CCD vs CCPS vs Equity Shares: Best Funding Instrument for an Indian Subsidiary

When a foreign business sets up its subsidiary or a Wholly Owned Subsidiary in India, one of the most crucial and consequential decisions is which financial instrument to choose to fund their subsidiary. Choosing between Compulsorily convertible debentures (CCDs), Compulsorily Convertible Preference Shares (CCPS), and plain equity shares is not just a structural preference. It shapes the entire journey of the business.

Each funding instrument has different rules and regulations under different legal frameworks. Choosing the wrong one can result in regulatory non-compliance or unexpected tax liabilities. Whether it’s CCD vs CCPS India or equity vs CCPS India for your Indian Subsidiary, it is very important to understand the difference. This blog covers the three structures in detail.

Understanding the Basic Landscape

According to the RBI, foreign investment is broadly classified into two categories: Equity (non-debt) and Debt. Before comparing the instruments in detail let’s understand what they mean:

• Equity (non-debt): These are instruments in which subsidiaries get fund in exchange for equity. Equity shares, CCPS (Compulsory Convertible Preference Shares), and CCDs (Compulsorily Convertible Debentures) are all Equity (non-debt) instruments. Under FDI rules, they are treated as equity, so they must be reported to the Reserve Bank of India (RBI) via Form FC-GPR within 30 days of allotment.
• Debt: These are different from ownership instruments; they are borrowing or loan like instruments. This includes External Commercial Borrowings (ECBs), optionally convertible debentures, and non-convertible preference shares. These follow separate rules and regulations under FEMA ECB guidelines.

Since CCDs and CCPS are compulsorily convertible into equity shares, the Indian law treats them as equity instruments. This is the reason they are a popular choice for foreign investors who want flexibility with simpler FDI compliance.

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Equity Shares

Equity reflects direct ownership of the investor in Indian Subsidiary. When a foreign parent subscribes to equity shares, they get proportional ownership rights, voting power and dividend benefits.

Foreign investor subscribes to the shares at a value determined by FEMA’s valuation rules. For unlisted companies, valuation is generally done using DCF method by a SEBI registered Merchant Banker. Shares cannot be issued below the fair market value.

Advantages of Equity Shares

Here are some advantages of choosing equity shares:

• Simple structure: It is a simple structure with no conversion terms or future obligations.
• Dividend income: It is eligible for dividends declared by the Indian company, repatriable without RBI approval (subject to applicable taxes).
• Immediate ownership: The investors have full shareholder and voting rights from the date of allotment.
• No conversion requirement: Unlike CCDs or CCPS, no future conversion process is needed.
• Investor friendly: Commonly preferred in PE/VC and pre-IPO structures.

Limitations of Equity Shares

There are some limitations of equity shares:

• Immediate dilution: The parent company’s ownership changes as soon as shares are issued.
• Valuation challenges: For early-stage companies it can be difficult to determine fair value.
• Higher risk exposure: The equity investors face the highest risk if the business fails.
• Last in repayment: Equity shareholders are paid only after creditors, and preference shareholders have been paid.

Compulsory Convertible Preference Shares (CCPS)

CCPS are hybrid instruments that start as preference shares but must convert into equity shares at a future date or in a specific round like funding round or IPO (Initial Public Offering).

Foreign investors subscribe to CCPS at a fixed price. These shares may offer preferential dividends and priority over equity shareholders during liquidation. Later, the CCPS compulsorily convert into equity shares based on a pre-agreed conversion ratio or formula. According to the Companies Act, 2013, CCPS must have a definite conversion period and must not carry features of redeemability without conversion.

Advantages of CCPS

Here are some main advantages of CCPS:

• Liquidation preference: In case the company winds up, the Investors are paid before equity shareholders.
• Anti-dilution protection: Due to conversion terms investors can be protected in future down-rounds (When company raises money in a lower valuation than in an earlier round).
• Valuation flexibility: Useful for startups where future valuation is uncertain.
• Preferred dividends: Investors may receive fixed or cumulative dividends.
• FDI treatment: Treated as equity under FEMA, so ECB restrictions do not apply.

Limitations of CCPS

Here are some of the limitations of CCPS:

• Mandatory conversion: Investors cannot redeem the instrument directly; it must convert into equity first.
• Dividend taxation: Dividends are taxable in the hands of investors.
• Complex documentation: Conversion and investor protection terms require detailed drafting.
• No fixed repayment: Since CCPS must convert into equity, investors cannot structure a guaranteed capital return date.

Compulsorily Convertible Debentures (CCDs) in India

These are debt instruments issued by an Indian company, that must convert into equity shares within a specified period (maximum up to 10 years under the Companies Act, 2013). Until conversion, they usually pay interest to the investor.

The Indian company issues CCDs to the foreign investor with pre-agreed terms such as interest rate, conversion ratio, and conversion timeline.

Although CCDs are treated as debt for accounting purposes, they are classified as equity (FDI) under FEMA because conversion into equity is compulsory. This allows investors to earn interest income while avoiding stricter ECB regulations.

Advantages of CCDs

Compulsorily Convertible Debentures in India have these advantages:

• Interest income: Investors can earn periodic interest until conversion.
• FDI treatment: CCDs are treated as equity under FEMA, so ECB restrictions do not apply.
• Valuation flexibility: Conversion can happen later, useful for early-stage companies with uncertain valuations.
• Better liquidation priority: CCD holders rank above equity shareholders in case of liquidation.
• Flexible conversion terms: Conversion ratio can be fixed or linked to future valuation events.

