INTRODUCTION
The Reserve Bank of India (“RBI”) has released the draft Foreign Exchange Management (Foreign Investment) Rules, 2026 (“Draft Rules”) for public consultation. The Draft Rules propose to replace the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”), which presently form the principal framework governing foreign investment in India.
The Draft Rules follow the announcement in the Union Budget 2026 - 27 for a comprehensive review of the NDI Rules and propose a significantly simplified and principle-based foreign investment regime.
The changes are not limited to consolidation of the existing provisions. The Draft Rules propose to replace the concept of investment in “non-debt instruments” with a framework centred on investment in “equity”; introduce an “eligible investee entity” and a “foreign controlled entity” (“FCE”); revise the distinction between foreign direct investment (“FDI”) and foreign portfolio investment (“FPI”); integrate indirect foreign investment into the definition of foreign investment itself; and simplify the rules relating to transfers and pricing.
FROM “NON-DEBT INSTRUMENTS” TO “EQUITY”
The first significant change is to the subject matter of the framework itself. The NDI Rules regulate investment by persons resident outside India (“PROI”) in various categories of “non-debt instruments”. The Draft Rules instead apply to foreign investment in “equity” of an “eligible investee entity”.
“Equity” is proposed to include: (i) instruments classified as equity by the eligible investee entity, other than an investment vehicle, under applicable accounting standards; (ii) units of investment vehicles under the applicable Securities and Exchange Board of India (“SEBI”) regulations; and (iii) participating interests or rights in oil fields or mines of an Indian company or limited liability partnership (“LLP”).
This is an important conceptual shift. Instead of relying on an exhaustive identification of instruments constituting non-debt instruments, the Draft Rules seek to determine whether an instrument constitutes “equity”, including by reference to its classification under applicable accounting standards. The implications of this change, particularly for convertible and structured instruments, will require closer consideration once the Draft Rules and corresponding RBI directions are finalised.
A COMMON CONCEPT OF AN “ELIGIBLE INVESTEE ENTITY”
The Draft Rules introduce the defined term “eligible investee entity”, bringing different forms of Indian investment vehicles within a common framework.
The term includes an Indian company or body corporate, an LLP, specified SEBI-registered investment vehicles, and registered partnership firms and proprietary concerns. Specified investment vehicles include REITs, InvITs, AIFs, VC funds and specified mutual funds and exchange-traded funds.
The NDI Rules presently contain separate provisions and schedules for investments in different types of entities. The Draft Rules instead first identify the entities that may receive foreign investment and then apply a common set of principles to investment in their equity.
The proposed framework therefore seeks to be more investee-neutral, reducing the need for separate transaction rules based solely on the legal form of the investee entity.
DIRECT AND INDIRECT INVESTMENT BROUGHT WITHIN “FOREIGN INVESTMENT”
The Draft Rules also propose an important change to the definition of “foreign investment”.
Under the NDI Rules, foreign investment is broadly investment by a PROI on a repatriable basis in equity instruments of an Indian company or capital of an LLP, while indirect foreign investment is separately addressed through the downstream investment framework under the Rule 23 of the NDI Rules.
The Draft Rules propose to bring both concepts together. “Foreign investment” would include investment in the equity of an eligible investee entity by a PROI directly or indirectly, including through an FCE or specified PROIs that are owned, controlled or under common ownership or control with the foreign investor.
The proposed approach therefore focuses on whether foreign ownership or control exists through the investment chain rather than treating indirect foreign investment principally as a separate downstream investment regime.
INTRODUCTION OF THE “FOREIGN CONTROLLED ENTITY”
To support the revised approach to indirect investment, the Draft Rules introduce the concept of an FCE, broadly meaning a resident company, LLP or investment vehicle which is owned or controlled by a PROI.
Ownership and control would be determined in accordance with requirements prescribed by the relevant sectoral regulator in consultation with the Central Government. Where no such requirements exist, the determination would be made under the applicable Indian law governing the entity (the Companies Act, 2013 for Indian companies or LLP Act, 2009 for an Indian LLP or SEBI AIF regulations for AIFs etc.).
The concept is particularly relevant for Indian holding structures. For example, where a foreign investor controls Indian Company A and Company A subsequently invests in Indian Company B, the investment by Company A may itself carry the character of foreign investment in Company B. Company A’s incorporation in India would not, by itself, make the downstream investment domestic.
The Draft Rules therefore appear to replace a substantial part of the existing downstream investment analysis with a more direct foreign ownership and control - based framework.
A UNIFORM 10% THRESHOLD FOR FDI AND FPI
One of the most consequential changes concerns the distinction between FDI and FPI.
Under the NDI Rules, foreign investment in an unlisted Indian company is treated as FDI irrespective of the percentage held. For a listed Indian company, the 10% threshold becomes relevant, with investment of 10% or more of the prescribed equity base constituting FDI.
