The FEMA (Non-Debt Instruments) (Third Amendment) Rules, 2026

A FEMA amendment with income-tax consequences — the taxation of a foreign individual investing directly in Indian listed equity

What the Third Amendment Actually Changed

Inbound investment in equity instruments of Indian companies runs through Section 6 of FEMA, 1999, read with the FEMA (Non-Debt Instruments) Rules, 2019 (“NDI Rules”), which the Central Government frames under Section 46. The Third Amendment, notified in the Official Gazette on 12 June 2026 and operationalised by a parallel amendment to the FEMA (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019, makes one structurally decisive change and several consequential ones.

The Core Amendment: From “NRI/OCI” to “Any Individual”

In Rule 9, and consequently throughout Chapter V and Schedule III, the expression “Non-Resident Indian or Overseas Citizen of India” has been replaced by “an individual person resident outside India, including a Non-Resident Indian or an Overseas Citizen of India.” The chapter heading itself was recast to the broader formulation, and Rules 12 and 13 were amended to allow such individuals to purchase, sell, gift and transfer equity instruments on a repatriation basis. The consequence is unambiguous: the repatriable portfolio route into Indian listed equity, previously the preserve of the Indian diaspora, is now open to any foreign individual — German, Japanese, Brazilian, Emirati or American.

The Operative Schedule III Conditions

• Instrument and venue – An individual resident outside India may, on a repatriation basis, purchase or sell equity instruments of a listed Indian company on a recognised stock exchange through a designated branch of an authorised dealer (AD Category-I) bank.
• Individual cap – Holding of a single such individual must remain below 10% of the fully diluted paid-up equity capital of the company.
• Aggregate cap – Aggregate holding of all such individuals under this route cannot exceed 24% of fully diluted paid-up equity capital, unless otherwise permitted.
• Breach mechanism – A breach must be corrected by divestment within five trading days of the settlement of the triggering transaction, failing which the holding is reclassified as Foreign Direct Investment, the individual is barred from further portfolio investment in that company, and the breach must be reported to the company and depositories through the designated AD branch.
• Aggregation across schedules – Holdings under Schedule II (FPI route), Schedule III and other schedules, including through an “investor group” aligned with the SEBI FPI definition, are aggregated for threshold testing.

National-Security Overlay and Beneficial Ownership

The liberalisation is not unconditional. Where an investment or transfer would pass ownership, control or beneficial ownership of a listed Indian company to an entity or citizen of a country sharing a land border with India, prior government approval is required under the Press Note 3 (2020) policy, now embedded in the Rules. The amendment also aligns the definition of “beneficial owner” with the Prevention of Money-Laundering Act, 2002.

The Revised Reporting Architecture

The RBI has introduced Form LEC (IFI) Individual Foreign Investor reporting under which AD Category-I banks report purchases and transfers of equity instruments by individual foreign investors. This replaces a framework built almost entirely around NRI/OCI flows and gives the RBI transaction-level visibility over a far larger investor population.

Before vs. After the Third Amendment

The amendment changed no rate and amended no line of the Income-tax Act, 2025. What it changed is the population to whom the Act’s charging, withholding and compliance provisions apply, and the operational machinery that Indian companies, custodians and AD banks must now run.

The Foreign Individual’s Tax Lifecycle in India

This Part follows a single transaction end-to-end: a foreign individual, newly eligible under the Third Amendment, acquires Indian listed equity on a recognised exchange, holds it, receives dividends, and sells.

Before investment — Eligibility, Nexus and Set-up

• FEMA eligibility – Any individual resident outside India is now eligible under Schedule III (Rule 12), subject to the <10% individual and 24% aggregate caps and the land-border approval overlay. Pre-amendment, a non-diaspora individual was ineligible and had to invest via an FPI.
• Repatriable rupee account – Investment flows through a designated repatriable rupee account with an AD Category-I bank; inbound funds arrive through normal banking channels or from that account, and net-of-tax proceeds are freely repatriable.
• KYC and beneficial ownership – The AD bank performs KYC; beneficial ownership is tested against the PMLA-aligned definition, and after the Supreme Court’s 2026 Tiger Global decision, beneficial ownership and economic substance are increasingly examined behind any subsequent treaty claim.
• PAN – A Permanent Account Number should still be obtained at the outset. Its absence does not, after the Supreme Court’s November 2025 ruling, by itself defeat a properly documented treaty rate on withholding, but a PAN remains practically necessary for return filing, refunds and home-country credit, so it is not optional in substance for an investor who will file.
• No tax at set-up – Neither FEMA eligibility nor the opening of the account is a taxable event.

