Foreign investment regulation rarely attracts attention until a transaction is already moving.

A term sheet has been signed. The overseas investor is ready to remit funds. The cap table has been agreed. The legal team is finalising shareholder rights. Then someone asks whether the investor’s veto rights amount to “control”, whether the instrument qualifies as equity under FEMA, whether the price can differ from the valuation, or whether the Indian company’s future investment into another subsidiary will be treated as indirect foreign investment.

That is usually when a fast-moving commercial deal becomes a regulatory interpretation exercise.

India’s proposed Foreign Exchange Management (Foreign Investment) Rules, 2026 attempt to reduce this friction. Released by the Reserve Bank of India for public consultation on 21 July 2026, the draft proposes to replace the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, commonly known as the NDI Rules.

The stated objective is attractive: a simpler, principle-based and future-ready framework that separates FEMA procedures from sector-specific FDI policy, harmonises definitions and reduces unnecessary complexity.

But this is not merely a shorter version of the existing rules.

The draft changes important concepts, including the meaning of equity, the classification of FDI and foreign portfolio investment, the identification of foreign-controlled entities, pricing requirements, permitted gifts and the framework for direct listing on international exchanges. Some provisions appear genuinely facilitative. Others may materially affect private equity deals, joint ventures, downstream investments and governance arrangements if retained in their present form.

The draft is therefore best viewed as both a simplification exercise and a restructuring of India’s foreign investment architecture.

Why India Is Rewriting the NDI Rules

The NDI Rules, 2019 currently govern foreign investment in Indian companies, limited liability partnerships, investment vehicles and certain other structures. They operate alongside the consolidated FDI policy, sector-specific conditions, RBI directions, SEBI regulations and reporting rules.

Over time, this architecture became difficult to navigate. A single transaction could require the parties to review the NDI Rules for legal permission, the FDI policy for the applicable sectoral cap, RBI regulations for reporting, SEBI rules for listed securities and separate guidance for pricing, downstream investment or non-repatriation treatment.

The 2026 draft tries to create a cleaner division.

Under the proposed structure, the rules would deal with the broad FEMA framework for foreign investment, while the Government’s FDI policy would continue to prescribe entry routes, sectoral caps, prohibited sectors and sector-specific conditions. RBI would administer the FEMA rules and issue operational directions, while the Department for Promotion of Industry and Internal Trade would retain authority over interpretation of the FDI policy.

That division makes conceptual sense. It allows procedural rules and industrial policy to evolve without repeatedly rewriting the same provisions in multiple places.

However, businesses should not mistake reorganisation for deregulation. Government approval requirements, sectoral limits and prohibited activities do not disappear merely because the rulebook becomes shorter.

From “Non-Debt Instruments” to “Foreign Investment in Equity”

The most visible change is in the title itself.

The current regime is organised around “non-debt instruments”. The draft instead focuses on foreign investment in the equity of an eligible investee entity.

The expression “eligible investee entity” is broad. It includes Indian companies and specified bodies corporate, LLPs, SEBI-registered investment vehicles, registered partnership firms and proprietary concerns.

The proposed definition of investment vehicles is also expansive. It covers REITs, InvITs, AIFs, venture capital funds, mutual funds, exchange-traded funds and other SEBI-regulated vehicles investing more than 50% in equity.

This moves the framework away from a company-centric approach and recognises that foreign capital can enter India through several legal and investment structures.

Equity may depend on accounting classification

The draft defines equity, for entities other than investment vehicles, by reference to instruments classified as equity under applicable accounting standards. It separately includes units of investment vehicles and participating interests or rights in oil fields or mines.

This is a significant conceptual shift.

Under the existing framework, FEMA identifies specific equity instruments such as equity shares, fully and mandatorily convertible preference shares, fully and mandatorily convertible debentures and share warrants.

The draft’s accounting-based approach may provide flexibility for new financing instruments. At the same time, it could create classification questions where an instrument is treated as equity under one accounting framework but has debt-like commercial features.

For a startup issuing compulsorily convertible securities, or a multinational designing a structured capital instrument, the FEMA conclusion may increasingly require coordination between lawyers, accountants and valuation professionals. The instrument name alone may no longer answer the question.

The New FDI and FPI Definitions Need Careful Clarification

One of the most important issues in the draft lies in the proposed distinction between foreign direct investment and foreign portfolio investment.

The current rules treat every foreign investment in an unlisted Indian company as FDI. For a listed Indian company, the 10% threshold determines whether the investment is FDI or portfolio investment.

The draft defines FDI as foreign investment of 10% or more in the equity of a company or an LLP. Foreign portfolio investment is defined as foreign investment of less than 10%.

On a literal reading, the draft does not preserve the existing distinction between listed and unlisted companies.

This could represent a major policy change. A foreign investor acquiring 5% in an unlisted Indian company might, under the draft language, fall within foreign portfolio investment rather than FDI.

