Introduction
Foreign investments have been the key component of the growth curve in India. As the country continues to integrate with the global markets, downstream investments have taken a central position. The mechanism is based on Foreign Owned or Controlled Companies (FOCCs), i.e., companies that are incorporated in India but owned or controlled by non-residents, which is a contradiction that has, in the past, created a significant degree of uncertainty for businesses, particularly during mergers and acquisitions, where predictability is vital.
The latest regulatory changes, such as the 2024 amendments to the Foreign Exchange Management (Non-Debt Instruments) Rules (NDI Rules)[1] and the 2025 RBI Master Directions on Foreign Investment in India (Master Directions)[2], are intended to shed light on the long-standing questions, such as share swaps, deferred consideration, and some of the definitions. While they alleviate certain transactional problems, they do not entirely address the profound structural weaknesses that persist in influencing the downstream investment regime.
Through this blog, the author will go through these ideas, recent changes and the ongoing issues, providing a better insight into what remains to be done.
Nuances of Downstream Investment
According to the Reserve Bank of India (RBI), downstream investment is investment made by an Indian company owned or controlled by a foreign person in another Indian company. Rule 23 of the NDI Rules provides that anything prohibited in direct foreign investment cannot be carried out indirectly through downstream investment. Both come under the same restrictions.
FOCCs are at the heart of this regime, yet legally, Indian entities are treated as foreign for investment purposes. This is demonstrated by the application of pricing rules[3] under Rule 21 of the NDI Rules, where there is a floor price for transfers from residents to non-residents and a ceiling price for transfers from non-residents to residents. Rule 23(5) applies these standards in an inconsistent[4] way such that transfers by a FOCC to a Person Resident Outside India (PROI) are subject to only reporting obligations, while transfers to a Person Resident in India (PRII) are subject to only pricing guidelines. Transfers between two FOCCs are exempt from both reporting and pricing. So, FOCCs are treated as residents for reporting purposes and as non-residents for pricing purposes.
But, Rule 23(5) says nothing if the buyer is an FOCC. If a transfer is made from a PROI to a FOCC under Rule 21, the FOCC is treated as a resident and pricing guidelines should not apply. But bank-authorised dealers generally require it to follow pricing guidelines in practice.
Further complications arise from source-of-funds restrictions, limiting FOCCs to invest in downstream investments only using imported funds or internal accruals and not borrowing domestically. The rules also leave unclear whether the capital raised by resident shareholders can be invested downstream, raising uncertainty about M&A structures such as share swaps and deferred consideration.
Recent Regulatory Developments
The change in two years’ time has attempted to address several challenges. The 2025 Master Directions permit share swaps in downstream investments, in line with India’s FDI and overseas investment rules. It eliminates the long-standing requirement of government approval for ordinary share swaps.
The Master Directions also allow deferred consideration[5] under the 2025 NDI Rules, which allow up to 25% of the total consideration in a transfer between a resident and a PROI to be deferred, held in escrow, or secured by seller indemnities for up to 18 months after the transaction documents are executed. Before the Master Directions were issued, some FOCCs had received regulatory notices regarding such deferred payment arrangements.
Further, in the 2024 amendment to NDI Rules[6], Rule 9A was introduced to allow companies to issue equity shares for secondary share-swaps. Control is now expanded to allow clarity on the definition of control in each regulatory framework, so it is easier to determine if a company is an FOCC. In sum, the changes represent a step towards a more realistic approach and an important relief for investors who rely heavily on FOCC structures in their international M&A transactions.
Persistent Structural Problems
Nevertheless, even with these improvements, there are a number of underlying problems. The first being unresolved dual identity of FOCCs, is the most important of them. The NDI Rules still consider the FOCCs as resident or non-resident inconsistently across transactions.
This discrepancy[7] leads to a pricing paradox when conducting transactions between resident and non-resident sellers. For example, assume an FOCC acquires 100% of a target company. The target has a 60% resident shareholder and a 40% non-resident shareholder. The parties negotiate a price of INR 120 per share, while the Fair Market Value (FMV) is INR 100.