At the Time of Investment — Acquisition

Acquisition of listed equity does not, of itself, give rise to Indian income tax in the investor’s hands. The tax-relevant consequences of the purchase are those that fix the future gain computation and establish the compliance footprint.

• Securities Transaction Tax (STT) is levied on the market purchase. STT is not a cost of acquisition and is not creditable, but STT paid on both legs is the condition that qualifies the eventual gain for the concessional s.196 / s.198 rates rather than ordinary rates.
• No withholding on purchase. The investor is the buyer here; no Indian withholding arises on the investor’s own acquisition.
• Treaty documentation is assembled now, not later. A Tax Residency Certificate for the relevant tax year and Form 41, the successor to Form 10F under s.159(8), Rule 75 of the Income-tax Rules, 2026, should be in hand before the first dividend record date, since treaty relief is documentation-driven.
• FEMA reporting (Form LEC (IFI)) is discharged by the AD bank; the investor’s obligation is to keep the AD bank correctly informed, including on threshold breaches.

During the Holding Period — Dividends

Since abolition of the Dividend Distribution Tax in 2020, dividends are taxed in the shareholder’s hands. For a non-resident individual, an Indian-company dividend is India-source income and chargeable in India.

• Domestic withholding. The Indian company withholds under s.393(2), Table Sl. No. 17 (erstwhile s.195) at the domestic non-resident rate of 20% plus surcharge and cess on the gross dividend.
• Beneficial-provision rule. Under s.159 (erstwhile s.90) the investor may claim the lower of the domestic rate or the applicable treaty rate. Whether the treaty helps depends entirely on the investor’s jurisdiction (see Part III).
• Treaty conditions. A valid TRC for the period plus Form 41 must be on the company’s record by the record date, or the company will deduct at the domestic rate. Beneficial ownership must be genuine: post-Tiger Global, a bare TRC is a rebuttable eligibility condition, not conclusive proof.
• Surcharge and cess. Applied where tax is deducted at the domestic rate; where a treaty rate applies, that rate is generally treated as inclusive (no separate surcharge/cess), consistent with the “tax covered” article of most treaties.
• Return filing. If the treaty rate correctly withheld equals the final liability, and the investor has no other Indian income, a return may not be strictly required; but a return is necessary to claim a refund of excess withholding or to regularise the position, and is prudent in almost all cases.

On Sale of Shares — Capital Gains

• Source rule and taxing right. Gains on shares of an Indian company are deemed to accrue in India; India retains the primary domestic taxing right (charge on income accruing in India).
• Holding-period test. Listed equity is long-term if held more than 12 months; otherwise short-term.
• STCG. Under s.196 (erstwhile s.111A), STT-paid listed-equity STCG is taxed at 20% plus surcharge and cess. A non-resident individual is not entitled to set the basic exemption limit against s.196 STCG.
• LTCG. Under s.198 (erstwhile s.112A), STT-paid listed-equity LTCG is taxed at 12.5% on the amount exceeding the ₹1.25 lakh annual threshold, without indexation, plus surcharge and cess.
• Direct individual, not FPI. The special FPI regime (erstwhile s.115AD) does not apply to a foreign individual holding directly under Schedule III; the ordinary s.196 / s.198 rates govern.
• Collection mechanism. For an on-market sale through a recognised exchange there is no practical buyer-side withholding; the non-resident discharges tax by advance tax and self-assessment. For an off-market transfer, s.393(2) withholding applies, and a lower-/nil-deduction certificate (Form 128, erstwhile Form 13, under the s.395 machinery) is frequently required.
• Advance tax. Because on-market gains are not withheld, advance-tax instalment obligations arise once liability is expected to exceed the threshold; interest for shortfall or deferment applies.
• Treaty interaction on gains. Whether India’s domestic taxing right is preserved or ceded depends on the capital-gains article of the specific treaty — a point of very large variation across jurisdictions.

After Sale — Repatriation and Closing Compliance

• Repatriation. Net-of-tax proceeds are repatriable through the designated account; the AD bank will require evidence that Indian tax has been discharged before permitting remittance.
• Return filing. An ITR (typically ITR-2) is filed for the tax year of sale, reporting the capital gain, tax paid and any treaty position; filing is mandatory where income exceeds the basic exemption or a refund is claimed.
• Documentation. Contract notes, STT evidence, TRC, Form 41, PAN, bank confirmations and Form LEC (IFI) acknowledgements should be retained; these support both the Indian filing and the foreign-country credit claim.
• Reporting and currency overlays. Flows through the designated account feed the Common Reporting Standard exchange, so the Indian position and the home-country disclosure must be consistent.

