BY PURNIMA RATHI, FOURTH-YEAR STUDENT AT SYBIOSIS LAW SCHOOL, PUNE
On January 20, 2025, the Reserve Bank of India (‘RBI’) released a comprehensive revision of the Master Direction on Foreign Investment in India (‘Master Direction’). The update represents a landmark regulatory revision, particularly for Foreign Owned and/or Controlled Companies (‘FOCCs’) pursuing downstream investments. The updated Master Direction has attempted to resolve a number of ambiguities, align regulatory treatment with the Consolidated Foreign Direct Investment (‘FDI’) Policy, 2020 and the Foreign Exchange (Non- Debt_ Instruments) Rules, 2019 (‘NDI Rules’) and thus, stream lining the compliance requirements for both investors and companies.
The blog shall analyse key regulatory changes made through the Master Direction and its effects on downstream investments made by FOCCs. This analysis is made by comparing the recent update to the earlier versions of the Master Direction.
WHAT ARE FOCCs AND DOWNSTREAM INVESTMENTS ?
To understand the significance of the Master Direction, it is first necessary to understand the meaning and the context in which FOCCs and downstream investments operate. A FOCC is defined in the Foreign Exchange Management Act, 1999 (‘FEMA’) and the NDI Rules as an Indian entity that is:
• Owned by non-resident entities (more than 50% shareholding); or
• Controlled by non-residents (in the sense of a non-resident entity or person is empowered to appoint a majority of directors or is empowered to influence decisions which are deemed to be strategic business decisions).
Downstream investment is defined collectively, in this context, as an investment in capital instruments (equity shares, compulsorily convertible preference shares, etc.) made by said FOCC in another Indian entity. It is essentially an investment made by a company already partly or wholly owned by foreign investors, into another Indian entity.
Analysis of Key Changes
The updated Master Direction has important amendments which are aimed at reducing compliance complexities, providing legal clarity, and allowing flexibility with transaction structures. Analysed below are the key revisions from the Master Direction:
1. Consistency with General FDI Norms
The most important change is the explicit consistency of downstream investments by FOCCs with general FDI norms. Downstream investments are treated as a different investment category and require separate compliance obligations. However, now it requires that FOCCs must comply with the same entry routes (automatic or government), sectoral restrictions, price restrictions, and reporting requirements as any direct foreign investment investor. The guiding principle of “what cannot be done directly, shall not be done indirectly” has the intention to place downstream investments on an equal level with FDI.
This is particularly advantageous in sectors where the automatic route is available and removes unnecessary bureaucratic hurdles. For example, if a FOCC is investing in an Indian startup that provides services to the technology sector, they may now invest and treat it the same as a direct foreign investment provided that the sector cap and conditions are adhered to.
2. Share Swaps Approved
Another important change is the recognition of share swap transactions by FOCCs. Before the recent change, it was unclear whether share swaps were permitted for FOCCs at all, and companies tended to either seek informal clarifications or err on the side of caution.
The updated direction explicitly provides that FOCCs can issue or acquire shares in lieu of shares of another company (either Indian or foreign) subject to pricing guidelines and sectoral limitations. This is an important facilitative measure for cross-border mergers, joint ventures, and acquisition deals where share swaps are the predominant form of consideration.
This reform enhances transactional flexibility, encourages capital growth and will reduce friction in structuring deals between Indian FOCCs and foreign entities, thereby promoting greater integration with global capital market.
3. Permissibility of Deferred Consideration
The RBI now formally recognizes deferred consideration structures such as milestone-triggered payments, escrows, or holdbacks. However, they are still governed by the ’18-25 Rule’, which allows 25% of total consideration to be deferred, which must be paid within 18 months of execution of the agreement. This represents a pragmatic acceptance of the commercial acknowledgment that not all transactions are settled upon completion.
RBI shall have to give additional clarifications as the Master Direction still does not specify the extent to which provisions are applicable to downstream investments in comparison to the FDIs.
4. Limitations on the Utilisation of Domestic Borrowings
In an effort to safeguard the integrity of foreign investment channels and to deter round-tripping, or indirect foreign investment through Indian funds, the RBI continues to restrict FOCCs from utilising domestic borrowings for downstream investment. This implies that FOCCs can only downstream invest with foreign funds introduced through equity investments or through internal accruals. The restriction aims that downstream investments are made through genuine foreign capital introduced in the country through abroad, rather than through domestic borrowings.
Practically this means that if the FOCC receives a USD 5 million injection from the parent organization abroad, then they can utilize such funds for downstream investment, but not if they were to borrow the same amount in INR through a loan from an Indian financial institution. This maintains investor confidence and enhances transparency in capital flows.
5. Modified Pricing Guidelines for Transactions
The revised framework reiterated pricing guidelines in accordance with the different types of company:
• For listed companies: The pricing must comply with the Securities and Exchange Board of India (‘SEBI’) guidelines,
• By unlisted companies: The price cannot be lower than the fair market value determined by internationally accepted pricing methodologies.
Additionally, in all rights issues involving non-residents, if the allotment is greater than the investor’s allotted entitlement, price has to comply with these guidelines. In this case, the rights issue would protect minority shareholders and mitigate the dilution that would occur by no listings from unlisted companies.
6. Reporting and Compliance via Form DI
An excellent innovation is the new compliance requirement of filing on Form DI within 30 days of the date an Indian company becomes a FOCC or makes a downstream investment. This will assist the RBI in maintaining regulatory visibility and better tracking of foreign investment in India. Companies will have to implement stricter internal compliance mechanisms and timely reporting as failure to do so could result in penalties under FEMA. The RBI’s emphasis on transparency reflects a continuing trend toward digitization and live reporting of capital flows by Indian regulators.
7. Clearer Application of the Reporting Forms (FC-GPR, FC-TRS, DI)
In addition, the RBI has further clarified the documents to use the following forms:
• Form FC-GPR: is for reporting the issuance of shares by an Indian entity to a FOCC. • Form FC-TRS: is for any transfer of shares involving FOCC as the non-resident and between residents and non-residents.
• Form DI: is for downstream investments made by FOCC into any other Indian entity.
This clarity will help eliminate confusion around these procedures and synchronize the reporting regime of the RBI with the reporting systems of the Ministry of Corporate Affairs (‘MCA’) and SEBI. FOCC should implement strong internal controls to monitor and track when these filings will become due.
8. Classification of FOCCs based on Share Movement
The new regulations will also provide clarity on how the status of a FOCC will influence a regulatory classification. Specifically:
• if a FOCC receives shares from an Indian entity, it will be treated as a ‘Person Resident Outside India’; and
• if it transfers shares to an Indian entity, it will be deemed to be domestic in nature but needs to comply with the repatriation norms.
These classifications have an important bearing on the route and pricing of transactions especially in exits or complex internal restructuring transactions. Through these classifications, RBI intends to clarify the confusion from mischaracterizing transactions and reducing risk for the investors in the event of any enforcement action.
Conclusion
The amendments to the Master Direction represent a measured and thoughtful change in the foreign investment regulatory framework in India. The RBI has set the tone in favour of enabling policy predictability and investor confidence by clarifying FOCC structures’ downstream investment norms to be consistent with FDI, allowing for more sophisticated structures like share-swap transactions and deferred consideration, and imposing effective operational compliance requirements. Going forward, these refinements have set the foundation for deeper capital integration and increased investor trust in India’s FDI regime.
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