The Government of India, through Notification No. S.O. 1802(E) dated April 1, 2022, amended the Foreign Exchange Management (Non-debt Instruments) Rules, 2019. These changes were made to align the rules with the modified Foreign Direct Investment policy that was introduced through Press Note No. 1 dated March 14, 2022. The updated framework introduced several noteworthy revisions that impact startups, body corporates, share-based employee benefit schemes, mergers and acquisitions, the scope of real estate business, and foreign investment provisions related to Life Insurance Corporation of India.
Extension of Convertible Note Conversion Period
One of the significant changes introduced by the amendment relates to the period within which convertible notes issued by startups can be converted into equity shares. The revised Rule 2(e) permits startups to issue convertible notes that may be converted into equity shares of the issuing company within a maximum period of ten years. Before the amendment, this period was limited to five years. This change has been welcomed by startups and investors alike, as it allows for greater flexibility in funding arrangements and provides a longer runway for companies to assess their growth trajectories before equity conversion is triggered.
Definition and Characteristics of Convertible Notes
A convertible note is a hybrid financial instrument issued by a startup company. It acknowledges the receipt of money initially as debt, with a provision for either repayment or conversion into equity at the option of the holder. Under the revised rules, the definition of a convertible note now explicitly includes that the conversion period shall not exceed ten years from the date of issue. The conversion may occur upon the fulfillment of specific events that are detailed in the agreement between the parties and mentioned in the terms of the instrument. This structure is particularly useful for early-stage startups that seek investment without the immediate dilution of equity and allows investors the option to convert debt into ownership once the company attains certain milestones.
Legal Recognition of Body Corporate Under the Definition of Indian Company
Another major amendment is the expansion of the definition of an Indian company under the rules. Previously, the term was narrowly defined as a company incorporated in India. The updated language now includes a body corporate established or constituted by or under any Central or State Act within the definition of an Indian company. This change has significant implications. By including statutory bodies within the definition, the rules now permit such entities to be treated on par with companies to receive foreign investment. This is particularly relevant for public sector undertakings, special purpose vehicles, and infrastructure entities constituted under legislative authority, which were previously excluded from the scope of certain investment benefits and regulatory clarity.
Wider Inclusion and Reference in Regulatory Provisions
Following this expansion, all references in the rules to terms such as company, investee company, transferee company, or transferor company are to be read as including a body corporate established under a Central or State Act. This ensures consistency across regulatory provisions and facilitates smoother interpretation and implementation. It also aligns the rules with the practical realities of corporate structuring in sectors like insurance, infrastructure, and power, where entities are often established through special legislation. However, the amended rules also maintain exclusions by clarifying that the definition of an Indian company does not extend to societies, trusts, or any entity that is expressly excluded under the FDI policy as an eligible investee entity. This distinction ensures that the scope of foreign investment remains within the bounds of structured, regulated corporate forms.
Specific Definitions Introduced for Clarity
The amendments introduced two new definitions: Share-Based Employee Benefit and Subsidiary. These definitions were added to bring the rules in line with the modified FDI policy and to reduce ambiguity in their application.
Understanding Share-Based Employee Benefit
Share-Based Employee Benefit refers to any issue of capital instruments to employees under a share-based employee benefits scheme that is formulated by a body corporate established under any Central or State Act. The insertion of this definition formally recognizes the issuance of shares or stock options under employee compensation plans. This move provides clarity to organizations operating under statutory authority and assures regulatory support for employee ownership and reward mechanisms. With this amendment, such entities are allowed to issue capital instruments under share-based employee benefit schemes, enhancing their ability to attract and retain talent in a competitive environment.
Definition of Subsidiary in Line with Companies Act
The second new definition added is that of a subsidiary, which now carries the same meaning as provided under the Companies Act, 2013. This ensures uniformity in interpretation and application across various regulatory frameworks. As per the Companies Act, a subsidiary is a company in which another company, known as the holding company, controls the composition of the board of directors or exercises or controls more than half of the total share capital. This harmonization eliminates confusion and provides a consistent legal framework across different sets of legislation that apply to corporate governance and foreign investments.
