REWRITING INDIA’S FOREIGN INVESTMENT RULEBOOK: THE DRAFT FOREIGN INVESTMENT RULES, 2026

On 21 July 2026, the Reserve Bank of India placed the draft Foreign Exchange Management (Foreign Investment) Rules, 2026 (“Draft Rules”) in the public domain for stakeholder consultation. The Draft Rules propose to supersede the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”) and recast the legal architecture governing foreign investment into India. Comments have been invited until 31 August 2026.

The proposal is not merely a renumbering exercise. It replaces a detailed, instrument-and-investor-specific framework with a shorter, principles-based code centred on “foreign investment in equity”. Sectoral policy would reside in the Government’s foreign direct investment policy, while payment, reporting and operational requirements would be prescribed separately by the RBI. This separation may make the regime easier to update, but several new definitions could materially affect transaction structuring if retained in the final rules.

From Non-Debt Instruments to Foreign Investment

The first visible change is the proposed title itself. The expression ‘non-debt instruments’ is abandoned in favour of ‘foreign investment’. The Draft Rules apply to foreign investment in the equity of an ‘eligible investee entity’, or a transfer thereof, by a person resident outside India. Eligible investee entities extend beyond companies and limited liability partnerships (“LLPs”) to Indian statutory bodies, SEBI-registered investment vehicles, registered partnership firms and proprietary concerns. Societies and trusts are excluded.

This investee-neutral approach is intended to replace the multiple schedules and entity-specific routes found in the NDI Rules. Investment vehicles expressly include real estate investment trusts, infrastructure investment trusts, alternative investment funds, venture capital funds, mutual funds, exchange-traded funds and other SEBI-regulated vehicles investing more than fifty per cent of their assets in equity.

Accounting Classification as the Gateway

The most consequential conceptual change may be the replacement of ‘equity instruments’ with ‘equity’. Under the NDI Rules, equity instruments are statutorily identified as equity shares, fully and compulsorily convertible debentures, fully and compulsorily convertible preference shares and share warrants. The Draft Rules instead cover instruments classified as equity by the investee entity under the applicable accounting standards, together with units of investment vehicles and participating interests in oil fields or mines.

This shifts the inquiry from the legal label of an instrument to its accounting substance. The proposed approach may accommodate new financing instruments without repeated statutory amendments. At the same time, it risks producing different FEMA outcomes for economically similar instruments across Ind AS and non-Ind AS entities. The final rules should clarify whether the issuer’s accounting classification is conclusive and how compound instruments will be treated.

FDI, Portfolio Investment and the Ten Per Cent Line

The Draft Rules define foreign direct investment (“FDI”) as foreign investment of ten per cent or more in the equity of a company or LLP and foreign portfolio investment as investment below ten per cent. Unlike the existing definition, the draft does not expressly limit the ten per cent distinction to listed Indian companies. A literal reading could therefore classify a seven per cent investment in an unlisted private company as portfolio investment—an outcome inconsistent with the present regime, under which any foreign investment in an unlisted Indian company is FDI. The Draft Rules also permit portfolio investment reaching ten per cent to be reclassified as FDI, subject to FDI conditions and RBI and SEBI directions..

From FOCC to Foreign Controlled Entity

The familiar ‘foreign owned or controlled company’ or FOCC is proposed to be replaced by the wider expression ‘foreign controlled entity’ (“FCE”). An FCE includes a resident company, LLP or investment vehicle that is owned or controlled by a person resident outside India. Ownership and control would first be determined under standards prescribed by the relevant sectoral regulator in consultation with the Central Government; in their absence, the law governing the entity would apply.

The definition of control deserves particular attention. It refers to the right to appoint a majority of directors or control management or policy decisions, including through shareholding, management rights, shareholders’ agreements or voting agreements ‘that entitle them to ten per cent or more of voting rights’. If ten per cent voting rights are intended to constitute control by themselves, a large class of minority financial investments could convert Indian companies and investment vehicles into FCEs.