The PAN/Non-PAN Position After the Supreme Court

The erstwhile s.206AA (now consolidated into the 2025 Act’s TDS framework) escalates withholding to 20% where the payee furnishes no PAN. In CIT v. Manthan Software Services Pvt. Ltd. — the Wipro / Mphasis line the Supreme Court in November 2025 dismissed the Revenue’s appeals, following its earlier Air India ratio, and confirmed that this domestic machinery cannot override a beneficial treaty rate: the treaty rate applies even without a PAN, provided the TRC and treaty conditions are met. For a first-time foreign retail investor, this reduces set-up friction at the withholding stage, but the documentation burden shifts firmly onto the TRC and Form 41 and a PAN remains practically necessary to file a return and claim any refund.

Worked Example: A US-Resident Individual

Facts. A US-resident individual (not of Indian origin) — a non-resident for Indian purposes and a US person for US purposes — uses the Third-Amendment route to buy Indian listed equity in July 2026 and sells in October 2027 (holding > 12 months) for an INR 50 lakh gain, having received Indian dividends in the interim. Because both events fall on or after 1 April 2026, the Income-tax Act, 2025 governs throughout.

India Side

• Dividends. Withheld by the Indian company at the domestic 20% (plus surcharge and cess) under s.393(2) Sl. 17 — the India–US treaty’s 25% cap being worse than domestic, s.159 leaves the 20% rate in place.
• LTCG. s.198 at 12.5% on INR 48.75 lakh (INR 50 lakh less the INR 1.25 lakh threshold), plus surcharge and cess; Article 13 leaves India’s taxing right intact.
• Mechanics. On-market sale → no buyer withholding → discharged via advance tax and self-assessment; ITR-2 filed with PAN, TRC and Form 41.

US Side

• Worldwide charge (IRC §61). The same gain and dividends are included in US taxable income; long-term gain (holding > 1 year) is taxed at 0/15/20% federal, plus the 3.8% net investment income tax under §1411 where applicable.
• Foreign tax credit (IRC §901). Indian tax on the dividend and the gain is creditable, subject to the §904 limitation and passive-category basketing, claimed on Form 1116.
• PFIC caution. Direct listed shares are generally outside the PFIC regime (§1297); Indian mutual funds typically are PFICs and trigger adverse consequences absent a QEF or mark-to-market election — a reason a US investor may prefer direct equity over Indian funds under the new route.
• Information reporting. Test Form 8938 (FATCA) and FBAR (FinCEN 114) thresholds; a foreign brokerage/custody account and specified foreign financial assets may be reportable irrespective of whether additional US tax is due.

 Practical Consequences of the Widened Universe

1. A larger charging base. s.196, s.198 and s.393(2) now bite on any foreign individual transacting directly on Indian exchanges, without the erstwhile s.115AD FPI shield.
2. A multi-treaty operating problem. Custodians and companies must apply the correct dividend rate and capital-gains article across many bilateral relationships and an operational tax exercise, not a footnote, though in practice portfolio dividends cluster around a handful of rates.
3. Withholding calibrated per shareholder. Dividend deduction must now be determined investor-by-investor against a valid TRC and Form 41 on the record date, with a clear rule on whether the treaty rate is applied at source or recovered by refund.
4. Reclassification carries tax tails. Breaching the <10% / 24% caps converts the holding into FDI, drawing in pricing-guideline scrutiny and different downstream tax and regulatory consequences.
5. Substance matters proportionately. Post-Tiger Global, the beneficial-ownership inquiry behind a treaty claim is live for structured and layered arrangements. For direct individual holders below GAAR thresholds, it is a documentation-discipline point (valid TRC, Form 41, genuine residence) rather than an existential one.

Frequently Asked Questions

The questions below arise most often from individual investors navigating the widened route. They are summaries, not substitutes for advice on a specific fact pattern.

Eligibility and the FEMA route

1. Who can now invest in Indian listed equity under the Third Amendment?

Any individual resident outside India — not only NRIs and OCIs — may purchase and sell equity instruments of a listed Indian company on a recognised stock exchange, on a repatriation basis, through a designated AD Category-I bank branch under Schedule III. The route is subject to the <10% individual cap, the 24% aggregate cap, and the land-border prior-approval overlay.