Benefits of Clarity in Terminology
Before these amendments, neither of the above terms had been specifically defined in the NDI rules, leading to interpretative challenges. With their inclusion, there is now greater transparency and ease of compliance for Indian companies and foreign investors alike. These definitions will especially benefit companies seeking to issue employee stock options or raise funding through foreign investors while ensuring adherence to applicable legal norms.
Expansion of Rule 19 on Mergers, Demergers, and Amalgamations
The amended rules have widened the scope of Rule 19, which deals with the provisions related to mergers and amalgamations of Indian companies. Previously, Rule 19 primarily focused on the transfer of capital instruments by way of mergers or demergers under schemes sanctioned by the National Company Law Tribunal in accordance with the Companies Act, 2013. The amendment expands the scope to include additional forms of corporate restructuring.
Coverage of Schemes of Compromise and Arrangement
Under the amended framework, Rule 19 now covers any scheme of compromise or arrangement entered into between two or more Indian companies. This is a significant expansion, as compromise or arrangement schemes are commonly used in restructuring, debt resolution, and business consolidation. By explicitly including these within the rule, the regulatory framework now accommodates a broader set of restructuring activities that could previously fall into a grey area concerning foreign investment implications. This clarification provides legal certainty and facilitates the smoother execution of such schemes.
Transfer of Undertakings and Divisions Covered
The amendment also extends Rule 19 to include cases involving the transfer of undertakings of one or more Indian companies to another Indian company. Similarly, it covers situations involving the division of an Indian company. These changes are particularly relevant in sectors like manufacturing, infrastructure, and financial services, where corporate restructuring often includes partial asset transfers or business unit separation. The extended coverage ensures that such activities are subject to the same regulatory oversight as full-scale mergers and demergers, thereby promoting regulatory parity.
Simplification Under Automatic Route
A key clarification introduced through this amendment is that mergers and acquisitions falling within sectors governed by the automatic route under the FDI policy do not require prior government approval. This simplifies the compliance process significantly and encourages corporate restructuring in sectors open to foreign investment without added regulatory burdens. It enables Indian companies with foreign shareholders to plan and implement reorganizations more efficiently, as long as the sectoral caps and other conditions under the FDI policy are met.
Exemptions From Government Approval in Eligible Sectors
Sectors under the automatic route include key areas like e-commerce, greenfield pharma, IT services, and others where foreign investment is permitted without prior approval. By allowing merger-related capital flows in these sectors without additional permissions, the government reinforces its commitment to ease of doing business and reducing transactional friction for companies engaging in cross-border or domestic M&A activities. It also reduces the processing time and delays associated with obtaining multiple clearances, allowing quicker completion of restructuring deals.
Regulatory Certainty for Investors and Companies
The expansion of Rule 19 brings greater regulatory certainty to foreign investors. They can now be assured that capital instruments transferred under court-approved schemes will be treated by clear and predictable rules. It also strengthens the legal framework that governs foreign participation in mergers and reorganizations, which is particularly important when such transactions involve inbound investments or restructuring of joint ventures. As a result, this promotes investor confidence and enhances India’s attractiveness as a destination for mergers and acquisitions.
New Exclusions Under Real Estate Business Definition
The amended rules bring further clarity to the definition of real estate business in the context of foreign investment. Previously, the definition was broader and did not specify exclusions. As a result, certain activities that did not strictly fall within real estate development were sometimes ambiguously classified, leading to uncertainty regarding the permissibility of foreign investment in those areas.
Educational and Recreational Facilities Not Considered Real Estate
The amended Schedule I of the NDI Rules now provides that certain activities shall not be considered part of the real estate business. These include educational institutions and recreational facilities. This change acknowledges the unique public utility and developmental role these sectors play and distinguishes them from real estate for investment purposes. It ensures that entities operating in the education and leisure sectors are not mistakenly subject to restrictions applicable to real estate ventures and are thus eligible to receive foreign investment under standard norms.
