sudden shocks if these opaque, leveraged positions unwind or trigger contagion across interconnected market segments.
To meaningfully address the structural risks posed by shadow capital, India’s regulatory regime needs a coordinated upgrade. AI-driven, blockchain-based systems to detect sub-threshold deal fragmentation and connected party flows should be deployed by SEBI, which can be aligned with the intent behind Regulation 58B(1) of the ICDR Regulations. Further, the Unique Entity Identification Codes and rolling 12-month aggregation windows can make these mechanisms proactive rather than reactive. The purpose is to catch attempts to evade disclosure rules by breaking a large deal into many smaller ones that each stay below reporting thresholds. By aggregating them over time, authorities can see the true size and intent of connected deals, making enforcement more effective against fragmentation and hidden related-party transactions. To combat jurisdiction shopping, the GAAR provisions under the Income Tax Act must be paired with real-time source-country verification of FDI/FPI flows, and Sections 234–240 of the Companies Act, 2013 should be interpreted using economic substance standards. Materiality thresholds under Regulation 23 of LODR must be dynamic, sector-sensitive, and apply to group-level disclosures, particularly for NBFCs and manufacturing. To safeguard market integrity, SEBI must operationalise real-time surveillance for pricing distortions, mandate disclosure of debt arrangements above ₹1 crore, and enforce director-level certification with personal liability for reverse merger approvals. Without these reforms, the regulatory architecture will remain one step behind the structures it seeks to regulate.