What the regulation actually says

The governing law is the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (the "NDI Rules"), read together with the consolidated FDI Policy 2025. The concept at the heart of this is indirect foreign investment, more commonly called downstream investment.

The NDI Rules define an Indian entity that is "owned or controlled by non-resident entities" — often abbreviated as a FOCC (Foreign Owned or Controlled Company). An Indian company is:

Owned by non-residents if more than 50% of its capital is beneficially held by persons resident outside India; and
Controlled by non-residents if non-residents have the right to appoint a majority of its directors, or to control management or policy decisions (including through shareholder or voting agreements).

Here is the rule that surprises foreign founders: when a FOCC makes a downstream investment into another Indian company, that downstream investment is counted as indirect foreign investment in the second company. The Indian-ness of the investing entity does not "wash out" the foreign character of the money. So the second company must itself comply with:

The sectoral cap applicable to its business activity (for example, 100% in most manufacturing, 74% in defence, 26% in print media via approval, and so on);
The entry route — whether the activity falls under the automatic route (no prior government permission needed) or the government approval route (prior approval from the relevant administrative ministry required before the investment); and
The pricing guidelines — the FOCC cannot acquire shares of the downstream company below the fair value determined under internationally accepted valuation methodology.

Two practical conditions in the NDI Rules deserve emphasis. First, downstream investment must be funded only through the FOCC's own funds or from funds raised through equity abroad — it cannot be made from funds borrowed in the domestic Indian market for the specific purpose of that downstream investment. Second, the investment must be duly supported by a board resolution and, where applicable, a shareholders' agreement.

There is also a carve-out worth knowing: an Indian company that is not owned or controlled by non-residents (i.e., resident-owned and resident-controlled) can make downstream investment freely as a domestic investment — its onward investment is not treated as foreign investment. The trigger is ownership and control sitting with non-residents. Get the FOCC test wrong and you misclassify the entire transaction.

Practical implications — what happens if you get this wrong

The risk here is not theoretical. If a FOCC pushes money into a second Indian company that operates in a sector requiring government approval — and no approval was taken — the investment is a FEMA contravention from day one.

The consequences compound. Compounding is the formal RBI process of settling a FEMA violation by paying a monetary penalty; it is available, but it is not free, and repeated or large breaches attract higher amounts. Worse, an unapproved investment in a restricted sector may not be capable of regularisation at all without unwinding the transaction. A breach also surfaces at the worst possible moment: during due diligence for the next funding round or an exit, when an acquirer's lawyers find that a layer of the corporate structure was never FEMA-compliant. That finding can delay a deal, trigger an indemnity, or knock down valuation.

Missing the reporting obligation (covered below) is itself a separate, standalone contravention — even if the underlying investment was perfectly permissible. Many groups are caught not because the deal was wrong, but because nobody filed the form.

Step-by-step: what to do

Run the FOCC test on the investing entity first. Confirm whether your Indian company is "owned or controlled" by non-residents under the NDI Rules. If yes, every downstream investment it makes is indirect foreign investment. Document the analysis with a cap-table and a review of any shareholders'/voting agreements.
Classify the target company's sector. Identify the downstream company's actual business activity, then map it to the FDI Policy 2025 sectoral cap and entry route. Decide clearly: automatic route or government approval route? If approval route, obtain that approval before the investment, through the relevant administrative ministry (applications are filed on the FIFP portal, the Foreign Investment Facilitation Portal).
Obtain a valuation report. Get the downstream shares valued by a SEBI-registered Merchant Banker or a Chartered Accountant using internationally accepted methodology, so the price respects FEMA pricing guidelines (a foreign-origin buyer cannot acquire below fair value).
Check the funding source. Ensure the downstream investment is funded from the FOCC's own/equity funds, not from money borrowed in the Indian domestic market for that purpose. Pass a board resolution approving the investment.
File Form DI within 30 days. This is the form most groups miss. Form DI must be filed with the Reserve Bank of India (through the FIRMS portal, the same single-master-form system used for FC-GPR and FC-TRS) within 30 days of the downstream investment / allotment of shares by the second company. Keep this distinct from the FC-GPR the second company files for the share allotment itself.
Maintain the audit trail. Retain the board resolution, valuation report, Form DI acknowledgement, and the FOCC analysis together. This package is exactly what a future investor's or acquirer's diligence team will ask for.

FAQ

Q: My Indian subsidiary is 100% foreign-owned. If it buys shares in another Indian company, is that really "foreign investment" again?
Yes. Because your subsidiary is a FOCC (owned and controlled by non-residents), its onward investment is indirect foreign investment in the second company. The second company must respect its own sectoral cap, entry route, and pricing guidelines, exactly as if the foreign money had gone in directly.

Q: What is the single form I am most likely to forget?
Form DI, filed on the RBI FIRMS portal within 30 days of the downstream investment. It is separate from the FC-GPR the receiving company files. Missing Form DI is an independent FEMA contravention even when the investment itself was fully permitted.

Q: Can my foreign-owned Indian company fund the downstream investment with an Indian bank loan?
No. Downstream investment cannot be made from funds borrowed in the domestic market for that purpose. It must come from the company's own funds or equity raised abroad. Using domestic borrowings for downstream investment is a breach in itself.

Closing

Downstream investment is one of the most common blind spots for foreign-owned groups building a multi-entity structure in India — the money looks "domestic" but FEMA still treats it as foreign. Mapping the sector, route, valuation, and Form DI filing before the transaction is far cheaper than compounding a breach later.

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