India’s Foreign Investment Reset 2026: Draft FEMA Rules for FDI

Until now, foreign direct investment in India has meant any foreign equity in an unlisted company and a stake of 10% or more in a listed one. The draft Foreign Exchange Management (Foreign Investment) Rules, 2026 would collapse that split into a single 10% line for companies and LLPs, and would identify the equity itself by the accounting standards the investee applies.

A term sheet is signed. The money is ready to move. The cap table is agreed, and the lawyers are still arguing over shareholder rights. Someone then asks whether the investor's vetoes amount to control, whether the instrument counts as equity, and whether the price can sit below the valuation.

The draft answers those questions differently. Each answer moves the entry route, the sector cap, the reporting that follows a closing and, in a bad year, the compounding order.

It went out for public consultation on 21 July 2026 and would replace the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, known as the NDI Rules. The stated aim is a principles-based framework that keeps FEMA process and sector policy apart. This note tests that aim against the clauses as circulated, and closes with what a foreign parent should re-read before a final notification issues.

What Foreign Direct Investment in India Means Under the Draft Rules

Under the draft, foreign direct investment is equity investment by a person resident outside India in an eligible investee entity, acquired in a permitted mode. Which entities may receive the money, and which instruments count as equity, now turn on accounting standards and sectoral regulation.

The eligible investee entity is wider than the company-only view the NDI Rules carried. The draft names Indian companies and specified bodies corporate, LLPs, SEBI-registered investment vehicles, registered partnership firms and proprietary concerns, and the published analysis of the clause treats the partnership and proprietary-concern entry as a real expansion, because those vehicles needed RBI approval under the rules in force. Investment vehicles stand as their own category: REITs, InvITs, AIFs, venture capital funds, mutual funds and exchange-traded funds. Societies and trusts stay outside the definition, and financial institutions incorporated in the IFSC are carved out of the draft altogether.

Equity is the harder half. For an entity that is not an investment vehicle, the draft looks to instruments classified as equity under the accounting standards that apply to it, and adds units of investment vehicles and participating interests or rights in oil fields or mines. FEMA names the instruments today: equity shares, fully and mandatorily convertible preference shares, fully and mandatorily convertible debentures and share warrants.

The classification question therefore moves to the investee's auditors. An instrument that reads like debt in its commercial terms can sit in equity under the Indian Accounting Standards or IFRS and count as equity for FEMA, and the same instrument can fall outside the definition in a different accounting frame.

The draft also writes down who decides what. RBI administers the Rules and issues the directions that run them, while interpretation of the FDI Policy stays with DPIIT. Practitioners have worked that division for years without seeing it in the rules themselves, and the codification settles the forum without settling which view prevails where the two meet.

Set the two instruments side by side and the deal-level differences come down to five questions.

Where a term sheet is already drafted, the instrument and the holding structure can be put against both frameworks before the money moves.

India's FDI Record and Why the 2019 NDI Rules Are Being Replaced

The inflow numbers make the case for replacing the Rules easier to see. India drew more than $94 billion of foreign direct investment in FY 2025-26, and more than 90% of equity inflows came through the automatic route, according to News On Air's report of the DPIIT data published on 10 June 2026.

Cumulative inflows between 2014-15 and 2025-26 reached $843 billion, which News On Air reported as a 169% increase over the previous twelve-year period.

The case against the NDI Rules is structural. Those Rules defined their scope by exclusion, through the category of non-debt instruments, and left hybrid instruments and investment-vehicle units at the margins. The framework also ran across the Rules, the consolidated FDI Policy and RBI's directions, so a single question could need four documents to answer.

The draft's answer is procedural. Process sits in the Rules; sector policy sits in an annexure. Annexure II, which will carry the FDI Policy, was not published with the draft, and neither was Annexure III, the list of RBI regulations that will run beside it. Caps, entry routes and prohibited activities will live in documents a reader cannot open yet.

A shorter rulebook is not deregulation. Government approval, sector limits and barred activities survive, and the draft says so by leaving them to the Policy.

The 10% Line Between FDI and Foreign Portfolio Investment

The line between FDI and portfolio investment is the clause most likely to be read aloud in a board meeting. The position today is asymmetric: any foreign investment in an unlisted Indian company is FDI, while 10% or more of post-issue paid-up capital decides the classification for a listed company, as a current-affairs summary of the framework sets out.

The draft keeps the 10% threshold and states it for companies and LLPs alike. A published reading of the clause treats that as a clarification of a line the framework already drew. The draft also restates the reclassification rule, under which portfolio investment that crosses 10% becomes FDI, with the conditions and directions of both RBI and SEBI attached.

Read literally, the draft then drops the listed and unlisted distinction. A 5% stake in an unlisted Indian company would sit below the line and be portfolio investment on the draft's own words.

That reading needs the portfolio regime to travel somewhere it has not been. Portfolio investment in India runs through SEBI-registered foreign portfolio investors, a listed-securities regime with registration, investment limits and disclosure built into it. An unlisted company offers such an investor no market to trade in.

