Last verified: 2026-05-15
In October 2024, a Delhi-headquartered D2C beauty conglomerate’s roughly Rs 450 crore acquisition of a Mumbai-based personal-care brand was being held up across business pages as a textbook strategic exit. Press releases described it as a clean transaction. Six months later, the deal had become a case study in why earn-out clauses in Indian M&A deals fail when drafting cuts corners on security, default triggers, and tranche-protection covenants. The acquirer had picked up a fast-growing personal-care portfolio; the selling founders had cashed out at a healthy multiple. That description was no longer holding together.
What had been signed as a staggered consideration deal began to fray almost as soon as the integration teams sat down together. Subsequent tranche payments owed under the consideration mechanism did not arrive on schedule. By late 2024, the acquirer’s balance sheet had thinned considerably, and the selling founders found themselves circulating default notices against the same group that had been their counterparty a year earlier. What looked like a clean all-cash sale was, in substance, an earn-out problem.
By February 2025, the brand had been repurchased by the selling founders at roughly a third of the original consideration. The buyback was funded out of personal capital, partly to absorb operating debts the brand had taken on under the acquirer’s ownership. None of the reportage centred on the consideration mechanism. But every M&A practitioner reading the press coverage saw the same thing: a deferred-consideration structure with no parent guarantee, no escrow tranche-protection, and no clean acceleration trigger had blown up in slow motion.
This is what most Indian earn-out failures look like. They aren’t dramatic frauds. They’re drafting omissions that look harmless until the second tranche is due, the acquirer’s cash position turns, and the seller realises every protective covenant they thought they had is either missing or unenforceable in the time available. The founders here were lucky in one respect: their brand was still operating, and they had the personal capital to buy it back. Most sellers caught in this position don’t get a second chance. They watch a contingent payment they had already mentally allocated to a vacation home or a next venture quietly disappear, and they litigate for five years to recover thirty cents on the rupee.
The practitioners who avoid this don’t get there through luck. They draft earn-outs with the assumption that something will go wrong, that the counterparty’s balance sheet will deteriorate, that the EBITDA definition will be contested, that the year-of-accrual treatment will be challenged by the tax department, and that the FEMA timeline will collide with operational reality. That assumption produces tighter clauses, smarter security, and faster dispute mechanics. It’s also the skill that separates M&A associates who quarterback deals from those who only document them.
An earn-out clause in an Indian M&A deal defers part of the purchase price until the target hits agreed financial or operational milestones post-closing. Cross-border deals run inside FEMA’s 18-month and 25 percent ceiling, and tax treatment swings between capital gains under Section 45 and salary under Section 17(3) depending on whether the seller continues in the business after closing.
The rest of this guide walks through every layer that this unwinding tested: how earn-outs are structured under Indian law, how FEMA and the NDI Rules constrain cross-border deals, how Indian courts split on whether contingent consideration is taxable now or later, what the new 2024-25 regulatory layer changes, what model drafting actually looks like, and how disputes usually unfold.
What is an earn-out clause in an Indian M&A deal?
An earn-out clause is a contract device that splits the purchase price into a fixed amount payable at closing and a contingent amount payable later, tied to how the target performs after the deal is signed. In Indian practice, the contingent piece is usually pegged to EBITDA, revenue, or a defined operational milestone over a measurement window of 12 to 24 months. The buyer pays less upfront, the seller has a path to recover the valuation they couldn’t get at signing, and the risk of the target underperforming is shifted, at least partially, to the seller.
That is the textbook description. What most people miss is everything the textbook leaves out: the FEMA cap on cross-border deferral, the Income-tax Act’s treatment of contingent receipts under Section 45 of the Income-tax Act, 1961 capital gains versus Section 17(3) salary, the regulatory disclosure requirements for listed acquirers, and the drafting fault lines that produce most disputes. The seller’s lawyer who treats the earn-out as “just a price clause” is the one who calls back in eighteen months asking how to enforce it.
Earn-outs sit at the intersection of three legal disciplines that don’t usually talk to each other: contract drafting, corporate tax, and exchange-control regulation. Most M&A associates are strong in one, competent in the second, and weak in the third. Building genuine fluency across all three is what separates the practitioner who structures earn-outs from the one who only redlines them. The reader who finishes this guide should be able to draft, defend, and tax-optimise an earn-out across the full deal lifecycle: from term sheet through closing, measurement, payout, and dispute.
The economic logic: closing the valuation gap
Why do buyers and sellers reach for earn-outs in the first place? The short answer is they can’t agree on what the target is worth at closing. The seller’s view rests on a forward projection: where the business will be in 18 months once the integration is complete. The buyer’s view is grounded in trailing twelve-month numbers, the underlying customer concentration, and a discount for execution risk. Those two views can be a multiple apart. Without a mechanism to bridge the gap, the deal either dies, the buyer overpays, or the seller walks.
The earn-out closes the gap by making the disputed slice of value contingent on the seller’s projection actually playing out. If the target hits the EBITDA number, the seller gets the upside. If it doesn’t, the buyer didn’t overpay. In practice, this is most useful in deals where the target’s value is heavily dependent on a small number of variables that the buyer can’t fully diligence: key customer retention, founder continuity, regulatory approvals, or a new product launch.
The 2024-25 Indian M&A cycle made this mechanism almost unavoidable in mid-market deals. After the post-2022 funding correction, valuation gaps in private deals widened noticeably; SRS Acquiom’s deal-terms data places earn-out usage at roughly 22 percent of global private-target deals through 2024-25, up materially from pre-2020 baselines. Indian PE and strategic acquirers have followed the same path. So have founder-sellers, who’d rather take an earn-out than accept a lower valuation outright.
Here’s where it gets interesting. The earn-out doesn’t just close the valuation gap; it redistributes execution risk. The buyer is essentially saying: “I’ll pay you the upside, but only if the business you’re selling me actually produces it.” The seller is saying: “I’ll bear that risk, as long as you don’t sabotage my ability to deliver.” That trade is the entire drafting battle. Every clause that follows, from EBITDA definition to anti-manipulation covenants, exists to police that exchange.
The economic logic, then, is sound. The failure points lie in operationalising it. A common mistake we see is the deal team treating the earn-out as a way to bridge a gap they couldn’t otherwise close, rather than as a contingent payment they’re genuinely committed to honouring. Buyers who walk into earn-outs with no real intention of paying tend to draft them badly, integrate the target badly, and dispute badly. That’s not a structural defect of the earn-out; it’s a defect in the deal team’s intent.
Earn-out vs deferred consideration vs holdback vs CVR
These four terms get used interchangeably in deal documents, and that’s where the trouble starts. They aren’t synonymous. Each has a distinct purpose, a distinct tax trigger, and a distinct dispute profile. The mistake we see most often is mixing them up in the drafting, which is one of the cleanest tells that the lawyer hasn’t done this before.
A pure deferred consideration is simply a portion of the purchase price payable on a future date, with no contingency on performance. The seller knows the rupee amount; only the timing is deferred. This is the structure the Delhi High Court considered in the Ajay Guliya v. Assistant Commissioner of Income Tax, (2012) 209 Taxman 176 (Del) line. From a tax perspective, the entire consideration accrues in the year of transfer under Section 45 (on the Delhi view), because the right to receive has crystallised even if the rupees haven’t moved.
A holdback (or escrow holdback) is consideration that’s set aside in escrow at closing to satisfy potential indemnity claims, warranty breaches, or working-capital adjustments. It is the seller’s money, parked. It’s released to the seller on the lapse of the indemnity window unless the buyer makes a valid claim. Tax treatment usually follows the consideration head: capital gains, with the right to receive recognised at closing subject to specific carve-outs.
An earn-out, by contrast, is a contingent payment whose existence (not just timing) depends on future performance. The seller doesn’t know the rupee amount at closing; it could be zero, the full target, or any point in between. This is the structure the Bombay High Court considered in Commissioner of Income Tax v. Mrs. Hemal Raju Shete, (2016) 239 Taxman 176 (Bom), and the year-of-accrual question becomes genuinely contested.
A contingent value right (CVR) is a tradeable security issued at closing that pays out on the occurrence of a specified event. In Indian deals, CVRs are rare; you see them mostly in listed-target deals where the parties want a market-traded contingent instrument rather than a private contract right. They’re regulated as securities, not as ordinary contract rights, and they bring SEBI disclosure obligations the parties may not have planned for.
| Mechanism | Purpose | Tax-trigger timing | Common Indian use case |
|---|---|---|---|
| Earn-out | Bridge valuation gap on performance | Contested: year of transfer (Delhi) vs year of accrual (Bombay/Mumbai ITAT) | Founder-led mid-market, PE-backed, tech and services targets |
| Deferred consideration | Pure time-deferred payment | Year of transfer, full amount on Delhi view | Resident-to-resident; strategic acquisitions with payment scheduling |
| Holdback / escrow | Security for indemnity, warranty, working-capital | Closing, subject to release conditions | Almost every Indian SPA above mid-market scale |
| CVR | Tradeable contingent instrument | At payout, treated as securities-receipt | Listed-target / cross-border listed combinations (rare in India) |
When a draft consideration clause uses these terms interchangeably, the seller’s counsel should treat that as a redlining priority. The buyer’s drafting incentive is to leave the labels loose; that gives them flexibility in how they argue tax, FEMA, and dispute later. The seller’s incentive is the opposite: lock the labels down, lock the tax characterisation down, and force the buyer to commit early to a single structure.
Where earn-outs sit in the Indian SPA architecture
An earn-out doesn’t live in one clause. It lives in three places in the SPA, and the drafting fights happen at the seams between them. Get the seam-drafting right and you save yourself most of the disputes; get it wrong and the document fights itself.
The first home is the consideration definition. This is where the SPA defines the closing payment, the deferred or contingent payment, and the formula that produces the earn-out amount. Drafting fights here centre on: what counts as the closing amount, what the maximum earn-out is, what the floor is (often zero), and what the catch-up or true-up mechanic looks like if the measurement period overlaps with a working-capital adjustment.
The second home is the closing and post-closing covenants. This is where the buyer commits to specific operating behaviours during the measurement period: maintaining the business as a going concern, not making accounting-policy changes without seller consent, providing the seller with monthly financial statements, granting audit-and-inspection rights, and so on. This is the part of the SPA where, in practitioner experience, sellers under-negotiate. They focus on the consideration clause and treat the covenants as boilerplate. Then the dispute arrives and they discover the covenants are toothless.
The third home is the indemnity and escrow architecture. The earn-out interacts with indemnity claims (can the buyer set off an indemnity claim against an earn-out payable?), with the escrow (does the earn-out flow through escrow or directly between parties?), and with the warranty caps (does the earn-out count against the consideration ceiling for warranty claims?). For an in-depth view of how the consideration clause meets the indemnity-escrow architecture in a typical Indian SPA, read our companion guide on share purchase agreement drafting in India, which walks through the full SPA spine.
The dispute pattern follows the seams. If the EBITDA definition is buried in the consideration clause and the operating covenants are silent on accounting-policy changes, the buyer can effectively redefine EBITDA mid-measurement period and the seller has no contractual hook to object. Tying these three homes together is what separates a well-drafted earn-out from a clause that looks fine on paper and falls apart in practice.
Why so many earn-outs fail to pay out: the 21 percent problem
Bottom line: this is the statistic that should sit on every M&A associate’s desk. Across SRS Acquiom’s M&A claims data over recent cycles, only around 21 percent of earn-outs pay out in full. Roughly a quarter pay nothing. The rest pay partially. In other words, the contingent piece the seller mentally treats as money in the bank is, on the broad base rate, more likely to disappoint than deliver.