Infrastructure and Township Projects Excluded
Similarly, the amended rules clarify that city and regional level infrastructure, as well as township projects,, are not to be considered as real estate business. These types of development activities often involve construction and land usage but are fundamentally different in purpose and scale from speculative real estate development. By excluding such activities, the government provides a clearer regulatory path for foreign investment into urban development projects that are often backed by public-private partnerships or implemented through special-purpose vehicles.
Real Estate Broking Services Also Excluded
Another notable exclusion introduced through the amendment is that of real estate broking services. These are service-oriented businesses that facilitate property transactions but do not themselves involve owning or developing land or buildings. By removing broking services from the definition of real estate business, the amendment removes unnecessary barriers to foreign investment in this sector. It allows broking and advisory firms to receive foreign capital without facing restrictions designed for real estate developers.
Implications for Foreign Investors in Service-Oriented Sectors
The redefinition and exclusion of specific activities from the scope of the real estate business are expected to benefit sectors that offer services rather than physical development. This includes real estate platforms, proptech companies, online aggregators, and other technology-based solutions that facilitate property-related services. With this regulatory clarification, such entities are likely to attract more foreign investment, boosting innovation and professionalism in the real estate service ecosystem.
Foreign Investment in Life Insurance Corporation of India
One of the most anticipated changes in the amendment was the inclusion of specific provisions related to the Life Insurance Corporation of India. Earlier, there were no express rules under the NDI framework governing foreign direct investment in LIC. This lack of clarity created uncertainty for prospective foreign investors, particularly in the context of the Government’s disinvestment plans involving LIC’s public offering.
Alignment With Modified FDI Policy
In March 2022, the Government revised the FDI policy to permit foreign investment in LIC. The amendment to the NDI rules now brings the regulatory framework in line with this revised policy by formally including provisions that govern foreign investment in LIC. This alignment was essential to enable the smooth processing of investments and avoid legal or procedural hurdles. It also signals the importance of LIC as a strategic asset that is now open to global investors under a defined set of conditions.
Specified Conditions for Foreign Investment in LIC
While the amended rules do not detail all the terms within the section discussed here, it is understood that foreign investment in LIC is subject to a cap and specific compliance requirements. These conditions are aimed at ensuring that the strategic and social roles of LIC are preserved while allowing for global capital participation. The inclusion of these provisions under Schedule I ensures consistency with the broader FDI policy and establishes a clear legal route for investment into LIC.
Impact on LIC’s Fundraising and Public Offerings
With foreign investment now explicitly allowed in LIC under the NDI rules, the company is better positioned to access international capital markets. This will facilitate LIC’s future fundraising efforts and create opportunities for global investors to participate in the insurance sector. It also enhances transparency and investor protection by bringing LIC under the ambit of a defined investment framework. Given LIC’s scale and significance, this move represents a major policy shift in liberalizing India’s insurance and financial services sectors.
Legal Significance of Extending Convertible Note Tenure
The extension of the convertible note tenure from five to ten years provides a substantial legal and commercial benefit to startups and their investors. Startups generally face longer gestation periods before becoming profitable or achieving significant valuations. In such cases, a five-year limit could force early conversion or repayment of notes at a time when the company’s valuation may not reflect its full potential. By extending the conversion period to ten years, the amendment aligns legal requirements with the practical realities of startup growth cycles, providing both flexibility and predictability in structuring financing instruments.
Investor Confidence and Start-up Ecosystem
Foreign and domestic investors now have a broader time window to evaluate the performance of the startup and determine whether or not they should convert the debt into equity. This change reduces pressure on founders and enhances investor confidence by enabling a longer association without immediate equity dilution. This is particularly beneficial for venture capital and private equity funds that prefer long-term strategic investments. The ten-year term allows investors to better synchronize their investment exit strategies with company milestones and market conditions.
Alignment With International Practices
The extended tenure also brings India’s regulatory norms more in line with international investment practices. In many developed jurisdictions, convertible instruments with longer maturity or conversion periods are common. By adopting a ten-year window, India signals its willingness to adopt global standards in startup financing and encourages foreign investors to explore opportunities in the Indian market without facing structural limitations.