However, such an interpretation raises practical questions. Portfolio investment is normally associated with listed securities, regulated market access and the SEBI FPI framework. An unlisted company or LLP does not fit naturally into that architecture.

The confirmed fact is the wording of the draft. Whether the Government intends to permit portfolio-style investment below 10% in unlisted entities is not yet clear.

This is precisely the kind of issue that should be resolved before final notification. Businesses should not restructure or classify transactions based on a literal interpretation of a consultation draft.

Foreign Control Could Become the Most Debated Provision

The draft expressly recognises indirect foreign investment through a “foreign-controlled entity”, or FCE.

An FCE is broadly an Indian company, LLP or investment vehicle owned or controlled by a person resident outside India. The applicable sectoral regulator would determine ownership and control where relevant provisions exist. In their absence, the applicable Indian law governing the entity would apply.

This may provide useful clarity for regulated sectors. A bank, insurance company, AIF and ordinary private company may not need to be forced into one identical control test.

The more controversial point is the proposed control definition used elsewhere in the draft.

Control includes the right to appoint a majority of directors or control management or policy decisions, directly or indirectly, through shareholding, management rights, shareholder agreements, voting agreements or another arrangement. The wording also refers to agreements that entitle a person to 10% or more of voting rights.

Why minority investor rights matter

Consider a private equity fund acquiring 15% of an Indian company. The fund does not manage daily operations. It cannot appoint a majority of directors. It does, however, negotiate customary veto rights over issuing new shares, changing the business, taking substantial debt or selling major assets.

Historically, parties distinguish between protective rights and rights that confer real control over management or policy decisions.

The draft’s reference to 10% voting rights could create uncertainty over whether minority investors are more readily treated as exercising control. If that happens, an Indian company may become an FCE earlier than expected, affecting its downstream investments into other Indian entities.

This could influence how private equity rights, joint venture agreements and reserved-matter clauses are negotiated.

The draft does not conclusively say that every investor holding 10% voting rights controls the company. Its wording, however, is broad enough to require clarification. The commercial concern is not theoretical because foreign-control classification can alter sectoral eligibility, approval requirements, pricing conditions and downstream investment compliance.

Downstream Investment Becomes a Governance Question

When an Indian entity owned or controlled by foreign investors invests in another Indian entity, that onward investment may be treated as indirect foreign investment.

This is commonly called downstream investment.

The underlying principle is that a transaction that cannot be undertaken directly by a foreign investor should not be achieved indirectly through an Indian intermediary.

The draft’s express recognition of FCEs makes it essential for groups to map ownership and control before undertaking downstream transactions.

Take an Indian operating company with foreign venture capital investment. It later incorporates a wholly owned Indian subsidiary to conduct a regulated activity. Whether the subsidiary’s capital is treated as domestic or indirect foreign investment may depend on whether the parent qualifies as an FCE.

If control is interpreted more broadly, more Indian companies may enter the downstream investment framework. That could require compliance with sectoral caps, entry routes and other FDI conditions at the subsidiary level.

The board should therefore not approve downstream investments based only on the fact that the investing company is incorporated in India. Under FEMA, Indian incorporation does not necessarily mean Indian capital.

Pricing May Move From a Boundary to an Exact Number

The draft’s proposed pricing framework appears concise, but its impact on transactions could be substantial.

For listed Indian companies and investment vehicles, pricing would follow the relevant SEBI regulations. For public companies listed on an international stock exchange, the direct-listing annexure would apply. In other cases, the price would be determined using an internationally accepted arm’s-length valuation methodology and certified by a Chartered Accountant, SEBI-registered merchant banker or cost accountant.

The current rules generally establish directional pricing boundaries.

When a resident sells shares to a non-resident, the price cannot ordinarily be below fair value. The parties may agree to a higher price. When a non-resident sells to a resident, the price cannot ordinarily exceed fair value. The parties may agree to a lower price.

The draft instead says that foreign investment or its transfer shall be “at a price” determined through the prescribed methodology.

If interpreted as requiring the transaction price to equal fair market value, the proposal could reduce the negotiating flexibility currently available within the FEMA pricing boundaries.

Why this matters in real deals

A valuation is not always the final commercial price.

A strategic investor may pay a control premium. A founder may accept a discount because of liquidity needs. A buyer may adjust the price for indemnities, contingent liabilities or earn-out mechanisms. A family restructuring may use a commercially agreed value within the existing FEMA limits.

An exact fair-value requirement could create difficulty where valuation and commercial negotiation produce different numbers.

The draft should ideally clarify whether valuation remains a floor or ceiling, or whether exact fair value is intended. Until then, transaction teams should treat this as a material proposed change, not a drafting curiosity.