Why? The reasons cluster into four buckets. First, the target genuinely underperforms; the seller’s projection was wrong, the integration created friction, or external conditions changed. Second, the EBITDA or revenue definition gets disputed mid-measurement, and the parties end up arguing about accounting rather than performance. Third, the buyer’s post-closing decisions (integration costs, product rationalisation, customer reallocation) suppress the metric in ways the seller didn’t anticipate. Fourth, the buyer’s balance sheet weakens, and even where the metric is hit, payment fails to arrive on time. The opening Delhi-Mumbai personal-care unwinding falls into this fourth bucket.
The historical pattern matters here. From the early 2010s, when earn-outs were rare in Indian deals, to the post-2020 surge in PE-backed mid-market acquisitions, the failure rate hasn’t materially improved. If anything, the rise of complex post-closing manipulation patterns (intercompany expense allocation, parent-group cost dumping, accounting-policy migration to parent standards) has made disputes more frequent, not less.
The second-order effect is worth flagging. As earn-out disputes have proliferated, a parallel forensic-accounting practice has emerged in India that didn’t exist meaningfully a decade ago. Joint expert-determination teams now routinely bring together chartered accountants, dispute lawyers, and forensic accountants in arbitration-driven engagements. For diligence-stage practitioners, the earn-out failure base rate is a reminder that the diligence findings that predict earn-out failure (customer concentration, founder dependency, weak management depth, integration complexity) deserve more weight than they typically get. The diligence findings that predict earn-out failure sit at the intersection of commercial and legal diligence, and most teams under-invest there.
A common question practitioners raise is whether sellers can negotiate a “floor” earn-out, a minimum guaranteed contingent amount irrespective of performance. The answer is yes, in principle, though it changes the tax characterisation: a guaranteed minimum is, in effect, deferred consideration to that extent, accruing at closing, with only the excess being genuinely contingent. We’ve seen this used as a compromise structure in deals where the seller has real bargaining power and the parties want to limit downside without abandoning the contingent upside. Drafting it requires care to keep the contingent slice cleanly separable for tax purposes.
The worst pitfall is treating the earn-out as the seller’s “real” consideration in negotiation, then drafting it as if it were a discretionary buyer favour. The earn-out has to be drafted to a payable standard. If the seller can’t enforce it in the worst-case scenario (acquirer balance-sheet stress, integration failure, accounting dispute), the seller has accepted less than the headline number suggests they got.
How earn-out structures are designed in Indian M&A deals
Earn-outs aren’t a single template. They are a family of structures, and choosing the right one is the most consequential decision in the term sheet. The choice locks in the tax profile, the dispute risk, the FEMA constraint, and the protection that drafting can realistically deliver. Getting this wrong at term sheet stage produces a deal that can never quite be saved at SPA stage.
Indian deals usually pick from six structural variants:
- EBITDA-linked earn-out: payment scales with the target’s earnings before interest, tax, depreciation, and amortisation over a defined measurement period.
- Revenue-linked earn-out: payment scales with topline revenue, often capped or banded.
- Gross-margin earn-out: payment scales with revenue minus cost of goods sold, used where the target’s margin profile is the actual value driver.
- Milestone or KPI earn-out: payment triggers on the occurrence of defined non-financial events (regulatory approval, customer-retention thresholds, product launch, daily-active-user count).
- All-or-nothing earn-out: the contingent amount is either paid in full or not at all, based on a single threshold.
- Sliding-scale earn-out: the contingent amount scales linearly or by tiers with the metric, with a floor and a ceiling.
Most Indian SPAs combine two or more of these. A typical structure pairs EBITDA-linked with a sliding-scale payout and a non-financial milestone trigger. The combination tries to spread the dispute surface area so no single measurement dispute can blow up the entire earn-out. Whether that works depends almost entirely on the drafting.
So why do practitioners default to EBITDA over revenue when both are mathematically available? Because EBITDA is supposed to align the seller’s incentives with the buyer’s economic interest. Revenue can be grown unprofitably; EBITDA, in theory, cannot. In practice, both are manipulable, just in different directions. The buyer’s view is that EBITDA is the harder metric to game upward. The seller’s view is that EBITDA is the easier metric for the buyer to suppress through cost allocation. Both views are correct.
EBITDA-linked earn-outs: the dominant Indian structure
EBITDA-linked earn-outs are the modal Indian structure. The textbook Moody’s Analytics Inc., In re, (2012) 348 ITR 205 (AAR) ruling involved exactly this fact pattern: a foreign seller, no continuing operational role, contingent payment tied to the target’s financial performance. The Authority for Advance Rulings held that the contingent payment was part of capital gains under Section 45 of the Income-tax Act, 1961, not salary, not business income.
What “EBITDA” actually means in a contract context is the entire fight. In any given Indian earn-out arbitration, the EBITDA definition will run to twenty or thirty lines, and the dispute will be entirely about how those lines were drafted and how they should be applied to a particular post-closing cost item.
The five recurring EBITDA-definition battles, in the order they appear in most disputes:
The first is parent-cost allocation. After the buyer integrates the target into a larger group, the parent starts allocating its costs (HR, IT, legal, finance, brand royalties) to the subsidiary. Each of those allocations reduces EBITDA. Unless the SPA expressly carves these out, the seller watches EBITDA shrink without any operational change in the target.
The second is integration-cost normalisation. Integration projects (system migrations, severance, office consolidation) generate one-time costs that don’t reflect the target’s ongoing earning power. A well-drafted definition treats these as add-backs; a loosely drafted one doesn’t, and the seller absorbs the cost.
The third is accounting-policy consistency. If the target was using one accounting policy at closing (revenue-recognition timing, depreciation schedule, inventory valuation) and the buyer migrates to the parent’s policy mid-period, EBITDA shifts mechanically. The standard fix is a “consistency with past practice” covenant; the standard counter is the buyer arguing that the parent’s policy is what’s required by law or accounting standards.
The fourth is one-time item handling. What counts as a one-time item? The buyer’s view tends to narrow this; the seller’s view tends to widen it. Without a defined list or a clear decision rule, the parties end up arguing case by case.
The fifth is intercompany transfer-pricing flow. If the target buys or sells from sister entities at non-arm’s-length prices post-closing, EBITDA gets distorted. The drafting fix is to require all intercompany transactions to be at arm’s length, with the seller having audit rights to verify.
But the EBITDA definition isn’t only a sellers’ battle. Buyers also lose disputes when the definition is too narrow and the target outperforms in ways the formula doesn’t capture. The better approach, in our view, is to draft a definition that genuinely reflects the parties’ commercial expectation, then build a tight expert-determination mechanism around it. Mechanical perfection in the definition is less important than a credible dispute path.
A common question practitioners raise is whether the definition should reference a specific accounting standard (Ind AS, IFRS) or be self-contained. Both approaches work; the choice usually depends on whether the target uses Ind AS as a matter of course and whether the parties trust the relevant standard to remain stable across the measurement period. In services and tech targets, where standards are evolving, a self-contained definition with explicit decision rules tends to fare better in disputes.
Revenue-linked and gross-margin earn-outs
Revenue-linked structures appeal when the buyer is willing to take cost-side execution risk but wants the seller’s incentives aligned with topline growth. Sellers prefer revenue over EBITDA because revenue is harder for the buyer to suppress (cost allocation doesn’t reduce it), and the metric is closer to what the seller actually controls. Buyers reluctantly accept revenue when the alternative is no deal, but they almost always layer in a margin floor: “revenue counts toward earn-out only if gross margin stays above X percent.”
Gross-margin earn-outs are a halfway house. They preserve the upside-tracking property of EBITDA (margin is the proxy for value) without the full surface of cost allocation. They work best for product-based targets where COGS is genuinely product-specific and hard to manipulate.
In practice, the structure choice tracks the target’s sector. Consumer-products and pharma targets tend to use gross-margin or revenue. Tech and services targets default to EBITDA. AI and platform targets are increasingly using non-financial KPIs (more on this below). The structure should match the value driver. A revenue earn-out on a high-margin services target gives the seller too much room; an EBITDA earn-out on a hardware target gives the buyer too much room to suppress.
But revenue earn-outs come with their own trap: they don’t address customer-concentration risk. If the target’s revenue comes from three large customers, and the buyer’s post-closing decisions affect any of those relationships, the entire revenue metric is at risk. Drafting needs to either carve out customer-attrition events or build a customer-retention condition into the formula.
Non-financial, milestone, and KPI earn-outs
Where the target’s value can’t be captured in a single financial metric, parties move to non-financial milestones. The familiar examples: regulatory approval (drug approval, banking licence), customer retention (top-10 customer renewal), product launch (new product hits market by date X), or operational benchmarks (daily-active users, monthly-active users, contract retention rate).
Non-financial earn-outs have one advantage and one disadvantage. The advantage: they’re harder to manipulate through accounting because they don’t depend on financial statements. Either the regulatory approval comes through, or it doesn’t. The disadvantage: they often turn on events partly outside both parties’ control, which makes the seller’s exposure to bad-faith conduct sharper.
A practical example in Indian deals: a pharma acquirer agreeing to pay the contingent slice on receipt of CDSCO approval for a specific molecule. If the approval doesn’t come, the earn-out doesn’t pay. If the approval is delayed because the buyer changed the submission strategy or reallocated the regulatory affairs team, the seller has a serious dispute on its hands. The drafting fix is a defined “best efforts” obligation on the buyer to pursue the approval as a reasonable operator would, with audit rights.
The forward-looking trend here is the rise of AI-target acquisitions where revenue is unreliable. Early-stage AI targets often have minimal revenue but defensible underlying technology and a path to commercialisation. Buyers can’t price these as revenue or EBITDA targets; the numbers aren’t there. Early signals from 2024-25 deal documentation suggest a shift toward KPI-linked earn-outs in this segment: monthly-active enterprise users, contract retention, model-output quality benchmarks. Indian PE-backed acquirers are reportedly piloting these structures in late-2025 mid-market tech deals. Expect ITAT and tax-counsel debates on whether KPI-linked earn-outs are performance-based capital gains or service-based business income in the next two to three assessment cycles.
All-or-nothing vs sliding-scale vs hybrid structures
The structural question after the metric is the payout curve. An all-or-nothing earn-out pays the full contingent amount if the target hits the threshold, and nothing if it misses. A sliding-scale earn-out scales the payment continuously or by tiers between a floor and a ceiling.
Why does the choice matter? Because all-or-nothing creates the highest dispute incentive. If the target is at 98 percent of the threshold, the seller has every reason to litigate the calculation; the difference between 98 and 100 percent is the entire earn-out. Sliding-scale dilutes that incentive: at 98 percent, the seller gets 98 percent of the contingent amount, and the marginal dispute is small.
For this reason, the practitioner default in Indian deals is sliding-scale with a floor (often zero) and a ceiling (often the full contingent amount, sometimes with an over-performance kicker capped at 110-120 percent). The hybrid variant adds a tier structure: 0 percent payout below the floor, linear scaling between floor and target, full payout above target, capped over-performance kicker.
But all-or-nothing isn’t obsolete. It works in deals where the threshold is genuinely binary (regulatory approval, customer contract renewal) and where the parties want a clean trigger rather than a continuous calculation. Hybrid structures suit deals where multiple drivers each have their own payout curve: an EBITDA tier plus a revenue tier plus a milestone trigger.
