Introduction 

The Reserve Bank of India (“RBI”) released the draft Foreign Exchange Management (Foreign Investment) Rules, 2026 (“Draft Rules”) on July 21, 2026. Upon notification, the Draft Rules shall: (i) supersede the existing Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”); and (ii) apply to foreign investments in equity of an eligible investee entity by a person resident outside India or transfers thereof. Investments made by a person resident outside India in a financial institution set up in an IFSC will not fall within the scope of the Draft Rules, and actions undertaken pursuant to the NDI Rules have been grandfathered.

The stated objective is to simplify the foreign equity investment regime, reduce regulatory complexity, enhance ease of doing business, and align the rules with the foreign investment policy (i.e., the FDI policy). The Draft Rules are open for public comments until August 31, 2026.

A brief overview of some of the key changes proposed to be introduced is set out below.

Key changes

1. Eligible Investee Entity 

• • New construct of “Eligible Investee Entity” has been added to consolidate different form of entities that can receive foreign equity investment from persons resident outside India under one definition.
  • The term covers: (i) company as defined under the Companies Act, 2013; (ii) a body corporate established or constituted by or under any Central or State Act (excludes society or trust other than as permitted under (iv) below); (iii) LLP registered under the Limited Liability Partnership Act, 2008; (iv) an investment vehicle registered with SEBI (including: (I) REITs; (II) InvITs; (III) AIFs; (IV) Venture Capital Funds; (V) Mutual Funds or Exchange Traded Funds, or any other investment vehicles which invest more than 50% in equity which are registered and regulated under applicable SEBI regulations); (v) partnership firm registered under the Indian Partnership Act, 1932; and (vi) a proprietary concern registered under the applicable domestic laws.

• Key implication: Under NDI Rules, only NRIs and OCIs could invest in the capital of a firm or a proprietary concern.

2.Definition of “Equity” 

• • Single unified definition introduced to replace the earlier definitions of “equity instruments” and “non-debt instruments” under NDI Rules.
  • “Equity” has been defined as: (i) instruments classified by the eligible investee entity (other than an investment vehicle) as equity as per applicable accounting standards; (ii) units of investment vehicle; and (iii) participating interest or right in oil fields or mines of an Indian company or LLP.

• Key implication: On linking “equity” to the accounting standards –

• • mandatorily convertible instruments with fixed conversion ratios should qualify as “equity” under the applicable accounting standards; however, instruments which do not have a fixed conversion ratio (for instance, the conversion is linked to enterprise value, IRR, or pricing in a future liquidity event), and/or require payment of cash amounts which is not fixed (such as interest, event linked dividends, convertible notes) may be classified as financial liabilities. This is a significant departure from the current definition of “equity instruments” under the NDI Rules; and 
  • characterisation of instruments under accounting standards would influence FEMA compliance, impact structuring of deals, and this may result in interpretational issues under the accounting standards also seeping into FEMA related analysis. This change would also necessitate greater involvement of auditors/ chartered accounts in understanding terms of instruments and determining whether the same qualify as “equity”. 

3.“Foreign Investment in Equity” (referred to as “foreign investment” in the Draft Rules)

• New construct introduced in the Draft Rules which covers both: (i) direct investment; and (ii) indirect investment through a: (I) Foreign Controlled Entity (“FCE”) (please refer to #4 below) or (II) any other person resident outside India (other than the one investing directly) which is owned or controlled by the person resident outside India, or is under common ownership or control with the person resident outside India.

• Key implication:

• • Direct and indirect investment has now been consolidated under one definition. NDI Rules dealt with indirect foreign investment separately under the downstream investment framework.
  • On a prima facie reading, it appears that #3(ii)(II) intends to cover the controlling entities of the direct foreign investor. For determining ownership and control for the purpose of this #3(ii)(II), the Draft Rules peg “ownership” to beneficial ownership of more than 50%, and uses the definition of “control” under the Overseas Investment Rules (which includes shareholders’ or voting agreements that entitle the holder to 10% or more of voting rights). Given such types of tests are more relevant in the context of beneficial ownership related requirements, and  investment by the direct foreign investor (irrespective of percentage) is already within the scope of the regulatory framework, it would be critical to obtain regulatory guidance on: (A) relevance of including these entities within the compliance regime of the Draft Rules; and (B) the manner in which these entities will comply with the requirements from an operational perspective.
  • Given that a direct foreign investment and downstream investment has been brought into the same fold, it is yet to be seen how the reporting requirements for indirect foreign investment/ downstream investment would change. 

4.Foreign Controlled Entity (FCE)”

• Replaces the construct of FOCCs under the NDI Rules. “Ownership” and “Control” for determining whether an entity is FCE shall be as per the provisions under relevant sectoral regulations, and in the absence of the same, the Companies Act / SEBI AIF Regulations, etc (as applicable).
• Investment vehicles which are owned or controlled by a person resident outside India have been included in the definition of FCE.

