Foreign Investment (“FI”) | Foreign Direct Investment (“FDI”)

April 21, 2025
Company Law
admin

With growth of the economy and issuance of various other policies related to globalisation and liberalisation, Cross border investment has become very usual. Cross country investment can be made through various channels such as sale or purchase of Immovable property, investment in securities issued by various corporate entities, Borrowing or lending of money, mergers etc.

All transactions which increase/decrease assets or liabilities in India of a person resident outside India is considered as “Capital Account transactions” under Foreign Exchange Management Act (“FEMA”). All capital account transactions are prohibited unless specifically approved. Therefore, all cross border investments are prohibited unless specifically permitted.

Among various other routes, Investment through securities (Equity Shares, Preference shares, Debentures, share warrant etc.) of any company or capital contribution in a Limited Liability partnership firm is one of the commonly adopted models of investment. Investments through securities or capital contribution are denominated as “Foreign Investment”/Foreign Direct Investment “FDI”/Foreign Portfolio Investment (FPI) under FEMA with technical differentiations.

Other forms of investment such as sales or purchase of Immovable Property, Merger and Acquisition, Lending or borrowing money etc. are technically not covered under “Foreign Investment”/FDI/FPI.

1. Regulatory Framework for Foreign Investment in India

For all capital Account transactions, the Reserve Bank of India (“RBI”) was regulatory authority, i.e., RBI was having the right to prepare and prescribe rules, regulations, restrictions and prohibitions in relation to capital account transactions. However, with effect from 17.10.2019, the Central Government became the regulatory authority of Capital Account Transactions except for debt instruments.

Therefore, few regulations issued by RBI got superseded and the Central Government prescribed new Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 (“FEM (Not Debt) Rules”) w.e.f. 17th October, 2019 for regulations of Foreign Investment. However, regulations issued by RBI and still not repelled by the Central Government continue to remain valid.

Though, for foreign investment in India, the Central Government is a regulatory authority. However, RBI is still empowered to determine policy and procedures for mode of payment, remittance of sales proceeds and reporting documents. Accordingly, RBI has issued FEM (Mode of Payment and reporting of Non-Debt Instrument) Regulations, 2019.

Apart from above mentioned regulations, while making Investment In India, following regulations are to be keep in India:

Companies Act 2013
Securities and Exchange Board of India Act, 1992 and SEBI Regulations
Income Tax Act, 1961

For other capital account transactions, different regulations are prescribed such as:

FEM (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015;
FEM (Borrowing and Lending in Foreign Exchange) Regulations, 2000;
FEM (Borrowing or lending in Rupee) Regulations, 2000;
FEM (Cross Border Merger) Regulations, 2018.
FEM (Export and Import of currency) Regulation, 2015

2. Foreign Investment (FI)/Foreign Direct Investment (FDI)/Foreign Portfolio Investment (FPI”)

FEM (Non-Debt) regulations has defined three following forms of investment:

“Investment” means to subscribe, acquire, hold or transfer any security or unit issued by a person resident in India.
“Foreign Investment” means any investment made by a person resident outside India on a repatriable basis in equity instruments of an Indian company or to the capital of a LLP. “Investment on repatriation basis” means an investment, sale or maturity proceeds of which are eligible to be repatriated out of India.
“FDI” or “Foreign Direct Investment” means investment through equity instruments by a person resident outside India in an unlisted Indian company; or in 10% or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company;
“Foreign portfolio investment” means any investment made by a person resident outside India through equity instruments where such investment is less than 10% of the post issue paid-up share capital on a fully diluted basis of a listed Indian company or less than 10% of the paid-up value of each series of equity instrument of a listed Indian company.

*“equity instruments” means equity shares, convertible debentures, preference shares and share warrants issued by an Indian company.

3. Advantages of Foreign Investment in India

Economic Development Stimulation: Foreign direct investment can stimulate the target country’s economic development, creating a more conducive environment for you as the investor and benefits for the local industry.

Easy International Trade: A country has its own import tariff, and this is one of the reasons why trading with it is quite difficult. Also, there are industries that usually require their presence in the international markets to ensure their sales and goals will be completely met.

Employment and Economic Boost: When money is invested in another country, it creates jobs, new companies, and new factories/buildings. This brings about new opportunities for local residents and can stimulate further growth.

Development of Human Capital Resources: One big advantage brought about by FDI is the development of human capital resources, which is also often understated as it is not immediately apparent. Human capital is the competence and knowledge of those able to perform labor, more known to us as the workforce

Tax Incentives: Reduced levels of corporation tax can save big businesses billions each year. This is why big firms such as Apple use sophisticated techniques to offshore money in international subsidiaries.

Resource Transfer: Foreign direct investment will allow resource transfer and other exchanges of knowledge, where various countries are given access to new technologies and skills.