Under NDI Rules, the FOCC must buy the resident’s shares at not less than INR 100, but cannot buy the non-resident’s shares at more than INR 100. As a result, despite agreeing on INR 120, the transaction effectively closes at INR 100 per share to comply with pricing norms, disregarding the negotiated price between the parties.
Even though the FOCCs are not allowed to utilise domestic borrowings to invest in downstream, the regulations are not clear on whether equity capital that is raised by the resident shareholders can be utilised. Such an omission puts Indian shareholders in a disadvantaged position and undermines the operation of joint ventures, in which capital contributions are frequently made by both domestic and foreign partners.
The second issue that remains unresolved is the discrepancy between the Master Directions and the NDI Rules. Though non-cash considerations (including swaps of shares and deferred payments) are allowed under the Master Directions, Rule 23(4)(b) of the NDI Rules only mentions funds of foreign origin or internal accruals, and this creates uncertainty in interpretation in highly regulated industries or cross-border dealings being examined by banks.
The third issue, being the field of deferred consideration, is also still uncertain. Though the Master Directions have made their usage possible, they fail to explain whether the indemnity payouts, which are common in M&A deals to cover tax or business risks, are subject to the 18-25 Rule of the NDI Rules. There is also no guidance on how to structure escrow accounts and holdback mechanisms of downstream transactions. Authorised Dealer Banks tend to take conservative interpretations with no express directions and postpone deal execution.
The fourth issue is the ambiguity of the term capital instruments in Rule 23 of the NDI Rules. The drafting oversight of Rule 23 persists as the use of the term “capital instruments” instead of “equity instruments,” without any definition, creates ambiguity. This results in situations where a FOCC’s subscription to OCDs or OCPSs leads to a deferred triggering of downstream investment obligations, causing regulatory uncertainty and reducing the attractiveness of optionally convertible instruments.
Lastly, despite the definition of control being narrowed down under the NDI Rules, i.e., under Rule 2, now control has the same meaning as assigned under the Companies Act, 2013 (appoint majority of directors, & control the management and policy decision of the company). In the case of a limited liability partnership, it refers to the right to appoint a majority of the designated partners, where such designated partners, to the exclusion of others, exercise control over all the policies of the LLP. But there are still practical ambiguities regarding the veto rights, shareholder reserved matters, and the difference between operational and strategic control.
In jurisdictions like the UK, EU and Singapore, there is detailed guidance and illustrations on control, which assist investors to structure transactions with more confidence. Whereas in India, it puts parties at risk of regulatory interpretation resulting in an unintended classification of a domestic company as an FOCC.
Proposed Solutions & The Way Forward
These problems need specific legislative changes, such as the dual-identity dilemma, i.e., FEMA’s rigid, entity-based notion of residency, under which a person is classified as either resident or non-resident for all regulatory purposes. The same could be resolved by introducing transaction-limited deeming fiction, i.e., A FOCC would remain a non-resident for all FEMA purposes, while being deemed resident or non-resident solely for the limited purpose of pricing and regulatory treatment under Rule 23. By confining the fiction to specific transactions and expressly preserving FEMA’s definitional framework, this approach resolves pricing distortions without disrupting FEMA’s regulatory structure.
The source of funds rule should also be changed to permit FOCCs to make use of equity capital supplied by resident shareholders, while still providing for domestic debt. It would not only empower the Indian shareholders but also align the rules with the commercial realities of a joint venture.
Furthermore, Rule 23 can be amended in order to explicitly recognise share swaps and deferred consideration, in order to align the NDI Rules and Master Directions. Further, RBI should give detailed guidelines on the escrows, indemnity systems and handling the indemnity payouts in accordance with the 18-25 NDI Rules, which will reduce the interpretation risk among investors. Defining the word capital instruments in Rule 23 would remove misunderstanding on hybrid instruments like the OCDs and OCPSs.