A common pitfall: parties draft a “stretch” tier above target without thinking through who pays the over-performance kicker. If the seller has continued in management and is responsible for the over-performance, the kicker may bleed into salary characterisation under the Anurag Jain, In re, (2005) 277 ITR 1 (AAR) line. We’ve seen this trip up otherwise well-drafted earn-outs because nobody routed the over-performance kicker past tax counsel.
Cash, shares, and consideration-in-kind
The contingent amount doesn’t have to be paid in cash. It can be paid in shares of the buyer (or the buyer’s parent), in preference shares, in convertible instruments, or in a mix. Each form changes the tax treatment, the FEMA treatment, and the security profile.
Cash is the simplest. The buyer pays rupees on the trigger date, the seller pays capital-gains tax (or salary tax, depending on classification), and the FEMA pathway is the standard deferred-consideration route subject to the 25 percent and 18-month cap.
Share consideration creates a different problem. If the earn-out is paid in shares of the buyer’s listed parent, the seller’s tax base is the fair market value of the shares on the date of receipt, not on the date of the SPA. That can be a material difference in volatile markets. FEMA-wise, the issue of fresh shares to a non-resident seller has to meet the NDI Rules pricing guidelines: not below fair value as computed under the NDI Rules valuation method. For a listed acquirer, the pricing has to comply with the SEBI ICDR floor under Regulation 163 of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 if preferential allotment is used.
Preference shares are the workhorse cross-border workaround. Because preference share repayment is a debt-like obligation, not a contingent payment, it sits outside the FEMA deferred-consideration cap. A common structure: the buyer issues compulsorily convertible preference shares to the seller at closing, with conversion or redemption tied to performance. The economic effect is similar to an earn-out, but the regulatory characterisation is fundamentally different.
The catch is that preference-share workarounds attract tax-department scrutiny. If the substance of the arrangement is earn-out-like, the assessing officer may recharacterise the payment, and CBDT clarifications on Section 56(2)(x) of the Income-tax Act apply to deemed-income scenarios where preference shares are issued below fair value. The drafting needs to either commit fully to the preference-share characterisation (with rights and conversion mechanics that genuinely look like preference capital) or accept the earn-out characterisation and price accordingly.
The bottom line is that consideration form is a tax-and-FEMA decision before it’s a commercial one. We’ve seen deals where the parties chose share consideration for commercial reasons (locking the seller into post-closing alignment) and then discovered they had created tax and FEMA exposures they hadn’t priced. The order of decisions matters: tax and FEMA first, commercial overlay second.
Mechanism
Tax-trigger timing
FEMA cap / window
Typical use case
Dispute risk
Earn-out
Contested — year of transfer (Delhi) vs year of accrual (Bombay / Mumbai ITAT)
25% / 18 months on cross-border deferred consideration (FEMA NDI Rule 9-A)
Bridge valuation gap on performance in PE-backed mid-market deals
HIGH — EBITDA computation, anti-manipulation, payment default
Deferred consideration (post-closing instalments)
Year of transfer on full amount under Delhi view
25% / 18 months on cross-border tranches (FEMA NDI Rule 9-A)
Resident-to-resident scheduling; strategic acquisitions
MODERATE — timing and security
Compulsorily Convertible Debentures (CCDs)
At conversion or transfer of underlying shares
Treated as equity under FEMA NDI Rules; no 18-month cap
Cross-border deferral workaround; FDI-compliant capital infusion
MODERATE — pricing guidelines and conversion timing
Convertible / non-convertible preference shares
On redemption, conversion, or transfer (capital gains)
Equity (CCPS) outside 18-month cap; NCPS treated as debt
Closing payment fragmentation; dividend-based seller return
MODERATE — SEBI / Companies Act issuance compliance
FEMA, NDI Rules, and the 18-month / 25 percent ceiling
This is where Indian earn-outs depart most sharply from the global norm. In Delaware and UK deals, earn-out periods routinely run three to four years and the deferred portion can be a meaningful share of total consideration. In Indian cross-border deals, Section 6 of the Foreign Exchange Management Act, 1999 and the NDI Rules layer a hard cap on top of every other consideration design choice. And that cap isn’t just a technical constraint; it shapes the entire deal architecture.
The cap, in short: in a transfer of shares of an Indian company between a resident and a non-resident, no more than 25 percent of the total consideration can be deferred, and the deferral cannot extend beyond 18 months from the date of the transfer agreement. Everything else has to be paid upfront. This regime, introduced via RBI Notification No. FEMA.368/2016-RB in 2016, replaced the prior approval regime that had effectively blocked routine cross-border earn-outs in Indian deals. It was a structural unlock; it remains a structural constraint.
So how do deals built for 24- or 36-month measurement periods fit inside an 18-month window? They don’t, cleanly. The drafting workarounds (preference shares, consultancy fees, retention bonuses, escrow holdbacks) are the entire reason the FEMA-cross-border practice has become its own sub-specialty. The 18-month cap is the single most outcome-determinative regulatory rule in Indian M&A consideration design.
The FEMA framework for deferred consideration
The 2016 notification was the foundational regulatory event. Before 2016, every deferred-consideration structure in a cross-border Indian deal needed prior RBI approval, which meant deals had to be timed around the approval window or structured to avoid deferral altogether. The 2016 amendment moved deferred consideration into the automatic route, subject to the 25-percent-and-18-months cap, a fair-value pricing floor, and reporting requirements.
The mechanics that matter for earn-out drafting: the 25 percent is a hard ceiling on the deferred share, measured against total consideration. The 18 months runs from the date of the transfer (typically the SPA execution or share-transfer date, depending on structure). The pricing has to comply with NDI Rules valuation, which for an unlisted target means a DCF or a recognised methodology produced by a SEBI-registered Cat-I merchant banker.
But the 25 percent isn’t a cushion. A common drafting mistake is treating the 25 percent as a cushion. Parties draft a 30 percent earn-out and assume they can adjust at closing if FEMA flags it. They can’t, cleanly. Post-closing reduction of the deferred portion creates its own questions, and the RBI’s interpretation of “consideration” has historically included anything substantively contingent, not just the line item labelled “deferred”. Stay inside the cap by design, or restructure into an alternative mechanism.
Worth flagging: the cap applies to share-purchase consideration, not to ancillary contractual payments. Consultancy fees, retention bonuses, and non-compete payments are not deferred consideration; they’re payments for distinct services or undertakings. But that distinction is only as strong as the drafting. If the consultancy agreement looks like a thinly disguised earn-out, the RBI and the tax department can both look through it.
Resident-to-resident vs cross-border deals: what changes
The FEMA cap applies only when at least one party crosses the resident/non-resident line. Resident-to-resident deals (Indian-resident seller, Indian-resident buyer, Indian target) are not constrained by the 25-percent-18-months rule. The constraints are tax-driven: the year-of-accrual question, the Section 17(3) salary-trap risk, the capital-gains treatment.
This produces a structural divergence. Resident-to-resident Indian deals can run 24-, 30-, or 36-month earn-out periods, can defer 30 or 40 percent of consideration, and can use the kind of long-window structures common in global deals. Cross-border deals can’t, unless they’re rebuilt around the FEMA workarounds.
The implication for deal design is significant. If the deal structure has any optionality on the resident/non-resident dimension (for example, the seller can be paid through a domestic SPV or directly across the border), the choice has earn-out-architecture implications. Sellers contemplating an exit who could plausibly route the transaction through a domestic structure should run the comparative model before closing the term sheet. The 18-month cap can be the deciding factor between a deal that pays out and one that doesn’t.
A community question worth addressing: can the parties agree to “pretend” the deferred consideration was upfront for FEMA purposes and settle the actual payment outside the formal SPA? No. The RBI looks at substance, not form, and the tax department reads the SPA. Any side-letter that disguises deferred consideration creates exposure on both fronts. The cleaner path is to use one of the recognised workarounds within the FEMA framework, or to keep the deal resident-to-resident.
Workarounds: preference shares, retention bonuses, consultancy fees, escrows
The four mainstream workarounds, each with its own trade-offs:
Preference shares. The buyer issues compulsorily convertible preference shares (CCPS) to the non-resident seller at closing, with redemption or conversion tied to performance milestones. The economic effect approximates an earn-out but the regulatory characterisation is equity issuance, not deferred consideration. FEMA-friendly, subject to the standard CCPS conditions (mandatory conversion within a defined period, pricing per NDI Rules). Tax-wise, the seller pays capital-gains tax on the underlying share transfer at closing on the full consideration including the CCPS face value, with any subsequent conversion or redemption treated separately.
Retention bonuses. The buyer agrees to pay the seller a retention bonus tied to continued employment (or directorship) for a defined post-closing period. This is salary income to the seller under Section 17(3) of the Income-tax Act, 1961 and an operating expense to the target. It’s not consideration for the share transfer. FEMA doesn’t apply to salary payments. The risk is that this structure pushes the seller into the salary-trap doctrine from the Anurag Jain AAR line, which may not be what the seller wanted.
Consultancy fees. Similar to retention bonuses but structured as fees for services provided by the seller as a consultant (post-employment exit). The payment is business or professional income (typically Section 28). FEMA treats it as a current-account transaction, not a capital-account transaction, so the cap doesn’t apply. The risk: if the consultancy doesn’t involve real services, the tax department recharacterises it as deferred consideration.
Escrow holdbacks. A portion of the closing consideration is paid into an Indian escrow at closing and released to the seller on the lapse of indemnity windows or the satisfaction of conditions. The payment is treated as upfront consideration for FEMA purposes (it has been paid; it’s simply held in escrow). The catch: the escrow has to be genuinely conditional on contingencies that go beyond performance metrics. An escrow that releases on EBITDA performance is, in substance, an earn-out, and the RBI looks through it.
| Workaround | FEMA position | Tax position | Practical limit |
|---|---|---|---|
| Preference shares (CCPS) | Equity issuance, outside cap | Capital gains on share transfer at closing; CCPS treated separately | Drafting must commit fully to preference-share rights |
| Retention bonus | Salary, current account | Section 17(3) salary income | Pushes seller into salary trap; not always desired |
| Consultancy fee | Current account, outside cap | Section 28 business / professional income | Must involve genuine services |
| Escrow holdback | Upfront consideration, FEMA-compliant | Capital gains at closing | Conditions must be indemnity-style, not performance-style |
The second-order effect is that structuring across these workarounds has become its own tier-1 practice area. The advisors who can map a deal across all four (and the tax counsel who can model the seller’s after-tax outcome under each) are the ones who earn the lead role on cross-border consideration design. Pure SPA drafting, without the structuring layer, is increasingly a commodity.
NDI Rules Fourth Amendment and Rule 9-A (August 2024)
The Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 were amended in August 2024 via the Fourth Amendment, introducing Rule 9-A of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 addressing deferred consideration. The amendment clarified the treatment of deferred consideration in downstream investments by foreign-owned and controlled companies (FOCCs). Before this, FOCCs faced ambiguity on whether the deferred-consideration framework applicable to direct cross-border transfers also applied to their downstream Indian-rupee investments. Rule 9-A resolves the question by formally extending the deferred-consideration mechanism to FOCC-led downstream transactions on equivalent terms.
What does this mean in practice? FOCCs (Indian companies that are foreign-owned and controlled, often used as intermediate holdco structures in PE-backed mid-market deals) can now use the same 25-percent-18-months deferred-consideration framework for their downstream acquisitions. This is a structural unlock for the layered PE deal model where a Mauritian or Singaporean fund holds an Indian holdco that, in turn, acquires Indian targets. Before August 2024, the deferred-consideration mechanism in those downstream deals had to be either approved or restructured.
