On 20 January 2025, the Reserve Bank of India (“RBI”) issued an updated Master Direction on Foreign Investment in India (“Master Direction”). 

Some of the important changes and clarifications made by the Master Direction are as follows: 

A.     Clarification regarding downstream investments 

The Master Direction now expressly states that, based on the guiding principles of downstream investment, arrangements permitted for direct investment under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”), such as investment through equity instrument swaps and deferred payment arrangements, will also be available for downstream investments, provided they comply with the provisions governing such investments under the NDI Rules. 

This clarification addresses longstanding uncertainty regarding whether foreign owned or controlled companies (“FOCCs”) making downstream investments are permitted to enter into deferred payment arrangements. The NDI Rules stipulate that, in cases involving the transfer of equity instruments between a person resident in India and a non-resident, the buyer may defer up to 25% of the total consideration for a period not exceeding 18 months from the date of the transfer agreement. However, as FOCCs were not explicitly mentioned in the provision permitting deferred consideration, ambiguity arose regarding their eligibility to avail this benefit. Consequently, there were divergent views being taken in this regard. 

This uncertainty was further exacerbated in 2023, when the RBI issued notices to several FOCCs that had entered into deferred payment arrangements for their downstream investments. This resulted in an anomalous situation where indirect foreign investments by FOCCs were subjected to more stringent regulatory standards than direct foreign investments made by non-residents. 

The recent clarification by the RBI resolves this discrepancy, and subject to compliance with all relevant regulatory requirements, FOCCs may now structure their downstream investments with the same flexibility which is available to direct investment by non-residents. While the amendments introduced in the Master Direction provide long awaited clarity in relation to permissibility of an FOCC to undertake deferred consideration transactions and equity instrument swaps; however, given the clarification does not specify the extent to which provisions applicable to direct investments will apply to downstream investments, the fundamental differences in the scope of downstream and direct investments may give rise to a need for certain additional clarifications from the RBI. 

B.    Other notable changes 

Certain other notable changes have been introduced by the updated Master Direction which are set out below: 

1. Form DI filing requirement has been extended to reclassification of investments where an investor entity, who had made the original investment in the investee entity as a resident, but later becomes an FOCC, will be required to report such reclassification of investment into downstream investment, within 30 days from the date on which the investor entity becomes an FOCC, in Form DI. 

2. Minimum Net Owned Fund (NOF) criteria has been clarified to state that an Indian investee company whose proposed activities are regulated by a financial sector regulator, may receive foreign investment to comply with the criteria of minimum NOF prescribed by such regulator. However, such investment can only be used to comply with the minimum NOF / capitalization criteria and cannot be used for any other purpose/activity. In the event the relevant registration/license is not granted to the investee company, then the investment so received shall be repatriated or shall be subject to the conditions applicable on an investment in an Indian company not housing any operations. 

3. Acquisition through rights issue has been updated to state that an Indian company may undertake disposition of unsubscribed equity securities in a rights issue (in the manner prescribed under Section 62(1)(a)(iii) of the Companies Act, 2013) by issuing equity instruments to a person resident outside India (other than overseas corporate bodies (OCBs)). Such issuance shall be subject to adherence to entry routes, sectoral caps/investment limits, pricing guidelines and other attendant conditions under the NDI Rules. 

Previously, a rights issue over and above the rights entitlement of a person resident outside India could be done on an application made to the Indian investee company and such issuance was subject only to individual or sectoral caps. However, such provision has been modified pursuant to the Master Directions. 

4. Employees stock options, sweat equity shares and Share Based Employee Benefits has been updated to state that the percentage of foreign investment shall be calculated on a fully diluted basis upfront, at the time of issuance of such instruments. 

5. Transfer on deferred payment basis, under indemnification or escrow has been modified to require that a transaction intended to be undertaken under any of these mechanisms should be appropriately captured in the share purchase/transfer agreement, along with the related conditions for such arrangement. 

6. Authorised Dealer Banks’ role has been codified by introducing a mechanism for requests for clarification pertaining to foreign investment framework to be routed through the concerned authorized dealer bank (“AD Bank”). The AD Banks have been provided the discretionary power to forward such request to the concerned Regional Office of the RBI (determined basis the registered office of the Indian investee company) for guidance.

Authors – Akshita Alok – Managing Associate and Shamik Gupta – Associate

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