The Draft Rules treat investment made through an FCE as foreign investment. However, they state that an FCE must comply with applicable conditions only for sectors specifically prescribed in the FDI Policy. This differs from the detailed downstream-investment regime under Rule 23 of the NDI Rules, which generally applies entry routes, sectoral caps, pricing and other conditions to indirect foreign investment. The draft does not reproduce restrictions concerning downstream funding through domestic borrowings or the present reporting architecture. Whether these requirements are being relaxed or merely shifted to the FDI Policy and RBI directions will become clear only when the proposed annexures are fully populated.

Simplification of Acquisition and Transfer

The Draft Rules consolidate the permitted modes of investment. A non-resident or FCE may acquire equity through subscription, purchase, gift between natural persons, pledge and other specified routes. Invocation of a pledge is permitted if the resulting acquisition complies with the foreign-investment conditions. The proposal also expressly recognises Indian–foreign equity swaps and allows an investment vehicle to issue units to a non-resident against the equity of a special purpose vehicle proposed to be acquired by it.

A transfer from non-repatriation to repatriation basis by way of gift is permitted where the parties are close relatives under the Companies Act, 2013 and the value transferred during the financial year remains within the applicable Liberalised Remittance Scheme limit. The provision recognises that such a transfer creates a repatriable entitlement and therefore requires a separate safeguard.

Pricing: From Floor and Ceiling to Arm’s-Length Value

For unlisted investments, the Draft Rules prescribe a price determined using an internationally accepted valuation methodology on an arm’s-length basis, certified by a chartered accountant, SEBI-registered merchant banker or cost accountant. Listed-company and investment-vehicle pricing would follow SEBI regulations, while internationally listed Indian companies would be governed by the direct-listing annexure.

Notably, the draft does not reproduce the directional pricing rules under which a non-resident generally cannot subscribe or purchase below fair market value and cannot sell to a resident above fair value. A neutral arm’s-length standard could allow greater commercial flexibility, including valuation ranges, negotiated discounts and control premiums. The final rules should state whether valuation operates as a floor, ceiling, range or benchmark, particularly for deferred consideration, earn-outs and option-based exits.

Subscription on a rights basis is expressly exempt from pricing guidelines. This is a meaningful relaxation for distressed companies and pro rata recapitalisations, where the commercial subscription price may be substantially below an independently determined value. Rights and bonus issues are also exempt from entry-route, sectoral-cap and sectoral-condition requirements where the foreign investors’ shareholding pattern does not change.

Non-Repatriation Investment: A Potential Expansion

The Draft Rules provide that foreign investment on a non-repatriation basis need not comply with the general conditions concerning entry routes, sectoral caps, sectoral conditions or pricing, although investment in prohibited sectors remains barred. The core provision is not expressly confined to NRIs and OCIs. If intentional, this would significantly widen the existing deemed-domestic investment route. If the benefit is intended to remain investor-specific, the restriction will need to be restored in the FDI Policy or RBI directions.

A Cleaner Framework, but an Incomplete One

The Draft Rules draw a clearer institutional boundary: RBI will administer and interpret the FEMA framework and prescribe payment and reporting requirements, while DPIIT will interpret the FDI Policy, including entry routes, caps and sectoral conditions. They also place the onus of compliance jointly on the foreign investor, investee entity, transferor and transferee, supporting a more balanced allocation of information and filing obligations in transaction documents.

Yet the proposed simplicity is achieved partly by moving substantive content outside the Rules. Annexure II presently refers to the FDI Policy as amended from time to time, while Annexure III refers broadly to RBI regulations and directions. Detailed provisions on startup convertible notes, optionality, deferred consideration, downstream funding, reporting forms and investor-specific routes are not contained in the core draft. Their omission should not be mistaken for deregulation until the accompanying framework is released.

The Draft Rules are a credible attempt to modernise India’s foreign-investment regime. Their success, however, will depend less on their brevity than on the precision of their foundational concepts. Accounting-based equity, the ten per cent control limb, treatment of sub-ten per cent unlisted investments, the scope of non-repatriation benefits and the obligations of an FCE require careful revision. If these issues are resolved, the new framework could reduce duplication without sacrificing certainty. If left open, the rules may replace procedural complexity with interpretational risk.