2. Does the amendment change how much tax a foreign individual pays?

No. It changes who is brought within the Indian tax net, not the rates. The dividend, STCG (s.196) and LTCG (s.198) rates are unchanged. What is new is that a non-diaspora individual now holds the asset directly and is taxed in their own name under the ordinary non-resident provisions, rather than through the FPI special regime.

3. What happens if I breach the 10% individual limit?

The excess must be divested within five trading days of the settlement of the transaction that caused the breach. If it is not, the holding is reclassified as Foreign Direct Investment, the investor is barred from further portfolio investment in that company, and the breach must be reported to the company and the depositories through the designated AD branch. Reclassification also draws in FDI pricing-guideline scrutiny and different downstream consequences.

4. When is prior Government approval required?

Where the investment or transfer would pass ownership, control or beneficial ownership of a listed Indian company to an entity or citizen of a country sharing a land border with India (the Press Note 3 policy, now embedded in the Rules). The beneficial-owner test is aligned with the Prevention of Money-Laundering Act, 2002.

Tax Mechanics

5. How are dividends taxed and collected?

An Indian-company dividend is India-source income for a non-resident and is chargeable in India. The company withholds under s.393(2), Table Sl. No. 17 (erstwhile s.195) at the domestic non-resident rate of 20% plus surcharge and cess. Under s.159 (erstwhile s.90) the investor may claim the lower of the domestic rate or the applicable treaty rate, provided a valid TRC and Form 41 are on the company’s record by the record date.

6. How are capital gains taxed on listed equity?

If held for more than 12 months, the gain is long-term and taxed under s.198 (erstwhile s.112A) at 12.5% on the amount exceeding the ₹1.25 lakh annual threshold, without indexation, plus surcharge and cess. If held for 12 months or less, it is short-term and taxed under s.196 (erstwhile s.111A) at 20% plus surcharge and cess. STT must have been paid on both legs for these concessional rates to apply.

7. Is the basic exemption limit available to a non-resident?

No. A non-resident individual is not entitled to set the basic exemption limit against s.196 short-term capital gains on listed equity.

8. Who deducts tax when I sell — and how do I pay?

For an on-market sale through a recognised exchange there is no practical buyer-side withholding; the non-resident discharges the liability through advance tax and self-assessment, and advance-tax interest applies to shortfalls. For an off-market transfer, s.393(2) withholding applies and a lower-/nil-deduction certificate (Form 128, erstwhile Form 13, under the s.395 machinery) is frequently needed.

Documentation and Compliance

9. Do I still need a PAN if a treaty applies?

Following the Supreme Court’s November 2025 disposal in the Manthan Software / Wipro / Mphasis line (affirming the Air India ratio), the absence of a PAN does not, by itself, defeat a beneficial treaty rate on withholding, provided the TRC and treaty conditions are met. In practice, however, a PAN remains necessary to file an Indian return and to claim any refund of excess withholding, so an investor who will file should obtain one at the outset.

10. When do I need to file an Indian income-tax return?

An ITR (typically ITR-2) is filed for the tax year of sale, reporting the capital gain, tax paid and any treaty position. Filing is mandatory where income exceeds the basic exemption limit or where a refund is claimed, and is prudent in almost all cases to regularise the position and support a home-country credit claim.

Treaty and Cross-Border

11. I am a US person — what should I watch on the US side?

The same dividends and gains are included in US worldwide income; long-term gains are taxed at 0/15/20% federal, plus the 3.8% net investment income tax where applicable. Indian tax is creditable on Form 1116 (subject to the §904 limitation and passive basketing). Direct listed shares are generally outside the PFIC regime, but Indian mutual funds typically are PFICs. Test Form 8938 (FATCA) and FBAR reporting thresholds regardless of whether additional US tax is due.

12. Can I gift or transfer the shares to another non-resident?

Yes. Rule 13, as amended, permits an individual person resident outside India holding equity instruments on a repatriation basis to transfer them by sale or gift to another person resident outside India, subject to the prescribed conditions — with the land-border prior-approval overlay continuing to apply to transfers that would pass ownership or control to entities or citizens of border-sharing countries.

This advisory is general in nature and is not legal, tax or investment advice. Statutory numbering under the Income-tax Act, 2025 is new and, in places, not yet uniformly reported; any specific transaction should be evaluated with qualified advisors against the primary instruments and the treaty position in force at the relevant time. Where the exact 2025-Act citation for a rule is not settled, this note flags it expressly rather than asserting false precision.