FEMA Amendment 2025: Clarity on Bonus Shares for Non-Resident Shareholders in FDI-Prohibited Sectors

The Ministry of Finance, through a notification dated 11 June 2025, has amended the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”) by revising Rule 7 and inserting a new sub-rule, Rule 7(2) (“Amendment”). The Amendment expressly permits Indian companies operating in sectors where FDI is prohibited (“FDI-Prohibited Sectors”) to issue bonus shares to their existing non-resident shareholders, subject to certain specified conditions.

Prior to the Amendment, on 7 April 2025, the Department for Promotion of Industry and Internal Trade had released Press Note No. 2 (2025 Series) (“PN2”), inserting a similar clarification under Paragraph 1 of Annexure 3 of the Consolidated FDI Policy Circular of 2020 (“FDI Policy”). The subsequent Amendment to the NDI Rules now provides statutory force to this clarification.

The Pre-Amendment Ambiguity — A Persistent Grey Area

Historically, India’s FDI policy framework has drawn clear distinctions between activities where foreign investment is permitted and those where it is expressly prohibited, particularly in sensitive or restricted sectors.

Schedule I of the NDI Rules, read with Paragraph 5.1 of the FDI Policy, prohibits foreign investment in certain activities, including lottery and gambling, chit funds, Nidhi companies, real-estate business, and the manufacture of tobacco and tobacco substitutes. The restrictions on gambling and betting, including casinos and lotteries, were introduced under the FDI Policy Circular of 2000, while the prohibition on tobacco manufacturing was introduced through Press Note 2 (2010 Series).

Before these sectoral prohibitions were imposed, certain Indian companies operating in these sectors had already received foreign investment, and the non-resident shareholders in such companies continued to hold their stakes under a grandfathered status. Following the introduction of these prohibitions, however, such companies faced uncertainty as to whether their existing non-resident shareholders were eligible to participate in a rights issue or a bonus issue. Since a bonus issue technically constitutes an issue of shares, authorised dealer banks adopted divergent interpretations. Some insisted on prior government approval, treating it as a fresh foreign investment even though no new funds flowed in, while others permitted it under the automatic route, viewing it as a non-cash capitalisation of reserves.

This regulatory inconsistency left companies and shareholders in prolonged uncertainty. For instance, tobacco manufacturer Godfrey Phillips reportedly sought an approval/clarification from the Reserve Bank of India regarding the issuance of bonus shares to its existing non-resident shareholders. The lack of uniformity in approach among authorised dealer banks and the absence of a specific clarification under the earlier FDI Policy or FEMA framework resulted in inconsistent interpretations and compliance uncertainty for Indian companies operating in FDI-Prohibited Sectors.

Post-Amendment Clarity

The amended rule now expressly allows Indian companies engaged in FDI-Prohibited Sectors to issue bonus shares to their existing non-resident shareholders, provided that the shareholding pattern of such Indian companies remains the same (i.e., no change in ownership percentage) and the bonus issuance complies with applicable laws, rules, and guidelines.

The Amendment also retrospectively validates past bonus issuances that met the ownership-neutrality test.This provides much-needed legal certainty and protects historic issuances from technical FEMA non-compliance, being a common diligence and representation concern in M&A and private equity transactions.

Analysis

For Indian companies engaged in FDI-Prohibited Sectors, the Amendment enables them to restructure capital by issuing bonus shares to their long-term non-resident shareholders. It also grandfathers past bonus issuances that were previously in a regulatory grey area, removing the risk of any FEMA non-compliance.

For non-resident shareholders of such Indian companies, the Amendment allows them to increase their shareholding and return on investment without any additional capital inflow. It also helps maintain their proportional rights and avoid economic dilution by enabling participation through bonus issuances instead of cash infusions.

However, it is pertinent to note that while the Amendment explicitly permits bonus issuances, it remains silent on the permissibility of rights issue by Indian companies engaged in prohibited sectors to their existing non-resident shareholders. This distinction likely reflects the regulator’s view that bonus issuances are treated as purely non-cash corporate actions and therefore do not represent fresh foreign inflows, while a rights issue would involve new capital infusion and could re-engage FDI restrictions.

Another crucial point is that the clarification under PN2 does not extend to non-resident shareholders governed by Press Note 3 (2020 Series) (“PN3”), which requires prior government approval for any investment where the investor or its beneficial owner is situated in a country sharing a land border with India. Accordingly, if a non-resident shareholder falls within the PN3 category, prior approval may still be required even for a bonus issue. It can, however, be argued that the same rationale underlying the PN2 clarification, which recognises bonus issuances as purely non-cash corporate actions, should logically extend to PN3 investors as well. Issuing a similar clarification for such shareholders would therefore provide greater regulatory clarity and consistency.

Conclusion

The Amendment is a welcome development for Indian companies with non-resident shareholders, as it resolves a long-pending regulatory uncertainty by explicitly permitting bonus issuances to non-residents in FDI-Prohibited Sectors and grandfathering past bonus issuances.

Although the Amendment is silent on the permissibility of rights issues and its applicability to PN3 investors, it reflects a balanced reform and a step towards a more practical and business-friendly FDI regime.