Reduced Disparity Between Revenues and Costs: Foreign direct investment can reduce the disparity between revenues and costs. With such, countries will be able to make sure that production costs will be the same and can be sold easily.

Increased Productivity: The facilities and equipment provided by foreign investors can increase a workforce’s productivity in the target country.

4. Restriction on Investment in India by Person resident Outside India

As per Rule 3 of FEM (Non-Debt) Regulations, persons resident outside India are prohibited to make investment in India. However, the Reserve Bank of India may permit any investment by a person resident outside India on sufficient reasons being shown and RBI shall grant permission in consultation with the Central Government.

However, if any investment is prevailing as on 17th October, 2019 and the same was made in accordance with regulations issued earlier then it shall remain valid under FEM (Non-Debt) regulations also.

Similarly, as per Rule 4 of FEM (Non-Debt) Regulations, No Indian Company or investment vehicle or any other concern shall record any investment by a person resident outside India unless otherwise permitted or special permission is given by RBI.

5. Permission for making foreign direct Investment in India

Any investment made by a person resident outside India shall be subject to the entry routes, sectoral caps or the investment limits, as the case may be, and other conditions for such investment as laid down in these rules.

6. Sector prohibited for FDI

There are a few industries where FDI is strictly prohibited under any route. These industries are

Activities or Sectors not open for private investment such as Atomic Energy Generation, Railway operations
Any Gambling or Betting businesses including casinos
Lotteries (online, private, government, etc)
Investment in Chit Funds
Nidhi Company
Real estate business or construction of farm house. Real estate business shall not include development of township, construction of residential or commercial premises etc.
Trading in Transferable Development Rights (“TDR’s”)
Manufacturing of the Cigars, Cigarettes, or any related tobacco industry

7. Entry Routes for total Foreign Investment in Indian Entity

As per Schedule I of FEM (Non-Debt) Regulations, following are the possible entry routes for Foreign Investment in India. The entry of Foreign Direct Investment by non-residents into India is regulated through two routes –automatic route of approval and government route. The automatic route is aimed for those sectors and levels of investment that are less restricted. On the other hand, in the case of approval route, government agencies regulate and scrutinizes foreign investment while approving it.

7.1 Automatic route for foreign direct investment in India

The automatic route stands for less restricted or more liberalized regulation. Under the Automatic Route, a person resident outside India does not require any approval from the Reserve Bank or Central Government of India for making any investment in India. The approval route FDI is allowable in all sectors and activities specified under the consolidated FDI policy.

7.2 Approval Route / Government Route for foreign direct investment in India

Under the approval route or government route, the foreign investor or the Indian company should obtain prior approval of the Central Government of India. Investments made through this route shall be subject to conditions specified by the government for granting approval.

In case where all of the following conditions are satisfied, there will be no requirement of government approval or compliance of sectoral conditions:

Where aggregate foreign investment is made upto 49% of paid-up capital on a fully diluted basis or the sectoral or statutory cap, whichever is lower, and
Investment does not result in transfer of ownership and control from resident Indian to person resident outside India.

8. Conditions for Foreign Investment in equity instruments

Following are the conditions need to be fulfilled for making foreign investment in equity instruments:

Sectoral Cap for total foreign investment: for some sectors, FEM (Non-Debt) instrument specifies maximum limit of foreign investment in equity instruments.
Foreign investment is subject to applicable laws in India as provided in Schedule I of FEM (Non-Debt) Rules.
100% FDI is permitted through an automatic route where in those sectors where no sectoral caps are given, government approval is not required and which are not covered under prohibited sectors.
Foreign investment in Financial services requires prior approval of the central Government. However, as per S. No. F of Schedule I, following investments are automatically approved in financial services:
1. 100% FDI in ARCs
2. 49% in Private Banks under automatic route
3. 20% in public sector banks with government approval,
Foreign investment in investing companies, other than NBFC or CIC (“Core Investment Company”) requires specific approval.
100% FDI is permitted in NBFC through automatic route.
Foreign investment can be made in existing companies where an automatic route is available and the Indian entity has not made any downstream investment.
Burden of compliance such as sectoral or statutory caps shall lie on the company receiving the investment.
100% foreign investment in NBFC under automatic route allowed.
Burder of compliances with respect to Sectorial or statutory cap is on the company receiving such foreign investment.

9. Different types of FDI

Foreign direct investment or FDI is an investment made by a foreign entity (an individual or a company) into a business based in another country. FDI is characterized by a notion of direct control and is not simply the transfer of monetary funds. A lasting interest differentiates foreign direct investment from foreign portfolio investment.

There are mainly two types of FDI- Horizontal and Vertical:

Horizontal Investment: Under this type of Investment, a business expands its inland operations to another country. The business undertakes the same activities but in a foreign country.
Vertical Investment: in this case, a business expands into another country by moving to a different level of the supply chain. Thus, business undertakes different activities overseas, but these activities are related to the main business.