• Key implication:

• • Foreign investments by FCE would be required to comply with applicable conditions only for sectors specifically prescribed under the foreign investment policy. While changes to this effect under the foreign investment policy are yet to be seen, this may potentially reduce compliance burden for holding company structures outside of the identified sectors.
  • Under the NDI Rules, investment by an investment vehicle is considered ‘indirect foreign investment’ if the sponsor or manager or investment manager of the vehicle is not owned or controlled by a resident Indian, or is owned or controlled by person resident outside India. The Draft Rules propose replacing the current test of ownership as applied to the sponsor/ manager/ investment manager of an investment vehicle with a new criteria based on the ownership of the non-resident unit holders in the investment vehicle.
  • The Draft Rules as currently drafted do not include certain requirements of downstream investment from the earlier regime (such as source of funds restrictions, and requirement to obtain auditor certificate by the first-level Indian company making the downstream investment). It will have to be seen if any FCE specific conditionalities are brought in Annexure II or Annexure III of the Draft Rules.
  • Under the NDI Rules, only “Indian Entities” (which comprised of Indian companies and LLPs) were permitted to receive downstream investment. The Draft Rules have expanded this to “Eligible Investee Entities” thus including partnerships registered under the Indian Partnership Act ,1932, and permitted trusts, and proprietary concerns as set out in #1 above. 

5.Foreign Direct Investment (“FDI”) and Foreign Portfolio Investment (“FPI”)  

• A uniform threshold for listed and unlisted companies has been introduced in the Draft Rules.
• Foreign investments of 10% or more in the equity of a company or a LLP shall be treated as FDI, while investments below the 10% threshold shall be FPI.
• This is a change from the NDI Rules where: (i) any foreign equity investment in an unlisted Indian company, or in 10% or more in the post issue paid-up equity capital of a listed company is considered as FDI; and (ii) foreign equity investment of less than 10% in the equity of a listed company is classified as FPI. Practical implication of changes in definitions of FDI and FPI is yet to be seen. 

6.Pricing Guidelines 

• • Pricing requirements have been consolidated into 3 categories.
  • The requirement now states that foreign investment and transfers shall be at a price determined: (i) in accordance with the relevant SEBI regulations in case of listed companies and investment vehicles; (ii) in accordance with Annexure I of the Draft Rules for companies listed on an international stock exchange; and (iii) in all other cases as per any internationally accepted pricing methodology for valuation on an arm’s length basis by a chartered accountant or merchant banker registered with SEBI or cost accountant.

• Key implication:

• • The Draft Rules require the investment/ transfers to be at the price determined in accordance with the above formulations. Accordingly, the existing construct of stipulating a floor for issuances, and a ceiling/ floor (depending on the residency of the parties involved in transfers) has not been included. In our view, this could be a drafting error and not reflective of legislative intent.
  • The Draft Rules do not contain certain explicit requirements of NDI Rules, such as: (I) pricing of convertible instruments to be fixed upfront at the time of issuance of the instrument; (II) issuance of shares to a person resident outside India by way of subscription to memorandum of association to be undertaken at face value; and (III) requirement of a SEBI registered merchant banker/ investment banker report for swap of equity instruments (please note investments through a swap continue to be permitted). 

7.Pledge 

• • The Draft Rules permit persons resident outside India and FCEs to make foreign investment by way of pledge.

• Key implication:

• • NDI Rules permit following categories of persons to create pledges: (I) promoters of companies which have raised external commercial borrowings (“ECBs”) in accordance with the ECB regulations can pledge shares of the borrowing company; and (II) persons resident outside India can pledge their equity instruments in an Indian company/ units in an investment vehicle in favour of (i) overseas banks; and (ii) Indian banks and non-banking financial companies, subject to certain conditions. This scope appears to have been widened under the Draft Rules, and greater clarity on transfers is likely to emerge once RBI publishes the transfer related provisions under Annexure III. 

8.Onus of Compliance 

• Onus of compliance has been placed on the foreign investor and the eligible investee entity, or transferor and transferee in a foreign investment.
• As currently drafted, the scope appears to be broader than the NDI Rules under which the responsibility is on the investee entity, or for downstream investments, on the first-level Indian company making the investment, or in case of transfer related reporting, the resident transferor/ transferee. This will need to be evaluated further from an implementation perspective.

Conclusion

While the Draft Rules aim to materially simplify the existing regime on foreign equity investments by consolidating key concepts, clarifications and regulatory guidance on certain aspects is awaited. In particular, since Annexure II (foreign investment policy) and Annexure III (conditions applicable to foreign investments) will form an integral part of the proposed framework, the full extent and practical effect of the changes introduced by the Draft Rules can only be assessed once the detailed requirements and subordinate policy set out in these Annexures are available. Further, the Draft Rules do not expressly address certain matters currently covered under the NDI Rules (such as deferred consideration, issuances pursuant to NCLT schemes, acquisition and transfer of immovable property, and employee stock option plans). It remains to be seen if any of the foregoing reflects a deliberate move towards a leaner framework, or relevant requirements will be set out under the Annexures or through other directions.

Authors – Gautam Saha – Joint Managing Partner, Amrita Patnaik – Partner and Ambika Sahai – Managing Associate

Disclaimer: This alert only highlights key issues and is not intended to be comprehensive. The contents of this alert  do not constitute any opinion or determination on, or certification in respect of, the application of Indian law by Talwar Thakore & Associates (“TT&A”). No part of this alert should be considered an advertisement or solicitation of TT&A’s professional services.