Implications for Startups in Capital-Intensive Sectors
The amendment is especially significant for startups operating in capital-intensive sectors such as renewable energy, deep tech, biotechnology, and manufacturing. These businesses often require longer periods to scale and generate revenue. A ten-year window to convert debt into equity gives them time to reach meaningful valuation thresholds, enabling better negotiation terms with investors. It also reduces the likelihood of forced early-stage exits or adverse financial arrangements due to time-bound regulatory requirements.
Compliance and Documentation Challenges
While the change is investor-friendly, it does require startups to revisit existing convertible note agreements and potentially amend them to reflect the new timeline. Legal teams and compliance officers must ensure that convertible note instruments issued post-amendment conform to the revised definition under Rule 2(e). Companies may also need to update their internal policies and investor communication strategies to reflect this regulatory change accurately.
Relevance of Including Body Corporates in the Indian Company Definition
The amendment that expanded the definition of an Indian company to include body corporates constituted under Central or State Acts is a significant regulatory reform. In India, several important economic entities operate under legislative authority and do not fall within the purview of the Companies Act. Examples include statutory authorities, infrastructure development boards, and specific-purpose agencies. Before the amendment, such entities faced ambiguity regarding their eligibility for foreign investment under the NDI rules.
Enabling Foreign Investment in Government-Backed Projects
With the inclusion of body corporates in the definition of an Indian company, these institutions can now legally receive foreign investment, provided all other conditions of the FDI policy are satisfied. This change is expected to enhance foreign capital inflow into government-backed infrastructure and public utility projects. It also improves the viability of projects that rely on global funding partnerships or development finance institutions.
Operational Autonomy and Investment Structuring
Body corporates under legislative acts often have a unique governance structure and operational autonomy. Recognizing them as Indian companies under the NDI rules allows for a standardized approach to investment structuring, compliance, and documentation. Investors can now treat such entities as regulated recipients of foreign capital, which reduces legal uncertainty and opens new avenues for investment in public-private partnership models.
Clarification on Exclusions From the Definition
Although the definition has been expanded, the rules make it clear that certain entities, such as societies and trusts, continue to be excluded from the scope oan f an Indian company. These exclusions align with the FDI policy, which designates eligible investee entities. Societies and trusts may not meet the standard corporate governance and disclosure norms required for foreign investment, and their exclusion ensures that investments are channeled only into structured, regulated corporate forms.
Broader Impact on Public Sector Undertakings
Public sector undertakings that are constituted by statute and not registered under the Companies Act will benefit from this amendment. These include entities in sectors such as defense production, energy distribution, ports, and logistics. As India pursues disinvestment and modernization of its public sector, the inclusion of such bodies within the foreign investment framework adds another tool for attracting international capital and forming strategic collaborations.
Strategic Advantage for Joint Ventures and SPVs
Special-purpose vehicles created by governments or public authorities for implementing large-scale projects can also benefit from the amended definition. These SPVs are often body corporates under special laws and have previously faced challenges in raising foreign capital due to their legal status. The amendment provides regulatory clarity and enhances their ability to attract investment partners on equal terms as private companies, making it easier to execute infrastructure and development plans.
Share-Based Employee Benefit Schemes and Talent Retention
The specific inclusion of the definition of share-based employee benefit schemes is a notable reform that aligns the NDI rules with modern business practices. Startups and corporates often use equity-based compensation to attract and retain high-quality talent. Before the amendment, the absence of a specific definition under the NDI rules created interpretational challenges, particularly for statutory bodies or non-traditional companies offering such benefits.
Legitimizing Equity Compensation Practices
The amendment legitimizes and regulates the issuance of capital instruments under share-based employee benefit schemes by body corporates established under Central or State Acts. This is crucial for public authorities or development-focused institutions that seek to reward high-performing employees through ownership stakes. It also standardizes the regulatory framework, ensuring that equity compensation is treated uniformly regardless of the nature of the issuing entity.
