A S BANKA ADVISORS

Key Takeaways

• Downstream investment under FEMA is an investment by an Indian company that has foreign investment in it, into the shares or capital of another Indian company or LLP.
• If your startup is owned or controlled by persons resident outside India, its investment in another Indian entity is treated as indirect foreign investment for that entity, and the foreign investment rules apply to it: entry route, sectoral caps and pricing.
• The money for that investment must come from abroad or from internal accruals (profits transferred to reserves after tax). Funds borrowed in India cannot be used.
• The company making the investment notifies the Secretariat for Industrial Assistance in DPIIT within 30 days of the investment, and files Form DI with the Reserve Bank within 30 days of the allotment.
• Our view: run the ownership and control test, and decide where the money will come from, before you sign a term sheet to acquire or fund another Indian company, not at closing.

Your company is incorporated in India, run from India and filed in India. Once foreign investors own or control it, India’s foreign exchange law treats the next Indian company it invests in as receiving foreign investment too. Downstream investment under FEMA is the set of rules for that moment, and it reaches founders who set up a second Indian company, acquire a smaller startup or put money into a partner.

This guide covers when your startup’s investment counts as foreign investment, what changes for the company you invest in, where the money may come from, what to file and when, and the yearly check that follows.

What is downstream investment under FEMA?

The Foreign Exchange Management (Non-debt Instruments) Rules, 2019 define downstream investment as an investment made by an Indian entity that has total foreign investment in it, or by an investment vehicle, in the capital instruments or capital of another Indian entity. An Indian entity means an Indian company or an LLP.

That definition is wide. The rules then pick out the investments that matter most: downstream investment that counts as indirect foreign investment for the company receiving it. The funding and filing conditions below attach to that narrower group.

When does your startup’s investment count as foreign investment?

Indirect foreign investment is downstream investment received by an Indian entity from another Indian entity that has foreign investment and either is not owned and not controlled by resident Indian citizens, or is owned or controlled by persons resident outside India. In plain terms, the test is about your company, the one making the investment.

• Ownership: an Indian company is owned by persons resident outside India when they beneficially hold more than fifty per cent of its equity instruments. The rules define equity instruments to include equity shares, convertible debentures, preference shares and share warrants.
• Control: the rules take the meaning of control from the Companies Act, 2013. It includes the right to appoint a majority of the directors, or to control management or policy decisions, held directly or indirectly, including through shareholding, management rights, shareholders’ agreements or voting agreements.
• Counting: total foreign investment is the total of direct and indirect foreign investment, counted on a fully diluted basis.

Two practical points follow. First, add up every foreign investor together, not one at a time, and include their convertible preference shares and debentures. Second, read the investor rights in your shareholders’ agreement as well as the share count, because control can sit in those rights.

One more rule matters if you plan a subsidiary. Indirect foreign investment received by a wholly owned subsidiary of an Indian company is limited to the total foreign investment received by the company making the downstream investment.

What changes for the company you invest in?

The NDI Rules say an Indian entity that has received indirect foreign investment must comply with the entry route, sectoral caps, pricing guidelines and other attendant conditions that apply to foreign investment. For the company you invest in, that means:

• Entry route: if its sector needs Government approval for foreign investment, your investment needs it too.
• Sectoral caps: your investment counts towards any limit on foreign investment in its sector.
• Pricing: the price follows the foreign investment pricing rules. For shares an unlisted Indian company issues to a person resident outside India, the price cannot be less than a valuation done on an arm’s-length basis using an internationally accepted pricing method, certified by a Chartered Accountant, a SEBI-registered merchant banker or a practising cost accountant.

Before you agree a price, get that valuation. Before you agree the structure, confirm the investee’s sector and its entry route under the FDI policy. Our guide to FDI routes and structuring for startups covers the automatic and Government routes.

Where can the money for a downstream investment come from?

This is the condition that can change a deal. The NDI Rules say that, for downstream investment that counts as indirect foreign investment, the Indian entity making it must bring in the funds from abroad and must not use funds borrowed in the domestic market. It may also use internal accruals, which the rules define as profits transferred to the reserve account after payment of taxes.

So a foreign-owned startup has two sources for the money, and one it cannot use:

1. Funds brought in from abroad.
2. Profits it has transferred to reserves after tax.
3. Not money borrowed in India. Any borrowing the company raises must itself comply with the law, but domestic borrowing cannot fund the downstream investment.

If your plan is to fund an acquisition with venture debt raised in India, this is the line to check first.

What has to be approved and filed?

