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Draft Foreign Exchange Management (Foreign Investment) Rules, 2026: Hits and misses

Summary: The draft FEMA (Foreign Investment) Rules, 2026, propose to replace the NDI Rules with a consolidated framework, introducing reworked thresholds, a broader pledge regime, relaxed gift norms, and recalibrated pricing requirements. This article attempts to analyse some of the key hits and misses, in comparison to the NDI Rules.

Introduction

The RBI on July 21, 2026, released the draft Foreign Exchange Management (Foreign Investment) Rules, 2026 (“FI Rules”), for public consultation. Stakeholders may submit their comments on the proposed framework by August 31, 2026. The FI Rules aim to supersede the existing Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”).

While the FI Rules apply to investments by non-residents and foreign-controlled entities (“FCE”), they do not extend to investments in financial institutions set up/incorporated in the IFSC.

Concepts Modified through Definitions

Key definitions under the FI Rules with potential implications are as follows:

  • “eligible investee entity”: The NDI Rules prescribe separate definitions for different categories of eligible investee entities, including “Indian company” and “Indian entity”. The FI Rules consolidate these under the umbrella “eligible investee entity” inter alia comprising companies, body corporates (excluding societies and trusts), LLPs, SEBI-registered investment vehicles (REITs, InvITs, AIFs, MFs, etc.), partnership firms and proprietary concerns registered under applicable laws. This shifts the framework from entity-specific schedules to a consolidated approach. The NDI Rules permit only NRIs or OCIs to invest in a partnership firm or proprietary concern (subject to certain restrictions) on a non-repatriation basis. Further, LLPs can presently raise foreign investment only if they operate in sectors where foreign investment is permitted up to 100% under the automatic route, having no FDI linked performance conditions.
  • “equity”: Intending to replace“equity instruments” and “non-debt instruments” under the NDI Rules, “equity” is proposed to be an instrument classified as equity by the eligible investee entity per applicable accounting standards. Accordingly, mandatorily convertible instruments with fixed-conversion ratio and fixed consideration would qualify as equity instruments[1]. This will require careful structuring of the instruments to be issued (including the terms thereof). The definition includes units of investment vehicles and participating interests or rights in Indian companies or LLPs but does not expressly refer to interests in partnership firms or proprietary concerns (despite them being eligible investee entities). Further, the proposed definitions of “FDI” and “FPI” confine foreign investment to equity of a company or LLP and do not appear to extend to other eligible investee entities. Clarity may emerge upon the release of the Annexures. Further, unlike the NDI Rules, the FI Rules do not address acquisition of immovable property by non-residents.
  • “FDI” and “FPI”: The NDI Rules limit FPI to investments below 10% in listed companies, while FDI includes investments in unlisted companies and investments of 10% or more in listed companies. The FI Rules remove this distinction tied to listing and simply indicate that: (i) FDI means investment of 10% or more; and (ii) FPI means investment of less than 10%, in each case, in equity of a company (listed or unlisted) or an LLP. The conditions RBI will prescribe for FDI and FPI investments in the Annexures remain to be seen.
  • “foreign investment in equity”: This encompasses both direct and indirect foreign investment, including investments by: (i) FCEs; or (ii) persons resident outside India through entities owned or controlled by them, or through entities under common ownership or control. In the context of foreign investment by persons resident outside India: (i) “ownership”means beneficial holding of more than 50%; and (ii) “control” means the right to appoint majority of directors or control management or policy decisions, including through shareholding, management rights, or agreements entitling 10% or more voting rights. The NDI Rules do not have such quantitative threshold for “control” at the investor (and its group) level, basing it solely on qualitative factors vis-à-vis the investee entity. Below is an analysis of “ownership” and “control” in the context of FCEs.
  • “foreign controlled entity” or “FCE”: The FI Rules aim to replace the existing “foreign owned and/ or controlled company” (“FOCC”) construct legislated for under Rule 23 of the NDI Rules. The FI Rules define an FCE as a resident company, LLP, or investment vehicle owned or controlled by a non-resident, with “ownership” and “control” to be prescribed by the relevant sectoral regulator in consultation with the Central Government. Absent sector-specific definitions, these concepts will be determined under the applicable law. While the “foreign investment in equity” definition uses fixed thresholds (more than 50% for ownership and 10% or more voting rights for control), the FCE definition defers to sector-specific or statutory thresholds, which may complicate multi-layered structures where ownership and control must be evaluated at each level. Under the NDI Rules, an AIF’s investment is treated as domestic if its sponsor, manager, or investment manager is Indian owned and controlled (regardless of foreign capital in its corpus). By introducing the FCE concept for investment vehicles and deferring “ownership” and “control” to SEBI, the FI Rules leave open the possibility of AIFs with majority foreign capital (even with Indian-owned and controlled sponsor, managers, or investment manager) being classified as FCEs, triggering indirect foreign investment compliance. Further, the NDI Rules prescribe restrictions on funds for making downstream investments. Considering the FI Rules omit such conditions, whether they would be reintroduced through Annexures remains to be seen.

