On August 16, 2024, the Ministry of Finance issued the Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2019 (Notification). This Notification was introduced to modify the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules) in response to the Union Budget 2024-25. The objective of the Notification is to streamline compliance processes and facilitate easier Foreign Direct Investment and Overseas Investment.

Key Changes

The changes introduced in the Notification are aimed to simplify cross-border share swaps and facilitate the issuance or transfer of equity instruments of Indian companies in exchange for those of foreign companies. According to the press release from the Ministry of Finance issued alongside the Notification, this initiative aims to bolster the international expansion of Indian companies through mergers, acquisitions, and other strategic efforts, encouraging them to enter new markets and enhance their global footprint. A new rule, Rule 9A, has been inserted into the NDI Rules, which states as follows:

“9A. Swap of equity instruments and equity capital. –– The transfer of equity instruments of an Indian company between a person resident in India and a person resident outside India may be by way of––

(i) swap of equity instruments, in compliance with the rules prescribed by the Central Government and the regulations specified by the Reserve Bank from time to time;

(ii) swap of equity capital of a foreign company in compliance with the rules prescribed by the Central Government including the Foreign Exchange Management, (Overseas Investment) Rules, 2022, and the regulations specified by the Reserve Bank from time to time:

Provided that prior Government approval shall be obtained for transfer in all cases wherever Government approval is applicable.

Explanation. – For the purposes of this clause, the expression “equity capital” shall have the same meaning as assigned to it in the Foreign Exchange Management, (Overseas Investment) Rules, 2022, as amended from time to time.’’

1. Further, under proviso (i) to the Explanation of Rule 9 (1) of the NDI Rules, the following is inserted in place of requirement of prior government approval for any transfer in case the company is engaged in a sector which requires government approval:

“(i) prior Government approval shall be obtained for transfer in all cases wherever Government approval is applicable.”

2. Another significant update in the Notification is the clarification on how downstream investments by entities owned by Overseas Citizens of India (OCI) are treated when made on a non-repatriation basis. The amendment to Rule 23 (7) of the NDI Rules provides clearer guidelines on this matter. As a result, investments made by OCI-owned and controlled entities will now be treated the same as those made by entities owned and controlled by Non-Resident Indians. Consequently, these investments will no longer be counted towards the calculation of indirect foreign investment, thereby encouraging more OCIs to invest in India through their own entities.

Analysis of Other Changes

Other amendments contained in the Notification include:

1. Rule 2 of the NDI Rules is amended to include the definition of ‘control’ under sub-rule (da), which reads as under: –

“(da) “control” shall have the same meaning as assigned to it in the Companies Act, 2013 and for the purposes of Limited Liability Partnership, shall mean the right to appoint majority of the designated partners, where such designated partners, with specific exclusion to others, have over all the policies of an LLP;”

This inclusion standardizes the definition of ‘control’ in order to guarantee consistency across various acts and laws.

2. The definition of ‘startup company’ in sub-rule (an) of Rule 2 of the NDI Rules has been revised to refer to a private company incorporated under the Companies Act, 2013, which is recognized as a ‘startup’ according to Government of India notification number G.S.R. 127(E) dated February 19, 2019, issued by the Department for Promotion of Industry and Internal Trade (DPIIT) and as updated periodically. This revised definition is consistent with the latest DPIIT notification from February 19, 2019, which included important updates to the criteria for classifying a company as a ‘startup.’

3. In furtherance to the aforesaid amendments, the following amendments have been made under Schedule I of the NDI Rules:

(i) In paragraph (1), for sub-paragraph (d), the following sub-paragraph is substituted, namely:

“(d) An Indian company may issue, subject to compliance with the rules prescribed by the Central Government and the regulations specified by the Reserve Bank from time to time, equity instruments to a person resident outside India against, –

(i) swap of equity instruments; or
(ii) import of capital goods or machinery or equipment (excluding second-hand machinery); or
(iii) pre-operative or pre-incorporation expenses (including payments of rent, etc.);
(iv) swap of equity capital of a foreign company in compliance with the rules prescribed by the Central Government including Foreign Exchange Management, (Overseas Investment) Rules 2022, and the regulations specified by the Reserve Bank from time to time.

Explanation. – For the purposes of this clause, the expression “equity capital” shall have the same meaning as assigned to it in the Foreign Exchange Management, (Overseas Investment) Rules, 2022, as amended from time to time:

Provided that Government approval shall be obtained in all cases wherever Government approval is applicable and the applications for approval shall be made in the manner prescribed by the Central Government from time to time.”

(ii) Under paragraph 3(a)(iii), prior to this Notification, government approval was required if the total foreign portfolio investment exceeded 49% of the paid-up capital on a fully diluted basis or the sectoral/statutory limit, whichever was lower, and if such investments led to a change in ownership or control of the resident Indian company from Indian citizens to foreign residents.

With the new Notification, the 49% threshold has been removed. Now, government approval is only necessary if the total foreign portfolio investment reaches the sectoral or statutory cap and results in a transfer of ownership or control of the resident Indian company from Indian citizens to foreign residents. If these conditions are not met, no government approval is required.

4. Further, the Notification amended the NDI Rules to include a new entry F11 in Schedule I that relates to Foreign Direct Investment in White Label ATM Operations sector. The new entry allows FDI up to 100% under the automatic route in such sectors, subject to the conditions provided under the Notification.

5. In the NDI Rules, in Schedule II, in paragraph (1), in sub-paragraph (a), in clause (ii), for the explanation, the following explanation is substituted:

“Explanation, – In case two or more FPI’s including foreign Governments or their related entities are having common ownership, directly or indirectly, of more than fifty percent or common control, all such FPI’s shall be treated as forming part of an investor group.”

6. Lastly, in the NDI Rules, in Schedule VII, in paragraph (1), for sub-paragraph (iii), the following sub-paragraph is substituted:

“(iii) equity or equity linked instrument or debt instrument issued by an Indian startup company irrespective of the sector in which the startup company is engaged: Provided that if the investment is in equity instruments, then the sectoral caps, entry routes and attendant conditions shall apply.”

The amended language removes the reference to the definition of ‘start-up’, which was defined as per the DPIIT Notification No. G.S.R. 364(E).