Non-Repatriation Investment Could Become Simpler

The draft provides that foreign investment on a non-repatriation basis would not need to comply with the conditions prescribed in the general foreign investment rule, except that it cannot be made in prohibited sectors.

This appears to continue and broaden the principle that certain NRI and OCI investments on a non-repatriation basis are treated closer to domestic investment.

The practical benefit could be reduced friction around pricing, sectoral conditions and transactional structuring.

But the provision should not be read as eliminating all compliance. Mode of payment, reporting, eligibility and other operational requirements may still be prescribed separately by RBI.

Non-repatriation means that sale proceeds are not freely repatriable outside India. It does not mean the investment exists outside FEMA.

Gifts May Receive a More Practical Framework

Under the current framework, a resident gifting Indian securities to a non-resident generally requires RBI approval and must satisfy conditions including the relationship between donor and donee, a 5% capital limit and a value ceiling of USD 50,000 per financial year.

The draft permits acquisition or transfer by gift between natural persons. Where an investment held on a non-repatriation basis is gifted on a repatriation basis, the parties must be close relatives under the Companies Act and the value transferred during the financial year must remain within the Liberalised Remittance Scheme limit.

This appears to replace the fixed USD 50,000 ceiling with the prevailing LRS limit and may remove certain existing restrictions from the rules themselves.

That could make genuine family transfers easier. But the final operational process, including whether prior approval or reporting will remain necessary, will depend on RBI’s directions.

Direct International Listing Moves Into the Main Rulebook

The draft incorporates the framework for direct listing of equity shares of Indian public companies on international stock exchanges into a dedicated annexure.

Eligible public companies may issue new equity or allow existing shareholders to offer equity on permitted international exchanges, subject to company-law requirements, sectoral caps, eligibility conditions and beneficial ownership restrictions.

For an unlisted public company undertaking its initial international listing, pricing would be determined through the book-building process allowed by the overseas exchange. For an Indian-listed company, the international issue price cannot be below the price applicable to a corresponding domestic issuance.

The draft also limits transfers from a non-resident holder to a resident on the international exchange to specified situations such as delisting, insolvency resolution, buyback, merger, amalgamation or transmission by inheritance.

Bringing the direct-listing scheme into the main foreign investment rules should improve regulatory visibility. It does not, by itself, guarantee that companies will rush to list overseas. Valuation, liquidity, tax, listing cost, investor demand and corporate governance will remain decisive.

Compliance Responsibility Is Expressly Shared

The draft places the onus of compliance on both sides of the transaction.

For an issue of equity, responsibility would rest with the foreign investor and the eligible Indian investee entity. For a transfer, responsibility would rest with the transferor and transferee.

This matters because FEMA compliance is sometimes treated as the Indian company’s administrative burden or left entirely to the authorised dealer bank.

The draft makes the position more balanced. A foreign investor cannot assume that the Indian company will cure every eligibility, ownership or payment issue. An Indian company cannot accept funds first and ask questions later.

The AD bank remains an important gatekeeper, but it is not the legal owner of the transaction.

What Businesses Should Do During the Consultation Period

The first step is not to change existing structures. The rules are still in draft.

Businesses should instead identify where the proposals could change their current analysis.

Private equity and venture capital investors should review voting rights, board rights and reserved matters. Indian companies with foreign shareholders should reassess whether they could be treated as FCEs and whether their current or planned subsidiaries involve downstream investment.

Companies raising capital should compare their instruments against the proposed accounting-based definition of equity. Parties negotiating share transfers should assess how an exact fair-value rule would affect commercial pricing, deferred consideration and indemnity arrangements.

Groups considering non-repatriation investments, gifts or international listings should identify which elements appear simplified and which operational questions remain unanswered.

Most importantly, stakeholders should use the consultation period. Clear examples submitted to RBI can help ensure that the final rules distinguish genuine control from minority protection, direct investment from portfolio investment, and valuation compliance from commercial price negotiation.

The Bigger Takeaway

The Draft Foreign Investment Rules, 2026 are being presented as a simplification project. In many respects, they are.

The framework is shorter, more principles-based and better separated from sector-specific FDI policy. It recognises a wider range of investee entities, incorporates direct listing and attempts to modernise definitions.

But simplification of language does not always mean simplification of outcomes.

The proposed definitions of FDI, control, foreign-controlled entities and equity could change how businesses classify investments and governance rights. The pricing wording could affect transaction negotiations. The treatment of indirect investment could require more Indian companies to examine downstream compliance.

The final quality of the reform will depend on whether the rules remain flexible without becoming uncertain.

For investors and Indian companies, the correct response is neither alarm nor complacency. It is structured review.

The draft does not yet change the law. It does, however, show where India’s foreign investment regulation is heading.

And in cross-border transactions, understanding the direction of the rulebook before the deal is signed is usually much cheaper than discovering it after the money has moved.