The wording and the intention are separate questions. Whether portfolio-style holdings below 10% in unlisted entities are intended is not settled by the text read here, and I would not label or restructure a deal on a literal reading of a consultation draft.

The exposure that is settled is reclassification. A holding that begins at 8% and crosses 10% in a follow-on round becomes FDI at that point, and the FDI conditions attach from there.

Foreign Control, the FCE Test and Minority Veto Rights

The draft accepts indirect foreign investment through a foreign-controlled entity, and it defines the FCE in the Rules rather than leaving the concept to directions. An FCE is an Indian company, LLP or investment vehicle that a non-resident owns or controls.

The definition carries a clarification that matters in a group. Ownership and control for FCE purposes follow what the sectoral regulator stipulates in consultation with the Central Government, and the domestic law governing the entity where the regulator has said nothing, as the clause-by-clause analysis records. A bank, an insurer, an AIF and a trading company can therefore land on different tests.

Thresholds sit in the indirect investment rule. Ownership means beneficial holding of more than 50%. Control follows the 10%-of-voting-rights or management-rights formulation familiar from the Companies Act and the SEBI takeover code, and it runs through shareholding, management rights, shareholder agreements and voting pacts.

Where the two point in different directions, the draft says nothing, and the published analysis flags that silence as a gap for comment. A fund can hold 40% of the equity without a board majority, or a small stake with a veto that decides policy, and neither case is resolved.

Why minority investor rights matter

Take a private equity fund that buys 15% of an Indian company. It cannot name most of the board and does not run the business. It does bargain for vetoes over new share issues, a change of business, large borrowings and the sale of major assets, and it may hold a voting pact with the founder. Whether those terms give it the right to direct policy is not a question the term sheet answers.

The draft nowhere says that a 10% holder controls the company. Its words are wide enough to be argued, and the cost of losing that argument is specific: sector eligibility, the approval route, the pricing condition and downstream compliance all move when an Indian company becomes an FCE.

Investors from land-border jurisdictions meet the same mapping problem one layer out, under the land-border FDI reset and its beneficial-ownership safe harbour, which tests beneficial ownership of the investor rather than the register of the Indian company.

Downstream Investment Becomes a Governance Question

When an Indian entity that foreign investors own or control puts money into another Indian entity, that onward step may count as indirect foreign investment.

This is what the rules call downstream investment.

The logic is that a deal a foreign investor cannot do directly should not be done in roundabout form through an Indian intermediary.

Because the draft names FCEs outright, groups must map who owns and controls what before any downstream deal.

Take an Indian operating company with foreign venture capital money. It later sets up a wholly owned Indian subsidiary to run a regulated activity. Whether that unit's capital counts as domestic or as indirect foreign investment may turn on whether the parent is an FCE.

If control is read more widely, more Indian companies may fall inside the downstream investment rules. That could mean meeting sector caps, entry routes and other FDI conditions at the subsidiary level.

So a board should not clear a downstream deal just because the investing company is set up in India. Under FEMA, an Indian company does not always mean Indian capital.

Pricing May Move From a Boundary to an Exact Number

The pricing rule is short, and its effect on a deal can be large. For listed Indian companies and investment vehicles the SEBI regulations apply. For a public company listing on an overseas exchange, the conditions sit in Annexure I. Everywhere else the price comes from an internationally accepted arm's-length valuation method, certified by a chartered accountant, a merchant banker or a cost accountant.

Today's rules set bounds that run one way. A resident selling to a non-resident cannot normally go below fair value and may agree on more. A non-resident selling to a resident cannot normally go above fair value and may agree on less.

The draft instead says that foreign investment, or its transfer, shall be made at a price determined through the prescribed method. Read as an instruction to transact at exact fair value, that wording would remove the room the present bounds leave to negotiate.

The published reading of the clause goes the other way, at least in part: the analysis records that the pricing guidelines are retained in substantially the same form, with the same certifying professionals and the exemption for rights-basis subscriptions intact. On that reading the change is one of drafting, and the negotiation room survives.

Why this matters in real deals

A strategic buyer may pay a control premium, and a founder short of cash may accept a discount. A buyer may adjust for indemnities, contingent liabilities or an earn-out, and a family reshuffle may settle on a value inside the present limits.

Where the valuation and the bargain give different numbers, the question is whether the gap is a permitted spread or a breach. The draft as circulated does not answer it in the clause, and a deal team should price on the assumption that the difference will be tested.

Equity is rarely the only money in a transaction. Where the parent also lends, the borrowing sits under a separate instrument, and the 2026 ECB regime caps external commercial borrowing at 300% of net worth or USD 1 billion, whichever is higher.

Entry Routes, Sector Caps and the Gifts and Listing Changes

Entry routes are the part of the framework the draft leaves to the Policy. The automatic route needs no prior approval; the government route needs it first. The route and the cap for each sector sit in the FDI Policy, which the draft carries as Annexure II.