The NDI Rules require board approval for the downstream investment, and approval under a shareholders’ agreement if there is one. The Reserve Bank’s reporting regulations for non-debt instruments then set two filings for the company making the investment:

• DPIIT notice: notify the Secretariat for Industrial Assistance, DPIIT, within 30 days of the investment, even if the shares have not yet been allotted, stating how the investment is being made.
• Form DI: file Form DI with the Reserve Bank within 30 days of the date the shares are allotted.

The same regulations make the person responsible for a report liable to a late submission fee, decided by the Reserve Bank in consultation with the Central Government, for any delay. Put both dates in the closing calendar the day the board approves the deal. If your company has also just raised foreign money, our guide to the FC-GPR and FC-TRS reporting clock covers the filings on the money coming in.

The yearly check: an auditor’s certificate

The first-level Indian company that makes the downstream investment is responsible for compliance with these rules at the second level and below. Each year it must obtain a certificate to that effect from its statutory auditor, and its compliance must be mentioned in the directors’ report in its annual report.

If the statutory auditor gives a qualified report, it must be brought to the notice of the Reserve Bank regional office for the place where the company’s registered office is located, and the company must obtain an acknowledgement. Keeping the board approval, the valuation and both filings in one folder makes that certificate a short exercise rather than a reconstruction.

Selling those shares later

The rules also cover the exit. Shares of an Indian company held by a foreign-owned or foreign-controlled Indian company may be transferred to a person resident outside India, subject to the Reserve Bank’s reporting requirements; to a person resident in India, subject to the pricing guidelines; or to another Indian company that is itself foreign-owned or foreign-controlled. Build that into any exit clause you agree with the founders of the company you invest in.

Are these rules changing?

The Reserve Bank has placed draft Foreign Exchange Management (Foreign Investment) Rules, 2026 for public comment, as a replacement for the Non-debt Instruments Rules, 2019 (press release of 21 July 2026). They are a draft. The 2019 rules described in this guide are the law until new rules are notified.

A checklist before you sign

1. Add up all foreign holdings in your company, including convertible instruments, and read the investor rights in your shareholders’ agreement. Decide whether your company is foreign-owned or foreign-controlled.
2. If it is, confirm the investee’s sector, its entry route and any cap.
3. Get a valuation that meets the pricing rules before you agree the price.
4. Fund the investment from money raised abroad or from post-tax profits transferred to reserves, never from a domestic loan.
5. Pass the board resolution and get any approval your shareholders’ agreement requires.
6. Notify DPIIT within 30 days of the investment and file Form DI within 30 days of allotment.
7. Diary the statutory auditor’s certificate and the directors’ report line for the year end.

Our FDI compliance checklist for startups covers the decisions to make before the foreign money arrives in the first place.

Frequently asked questions

Does every startup with a foreign investor have to follow the downstream investment conditions?

No. The conditions on funding, the DPIIT notice and Form DI attach to downstream investment that counts as indirect foreign investment for the company receiving it. That depends on whether the investing company is owned or controlled by persons resident outside India, or is not owned and not controlled by resident Indian citizens.

Does a wholly owned subsidiary of a foreign-owned startup count as fully foreign-owned?

Not automatically. The rules limit the indirect foreign investment received by a wholly owned subsidiary of an Indian company to the total foreign investment received by the company making the downstream investment.

Can a foreign-owned LLP make a downstream investment?

Yes, within a limit. Under the NDI Rules, downstream investment by an LLP that is not owned and not controlled by resident Indian citizens, or is owned or controlled by persons resident outside India, is allowed in an Indian company operating in a sector where foreign investment up to one hundred per cent is permitted under the automatic route and there are no FDI-linked performance conditions.

The bottom line

A foreign-owned Indian startup can invest in other Indian companies. It does so on foreign investment terms: the investee’s sector rules apply, the price has a floor, the money cannot come from a domestic loan, and there are two filings and a yearly certificate. Our view: the test takes an afternoon before the term sheet and much longer after closing, so do it first.

Planning to set up a second Indian company, acquire a startup or invest in a partner after raising foreign money, and want the ownership test, funding and filings worked out first? You can book a quick call with A S Banka Advisors Private Limited.

Sources: Ministry of Finance (Department of Economic Affairs), Foreign Exchange Management (Non-debt Instruments) Rules, 2019, as amended, consolidated text published by the Reserve Bank of India (rbi.org.in). Reserve Bank of India, Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019, Notification No. FEMA 395/2019-RB, as amended up to 13 June 2026 (rbi.org.in). Ministry of Corporate Affairs, Companies Act, 2013 (indiacode.gov.in). Reserve Bank of India, press release 2026-2027/726 dated 21 July 2026, Draft Foreign Exchange Management (Foreign Investment) Rules, 2026 for comments (rbi.org.in).

Disclaimer: This article is general information for founders and is not legal, tax or investment advice. It states the position as on the date of publication; confirm the current position for your company before acting.