Tax Red Flags PE Diligence Finds in Indian Targets

The same tax exposures recur across Indian targets: ITC reconciliation gaps, under-withholding on cross-border payments, unfiled FEMA reporting, contractor misclassification, and share premium valuation without adequate support. Most are cheap to fix before a process and expensive to address during one.

Why the same issues keep appearing

These are not sophisticated failures. They are the predictable consequence of a company growing faster than its finance function, where compliance is handled transactionally by an external accountant without anyone owning the aggregate position.

The cost asymmetry is what matters. An unfiled FEMA form costs a Late Submission Fee to fix before a process. Discovered during diligence, it becomes a condition precedent, delays completion, and hands the buyer a lever.

The recurring findings

ITC claimed against non-filing suppliers. Almost universal to some degree. Fixable prospectively by monthly reconciliation; historical gaps are quantified and negotiated.

Under-withholding on cross-border payments. Foreign software, cloud services, intra-group charges and overseas professional fees paid without a chargeability analysis. The exposure is not just the withholding shortfall but disallowance of the expenditure — typically the larger number.

Unfiled or late FEMA filings. FC-GPR filed late, FLA returns never filed, downstream investment unreported. Directly obstructive, because a buyer will not complete over an unresolved contravention. Note the Late Submission Fee route closes at three years.

Share capital and premium without supporting documentation. Historic rounds raised without a contemporaneous valuation report, or without a clear record of the subscriber’s identity and source of funds. The angel tax charge under Section 56(2)(viib) was abolished from AY 2025-26, so for current years this is no longer a valuation-based charge. But Section 68 still allows the department to question the genuineness of share capital and premium, earlier years may remain open, and FEMA pricing rules apply independently to issues to non-residents. Difficult to remediate after the fact, because the evidence has to be contemporaneous.

Contractor misclassification. Individuals engaged on contract who are functionally employees — fixed hours, direction and control, exclusivity, integration into the organisation. Creates provident fund, ESI and withholding exposure compounding over years.

Reverse charge under-declaration on imported services.

Transfer pricing documentation that does not match operations.

Legacy indirect tax matters assumed closed but still live.

ESOP withholding not deducted at exercise, or valuations obtained retrospectively.

[INSERT: an anonymised Solique example — a pre-process remediation and what it preserved in the eventual transaction.]

What founders should do before a process

Start twelve to eighteen months ahead where possible. Most items are remediable, but remediation takes time and several cannot be done retrospectively.

Run a FEMA filing audit and regularise anything outstanding through Late Submission Fee while it remains available.

Reconcile ITC for all open years and pursue supplier defaults while commercial leverage remains, keeping the 30 November deadline in view.

Perform the chargeability analysis for every recurring cross-border payment and correct withholding prospectively.

Review contractor arrangements against the substance factors and regularise where the facts point to employment.

Confirm valuation reports exist and are contemporaneous for every round.

Related reading

• buyer-side diligence scope — Tax Due Diligence for Acquiring an Indian Target
• FEMA compounding — FEMA Contraventions and RBI Compounding: What Triggers Action
• scrutiny triggers — Income Tax Scrutiny Triggers for Growth-Stage Companies