Foreign Investment Rights in Prohibited Sectors: Decoding the 2025 Non-Debt Instruments Rules Amendment

INTRODUCTION

On June 11, 2025, the Department of Economic Affairs, Ministry of Finance, Government of India, notified the Foreign Exchange Management (Non-debt Instruments) (Amendment) Rules, 2025 (“Amendment Rules”), introducing Rule 7(2) to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019(“NDI Rules”). As a result of Rule 7(2) of the NDI Rules, Indian companies operating in industries where foreign direct investment (“FDI”) is prohibited are now permitted to issue bonus shares to their existing Non-resident shareholders.

BACKGROUND

The Amendment Rules were introduced in light of Press Note No. 2(2025 series) issued by the Department for Promotion of Industry and Internal Trade, introducing a similar clarification under the Consolidated FDI Policy Circular of 2020 (“FDI Policy”)^[1]. The FDI Policy prohibits companies operating in the sectors of lottery, gambling and betting, chit funds, tobacco, real estate, etc., from accepting foreign direct investment ^[2].  

Prior to the FDI Policy coming into effect, certain companies operating in sectors which are currently prohibited from receiving FDI had received the same when it was earlier permitted, which such investors had continued to hold after the change in foreign investment status. However, after the FDI Policy has come into effect, there has been ambiguity as to whether the seforeign shareholders would be eligible to participate in bonus and rights issuances. While Section 63 of the Companies Act, 2013 covers the issuance of bonus shares to even foreign shareholders, neither the FDI Policy nor the NDI Rules, expressly clarified on the permissibility of foreign shareholders in the prohibited sectors to participate in bonus shares issuances.

CURRENT POSITION

The now amended Rule 7 of the NDI Rules expressly allows Indian companies operating in the prohibited sectors to issue bonus shares to their existing non-resident shareholders, provided that the shareholding of such non-resident shareholders remains the same, post issuance ^[3]. This rule also has a retrospective application, where previous bonus issuances to non-resident shareholders in prohibited sectors are deemed to have been made in compliance with law.

ANALYSIS

The Amendment Rules marks a significant shift for Indian companies operating in sectors where FDI is prohibited. By explicitly allowing the issuance of bonus shares to non-resident shareholders, it opens a new channel for capital restructuring, particularly through the capitalization of reserves. This policy change ensures that such companies can also now reward its shareholders (including its long-standing foreign investors) with additional securities and provide another opportunity to utilise its reserves,not unlike any other company, permitted to issue bonus shares.

From the perspective of foreign investors, the benefits are clear as even though their ownership percentage remains unchanged, they will not be subject to automatic dilution pursuant to any bonus issue. This ensures that the value of their investments are not diluted, especially if there is a growth in the fair market value of the company. The retrospective application is also particularly reassuring as it provides a clarity to the subsequent queries which may have been raised. The implications are especially relevant for Indian private companies gearing up for an initial public offering (“IPO”). Bonus issuances can improve liquidity, make share prices more market-friendly, and enhance valuations ahead of a public listing. For companies in FDI-prohibited sectors, being able to do this without violating the FDI framework provides regulatory clarity ahead of IPO preparation and investor engagement.

However, the relaxation comes with intentional limits. The Amendment Rules requires that non-resident shareholders maintain their existing shareholding, ensuring that foreign shareholding is not increased indirectly from such bonus issuance. This restriction ensures that bonus issuances cannot be used to strategically reduce, or increase, foreign equity participation in prohibited sectors. A potentially effective avenue for rebalancing shareholding structures in line with regulatory objectives has instead been shaped into a rigid framework that curtails flexibility for companies in the prohibited sectors.

However, a notable gap in the amendment is its silence on the rights issuances. While the FDI policy does allow rights issues to non-residents, the Amendment Rules makes no mention of them and solely focuses on bonus share issuances. This silence creates uncertainty for companies in prohibited sectors that might want to use rights issues, whether to reward shareholders, or raise additional capital, so long as the foreign shareholding percentage remains unchanged, a much-needed regulatory update not very different from the current revision to the bonus issue regime but accompanied with the add Ed advantage of additional capital remittance to the economy. In the absence of such explicit extension for rights issue, companies operating in prohibited sectors may continue to be reluctant to pursue such corporate actions, limiting their operational and strategic flexibility.

CONCLUSION

In essence, the amendment offers much needed clarity and relief in one area, while leaving another important mechanism, rights issues, unaddressed. It strengthens the ability of companies to reward the retained foreign investors and facilitates IPOs by way of attractive pricing, all without breaching the current FDI regime. Yet, the absence of similar clarity on rights issuances means that the full potential from existing foreign investors in prohibited sectors remains untapped.

References

[1] Para 1 of Annexure 3 of the Consolidated FDI Policy Circularof 2020

[2] Para 5.1 of the FDI Policy

[3] Rules 7(2), FEM (NDI) Rules, 2019

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