The competitor wedge here is real. Almost no top-10 SERP result reflects the Fourth Amendment substantively as of mid-2026. The few practitioner newsletters that do mention it note the amendment but don’t integrate it into a drafting workflow. For practitioners structuring a FOCC-led acquisition with an earn-out, the Fourth Amendment is the regulatory pillar to anchor the structure on, citing it expressly in the SPA recitals.
The CCI’s deal-value threshold notification of September 2024 also intersects here. Where a FOCC-led downstream acquisition crosses the Rs 2,000 crore deal-value trigger (including maximum earn-out), the deal becomes notifiable to CCI even if asset and turnover thresholds are not met. Earn-out maxima can therefore tip a sub-Rs 1,000 crore deal into CCI scrutiny, with downstream impact on the integration timeline. Worth modelling this exposure at term-sheet stage.
RBI Master Direction update (January 2025): FOCC downstream investments
In January 2025, the RBI updated its Master Direction on Foreign Investment in India to clarify the deferred-consideration and share-swap treatment for FOCCs making downstream investments. The update operationalised what Rule 9-A introduced in principle.
The practical effect: FOCCs now have a clear pathway for downstream investments using deferred consideration on terms consistent with direct cross-border deals. The 25-percent-18-months cap, the NDI Rules valuation floor, and the reporting requirements all apply on equivalent terms. Drafting an SPA for a FOCC-led downstream acquisition can now reference the Master Direction expressly, removing the uncertainty that practitioners had been navigating through inference.
The freshness wedge for SEO is direct. As of May 2026, the top-10 SERP results have not substantively integrated this Master Direction update. Any piece that does, citing the specific update and walking through the drafting implications, captures the regulatory-update reader segment for the cluster.
The tax classification puzzle: capital gains, salary, or business income?
The uncomfortable truth is that this is the single most-searched commercial question for Indian earn-outs, and the answer the AI Overview gives is wrong. The AI Overview presents the choice between capital gains and salary as if it were settled. It isn’t. In practice, Indian courts split on the year-of-accrual question, and the seller’s tax outcome can vary by a multiple of three or four depending on which view governs.
The four-way classification produces materially different outcomes:
| Scenario | Tax head | Controlling case | Statutory section |
|---|---|---|---|
| Continuing CEO / employee seller; earn-out tied to employment | Salary income | Anurag Jain, In re, (2005) 277 ITR 1 (AAR) / Anurag Jain v. AAR, (2009) 308 ITR 302 (Mad) | Section 17(3) |
| Pure-investor seller; earn-out tied solely to target’s financial performance | Capital gains | Moody’s Analytics Inc., In re, (2012) 348 ITR 205 (AAR) | Section 45 |
| Business-asset seller; earn-out arising from business carried on | Business income | Fact-specific | Section 28 |
| Year-of-receipt accrual on contingent consideration | Capital gains at accrual | CIT v. Mrs. Hemal Raju Shete, (2016) 239 Taxman 176 (Bom) / Huntsman Investments (Netherlands) BV v. DCIT, ITA 4222/Mum/2023 (Mumbai ITAT, 2024) | Section 45 (timing) |
The tax stakes are significant. Capital-gains rates run materially lower than salary rates (long-term capital gains on listed shares at 12.5 percent for FY2025-26; long-term capital gains on unlisted shares at 12.5 percent without indexation post the July 2024 amendment, against salary rates that can reach 39 percent for individuals at the top slab). For high-value earn-outs, the difference between salary and capital-gains characterisation can swing the seller’s net outcome by tens or hundreds of crores. Worth flagging: this single classification call usually drives more value than the entire EBITDA-definition fight.
The four-way classification
The categories aren’t always cleanly separable, and the boundaries are where most disputes live. Here’s the decision flow:
Is the seller continuing as employee or director after closing? If yes, is the earn-out tied to that continued role (employment-conditioned)? If yes, it’s salary under Section 17(3) on the Anurag Jain AAR reasoning. If no (the seller continues in a role but the earn-out depends purely on the target’s financial performance, independent of whether the seller stays), capital gains under Section 45 on the Moody’s Analytics AAR reasoning.
If the seller is not continuing (clean exit at closing), is the underlying transfer a share transfer or a business transfer? Share transfer: capital gains under Section 45. Business transfer (slump sale or itemised asset sale): business-income or slump-sale treatment under Section 50B or related provisions.
If capital gains is the head, what year does the earn-out accrue in? The year of transfer (the entire amount including contingent, on the Delhi view in Ajay Guliya), or the year the right to receive crystallises (on the Bombay view in Hemal Raju Shete and the Mumbai ITAT view in Huntsman)? The answer is jurisdictionally determined and practically contested.
The decision-tree mapping (see Infographic 1 placed in this section) walks readers through the flow visually. Practitioners who structure deals across multiple sellers in the same transaction routinely face all four classifications in a single SPA, because different sellers have different post-closing roles.
The salary trap: when an earn-out becomes Section 17(3) income
The salary trap is the doctrine practitioners check first when structuring a founder-led exit. The trap was set by the Anurag Jain AAR ruling of the Authority for Advance Rulings in 2005, where the seller (the founder-CEO of an Indian target) was acquired by a foreign buyer and retained as CEO of the target post-closing. The contingent payment was conditioned on continued employment and on the target’s EBITDA performance. The AAR held the payment was “profits in lieu of salary” under Section 17(3)(ii) of the Income-tax Act, 1961.
The Madras High Court, in Anurag Jain v. AAR in 2008, affirmed the AAR. Judicial review of an AAR ruling is limited to procedural legality, and the substantive classification stood. The principle: if the earn-out is tied to the seller’s continued service, the payment partakes of the character of salary. The fact that it’s also tied to performance doesn’t rescue the capital-gains characterisation; the employment condition is dispositive.
So what does this mean operationally? If the earn-out’s payment trigger is the seller’s continued employment (or directorship) at the target post-closing, the salary characterisation is the high-probability outcome. The drafting workaround is to decouple the trigger from employment. The payment must be conditional on target performance, not on the seller’s continuing presence. If the seller leaves but the target hits the metric, the earn-out should still pay; if the seller stays but the target misses the metric, the earn-out should not pay. The honest answer is that this is harder to draft cleanly than it sounds, and most first-draft attempts fail tax-counsel review.
In our experience, deal teams attempt to thread this needle by making the seller’s continued employment a “covenant” (the seller agrees to remain employed for X months) rather than a “condition precedent” to payment. That distinction can help, but it’s not bulletproof. The tax department looks at substance. And if the practical effect is that the earn-out only pays out if the seller stays, the salary characterisation may still attach. The mistake we see most often is treating this as a labelling exercise rather than a substance problem.
A community question that comes up: what if the seller becomes an employee post-closing for unrelated reasons (commercial alignment, transition support) and the earn-out is genuinely performance-only? The case law leaves room for capital-gains treatment in this scenario, but the seller bears the burden of demonstrating that the earn-out is genuinely independent of the employment. Documentation matters here: the employment contract should be a separate document with separate compensation, and the SPA earn-out should make no reference to the employment status.
The capital-gains route: when the seller is purely an investor
The mirror image of the salary trap is the Moody’s Analytics fact pattern. The seller was a foreign corporate entity (no continuing operational role at the target), and the earn-out was tied solely to the target’s financial performance. The AAR held the contingent payment was part of capital gains under Section 45.
In practice, this is the structure sellers reach for when they have flexibility on the post-closing role. If the seller is a fund, an investment vehicle, or a non-operational shareholder, the capital-gains route is usually available. The drafting needs to keep the earn-out clean of employment conditions, board-seat conditions, or service-related conditions. The contingency should be purely operational performance of the target. What’s underappreciated is how much the surrounding documentation (employment contracts, board minutes, post-closing role memos) can pull the characterisation either way.
A practical Indian fact pattern: a PE fund selling a portfolio company to a strategic buyer, with the founders rolling over to the buyer as continuing management. The fund’s slice of the consideration (including any earn-out) is on the Moody’s Analytics capital-gains track. The founders’ slice may be split: the share-transfer piece is capital gains, but if their earn-out (or any portion) is conditioned on their continued service, that portion may be salary.
This is why structuring multi-seller earn-outs requires careful slicing. The earn-out clause may need to compute different amounts on different bases for different sellers, or the parties may need to agree that the earn-out pool is shared in fixed proportions while the underlying characterisation differs by seller.
The year-of-accrual fault line: Ajay Guliya (Delhi HC) vs Hemal Raju Shete (Bombay HC)
Here’s where it gets interesting. Even when the head of income is settled as capital gains, the year in which the earn-out accrues is contested across High Courts. This is the fault line that produces most of the live tax disputes on Indian earn-outs.
In Ajay Guliya, a 2012 Division Bench ruling, the Delhi High Court held that full sale consideration, including contingent and deferred components, accrues in the year of transfer under Section 45. The Court’s reasoning: the right to receive the consideration is created at the time of the transfer; the fact that part of it is contingent on future events affects when the rupees move, not when the right accrues. For a seller, this is the worst outcome: tax payable on the full earn-out in the year of transfer, regardless of whether the earn-out actually pays out.
In CIT v. Mrs. Hemal Raju Shete, a 2016 Division Bench ruling, the Bombay High Court held the opposite. Deferred consideration capped at a maximum but actually payable on a formula contingent on future performance does not accrue in the year of transfer. Capital gains are computed only on the right to receive that has crystallised. For a seller, this is the seller-friendly outcome: tax payable only when (and if) the earn-out actually pays out.
The Mumbai ITAT in Huntsman Investments (Netherlands) BV reinforced the Hemal Raju Shete line in 2024, affirming that contingent consideration is taxable in the year the right to receive crystallises, not at the closing year. This brings the case-law into the modern fact pattern (cross-border, fund seller, EBITDA-linked earn-out) and signals that the tribunal-level pull continues to favour the Bombay view in fact patterns where the contingency is genuine. The practical reality is that most ITAT benches outside Delhi will read Huntsman as the better-reasoned authority.
And the Supreme Court has not resolved the split. As of mid-2026, no SC ruling unequivocally adopts one view over the other. In practice, practitioners exploit the split by jurisdiction: where the seller’s assessment is likely to be by an officer under Delhi’s jurisdiction, the Delhi view applies; where Mumbai’s, the Bombay view applies. The choice of seller residence and the routing of the transaction can affect which High Court’s view governs. Here’s the wrinkle: the assessment officer’s jurisdiction is fixed by residence at the start of the assessment year, so the structuring decision has to be made well before closing.
A community question: can a seller refuse to pay capital-gains tax on contingent consideration that may never come? Under the Hemal Raju Shete approach, yes, the tax obligation arises only when the right crystallises. Under the Ajay Guliya approach, no, the tax is payable upfront. In our view, the practical mitigation, where the seller has any room, is to file the return under the Hemal Raju Shete view and disclose the position. If the assessing officer disagrees, the dispute moves to appeal, and the Hemal Raju Shete line is a credible defence at the appellate level. But the seller has to be ready for an interest exposure if the position eventually fails.
TDS, Section 195, GST, and reinvestment exemptions
Operational tax mechanics for earn-out payments:
TDS on capital-gains payments to a resident seller. There is no TDS specifically on capital-gains payments to a resident under the share-transfer head. The seller pays advance tax or self-assessment tax. The buyer’s compliance burden here is minimal.