Limitations of CCDs

Here are the limitations of CCDs:

• Interest taxation: Interest is taxable and subject to withholding tax in India.
• Mandatory conversion within 10 years: CCDs cannot remain outstanding indefinitely.
• Transfer pricing scrutiny: Interest rates must comply with arm’s length pricing rules.
• No redemption option: CCDs must convert into equity and cannot be repaid in cash directly.

Side-by-Side Comparison Between the Instruments

Here is a table comparing the key differences between the funding instruments.

Parameter	Equity Shares	CCPS	CCDs
RBI Reporting	Form FC-GPR (within 30 days of allotment)	Form FC-GPR (within 30 days of allotment)	Form FC-GPR (within 30 days of allotment)
Current Return	Dividends (not guaranteed)	Preferential dividend (if declared, subject to terms)	Interest / coupon income
Voting Rights	Full voting rights	Limited voting rights until conversion (except on matters affecting their rights)	No voting rights until conversion
Liquidation Priority	Lowest priority	Priority over equity, below debt	Generally, ranks as debt until conversion
Valuation Timing	At issuance	At issuance (conversion formula fixed upfront)	At issuance; conversion terms fixed upfront under FEMA pricing rules
Conversion	Not applicable	Compulsorily converts into equity shares	Compulsorily converts into equity shares
Max Tenor	Perpetual	As agreed in terms of issue	Commonly up to 10 years under Companies Act practice
Transfer Pricing Risk	Low	Moderate	Higher, especially due to interest/coupon benchmarking
Anti-dilution Protection	Possible through shareholder agreements	Commonly used	Possible, but less common
Preferred for	Long-term ownership and control	PE/VC investments with downside protection	Structured funding with debt-like economics

Tax Implications for Foreign Investors

Tax treatment is an important factor when choosing between equity, CCPS, and CCDs.

Equity Shares

• Dividends: Taxable for foreign investors. TDS is generally 20%, but lower DTAA rates may apply.
• Capital gains: Tax depends on whether the shares are held short-term or long-term.
• Buyback tax: A 20% tax applies at the company level on share buybacks, so investors are usually not taxed again on buyback proceeds.

CCPS

• Preferred dividends: Taxable in the hands of investors and subject to TDS.
• Conversion into equity: Not treated as a taxable event under Indian tax law.
• Sale after conversion: Gains are taxed as equity capital gains.
• DTAA benefits: Investors using treaty jurisdictions such as Singapore, Mauritius, or the Netherlands may receive lower tax rates.

CCDs

• Interest income: Taxable for the foreign investor and subject to TDS, though DTAA benefits may reduce the rate.
• Tax deduction for Indian company: Interest paid on CCDs is tax-deductible, unlike dividends on equity or CCPS.
• Transfer pricing rules: Interest rates must meet arm’s length standards (they must reflect what independent lenders and borrowers would agree to under similar terms) under Indian tax laws.
• Conversion into equity: Conversion of CCDs into equity is generally not taxable.

Which instrument is best for funding an Indian Subsidiary?

The right funding instruments depend on factors like subsidiary’s stage, control rights, investor expectations and return structure. Here are the recommended funding instruments according to each structure:

1. Wholly Owned Subsidiary (WOS)

If a foreign parent is setting up a 100% owned Indian subsidiary, simple structures usually work best because there are no outside investors.

Best choice:

• Equity Shares – Simple and straightforward ownership structure.
• CCDs – Suitable if the parent wants regular interest income before conversion into equity.

2. Venture Capital / Private Equity Investment

Foreign VC and PE investors generally seek downside protection, anti-dilution rights, and liquidation preference.

Best choice:

• CCPS – The most commonly used instrument in Indian startup funding rounds because it provides investor protection while remaining FEMA compliant.

3. Intercompany Funding with Regular Returns

If the foreign parent wants periodic returns on the capital invested in the Indian subsidiary, fixed coupon instruments are preferred.

Best choice:

• CCDs– Provide fixed interest income, subject to transfer pricing and benchmarking rules.

4. Sectors with FDI Caps

In sectors such as insurance or defence, FDI limits apply on a fully diluted basis. Since CCPS and CCDs are treated as equity under FEMA, conversion can affect sectoral cap calculations.

Best approach:

• Carefully model post-conversion shareholding before issuing CCPS or CCDs. Professional FDI structuring advice is recommended.

Conclusion

While choosing funding instruments for India subsidiary, it is important to compare the structures, in vision of what the business needs. While going through the ways to fund an Indian subsidiary, whether the comparison is between CCD vs CCPS India or equity vs CCPS India, each instrument serves different business and investor objectives. The right choice depends on the factors such as ownership goals, expected returns, investor protection, tax efficiency and regulatory compliance. Equity shares are often suitable for simple long-term ownership, CCPS are commonly preferred where investor protection and valuation flexibility are important, and CCDs can be useful where debt-like returns are commercially relevant.

It can be tough decision while choosing the instruments and evaluating the business needs. This is where an expert is needed, Stratrich Consulting has years of experience in helping business to grow and expand. Contact today to give your business a strong foundation for an extensive growth.