Potential Uptake by Public Institutions
With this clarity, institutions such as state-run development agencies, financial corporations, and statutory enterprises may be more inclined to implement performance-based equity incentive programs. These entities can now reward employees using share-based compensation plans without running afoul of investment norms or facing uncertainties related to regulatory compliance.
Subsidiary Definition Harmonized With Companies Act
The formal adoption of the term subsidiary in line with the Companies Act ensures that references in the NDI rules match the corporate legal framework. This eliminates inconsistencies and ensures that definitions used in foreign investment contexts align with those used in corporate governance, mergers, and regulatory disclosures. It also simplifies legal due diligence for foreign investors assessing the ownership and control structures of investee companies.
Ease of Cross-Border Transaction Structuring
Investors frequently evaluate the ownership chains of Indian companies and their subsidiaries to assess compliance with FDI norms, sectoral caps, and control thresholds. With the definition now harmonized, such evaluations become easier and more consistent across jurisdictions. It also ensures that restructuring transactions involving subsidiaries are governed by predictable legal interpretations.
Broader Regulatory Alignment
The harmonized definition supports regulatory convergence across ministries and departments, allowing for consistent enforcement of investment-related provisions. It also supports legal audits and tax assessments, where ownership relationships play a critical role in determining obligations and liabilities under Indian laws. This clarity is expected to reduce disputes and litigation, especially in cross-border transactions.
Encouraging Compliance and Governance
The precise definition of subsidiary encourages investee companies to maintain transparent shareholding structures and governance practices. This aligns with broader regulatory trends in India that promote responsible corporate conduct, disclosure, and compliance as prerequisites for accessing foreign capital.
Practical Impact on Startups and Venture Capital Ecosystem
The amendments to the NDI rules represent a strategic push by the government to enhance India’s startup investment environment. By extending the permissible period for convertible note conversion and clarifying the eligibility of various entities under the Indian company definition, the regulatory framework now accommodates a wider range of business structures and investment scenarios. This will likely lead to a more vibrant venture capital ecosystem, where both domestic and foreign investors feel more secure and supported by a transparent legal structure. The simplification and expansion of investment instruments also make it easier for early-stage companies to raise funds without immediately compromising ownership or control.
Facilitating Innovation and Long-Term Investment Planning
These regulatory changes encourage innovation by allowing founders and investors to take a long-term view when structuring financing instruments. Convertible notes with a ten-year horizon enable startups to postpone equity dilution and strategic decisions until the company reaches a more stable and scalable phase. This is especially critical for startups in emerging sectors such as artificial intelligence, deep technology, clean energy, biotechnology, and financial technology, which typically have long development timelines and delayed monetization potential.
Increased Interest From Foreign Institutional Investors
With a more comprehensive and investor-friendly regulatory environment, foreign institutional investors may be more inclined to invest in Indian startups and infrastructure projects. The expanded definitions, clear exclusions from real estate, and inclusion of entities like LIC make it easier for large global funds and financial institutions to evaluate opportunities without the fear of regulatory ambiguity. Additionally, the clarity around automatic route mergers further removes procedural bottlenecks for foreign capital entering the Indian market through complex transactions.
Boosting Public Sector Investment Opportunities
The recognition of body corporates as Indian companies under the NDI rules brings public sector entities into the mainstream investment narrative. This enables strategic collaborations between Indian public enterprises and foreign stakeholders for large-scale projects in sectors such as renewable energy, urban infrastructure, transport logistics, and industrial development. It also supports the government’s ongoing disinvestment and privatization agenda by making public sector units more attractive to global investors.
Improved Transparency in Employee Compensation Structures
By introducing specific definitions for share-based employee benefit schemes, the amended rules enhance transparency and legal certainty for organizations that seek to implement stock ownership or similar compensation models. These measures not only improve employee motivation and retention but also bring Indian entities in line with global corporate governance standards. Investors often assess the quality of talent and governance in a company before investing, and the formalization of such schemes under the rules adds to the professionalism and maturity of Indian businesses.