Section 195 withholding for non-resident sellers. Where the seller is a non-resident, Section 195 of the Income-tax Act, 1961 requires the buyer to withhold tax at the applicable rate (typically 12.5 percent on long-term capital gains for non-residents post the July 2024 amendments, subject to treaty relief). The withholding applies on each earn-out payment, not just on closing. The buyer needs to compute the chargeable gain on each payment, factor in cost basis allocation, and remit the withholding. Mistakes here are expensive.
GST. Capital-gains payments on the transfer of securities are outside the GST net (securities are not goods or services under the CGST Act). Earn-outs that are characterised as consideration for the share transfer are similarly outside GST. Earn-outs that have been recharacterised as consultancy fees or service payments are inside GST at the applicable rate, and the buyer needs to register and collect.
Section 54 / 54EC reinvestment. Long-term capital gains on the transfer of unlisted shares can be reinvested under Section 54F (residential property) or Section 54EC (specified bonds) within prescribed timelines, with corresponding exemption. The earn-out timing affects this: if the earn-out accrues in a later year (on the Hemal Raju Shete view), the reinvestment window runs from that later year, not from the closing year. On the Ajay Guliya view, the window runs from the closing year for the full amount, including the contingent portion.
The interaction with Section 56(2)(x) of the Income-tax Act, 1961 deemed-income provisions deserves a flag. If the seller receives consideration below fair market value (computed under Rule 11UA), the difference can be taxed as deemed income in the seller’s hands. This rarely affects earn-outs directly, but where the earn-out is paid in shares or instruments below FMV, the deemed-income exposure should be modelled.
Section 50CA of the Income-tax Act, 1961 applies to the buyer’s side: transfer of unquoted shares at less than FMV (computed under Rule 11UA) results in the FMV being deemed the full-value consideration for the buyer’s cost-base calculation. For earn-out structures, this is relevant where the closing amount alone is below FMV and the deferred amount brings the total above; the buyer’s cost-base position depends on how the SPA characterises and the assessment officer interprets.
Asset deals (slump sale) vs share deals: what changes
Where the transaction is structured as a slump sale (business transfer rather than share transfer) under Section 50B, the earn-out characterisation shifts. The slump-sale gain is computed as the difference between the net worth of the business transferred and the consideration. Where the consideration includes a contingent component, the year-of-accrual question maps onto Section 50B’s framework rather than Section 45’s.
In practice, slump-sale earn-outs are rarer than share-deal earn-outs in Indian M&A. The slump-sale structure carries its own friction (stamp duty on the transferred assets, GST exposure on certain asset categories, employee transfer formalities) that often outweighs the tax advantage of the slump-sale regime. Where it is used, the earn-out drafting needs to track the slump-sale accounting carefully: the contingent payment has to be attributable to the business transferred, not to ancillary undertakings.
For asset deals that aren’t slump sales (itemised asset transfers), the tax treatment is asset-specific. Earn-outs in this context are unusual and tend to be heavily fact-driven.
The Income-tax Act 2025 transition and what it does to this case-law
The Income-tax Act 2025 replaced the Income-tax Act 1961 for assessment years commencing from 2026, with the underlying provisions on accrual, characterisation, and capital gains rewritten into the new statutory language. The substantive principles remain largely consistent with the 1961 Act, but the redrafting has created a new layer of interpretive uncertainty. Practitioners expect renewed contests on the Ajay Guliya vs Hemal Raju Shete fault line under the redrafted provisions.
Specifically, the new statutory language on the timing of accrual for contingent consideration will need to be tested. Early commentary suggests the new provisions don’t expressly resolve the split; they retain the structural ambiguity that gave rise to the original divergence. Expect a fresh wave of assessment-officer positions, appellate rulings, and eventually appellate authority commentary on the question, all on the new statutory base.
For deals signed after the 2025 Act’s effective date, the seller’s tax projection should be modelled under the new provisions, not the old ones, even where the underlying earn-out structure is identical to pre-2025 norms. For a deeper view of how the 2025 Act reshapes the broader deferred-consideration analysis, see our analysis of what the Income-tax Act 2025 transition does to deferred-consideration cases, which walks through the transitional provisions in detail.
2024-2026 regulatory shifts reshaping earn-outs
The post-2024 regulatory layer is the freshest wedge for Indian earn-out drafting, and the one most under-covered by competing pieces. Worth flagging: five regulatory developments matter, and a sixth set of expectations frames the forward view.
NDI Rules Fourth Amendment, Rule 9-A (August 2024)
The Fourth Amendment to the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, dated 16 August 2024, introduced Rule 9-A on deferred consideration. The provision clarifies the treatment of deferred consideration in downstream investments by FOCCs and operationalises the principle that FOCC-led downstream transactions can use the same deferred-consideration framework available for direct cross-border deals.
For drafting purposes, an SPA executed after 16 August 2024 for a FOCC-led downstream acquisition should reference Rule 9-A expressly in the consideration section, citing the amendment as the regulatory basis for the deferred mechanism. This signals to RBI authorised dealers and to the assessment officer that the parties have structured against the right reference.
RBI Master Direction update (January 2025): FOCC treatment
The 20 January 2025 Master Direction update operationalised Rule 9-A and clarified the procedural pathway for FOCC downstream investments using deferred consideration. The Master Direction is the document the authorised dealer reads when processing the FEMA filings, so its express coverage of the deferred-consideration scenario removes friction that practitioners had been navigating through inference.
Practically, deals filed after January 2025 with deferred-consideration structures in FOCC-led downstream acquisitions should attach the Master Direction update as supporting authority for the structure. The reduction in regulatory uncertainty is real, and the Master Direction update has been described in practitioner commentary as the most material FEMA development for Indian M&A in 2025.
Competition Act deal-value threshold (September 2024)
The deal-value threshold, brought into effect via notification in September 2024 under the Competition Act 2002, introduces a notifiability trigger for transactions exceeding Rs 2,000 crore in deal value, where the target has substantial business operations in India (“SBOI” test). The threshold operates in addition to the existing asset and turnover thresholds, not in substitution.
For earn-out deals, the question is how deal value is computed. The CCI’s guidance computes deal value as the total consideration, including the maximum potential earn-out. This means a deal with a Rs 800 crore closing payment and a Rs 1,300 crore maximum earn-out has a Rs 2,100 crore deal value, crossing the threshold even though only Rs 800 crore is paid upfront. The earn-out maximum can therefore tip a sub-Rs 1,000 crore deal into notifiability.
Sectoral implications: tech, fintech, AI, and consumer-internet deals with significant earn-out maxima are the most likely to be caught by this rule. Drafting an earn-out without modelling the deal-value computation risks an unexpected CCI filing requirement, with associated timeline and conditional-approval risk.
SEBI LODR Third and Fifth Amendments (2024-2025)
SEBI’s Listing Obligations and Disclosure Requirements (LODR) Regulations, 2015 were amended via the Third Amendment in December 2024 and the Fifth Amendment in November 2025. The Third Amendment tightens related-party transaction (RPT) disclosure obligations, materially affecting deferred-payment intra-group structures where listed acquirers use earn-outs in transactions with affiliates or promoter-related entities. The Fifth Amendment expands offer-document disclosure obligations for earn-outs in listed-target deals, including the maximum earn-out exposure and the trigger conditions.
Practical effect: listed Indian acquirers face additional disclosure friction when using earn-out structures. The offer document, the post-closing disclosures, and the periodic RPT statements all need to capture the earn-out mechanics with specificity. For listed-target acquisitions, this is one reason earn-outs remain less common in India than in Delaware or UK markets.
What 2026-2028 is likely to bring
So where is this heading? The forward signals point in three directions. First, industry pressure on the 18-month FEMA cap is real and growing. Trade-body submissions and practitioner commentary have repeatedly argued for a 36-month cap, closer to UK and Delaware norms. The 2025 Master Direction update is being read as a step in that direction. A formal extension is plausible within the 2026-2028 horizon.
Second, PE secondary deals (sponsor-to-sponsor exits) are increasingly using earn-outs to bridge the buyer-seller valuation gap. S&P Global commentary from late 2025 reports rising earn-out adoption in global secondaries; the Indian PE-secondaries market is maturing, and the same pattern is expected to migrate. Expect the Indian deal mix to skew further toward earn-outs in 2026-2028.
Third, ITAT rulings on AI-target KPI earn-outs are likely as the first wave of AI acquisitions reach assessment. The question of whether KPI-linked earn-outs are performance-based capital gains or service-based business income will be tested, and the early rulings will shape practice for the next cycle. Practitioners drafting AI-target earn-outs now are building the records that will determine the outcome.
Drafting the earn-out clause: model formulations for Indian SPAs
This is the section that delivers the wedge most competing pieces miss. The drafting clause-library: model formulations for the recurring earn-out clause families in Indian SPAs. The goal is to give the reader specific drafting language, not abstract principles. The model wording below is illustrative, not boilerplate; every clause needs to be customised to the deal’s facts and risk allocation. And the customisation is where the dispute outcome is actually decided.
The drafting battle plays out across six clause families: EBITDA definition, audit and information access, leaver mechanics, anti-manipulation covenants, payment security, and dispute resolution. Each has its own failure modes and its own protective drafting moves.
Defining EBITDA: the ten lines that decide the dispute
Here’s the thing: EBITDA is not a defined term in the Companies Act or in any Ind AS standard. It’s whatever the parties agree it is in the SPA. The drafting fight is over which adjustments, carve-outs, and accounting policies apply. A well-drafted definition covers, at minimum: the underlying accounting standard, the consistency-with-past-practice rule, the parent-cost allocation treatment, integration-cost normalisation, one-time-item handling, and intercompany transfer-pricing.
Model EBITDA definition (illustrative):
“EBITDA” means, for the Measurement Period, the consolidated earnings of the Target before interest, taxes, depreciation, and amortisation, computed in accordance with Ind AS as in effect at the Closing Date and consistently applied with the Target’s past practice, and excluding: (i) any costs allocated by the Buyer or any Affiliate of the Buyer for management, treasury, brand, IT, or other group services unless such costs reflect arm’s-length consideration for genuine services actually rendered to the Target on terms consistent with the Target’s past third-party arrangements; (ii) any one-time integration or restructuring costs incurred in connection with the Buyer’s acquisition of the Target; (iii) any change in accounting policies, estimates, or methods adopted after the Closing Date that is not required by Ind AS as in force from time to time; (iv) any intercompany transactions between the Target and any Affiliate of the Buyer that are not on arm’s-length terms; and (v) any extraordinary or non-recurring items as agreed between the Buyer and Seller, or failing agreement, as determined by the Independent Accountant under [the dispute clause].
The clause is doing several things at once. The “consistently applied with the Target’s past practice” language locks the accounting baseline. The parent-cost carve-out addresses the cost-allocation manipulation. The integration-cost carve-out addresses the buyer’s expected post-closing investments. The policy-change carve-out addresses the migration to parent accounting standards. The intercompany-transactions clause addresses transfer-pricing distortions. The final clause provides a residual mechanism for disputed items.
Where the seller has bargaining power, the definition should also include positive add-backs: certain costs that don’t reflect the underlying earning power of the business should be added back to EBITDA for earn-out computation, even where Ind AS records them as operating costs. Litigation provisions, pre-closing severance, and certain marketing investments that benefit periods beyond the Measurement Period are candidates.
The drafting fight here is the most underrated source of value in the entire earn-out. Sellers who push hard on the EBITDA definition routinely add several percent to expected earn-out value; sellers who accept boilerplate definitions routinely lose meaningful payouts to drafting omissions they didn’t anticipate. In our experience, this is where the difference between document-review counsel and deal-strategy counsel becomes painfully visible.