Pledge: Relaxations

The NDI Rules permit pledge over equity instruments, subject to restrictions on eligible pledgors, pledgees, and permissible purposes. The FI Rules envisage a more permissive regime, allowing non-residents or FCEs to pledge equity without express limitations on categories of pledgors, pledgees, or end-use purposes. This affords broader latitude in structuring financing transactions, subject to any transfer upon invocation complying with prescribed entry routes, sectoral caps, conditions, and pricing guidelines.

Gift

The NDI Rules restrict gifts of equity to a 5% cumulative cap, a USD 50,000 annual ceiling, and prior RBI approval. The FI Rules propose removing these requirements and permitting gifts between natural persons who are “close relatives”. For transfers on a repatriation basis where the donor holds the investment on a non-repatriation basis, the donee must be a “close relative”, and aggregate transfers must not exceed LRS limits (currently USD 250,000 per financial year) – this is a welcome move, particularly for succession planning. Notably, “close relatives” remains undefined under the Companies Act (which merely defines “relative”).

Pricing Guidelines: Ambiguities and Complexities

  • The NDI Rules distinguish between floor and ceiling prices based on transaction character (subscription or transfer, by or to non-residents/ FOCCs), but the FI Rules contemplate a uniform pricing standard for all issuances and transfers, determined by prescribed methodology for listed and unlisted companies. If issuances must be at fair market value, anti-dilution structures common in PE and M&A deals (where investors seek a buffer between investment price and fair value to provide for any anti-dilution adjustments) may become untenable. The FI Rules also appear to apply pricing guidelines to transfers between two non-residents and from FCEs to non-residents, currently exempt under the NDI Rules. Necessary clarifications in this regard would be imperative.
  • The FI Rules neither address valuation of convertible equity instruments nor permissibility of assured returns to non-resident investors. Absent express prohibition on assured returns, structuring of exit rights may warrant reconsideration. Clarifications may be expected in the Annexures.
  • The NDI Rules separately address renunciation and exempted rights issues on the condition that the price offered to a non-resident is not lower than that offered to a resident. However, the FI Rules exempt rights issues from pricing guidelines without additional conditionalities (including those on renunciation and issuance of unsubscribed portions). This could enable circumvention of pricing guidelines, inadvertently creating more favourable pricing for participating non-residents.

Compliance Obligations: Onus

The FI Rules extend compliance obligations beyond the eligible investee entity to foreign investors and, where a transfer is contemplated, to transferors and transferees unlike the NDI Rules, which place the onus on the Indian investee entities or resident transferors/ transferees. The practical implementation of this provision remains unclear.

Matters Requiring Express Legislation/Clarification

The FI Rules do not address several commercially significant mechanisms, including deferred consideration, escrow and indemnity holdback arrangements, convertible notes issuance by startups, and the treatment of investments by foreign venture capital investors (including eligible sectors, pricing exemptions and reporting requirements). These provisions are material given their role in structuring investments.

These omissions may not reflect the legislative intent; however, one could hope for much-needed clarifications to come through in the Annexures.

[1] Under IAS 32 (Paragraph 11), an “equity instrument” is any contract evidencing a residual interest in an entity’s assets after deducting all liabilities – “entity” encompasses individuals, partnerships, incorporated bodies, trusts, and government agencies. Contracts settled in the entity’s own equity instruments include rights, options or warrants which acquire a fixed number of such instruments for a fixed amount in any currency.