Lastly, offering granular advice on what is control, grounded on international models such as the UK’s National Security and Investment Act 2021[8], which employs an elastic concept of “material influence” which does not only see the number or percentage but the actual influence that one is exercising, the EU’s FDI Screening Regulation[9] targets the “ultimate” controller i.e., the non-EU or EU individual or entity that effectively controls an investment, even if it is made through an EU-based vehicle to evade manipulation.
Singapore’s new Significant Investments Review Act (SIRA) 2024[10] establishes a regime to scrutinise transactions involving “indirect controllers” in entities critical to national security, applying tiered notification and approval thresholds. It ensures that the entities that are in control do not get safeguarded, as they are not directly involved.
These Jurisdictions emphasise the approach of substance over form while also providing clearer guidance and greater certainty to investors. Therefore, India should provide clearer guidance, with examples, on the meaning of “control” under the NDI Rules to improve certainty for investors, including aspects such as veto rights, board composition, and the line between operational and strategic control. This would be a major boost to regulatory predictability and avoid unintentional classification as a FOCC when structuring a deal.
Conclusion
The regime of downstream investment in India is at a critical crossroad. Although the recent reforms have alleviated most of the transactional barriers and show a strong policy direction of flexibility and transparency, they are still partial solutions to the structural anomalies of the regime.
The two-sided nature of FOCCs, which remains unresolved, as well as the lack of instrument categories and uneven pricing regulations, remain major problems. To have a genuinely predictable, regular and investor-friendly downstream investment structure, India requires deeper reform in legislation.
The explanation of the FOCC classification, harmonisation of statutory regulations and operations, and providing a detailed interpretational advice can go a long way in building confidence among investors to put downstream investment fully into practice as one of the motors of economic growth in India.
Notes:
[1] Foreign Investment Facilitation Portal, ‘ FEMA NDI Rules,2019’ https://fifp.gov.in/Forms/FEM_NDI_RULES_2019.pdf (last visited 28 June 2026)
[2] Master Directions – Reserve Bank of India, https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=11200 (last visited June 28, 2026).
[3] Kient, Pricing Dilemma in Acquisitions by Foreign Owned Companies, Law.asia (June 2, 2022), https://law.asia/pricing-dilemma-acquisitions/.
[4] The Importance of Foreign-Owned or Controlled Companies in India and the Need for a More Lucid Regulatory Framework to Govern Them, https://www.ibanet.org/the-importance-of-foreign-owned-or-controlled-companies-in-India-and-the-need-for-a-more-lucid-regulatory-framework-to-govern-them (last visited June 28, 2026).
[5] Deferred Consideration by ‘Foreign Owned or Controlled’ Indian Companies – Regulatory Overhang, https://www.ibanet.org/deferred-consideration-by-foreign-owned-or-controlled-indian-companies-regulatory-overhang (last visited June 28, 2026).
[6] Ministry of Finance, ‘Amendment to NDI Rules, 2024’ https://static.pib.gov.in/WriteReadData/specificdocs/documents/2024/aug/doc2024816377701.pdf (last visited 28 June 2026)
[7] Downstream Investments by FOCCs: Practical Challenges and Conundrums | Trilegal Quarterly Roundup: Jan – Mar 2024, https://trilegal.com/magazine/downstream-investments-foccs-practical-challenges-and-conundrums-insights-issue-11.html (last visited June 28, 2026).
[8] The National Security and Investment Act: Emerging Trends from the UK’s First Interventions in: Competition Law Journal Volume 21 Issue 3 (2022), https://www.elgaronline.com/view/journals/clj/21/3/article-p115.xml (last visited June 28, 2026).
[9] Chi-Chung Kao, The EU’s FDI Screening Proposal – Can It Really Work?, 28 European Review 173 (2020).
[10] Singapore Passes the Significant Investments Review Act 2024 to Regulate Investments in Critical Entities, https://www.cliffordchance.com/insights/resources/blogs/antitrust-fdi-insights/2024/03/singapore-passes-the-significant-investments-review-act-2024-to-regulate-investments-in-critical-entities.html (last visited June 28, 2026).
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