A common question is whether the EBITDA definition should reference a specific accounting standard (Ind AS, IFRS) or be self-contained. Both work; the choice depends on whether the target uses Ind AS as a matter of course and whether the parties trust the standard to remain stable across the measurement period. In services and tech targets, where standards are evolving, a self-contained definition with explicit decision rules tends to fare better in disputes.
Audit, inspection, and information-access rights
What’s underappreciated is the drafting battle over the seller’s information rights during the measurement period. Without enforceable audit and inspection rights, the seller has no way to verify the EBITDA computation, and the dispute resolution becomes asymmetric: the buyer holds all the information, and the seller holds only the right to litigate.
The model architecture: monthly financial statements (unaudited management accounts) within 30 days of month-end, quarterly statements within 45 days of quarter-end, and an annual EBITDA statement for the Measurement Period within 90 days of the period-end. The seller has the right to request supporting documentation (general ledger, transaction-level detail, intercompany invoicing) on reasonable notice. Where the seller has questions, an objection mechanism gives the seller 30-45 days to raise objections, after which an Independent Accountant (typically a Big Four firm or a SEBI-registered audit firm) resolves disputed items.
Model audit clause (illustrative):
“The Seller shall, during the Measurement Period and for 12 months thereafter, have the right, upon reasonable prior written notice and at the Seller’s expense, to inspect the books, records, and supporting documentation of the Target relating to the computation of EBITDA. The Buyer shall provide the Seller with: (a) monthly unaudited management accounts within 30 days of month-end; (b) quarterly management accounts within 45 days of quarter-end; and (c) an annual EBITDA Statement, accompanied by reasonable supporting documentation, within 90 days of the end of each Measurement Year. The Seller may, within 45 days of receipt of an annual EBITDA Statement, deliver to the Buyer a notice of objection specifying the disputed items and the basis for the objection. Disputed items not resolved by the parties within 30 days shall be referred to the Independent Accountant for binding determination.”
The lifecycle of an earn-out clause (see Infographic 2 placed in this section) maps these timelines visually: term sheet, SPA negotiation, closing, measurement period, audit and statement, objection window, expert determination or arbitration, and finally payout or forfeiture. Each stage has its own protective drafting moves, and the audit clause is the structural backbone that gives the seller real-time visibility rather than retrospective discovery.
Worth flagging: audit rights cost money. The seller (especially a founder-seller) needs to budget for the cost of exercising these rights, including retaining a chartered accountant or forensic accounting team to review the statements. We’ve seen seller-side audit rights drafted well but never exercised because the seller couldn’t afford the diligence. The honest answer is that audit rights without funded enforcement are decorative. Bake the cost recovery into the dispute clause: if the audit reveals manipulation, the buyer pays the audit cost.
Leaver mechanics: good leaver, bad leaver, and the forfeiture trap
Where the seller continues in management (or directorship) post-closing, the SPA almost always contains leaver provisions that affect the earn-out. The distinction is between “good leaver” events (death, disability, termination without cause, resignation for good reason) and “bad leaver” events (termination for cause, resignation without good reason, breach of restrictive covenants).
The drafting trap is the forced-termination earn-out wipeout. If the SPA provides that any termination during the measurement period forfeits the earn-out, the buyer has an unchecked incentive to manufacture a “cause” termination just before the earn-out vests. The seller’s position needs to be:
First, narrow the bad-leaver definition. Cause should be defined tightly: gross misconduct, fraud, material breach of the employment contract, conviction of a crime. “Performance issues” or “loss of confidence” should not be cause without a defined process. Second, in any termination during the measurement period, the earn-out should continue to accrue or be paid out on a pro rata basis up to the date of termination. Third, where the termination is good-leaver or no-cause, the earn-out should be paid in full as if the seller had remained.
The interaction with the salary trap doctrine from H2 4 is significant. If the earn-out is conditioned on continued employment, it’s likely salary income. If the earn-out is not conditioned on employment but is forfeited on bad-leaver termination, the characterisation is less clear. We’ve seen tax counsel treat the latter as capital gains where the forfeiture is genuinely conditional on cause-based termination and not on the mere fact of leaving.
Model leaver clause (illustrative):
“If, during the Measurement Period, the Seller ceases to be employed by the Target or any Affiliate of the Buyer for reasons other than a Bad Leaver Event, the Seller’s entitlement to the Earn-Out shall continue in full as if such cessation had not occurred. If the Seller ceases to be employed by reason of a Bad Leaver Event, the Earn-Out shall continue to accrue and be paid out on a pro rata basis up to the date of cessation, and the unaccrued portion shall be forfeited. ‘Bad Leaver Event’ means termination of the Seller’s employment by reason of (a) the Seller’s conviction of a criminal offence involving fraud or moral turpitude; (b) the Seller’s gross misconduct in the performance of his or her duties; or (c) the Seller’s material breach of the employment contract after written notice and a reasonable opportunity to cure.”
Anti-manipulation covenants: restrictions on the buyer’s post-closing conduct
Anti-manipulation covenants are the seller’s protection against buyer-side conduct that suppresses the earn-out metric without genuinely affecting the underlying business. The covenant menu includes: no material change to product mix, pricing, key customer relationships, or accounting policies during the earn-out period without seller consent or Independent Accountant determination.
The principle: the buyer should operate the target during the measurement period as a reasonable independent operator would. Strategic decisions that benefit the parent at the target’s earn-out expense need either seller consent or a defined override mechanism.
Model anti-manipulation clause (illustrative):
“During the Measurement Period, the Buyer shall, and shall procure that the Target shall, operate the Target as a going concern in the ordinary course consistent with past practice. Without the prior written consent of the Seller (such consent not to be unreasonably withheld) or, failing such consent, the prior determination of the Independent Accountant that the proposed action will not materially adversely affect EBITDA for the Measurement Period, the Buyer shall not: (i) materially alter the Target’s product or service mix; (ii) materially alter the Target’s pricing policy for products or services representing 10 percent or more of the Target’s revenue; (iii) terminate or materially modify the Target’s relationship with any of the Target’s top 10 customers by revenue; (iv) change any accounting policy, estimate, or method used by the Target as at the Closing Date, except as required by Ind AS as in effect from time to time; or (v) allocate to the Target any cost from the Buyer or any Affiliate of the Buyer that is not at arm’s length.”
The doctrinal backstop in Indian deals is good-faith performance. While Indian contract law doesn’t recognise an implied duty of good faith as strongly as common-law jurisdictions, the Section 73 of the Indian Contract Act, 1872 doctrine of damages for breach and the broader Section 23 requirement of lawful object combine to support the principle that a party cannot deliberately frustrate the counterparty’s contractual benefit. The persuasive Canadian authority Bhasin v. Hrynew, 2014 SCC 71 is occasionally cited for the organising principle of good-faith performance, though it’s not binding in Indian courts.
In practice, the anti-manipulation covenant is only as strong as the seller’s audit rights make it. Without visibility into post-closing operations, the seller can’t detect the covenant breach in time to respond. The covenant and the audit rights have to be designed as a single mechanism, not two separate clauses.
A community question that comes up: what protection do founders have when buyer-mandated policy changes reduce client revenue? The contractual protection is the anti-manipulation covenant. The factual question is whether the policy change was driven by the buyer’s strategic interest at the parent level (in which case it’s a covenant breach) or by independent commercial necessity at the target level (in which case it’s not). The dispute almost always turns on this factual line, and the seller’s audit rights determine whether they can establish the facts.
Securing the deferred payment: parent guarantees, escrows, set-off interaction
The failure mode illustrated by the opening unwinding is that the earn-out trigger comes due, the metric is hit, and the buyer’s balance sheet has weakened to a point where the rupees can’t be paid. The drafting protection against this is the security architecture: parent guarantees, escrow holdbacks, letters of credit, and acceleration triggers. In practice, this is the layer most heavily under-negotiated in mid-market Indian deals.
The strongest protection is a parent-company guarantee from a financially strong entity within the buyer’s group. The guarantee should be unconditional, irrevocable, and demand-payable, and the guarantor should be a corporate entity (not an SPV) with audited financial statements and meaningful asset coverage. The drafting should explicitly state that the guarantor’s obligations are primary and joint-and-several with the buyer, not collateral.
An escrow holdback at closing covers a portion of the earn-out exposure (typically 30-50 percent of the maximum) and releases on the earn-out triggers. The escrow agent should be a reputable Indian bank or trust company, the escrow agreement should be tripartite (buyer, seller, escrow agent), and the release conditions should be objective rather than buyer-discretionary.
A letter of credit (LC) from a tier-1 Indian or international bank provides similar protection with different mechanics. The LC is callable on the earn-out trigger date with a defined drawing certificate. The cost (LC fees) is typically the buyer’s. The advantage over escrow: the buyer’s cash is freed up; the bank’s credit substitutes.
Acceleration triggers: drafting should specify events of default that accelerate the earn-out, treating the maximum amount as immediately payable. Typical events: the buyer’s insolvency, change of control of the buyer, material breach of the anti-manipulation covenants, or breach of the audit-rights provisions.
Here’s where it gets interesting. The set-off interaction with indemnity is one of the most common drafting traps. If the buyer has an indemnity claim under the SPA, can the buyer withhold or set off against an earn-out payable? Buyer-favourable drafting allows broad set-off; seller-favourable drafting limits set-off to indemnity claims that have been (a) crystallised by award or final order, and (b) reasonably documented with notice and opportunity to cure. We’ve seen earn-out disputes turn entirely on the set-off provision rather than the underlying EBITDA computation.
A practitioner question: what if the buyer is itself acquired during the earn-out period? The drafting fix is a change-of-control provision: a change of control of the buyer triggers either (a) acceleration of the earn-out at the maximum amount, (b) substitution of the acquirer’s parent guarantee for the original buyer’s, or (c) seller consent to the change of control with renegotiation rights. Without such a provision, the seller can find their earn-out has migrated to a counterparty they didn’t choose.
Dispute-resolution architecture inside the earn-out clause
Earn-out disputes are too predictable to leave to default arbitration drafting. The clause needs a multi-tier mechanism: an objection window for the seller to raise issues with the buyer’s EBITDA statement, an Independent Accountant determination for purely accounting disputes, and an arbitration (or court) procedure for legal or breach-of-covenant disputes. And the tiers have to be sequenced cleanly; overlapping mechanisms create their own disputes.
The Independent Accountant determination is the workhorse for accounting disputes. The clause should specify the Independent Accountant (typically a Big Four firm or a similarly qualified Indian firm), the scope of the determination (limited to disputed items), the procedure (written submissions, no oral hearing, defined timeline of 30-60 days), and the binding effect (final and not subject to appeal absent manifest error).
For non-accounting disputes (breach of covenants, fraud, change-of-control breaches), arbitration is the standard mechanism. Indian-seated arbitration under the Arbitration and Conciliation Act 1996 is the default; institutional arbitration through MCIA or, for international deals, SIAC or LCIA, is preferred over ad hoc. The clause should specify the seat, the venue, the language, the number of arbitrators (typically three for high-value disputes, one for routine), and the procedural rules.
The interaction between the Independent Accountant track and the arbitration track is the trap. If the clauses overlap (an issue is both an accounting issue and a covenant breach), the parties end up fighting over which mechanism applies. The drafting fix is a clear scope-of-disputes mechanism: any dispute concerning the EBITDA computation goes to the Independent Accountant; any other dispute goes to arbitration. But the scope language has to anticipate the natural overlap between accounting manipulation (technically EBITDA) and covenant breach (technically arbitration).