The Draft Rules propose a simpler test. FDI would mean foreign investment of 10% or more in the equity of a company or LLP, while FPI would mean foreign investment of less than 10% in the equity of a company or LLP.
The Draft Rules therefore appear to remove the existing listed/unlisted distinction and introduce a uniform percentage-based threshold.
If retained in the final Rules, this would be a substantive change. For example, a 5% foreign investment in an unlisted Indian company, presently treated as FDI, would prima facie fall within the proposed definition of FPI.
The interaction of this definition with the existing SEBI framework for registered Foreign Portfolio Investors, particularly in relation to unlisted companies and LLPs, will therefore require further clarity.
SIMPLIFICATION OF THE DOWNSTREAM INVESTMENT FRAMEWORK
The NDI Rules presently contain detailed rules for downstream investment, including requirements relating to calculation of indirect foreign investment, funding of downstream investments, responsibility for compliance and certification.
The Draft Rules do not reproduce this framework in its existing form. Instead, indirect investment is incorporated into the definition of “foreign investment”, while the FCE concept identifies Indian entities whose investments may carry a foreign character.
Importantly, this does not mean that sectoral restrictions on indirect investment disappear. Foreign investment by an FCE would remain subject to applicable conditions where specifically prescribed under the Foreign Investment Policy.
The change is therefore primarily one of regulatory architecture: a detailed downstream investment regime is proposed to be replaced by broader principles based on foreign ownership and control.
SEPARATING THE FDI POLICY FROM TRANSACTIONAL FEMA RULES
Another important structural change is the proposed separation of the foreign investment policy (“FDI Policy”) from the transactional framework under FEMA.
The Draft Rules define the FDI Policy as the Government policy prescribing entry routes, sectoral caps, sectoral conditions and prohibited sectors, which is proposed to form Annexure II to the Draft Rules.
The Draft Rules also expressly divide regulatory responsibility between the RBI and the Department for Promotion of Industry and Internal Trade (“DPIIT”). The RBI would administer the Rules and prescribe modes of payment, reporting requirements and other operational requirements, while interpretation of the FDI Policy would lie with DPIIT.
The core Rules would therefore principally govern how foreign investment may be made and transferred, while the FDI Policy would determine where, to what extent and subject to what conditions foreign investment is permitted.
This separation should also permit sectoral policy and operational requirements to evolve without requiring repeated amendments to the core foreign investment rules.
SIMPLIFIED ACQUISITION, TRANSFER AND PRICING RULES
The Draft Rules also consolidate the manner in which foreign investment may be acquired and transferred. Subject to the applicable conditions, a PROI or FCE may acquire equity through subscription to an issue, purchase from another person, gift between natural persons or pledge.
This replaces several investor- and transaction-specific provisions under the NDI Rules with a common enabling framework.
Pricing requirements are similarly consolidated. Under the Draft Rules:
for a company listed on a recognised Indian stock exchange or an investment vehicle, pricing would follow applicable SEBI regulations;
for a public company listed on an international stock exchange, pricing would follow Annexure I; and
in other cases, pricing would be determined using an internationally accepted pricing methodology on an arm’s-length basis and certified by a chartered accountant, SEBI-registered merchant banker or cost accountant.
The Draft Rules further provide that the pricing guidelines would not apply to subscription to equity issued on a rights basis.
The proposed approach therefore moves away from multiple transaction-specific pricing provisions towards a common valuation principle.
LIBERALISED TREATMENT OF RIGHTS, BONUS AND NON-REPATRIATION INVESTMENTS
The Draft Rules provide that the ordinary foreign investment conditions would not apply to an issue of equity to a PROI on a rights or bonus basis where the shareholding pattern of the foreign investors does not change pursuant to the issue.
This recognises that a proportionate rights or bonus issue which does not alter the foreign shareholding pattern ordinarily does not change the extent of foreign participation in the investee entity.
The Draft Rules also simplify investment on a non-repatriation basis. Such foreign investment would generally not be required to comply with the conditions prescribed under Rule 8, although investment would continue to be restricted in sectors identified as prohibited for such investment under the FDI Policy.
CONCLUSION
The Draft Rules mark a shift towards a simpler, principles-based foreign investment regime, including through the new concepts of “equity”, “eligible investee entity” and FCE, a uniform 10% threshold for FDI and FPI, and a simplified framework for indirect investment and pricing.
The shorter rulebook, however, does not necessarily mean lighter regulation. Sectoral requirements would continue under the FDI Policy, while the RBI would prescribe payment, reporting and other operational requirements. Further operational clarity will therefore be important once the accompanying framework is issued.
The consultation window remains open until August 31, 2026, and it remains to be seen how stakeholder feedback is reflected in the final Rules.