Summary: The article examines the Draft Foreign Exchange Management (Foreign Investment) Rules, 2026 (“Draft FI Rules 2026”), describing them as a concise framework that raises several questions requiring clarification before finalisation. It discusses the proposed definition of “equity”, noting that instruments such as convertible notes and SAFE may not qualify if they do not meet the accounting-standards test. It also highlights the proposed 10% voting-rights threshold within the “control” definition and its potential effect on transaction structuring and downstream investments. On pricing, the article states that the draft requires foreign investment and transfers to be made at the price determined under applicable pricing methodology, potentially reducing flexibility previously available under the 2019 NDI Rules. It further discusses changes to the foreign-owned and controlled company (FOCC) and Indian-owned and controlled company (IOCC) framework, allocation of responsibilities between RBI and DPIIT, and the proposed consolidation of the existing NDI Rules. The article acknowledges that simplicity is welcome but states that key aspects require clarification and suggests that a concise framework could work if these issues are addressed.
- Draft Foreign Investment Rules 2026: Simplicity Raises New Questions
- Nature of Instrument Under Draft FI Rules 2026
- 10% Voting Rights Threshold and the Control Test
- Pricing Guidelines for Foreign Investment and Transfers
- Downstream Investments and FOCC/IOCC Framework
- Allocation of Responsibility Between RBI and DPIIT
- Concise Foreign Investment Rules Welcome, but Key Issues Need Clarity
Draft Foreign Investment Rules 2026: Simplicity Raises New Questions
“Frustra fit per plura, quod fieri potest per pauciora” is a latin maxim for “less is more”, and translates to “it is useless to do by many things what can be done by fewer”. This is a desired principle, and intended to ensure that minimalism and simplicity provide more clarity than excess or complexity. The draft Foreign Investment Rules of 2026 (“Draft FI Rules 2026”) adopt this principle literally, in the process raising more questions.
While simplicity is welcome, and it is likely that the final rules will provide the required clarity and detail, the current draft places stakeholders at crossroads!
Nature of Instrument Under Draft FI Rules 2026
The Draft FI Rules 2026 apply to “foreign investment in equity of an eligible investee entity by a person resident outside India or transfer thereof”. “Equity” is defined to include instruments classified as equity by the eligible investee entity, as per applicable accounting standards. Typically instruments like compulsorily convertible debentures are considered equity for the purpose of foreign exchange regulations, though considered debt for accounting purposes until conversion. The reference to accounting standards would mean that variable conversion ratios and other terms which do not apply to pure equity instruments may need to be relooked at, in terms of eligibility to qualify as “equity”. Foreign investments into Indian entities take several forms and instruments, but now will need to necessarily pass the test of being equity as per accounting standards as well. Given this strict definition of equity, common instruments issued by start-ups like convertible notes, SAFE, etc may not qualify as equity under the draft FI Rules.
10% Voting Rights Threshold and the Control Test
The Draft FI Rules 2026 could overcomplicate transaction structuring by stipulating a lower ‘control’ trigger attached to 10% of voting rights. This conflicts with the typically understood 50% ownership threshold, and other tests like right to appoint majority of the directors, and controlling management or policy decisions. Several investors typically seek veto rights particularly where they hold a 10% stake to protect their investment. Control has always been interpreted to mean positive control, and not negative control, and this will require to be appropriately clarified and addressed when the rules are finalised. If an investee entity is considered a foreign controlled entity with a 10% voting threshold, the norms governing downstream investment will also stand triggered, which may not also have been the intention.
Pricing Guidelines for Foreign Investment and Transfers
Pricing guidelines have always been at the core of cross border transactions, and the Draft FI Rules 2026 stipulate that foreign investment, and transfer shall be “at” the price determined as per an internationally accepted pricing methodology. Under the 2019 NDI rules, the FMV constituted a floor price for an investment. Similarly, transfer by a non-resident to a resident meant that the FMV constituted the ceiling price. With a specific stipulation of having to transact only at the FMV, the flexibility is lost. An Indian company could have negotiated a premium over the fair value and received foreign investment, which may not be possible if the rule is strict on price. Similarly, conversion ratios and anti-dilution ratios are typically attached to the FMV, to aid an investor if the premium over the FMV is not achieved by performance. The flexibility provided opportunity for an Indian company to seek a higher price and benefit from it if performance is met, and safeguarded the investor in a scenario it did not. Since these have been accepted norms, a rewrite was not warranted.
Downstream Investments and FOCC/IOCC Framework
The control and ownership test typically dictated if a company was a foreign owned and controlled company (“FOCC”) or an Indian owned and controlled company (“IOCC”). While an FOCC was considered akin to indirect foreign investment, and governed by the pricing and other norms applicable to downstream investments, an IOCC would not. The 10% threshold changes that basis. Although in the past there have been cases and transfers involving FOCCs and Indian residents which looked at the FMV price as the transaction price, but the pricing norm revision now seems to extend to all foreign investments and transfers.
Allocation of Responsibility Between RBI and DPIIT
The draft rules also contemplate allocation of responsibility between RBI and DPIIT, providing direction as to the relevant authority to be approached.
Concise Foreign Investment Rules Welcome, but Key Issues Need Clarity
The NDI rules were quite detailed, nuanced and fairly well understood, having been in place for over 6 years. In that background and with an intent to consolidate the rules, a rewrite of the framework may not have been necessary. A concise set of rules is however welcome, and with key aspects to be addressed, should perhaps work!
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Authored by: Raj Ramachandran, Partner at JSA Advocates & Solicitors