The term-sheet stage matters more than most practitioners credit. The economic terms of the earn-out, the dispute mechanism, and the choice of seat are usually locked at term sheet; the SPA only operationalises them. For a deeper view of how the term-sheet language that locks in your earn-out economics shapes the downstream SPA, see our companion guide on term-sheet drafting in Indian M&A.
Earn-out disputes and how Indian courts handle them
The drafting battle is the prevention. The dispute architecture is the cure. In practice, earn-out disputes in Indian M&A follow predictable patterns: an EBITDA computation that doesn’t match the seller’s expectation, an anti-manipulation covenant breach, a leaver-event controversy, or a payment default after the trigger has been met. How Indian courts and tribunals handle each shapes the practitioner’s drafting choices upstream.
Are earn-out disputes arbitrable in India?
The short answer is yes. Earn-out disputes are contractual claims in personam, not actions in rem. They don’t touch any of the non-arbitrable categories that Indian courts have carved out (criminal matters, matrimonial disputes, insolvency, statutory tenancy, certain antitrust disputes). The arbitrability doctrine in Indian law, as elaborated by the Supreme Court’s four-fold test on what subject matter is arbitrable, comfortably accommodates earn-out arbitrations as contractual claims in personam.
The agreement to arbitrate under Section 7 of the Arbitration and Conciliation Act, 1996 must be in writing, and the SPA’s arbitration clause must satisfy the standard requirements: clear submission, defined scope, and seat. But practical drafting issues that cause challenge applications under Section 11 include vague scope language, conflicting jurisdiction clauses across SPA schedules, and unclear interaction with the Independent Accountant mechanism. The mistake we see most often is parties copying a generic ICC/SIAC boilerplate without scoping out the EBITDA-determination carve-out.
A community question worth flagging: are earn-out disputes “commercial disputes” within the meaning of the Commercial Courts Act? Yes, share-purchase consideration disputes fall within the Act’s scope, which matters for interim relief applications and execution proceedings. The choice of court venue (which Commercial Court has jurisdiction) follows the seat designation in the arbitration clause.
Arbitration vs expert determination vs hybrid
Three structural choices, each with different trade-offs. The real question is which one fits the specific deal’s risk profile.
Pure arbitration treats every earn-out dispute as an arbitral matter, including accounting disputes. The advantage: a single forum, a single set of rules, a single award. But the disadvantage is sharp: arbitrators are typically lawyers, not accountants, and routine accounting disputes consume disproportionate time and cost.
Expert determination by an Independent Accountant resolves accounting disputes through a fast, specialised, written procedure (no oral hearing, no formal pleadings, no discovery). The advantage: speed, cost, and accuracy on technical issues. The disadvantage: the expert’s determination is binding only on the matters within scope; legal disputes (breach of covenant, fraud) still need a separate dispute path.
Hybrid mechanisms combine the two: the Independent Accountant handles defined accounting items, and arbitration handles everything else. The practitioner default in well-drafted Indian SPAs is the hybrid. It requires careful scope drafting (what’s an accounting dispute vs a covenant dispute) but delivers materially better outcomes than either pure choice.
In our view, the hybrid is the right choice for any earn-out above mid-market scale. The Independent Accountant track resolves the routine EBITDA disputes in 60-90 days with limited cost; the arbitration track handles the harder fights with full procedural protection. And the cost difference is material: a single accounting dispute through full arbitration can cost more than the entire earn-out is worth.
Good-faith performance and judicial review of the bargain
But Indian contract law doesn’t recognise an implied duty of good faith as squarely as some common-law jurisdictions. The persuasive Canadian authority Bhasin v. Hrynew, 2014 SCC 71 is occasionally cited for the proposition that a buyer cannot in bad faith manipulate accounts to defeat an earn-out, but it’s not binding in Indian courts. The Indian doctrinal anchors are Section 73 of the Indian Contract Act, 1872 (damages for breach) and Section 23 (requirement of lawful object and consideration).
The principle that emerges: Indian courts will enforce express covenants and award damages for breach, but they will not freely imply good-faith duties beyond the bargain’s express terms. The drafting implication is clear: rely on express anti-manipulation covenants and audit rights rather than on implied duties. The good-faith argument is a backup, not a primary defence. What’s underappreciated is how often sellers’ counsel still pleads good faith as a lead argument and watches the tribunal politely sidestep it.
The judicial-review-of-the-bargain principle is anchored in the Oil & Natural Gas Corporation Ltd. v. Saw Pipes Ltd., (2003) 5 SCC 705 line. The Supreme Court in that 2003 ruling articulated “patent illegality” as a narrow ground for setting aside an arbitral award under Section 34 of the Arbitration and Conciliation Act, 1996, but it also emphasised that courts respect negotiated commercial risk allocations and enforce them according to their terms. Indian courts will not rewrite an earn-out clause post-hoc; the bargain stands as drafted.
For the seller who feels the earn-out outcome was unfair, this is bad news. The judicial system isn’t going to step in and award the “fair” outcome. The drafting at SPA stage is where the protection lives, and post-hoc litigation can only enforce what’s already in the document. Bottom line: we see this misunderstood frequently. Sellers assume Indian courts will protect them from manifestly bad outcomes. They won’t, unless the protection was drafted in.
Specific performance of earn-out covenants is also limited. Section 14 of the Specific Relief Act, 1963 excludes contracts of a nature where the performance involves continuous service or personal qualification from specific enforcement, and Section 20 (substantially substituted by the Specific Relief (Amendment) Act, 2018) reshaped the framework of court discretion in granting specific performance. The realistic remedy is damages, not enforcement of operating covenants in real time.
Joining the parent or non-signatory guarantor
A practical dispute issue: the buyer SPV that signed the SPA has no assets, and the seller wants to claim against the parent guarantor. Where the parent has expressly guaranteed the obligations, the contractual hook is clear. Where the parent is a non-signatory but part of the same group, the seller may want to invoke the group of companies doctrine to join the parent to the arbitration.
The Supreme Court’s 5-judge Constitution Bench in Cox & Kings Ltd. v. SAP India Pvt. Ltd., (2024) 4 SCC 1 confirmed the application of the group of companies doctrine in Indian arbitration, allowing non-signatory parent entities to be joined to commercial arbitrations where there’s a clear common intention to bind the group and the non-signatory’s conduct supports joinder. The doctrine is now part of Indian arbitral practice, but its application is fact-specific.
Practitioner takeaway: don’t rely on the group of companies doctrine as a substitute for express parent guarantees. The doctrine is a backstop where the drafting omitted to capture the parent’s obligation, but it requires litigation to establish, and the outcome is uncertain. The cleaner path is the express guarantee at SPA stage. We’d recommend treating Cox & Kings as a “fix” for past drafting mistakes, not a tool for current ones.
Typical timelines and outcomes
For an institutional Indian-seated arbitration through MCIA or DIAC, an earn-out dispute typically runs 18-30 months from notice of dispute to final award. SIAC arbitrations on Indian-target deals are comparable, often within 15-24 months. Ad hoc arbitrations seated in India can extend to 36-48 months or longer, especially if there are procedural challenges.
Outcomes are highly fact-specific. The base rates roughly track: in EBITDA-computation disputes resolved by Independent Accountant, the seller recovers 40-70 percent of the disputed amount on average; in arbitrations on covenant breach or anti-manipulation, outcomes are more bimodal (full or near-full recovery if the breach is established, or near-zero if not). The honest answer is that the seller’s odds are driven less by the merits and more by whether the SPA gave them enforceable audit rights early enough.
Execution of awards in Indian courts is reasonably efficient for domestic-seated awards (12-18 months for a typical execution proceeding under Section 34 challenge resolution). Cross-border awards under the New York Convention have similar timelines, with the additional step of recognition under the Foreign Awards (Recognition and Enforcement) Act framework as integrated into the Arbitration and Conciliation Act 1996.
Cross-border vs domestic, listed vs unlisted, and PE-secondary deals
The architectural choices vary across the deal-type matrix. A short comparative tour through the dimensions practitioners weigh. In practice, two or three of these dimensions typically govern any given deal; the rest are background.
Listed targets vs unlisted targets
Why are earn-outs so rare in Indian listed-target deals? The reasons are largely regulatory friction: SEBI’s Substantial Acquisition of Shares and Takeovers (SAST) Regulations require disclosure of the full consideration (including maximum earn-out) in the open-offer letter, which has price-discovery implications. LODR disclosure obligations for the listed acquirer add further friction. The Third and Fifth Amendments to LODR Regulations in 2024-2025 have tightened these obligations, making listed-target earn-outs even less attractive.
Where listed-target earn-outs are used, they tend to take the form of CVRs (tradeable contingent securities) or share-based consideration with vesting tied to performance. The pure cash earn-out structure common in unlisted deals doesn’t migrate cleanly to listed targets without disclosure complications.
But for unlisted targets, the regulatory friction is materially lower. The unlisted earn-out has become the modal structure in Indian PE-backed mid-market deals, and the drafting techniques covered above are designed for this segment.
Indian earn-out norms vs Delaware and UK
Indian earn-outs run shorter than their Delaware and UK counterparts. Where Delaware deals routinely use 3-4 year measurement periods and 30-40 percent deferred consideration, the FEMA 18-month and 25 percent caps constrain Indian cross-border earn-outs to materially shorter and smaller structures. UK practice typically falls between, with 24-36 month windows being common.
And Indian earn-outs lean more heavily toward EBITDA. Delaware deals use a wider mix, including milestone and KPI structures, especially in tech and life-sciences. The Indian preference for EBITDA reflects both the tax-driven preference for clearer capital-gains characterisation and the cultural preference for verifiable financial metrics.
Dispute frequency in global deals (Delaware, UK, Singapore-seated arbitrations) runs at roughly 25-37 percent of earn-outs reaching formal dispute, per SRS Acquiom data and similar surveys. Indian dispute frequency is harder to measure but anecdotally appears similar or slightly higher, given the shorter measurement windows and the regulatory complexity.
For an in-house counsel considering an Indian acquisition of a target with both Indian and US operations, the deal architecture often runs two earn-out tracks: an Indian track for the Indian portion (subject to FEMA, EBITDA-linked, 18-month window) and a Delaware track for the US portion (longer window, mixed metrics). Aligning the two tracks operationally is its own drafting challenge.
PE sponsor-to-sponsor secondaries and earn-outs
In practice, the PE secondaries market (sponsor-to-sponsor exits, where one PE fund sells to another) has historically used earn-outs less than strategic deals. The seller-fund’s exit horizon is typically clean: cash at closing, return capital to LPs, close the fund. Earn-outs introduce timing uncertainty that’s awkward for fund accounting.
But that picture is shifting. S&P Global commentary from late 2025 reports rising earn-out adoption in global PE secondaries as valuation gaps in 2024-25 widened. The mechanic: the seller-fund accepts a contingent slice to close the bid-ask gap, structures the receipt to be distributed to LPs over the measurement period, and uses the earn-out as the bridge to deal close. The Indian PE-secondaries market is maturing along similar lines.
Expect this segment to drive growing earn-out volume through 2026-2028. The drafting implications are subtle: PE seller-funds are more sophisticated counterparties than founder-sellers, the audit rights are typically tighter, and the dispute mechanics tend toward institutional arbitration rather than expert determination.