Defence and broadcasting show how route and limit interact. Defence permits foreign investment up to 74% under the automatic route, with anything beyond that needing government approval, and broadcasting is capped at 49%, as the sector summary records.

Every other cap has to be read from the consolidated Policy, and the draft's own annexure is not available to check against. A reader cannot route or price a deal from the draft's text alone.

Gifts between natural persons become a permitted mode in the draft. A holding on a non-repatriation basis that is gifted on a repatriation basis must go to a close relative and stay within the Liberalised Remittance Scheme limit, as the clause analysis records. Reporting mechanics stay with RBI's directions.

Direct listing overseas moves into the rulebook as Annexure I. A listed or unlisted Indian public company may list on a permitted exchange if it clears the eligibility conditions, which exclude a capital-market debarment, a wilful default and fugitive economic offender status, and if it complies with the Companies (Listing of Equity Shares in Permissible Jurisdictions) Rules, 2024, as the analysis records.

The ownership condition attached to that route will shape structures. Indian residents cannot beneficially own the overseas-listed equity, apart from registered broker-dealers and investment bankers acting in a custodial capacity, which bites on promoter-led listings, as the same reading records. Equity stays denominated in rupees in the company's books and held in dematerialised form through depository arrangements. Transfers from a non-resident to a resident are allowed only on delisting, an IBC resolution plan, a buyback, a merger or succession, which narrows the exit routes.

Where a parent guarantees its Indian subsidiary's obligations, a parallel draft governs: the draft FEMA guarantee rules run alongside this one.

Compliance Responsibility Is Expressly Shared

The draft puts the duty to comply on both sides of the transaction. On an issue of equity the duty falls on the foreign investor and the eligible investee entity. On a transfer it falls on the seller and the buyer.

The AD bank stays a gatekeeper and stops being the owner of the obligation. A bank that clears a remittance without testing the instrument, the sector condition or the price has finished its part of the transaction file, and it has not taken over the parties' liability. That liability reaches FEMA compliance duties that were habitually left to the Indian company.

The draft is silent on the forms themselves. Their timing and the consequences of a late filing sit in RBI's directions, so a compliance team reading only the draft will not find the deadline it has to meet. The Rules change who carries the default when the deadline passes.

The cost of that default is now shared. A late FC-GPR filing, a missed FLA return or a mis-described instrument ends in late FC-GPR reporting and the compounding route, and RBI's order in the Apothecon case came to ₹40.52 lakh on filings of that kind. A shared onus puts the investor's name on a contravention the investee was meant to prevent.

What a Foreign Parent Should Re-Read Before the Final Notification

No structure should be changed on a reading of a draft. The work now is to re-read terms already agreed, and to note where a different answer would move the price, the route or the reporting. I would run it in this order.

1. Test every instrument against the accounting definition of equity, and get the auditor's classification in writing before the term sheet fixes it.

2. Map ownership and control at each layer: who holds more than 50% beneficially, and who holds the voting or management rights the draft calls control.

3. Mark every entity that may invest onward. Downstream investment is the point at which FCE status costs money, because sector caps, entry routes and pricing conditions can attach at the subsidiary.

4. Price against the valuation and keep the certificate, and record where the bargain departs from fair value and why.

5. Allocate the shared onus in the documents: who files, who certifies, who chases a late FC-GPR, and what happens between the parties if a filing slips.

6. Track Annexures II and III, which will carry the caps, routes and RBI regulations the draft refers to but does not publish.

The first item carries most of the value. The equity definition decides whether a deal is foreign investment at all, and every other test in the draft assumes an answer to it.

Comments on the draft closed on 31 August 2026, and no final notification had issued when this note was written. Nothing here changes what has to be filed today. The draft changes the questions a board should ask before it signs.

If a term sheet is already in drafting, contact us and the instrument, the control terms and the price can be read against both frameworks before the money leaves.

This note rests on the draft Foreign Investment Rules circulated for consultation on 21 July 2026, the published analysis of its clauses linked above, DPIIT inflow data reported on 10 June 2026 and the FDI Policy positions cited. Research cut-off: 21 October 2026.

Questions a Foreign Investor Asks at the Point of Entry

How can foreign investors invest in India?

A foreign investor buys equity in an Indian company through the automatic route, which needs no prior approval up to the sector cap, or through the government route, which needs approval first. The draft consolidates the permitted modes of acquisition: subscription, purchase, gift between natural persons, pledge, depository receipts and equity swaps.

Does India allow FDI?

FDI is allowed in India in most sectors, up to the cap the FDI Policy sets for each, and barred in the activities the Policy names. Prohibited sectors, the two entry routes and the caps all sit in that Policy, which the draft carries as Annexure II and did not publish with the consultation draft.

What has been the trend of foreign direct investment inflows in India over the last 10 years?

Reported inflows have risen over the period. Cumulative FDI from 2014-15 to 2025-26 reached $843 billion, a 169% increase over the previous twelve-year period, and FY 2025-26 alone drew more than $94 billion, DPIIT data reported in June 2026 shows. More than 90% of equity inflows came through the automatic route.