The draft FEM (Foreign Investment) Rules, 2026, shrink the statute itself and push the substance into the FDI Policy and RBI directions.
What has actually changed?
On 21 July 2026, the RBI released a draft of the Foreign Exchange Management (Foreign Investment) Rules, 2026, to be notified by the Ministry of Finance in supersession of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019. It follows a review announced in the Union Budget 2026-27 and the recommendations of a government-constituted committee. Comments close on 31 August 2026.
This is not a routine amendment cycle. The 2019 NDI Rules were a single dense instrument holding definitions, entry routes, the full sectoral cap table, pricing rules, downstream investment norms, and instrument-specific schedules. The draft runs to nine rules and three annexures.
That compression is the change. The draft separates three layers previously fused into one:
- The Rules: the FEMA framework: who may invest, in what, on what basis, subject to what general conditions;
- The foreign investment policy: entry routes, sectoral caps, sectoral conditions, and prohibited sectors, incorporated by reference as Annexure-II;
- RBI regulations and directions mode of payment, reporting, and operational requirements, listed in Annexure-III.
Under the draft, the rules confirm a transaction is permitted subject to the FDI Policy and subject to RBI directions, neither of which forms part of the rules and both of which can change without amending them.
The changes that matter commercially
“Equity” is defined by accounting classification, not instrument type.
The 2019 Rules use a closed list of equity shares, compulsorily convertible debentures and preference shares, and share warrants. The draft substitutes a principle: equity means instruments classified as equity by the investee entity under applicable accounting standards, plus units of investment vehicles and participating interests in oil fields or mines.
Whether an instrument sits inside the foreign investment regime or outside it, potentially in the borrowing framework, would then turn on its Ind AS classification rather than its legal form. Instruments with contingent settlement features, variable conversion ratios or put arrangements have long sat awkwardly between equity and liability in accounting terms; that judgement now carries exchange-control consequences. Term sheets need accounting review before execution.
One 10% test, the listed/unlisted distinction disappears.
Currently FDI means investment in an unlisted Indian company, or 10% or more of the post-issue paid-up equity capital on a fully diluted basis of a listed company, so any investment in an unlisted company is FDI, however small. The draft defines FDI as foreign investment of 10% or more in the equity of a company or an LLP, and portfolio investment as anything below, with no reference to listing status. A sub-10% stake in an unlisted company would therefore be a portfolio investment, with knock-on effects for monitoring, reporting, and reclassification. It also imports “portfolio investment” into LLPs, where no portfolio investor regime exists, a fair point for comment.
“Foreign Controlled Entity” replaces the downstream investment architecture.
Rule 23 of the 2019 Rules built an edifice around entities “not owned and not controlled by resident Indian citizens or owned or controlled by persons resident outside India,” with ownership fixed at a beneficial holding above 50% and a prescribed method for computing indirect foreign investment at each layer.
The draft introduces FCE: a resident company, LLP or investment vehicle owned or controlled by a person resident outside India. Critically, ownership and control are not defined in the Rules. They follow the stipulations of the respective sectoral regulators in consultation with the Central Government and, failing that, the Indian law under which the entity is incorporated. Investment by an FCE must satisfy FDI policy conditions only for sectors specifically prescribed for that purpose narrower than today’s blanket obligation. Rule 23’s scaffolding the bar on funding downstream investment from domestic borrowings, the annual auditor certificate, and the Director’s Report disclosure does not appear in the draft.
Why it matters: an entity may be foreign-controlled for one regulator and not another. Group classifications reached under a single FEMA test will need re-testing.
Indirect investment gets an offshore-chain test with a 10% control trigger.
The draft expressly captures investment made indirectly, through an FCE or through any other non-resident owned or controlled by, or under common ownership or control with, the investor. Ownership means beneficial holding above 50%. Control means the right to appoint a majority of directors or to control management or policy decisions, including through shareholders’ or voting agreements entitling the holder to 10% or more of voting rights.
That 10% marker is materially wider than the Companies Act standard applied today. Affirmative vote items, minority protections, and consortium arrangements standard in private equity documentation could pull an offshore affiliate inside the perimeter.
Sectoral caps and entry routes move out of the rules.
The sectoral table, including the land-border investor restriction, currently sits in the rules as delegated legislation. The draft carries none: routes, caps, conditions, and prohibited sectors are defined by reference to the FDI Policy at Annexure-II and can therefore be revised administratively. The trade-off is that the binding sectoral position no longer sits in a Gazette-notified rule, so for opinions, conditions precedent, and warranty packages, the source document changes.
Pricing becomes a principle rather than a floor-and-cap grid.