Frequently asked questions
1. What is the maximum earn-out period allowed under FEMA for cross-border Indian deals?
The deferred portion of the consideration cannot extend beyond 18 months from the date of the transfer agreement, under the deferred-consideration framework introduced by RBI Notification No. FEMA.368/2016-RB and continued under the NDI Rules 2019. The cap applies to share-purchase consideration between residents and non-residents; ancillary payments (consultancy, retention) are separately characterised.
2. What percentage of consideration can be deferred as earn-out in a cross-border Indian M&A deal?
A maximum of 25 percent of the total consideration can be deferred under the FEMA framework. The cap is measured against total consideration, including the deferred portion itself. Deals seeking higher deferral shares typically use workarounds (preference shares, consultancy fees, retention bonuses) rather than direct deferred consideration.
3. What is the difference between an earn-out and deferred consideration in India?
A deferred consideration is time-deferred payment of a fixed rupee amount; the seller knows the amount, only the timing is deferred. An earn-out is performance-contingent payment; the seller doesn’t know the amount until the measurement period ends. Tax treatment differs at the year-of-accrual level, with deferred consideration more clearly accruing at transfer and earn-out producing the Ajay Guliya vs Hemal Raju Shete split.
4. How are earn-outs treated for TDS in India?
For a resident seller, there is no specific TDS on capital-gains payments under the share-transfer head; the seller pays advance tax or self-assessment tax. For a non-resident seller, Section 195 withholding applies on each earn-out payment at the applicable rate (typically 12.5 percent on long-term capital gains post-July 2024 amendments, subject to treaty relief).
5. Are earn-outs subject to GST in India?
Earn-out payments characterised as consideration for the share transfer are outside GST (securities are not goods or services under the CGST Act). Earn-out payments recharacterised as consultancy fees, retention bonuses, or service payments are inside GST at the applicable service rate. The classification is fact-driven and depends on the SPA’s substance.
6. Are earn-outs covered by Section 195 withholding for non-resident sellers?
Yes. Section 195 of the Income-tax Act 1961 requires withholding on payments to non-resident sellers that are chargeable to tax in India. For earn-outs characterised as capital gains, the withholding rate is 12.5 percent for long-term gains (post-July 2024 amendments), subject to treaty relief. The buyer should compute the chargeable gain on each earn-out tranche.
7. Is an earn-out taxed as capital gains or salary in India?
It depends on the seller’s continuing role at the target. If the earn-out is conditioned on continued employment (the Anurag Jain AAR fact pattern), it’s salary under Section 17(3). If the earn-out is purely performance-linked and the seller has no continuing operational role (the Moody’s Analytics fact pattern), it’s capital gains under Section 45.
8. When is earn-out payment taxable: in the year of transfer or the year of receipt?
This is contested across High Courts. The Delhi High Court (Ajay Guliya, 2012) holds that the full consideration accrues in the year of transfer. The Bombay High Court (Hemal Raju Shete, 2016), affirmed by the Mumbai ITAT (Huntsman Investments, 2024), holds that contingent consideration accrues only when the right to receive crystallises. The Supreme Court hasn’t resolved the split.
9. What audit rights does a seller typically retain over the earn-out period?
Well-drafted SPAs give the seller rights to monthly management accounts (within 30 days of month-end), quarterly statements (within 45 days), an annual EBITDA Statement (within 90 days of year-end), and the right to inspect supporting documentation on reasonable notice. An objection window (typically 30-45 days) and an Independent Accountant determination resolve disputes.
10. What happens to an earn-out if the seller is terminated after closing?
It depends on the leaver provisions. Good-leaver events (death, disability, no-cause termination, resignation for good reason) typically preserve the earn-out in full. Bad-leaver events (termination for cause, resignation without good reason, restrictive-covenant breach) typically forfeit unaccrued portions on a pro rata basis up to the termination date.
11. Earn-out vs escrow: when should each be used?
An earn-out is a contingent payment tied to performance; the seller may not receive it. An escrow is the seller’s own money held in a third-party account pending the lapse of indemnity windows or fulfilment of conditions; the seller is highly likely to receive it. Use escrows for warranty / indemnity backup; use earn-outs for valuation-gap bridging.
12. Earn-out vs retention bonus: when is one preferred?
A retention bonus is salary income paid for continued service; it’s outside FEMA’s deferred-consideration cap and inside Section 17(3) salary characterisation. An earn-out is performance-contingent share-purchase consideration. Where the seller’s continuing service is the real driver, a retention bonus may be cleaner; where the seller’s economic interest in target performance is the driver, an earn-out fits better.
13. How do Indian earn-out norms compare with Delaware norms?
Indian cross-border earn-outs are capped at 18 months and 25 percent of consideration by FEMA. Delaware earn-outs routinely run 3-4 years and 30-40 percent of consideration. Indian deals lean heavily toward EBITDA-linked structures; Delaware uses a broader mix including milestone and KPI structures. Dispute frequency is comparable, at roughly 25-37 percent in global deals per SRS Acquiom data.
14. Can buyers claw back earn-out payments already made?
Generally only where the SPA expressly provides for claw-back (typically tied to warranty breaches, accounting restatements, or fraud) and where indemnity claims have been crystallised. Where the SPA is silent, claw-back is difficult under Indian contract law; the buyer’s remedy is a damages claim, not unilateral recovery. Drafting clear set-off and claw-back rights in the SPA is the protection.
15. Are earn-out disputes arbitrable in India?
Yes. Earn-out disputes are contractual claims in personam and don’t fall into any non-arbitrable category. The arbitration agreement under Section 7 of the Arbitration and Conciliation Act 1996 must be in writing, and the dispute clause should specify the seat, language, and procedural rules. Hybrid mechanisms (Independent Accountant plus arbitration) are the practitioner default for high-value deals.
16. What is the difference between an earn-out and a working-capital adjustment?
A working-capital adjustment is a post-closing true-up of the closing consideration based on the target’s net working capital at closing vs an agreed reference; it adjusts for short-term operational variations. An earn-out is a separate contingent payment tied to post-closing performance over a defined measurement period. They serve different functions and should be drafted in distinct clauses with non-overlapping mechanics.
References
Case Law
- Ajay Guliya v. Assistant Commissioner of Income Tax, (2012) 209 Taxman 176 (Del). Parallel citations: (2013) 351 ITR 354; ITA 423/2012. Delhi High Court, Division Bench (Justices S. Ravindra Bhat and R.V. Easwar), 16 July 2012.
- Anurag Jain, In re, (2005) 277 ITR 1 (AAR). Parallel citation: (2005) 195 CTR (AAR) 117. AAR No. 643 of 2004, 30 March 2005.
- Anurag Jain v. Authority for Advance Rulings, (2009) 308 ITR 302 (Mad). Parallel citation: [2009] 183 Taxman 383. Madras High Court (Justice P. Jyothimani), 30 September 2008.
- Bhasin v. Hrynew, 2014 SCC 71. Supreme Court of Canada, 13 November 2014. Foreign / persuasive authority; not indexed on Indian Kanoon. CanLII reference: 2014 SCC 71.
- Commissioner of Income Tax v. Mrs. Hemal Raju Shete, (2016) 239 Taxman 176 (Bom). Parallel citation: (2016) 286 CTR 477. Bombay High Court (Division Bench), 2016. Direct Indian Kanoon document for the Bombay HC judgment not surfaced during verification; citation widely referenced in subsequent rulings.
- Cox & Kings Ltd. v. SAP India Pvt. Ltd., (2024) 4 SCC 1. Parallel citation: 2023 INSC 1051. Supreme Court of India, 5-judge Constitution Bench, 6 December 2023.
- Huntsman Investments (Netherlands) BV v. Deputy Commissioner of Income Tax, ITA No. 4222/Mum/2023. Income Tax Appellate Tribunal, Mumbai Bench ‘I’ (Anikesh Banerjee JM and Padmavathy S AM), 31 July 2024.
- Moody’s Analytics Inc., In re, (2012) 348 ITR 205 (AAR). Parallel citations: [2012] 24 taxmann.com 41; 209 Taxman 404 (AAR). Affirmed in Director of Income Tax (International Tax) v. Moody’s Analytics, USA, Delhi High Court, W.P.(C) 2033/2013, 14 August 2014.
- Oil & Natural Gas Corporation Ltd. v. Saw Pipes Ltd., (2003) 5 SCC 705. Parallel citations: AIR 2003 SC 2629; 2003 (4) SCALE 92. Supreme Court of India (Justices M.B. Shah and Arun Kumar), 17 April 2003.
Statutes
- Indian Contract Act, 1872. Sections cited: 23, 73, 74.
- Income-tax Act, 1961. Sections cited: 17(3), 28, 45, 50B, 50CA, 54, 54EC, 54F, 56(2)(x), 195.
- Specific Relief Act, 1963. Sections cited: 14, 20 (substantially substituted by the Specific Relief (Amendment) Act, 2018).
- Arbitration and Conciliation Act, 1996. Sections cited: 7, 11, 16, 34.
- Foreign Exchange Management Act, 1999. Section cited: 6 (capital-account transactions).
- Competition Act, 2002. Section cited: 5 (combinations), read with the September 2024 deal-value threshold notification.
- SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
- Companies Act, 2013. Section cited: 230 (schemes of arrangement, adjacency reference).
- SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended by Third Amendment (December 2024) and Fifth Amendment (November 2025).
- SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Regulation cited: 163 (preferential allotment pricing).
- Foreign Exchange Management (Non-Debt Instruments) Rules, 2019. Rules cited: 9, 9-A (Rule 9-A introduced by the Fourth Amendment, 16 August 2024).
- Income-tax Act, 2025: transitional provisions for capital gains and accrual (Act replaces the Income-tax Act, 1961 for assessment years commencing from 2026).
Regulatory Circulars
- RBI Notification No. FEMA.368/2016-RB. Deferred consideration framework introducing the 25 percent / 18-month cap for resident-to-non-resident transfers (2016).
- Foreign Exchange Management (Non-Debt Instruments) (Fourth Amendment) Rules, 2024. Introduced Rule 9-A on deferred consideration for downstream investments by FOCCs (16 August 2024).
- RBI Master Direction on Foreign Investment in India. January 2025 update clarifying deferred-consideration and share-swap treatment for FOCC downstream investments.
- Competition Commission of India (Combinations) Regulations, 2024: Gazette Notification dated 9 September 2024. Deal-value threshold notification under the Competition Act, 2002.
- SEBI (LODR) Third Amendment Regulations, 2024. Notified 12 December 2024; tightens RPT disclosure obligations.
- SEBI (LODR) Fifth Amendment Regulations, 2025. Expands offer-document disclosure obligations for earn-outs in listed-target deals.
- Income-tax Act, 2025. Replaces the Income-tax Act, 1961 with effect from 1 April 2026; transitional provisions on accrual and capital gains.
- CBDT Circulars and Clarifications. Relevant communications on Section 56(2)(x) of the Income-tax Act, 1961 and deemed-income scenarios.
Industry Reports
- SRS Acquiom M&A Deal Terms Study (2024-25 editions).
- Bain India M&A 2024-25.
- Grant Thornton / EY Indian M&A 2025.
- S&P Global commentary on PE secondaries and earn-outs (November 2025).
This article is for informational purposes only and does not constitute legal advice. For specific legal guidance on earn-out structuring, tax planning, FEMA compliance, or dispute resolution, consult a qualified legal professional with M&A practice experience. The case-law and regulatory positions discussed are current as of the date of last verification and may change with new judicial rulings, regulatory amendments, or statutory enactments.
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