Impact on Sectoral Investment Strategies
The amendments also encourage a re-evaluation of sectoral investment strategies by clarifying what constitutes a real estate business. With the exclusion of educational institutions, recreational facilities, infrastructure projects, and broking services, investors can now confidently invest in these sectors without worrying about regulatory interpretation. This may lead to increased investments in urban planning, logistics support services, real estate tech platforms, and community development projects. The policy delineates speculative real estate activity from developmental projects with broader social and economic value.
Addressing Previous Legal Ambiguities
Before these amendments, there were several ambiguities in the application of NDI rules. Definitions were either too narrow or missing entirely, leading to interpretational conflicts and inconsistent regulatory enforcement. By providing clear definitions and expanding existing ones, the rules now offer a more complete legal framework. This reduces the risk of non-compliance and regulatory disputes, helping companies and investors operate within a well-defined legal environment. This change is particularly beneficial for legal and compliance professionals who require precise statutory language to structure transactions confidently.
Facilitating Corporate Reorganizations With Ease
The expansion of Rule 19 ensures that various forms of corporate reorganization, including mergers, demergers, compromises, and arrangements, are recognized under the NDI rules. This enables companies to pursue restructuring activities aligned with their growth and market strategies without fear of breaching foreign investment norms. The simplification of approval requirements in sectors under the automatic route further accelerates deal timelines and promotes greater dynamism in the corporate landscape.
Institutional Support and Procedural Clarity
The changes brought in by the amended rules also signal an institutional commitment to improving India’s foreign investment climate. By aligning the rules with the updated FDI policy and clarifying ambiguous provisions, the regulatory framework now reflects a more modern, responsive, and business-friendly approach. This is in line with broader efforts to improve India’s position in global ease of doing business rankings and to attract greater foreign capital inflows.
Complementing Broader Economic Reforms
The amendments to the NDI rules are part of a larger movement within Indian economic policy aimed at liberalization and reform. These rules support other government initiatives such as Startup India, Make in India, Digital India, and the National Monetization Pipeline. Together, these policies create a more cohesive and progressive economic framework that encourages both domestic entrepreneurship and foreign participation in India’s growth story.
Future Outlook for Legislative and Regulatory Evolution
The current amendments reflect only one phase of India’s evolving regulatory landscape. As economic activities become more diversified and complex, further changes to the NDI rules and related frameworks are expected. These may include digitization of compliance mechanisms, streamlined foreign exchange reporting processes, and tailored norms for emerging industries like blockchain, space technology, and e-commerce logistics. Stakeholders should anticipate and prepare for these changes to remain compliant and competitive.
Strategic Role of Reserve Bank of India and Other Authorities
The implementation of these amended rules will be overseen by the Reserve Bank of India and other relevant regulatory authorities. RBI’s role will be critical in interpreting and enforcing these provisions, especially in matters involving capital flows, foreign exchange compliance, and sectoral entry conditions. Coordination among regulators, including the Department for Promotion of Industry and Internal Trade, Securities and Exchange Board of India, and the Insurance Regulatory and Development Authority, will also be crucial in maintaining consistency across the financial ecosystem.
Summary of Key Amendments
The key changes brought about by the Foreign Exchange Management (Non-debt Instruments) (Amendment) Rules, 2022, can be summarized as follows. The conversion period for startup-issued convertible notes has been extended to ten years. The definition of an Indian company has been expanded to include body corporates established under Central or State Acts. Definitions of share-based employee benefits and subsidiaries have been formally included. Rule 19 governing corporate reorganizations has been widened to include arrangements, compromises, and the division of undertakings. Specific exclusions have been added to the definition of real estate business, and the rules have been updated to include provisions for foreign investment in LIC.
Conclusion
The amendments to the NDI rules mark a progressive shift in India’s foreign exchange regulatory regime. They promote inclusivity, clarity, and investor confidence while aligning the legal framework with the evolving dynamics of the global economy. By addressing critical gaps in definitions, timelines, and eligibility, the rules offer a forward-looking regulatory environment that balances investor interests with national economic priorities. Whether for startups, public enterprises, or international investors, the updated NDI rules create a more cohesive and enabling ecosystem for sustainable and responsible investment in India.