The 2019 Rules prescribe direction: issues and transfers to non-residents at not less than fair value; transfers from non-residents to residents at not more than fair value, with separate treatment for listed companies, swaps, and warrants. The draft states one rule: SEBI pricing for listed companies and investment vehicles, the Annexure-I regime for companies listed abroad, and in all other cases a price under any internationally accepted arm’s length methodology certified by a chartered accountant, SEBI-registered merchant banker, or cost accountant. Rights issues are exempt. The certificate survives; the directional guardrails and the express bar on assured returns are absent from the draft text. Whether that discipline returns through RBI directions is among the most important open items.
Non-repatriation, gifts, and a wider investee perimeter
- The non-repatriation basis is presently the domain of NRIs, OCIs, and their entities. The draft permits any non-resident, or an FCE, to invest on repatriation or non-repatriation basis, with non-repatriation investment exempt from the general conditions other than the prohibited-sector bar.
- A gift between natural persons becomes a permitted mode of acquisition and transfer, without the prior RBI approval, 5% ceiling, and USD 50,000 annual limit applicable today. Conditions survive only where a non-repatriable holding is gifted on repatriation basis close relative, within LRS limits.
- Eligible investee entities expressly include partnership firms and proprietary concerns, alongside companies, body corporates, LLPs, and SEBI-registered investment vehicles (extended to mutual funds and ETFs investing over 50% in equity). Societies and trusts remain excluded; investment in IFSC financial institutions is carved out entirely.
The onus of compliance is now shared.
Today the onus rests on the company receiving the investment. The draft places it on the foreign investor and the eligible investee entity, or transferor and transferee. Short, easy to miss, consequential: a foreign investor can no longer treat FEMA compliance as the investee’s problem, and it will surface in indemnity negotiation and investor-side diligence.
The bigger shift: two authorities, three instruments, one transaction
The draft is explicit on institutional design. The RBI administers the rules and may interpret them and issue regulations, directions, circulars, and clarifications for their implementation. But notwithstanding that power, interpretation of the foreign investment policy and directions or clarifications relating to it is vested in DPIIT. Mode of payment, reporting, and operational requirements stay with the RBI.
That is a cleaner allocation of authority than a position where the RBI administers rules containing sectoral policy and a more demanding one for advisors. A single transaction now sits across three instruments with two owners:
- Is it foreign investment in equity of an eligible investee entity, and is the mode permitted? – the Rules, RBI.
- Is the sector permitted, at what cap, under which route, on what conditions, and does any beneficial-ownership restriction apply? – the FDI Policy, DPIIT.
- How is it paid for and reported, and by when? – RBI regulations and directions.
The consequences are concrete. A clarification from one authority will not settle a question owned by the other. Opinions must be written against a defined stack of instruments as of a defined date, because both annexures are incorporated as amended from time to time. Conditions precedent referring generically to “the NDI Rules” need re-papering. And boundary questions about whether an FCE’s investment attracts sectoral conditions in a given sector require reading the rules and the policy together, not either alone.
The CFO lens: the risk behind each test
Characterization before structuring. Is the instrument “equity” under applicable accounting standards? Is the holding above or below the 10% line? Is the investor coming directly or through an offshore affiliate under common ownership or control? The risk is rarely that a deal is prohibited; it is that it is mischaracterized at inception and the defect surfaces at exit, at audit, or in the next round’s diligence.
Ownership and control mapping. If status follows sectoral regulator stipulations or the incorporating statute, a group must know its position entity by entity and regulator by regulator. For groups with regulated subsidiaries, NBFC, insurance intermediary, AIF managers, that is, fresh analysis, not a documentation exercise.
Shareholder rights as control risk. Where voting or shareholders’ agreements confer 10% or more of voting rights, the indirect-investment definition may be engaged. Minority protections drafted for corporate law purposes need a FEMA read.
Evidence to preserve. Accounting classification memoranda; valuation report, certificate, and workings; the ownership and control determination and its regulatory basis; proof of route and sectoral condition compliance referenced to the version of the policy in force on the transaction date; filings with acknowledgements. Under shared onus, the investor should hold its own set.
Transitional exposure. The draft supersedes the 2019 Rules “except as respects things done or omitted to be done before such supersession,” but does not reproduce the express provision deeming existing holdings to be made under the new framework. Intentional or an omission to be cured, it is worth raising in comments.
This article discusses a draft issued for public comment by the RBI on 21 July 2026. It is not a final law, and the position may change before notification. Primary sources: draft Foreign Exchange Management (Foreign Investment) Rules, 2026, and the RBI press release of 21 July 2026; Foreign Exchange Management (Non-debt Instruments) Rules, 2019, as updated to 12 June 2026. Nothing here is legal or tax advice on a specific transaction.