Legal provisions governing downstream investment
Issues related to downstream investment


Indirect foreign investment is an investment by an intermediate Indian entity, which is owned or controlled by a non-resident, in another Indian entity.

Under the current foreign exchange regime, the Foreign Exchange Management (Non-debt Instrument) Rules 2019 (the Non-debt Rules) govern the terms and conditions relating to indirect foreign investment and downstream investment in India.

Legal provisions governing downstream investment

The Non-debt Rules define downstream investment as investment made by an Indian entity that has total foreign investment in it, in the capital instruments or the capital, as the case may be, of another Indian entity.

Indian entities owned and controlled by foreigners (ie, non-residents) are called foreign-owned-and-controlled companies (FOOEs) and investment made by FOOEs in the capital instruments or capital, of other Indian entities is called downstream investment.

Issues related to downstream investment

Several issues around downstream investment are outlined below.

There is an issue about investment by FOOEs in optionally convertible preference shares (OCPs) and optionally convertible debentures (OCDs) of the Indian company under the downstream investment.

The Non-debt Rules consider OCPs and OCDs (collectively known as OCIs) as hybrid securities. However, the Non-debt Rules are silent on the issue of whether OCIs can be instruments under the downstream investment or not.

Under the downstream investment, FOOEs are required to invest in the capital instruments of another Indian entity. The term "capital instruments" is not defined in the Non-debt Rules. They only define "equity instruments" as equity shares, convertible debentures, preference shares and share warrants issued by an Indian company.

As the definition of equity instruments under the Non-debt Rules does not cover OCIs within its ambit, the first issue requiring clarification is whether FOOEs are allowed to invest in OCIs or not and, if they are, whether their investment will be governed by the Non-debt Rules.

Direct subscription of OCIs by a non-resident has been considered as debt under the Foreign Direct Investment Policy 2020 (FDI policy), and the Foreign Exchange Management (Borrowing and Lending) Regulations 2018 (ECB Regulations) are applicable on such investment.

Under the previous Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations 2017, the definition of capital instrument stated that OCPs were considered as debt.

However, whether the investment in OCIs by FOOEs will also be considered as debt under the foreign exchange regulations and whether, for this purpose, FOOEs will be considered on par with "non-resident", is an issue that needs clarification.

Further, if these OCIs are considered as debt, then it remains to be seen whether all provisions of the ECB Regulations will apply to such OCIs or not and, if they do, what the implications of this will be.

It is worth mentioning that OCIs have been considered as external commercial borrowings under the ECB Regulations. However, FOOEs do not fall within the definition of "recognised lender". Accordingly, the investment by FOOEs in OCIs will not be considered as external commercial borrowing.

Conversion of OCIs into equity shares would ultimately result in a downstream investment by FOOEs in the equity of another Indian entity.

Accordingly, how far it will be correct to say that FOOEs are restricted from investing in OCIs (since ultimately, investment in OCIs may be converted into equity instruments resulting in a downstream investment by FOOEs) requires deliberation.

Further, the guiding principle under the earlier FDI policy in 2010 (ie, "what cannot be done directly through FDI by a non-resident cannot be done indirectly through indirect foreign investment by non-resident") has been removed in subsequent FDI policies. Therefore, in the absence of this principle, the position that a non-resident, who is not allowed to invest directly in OCIs, is also restricted from indirectly acquiring OCIs through FOOEs requires further clarification and deliberation.

Applicability of the term "other attendant conditions" and deferred payment
Downstream investment has to adhere to the entry route, sectoral caps, pricing guidelines and other attendant conditions as applicable for foreign investment. In other words, "other attendant conditions" mean generic conditions. Accordingly, it can be inferred that generic conditions as applicable to foreign investment made by non-residents will also be applicable on downstream investment by FOOEs.

In this regard, attention is drawn to the definition of the term "FDI-linked performance conditions" (FIPCs) which essentially are sector-specific conditions stipulated in schedule I of the Non-debt Rules.

However, while dealing with downstream investment, the same has not been restricted to FIPCs, rather it has been linked to "other attendant conditions as applicable for foreign investment". The term "other attendant conditions" has not been defined in the Non-debt Rules and accordingly, cannot be equated with FIPCs.

In summary, the term "other attendant conditions" is too vast and, accordingly, all conditions as applicable for foreign investment, including FIPCs, may be applicable on the downstream investment by FOOEs and this in turn may have wider ramifications.

For example, one of the conditions applicable to foreign investment by non-residents is that in the case of a transfer of equity shares between a person resident in India and a person resident outside India, 25% of the total consideration can be paid on a deferred basis within 18 months from the date of transfer agreement.

As "other attendant conditions as applicable for foreign investment" are also applicable on downstream investment, the conditions related to deferred payment can be applicable on downstream investment by FOOEs, although the payment for such downstream investment by FOOEs may be in Indian rupees. Therefore, this aspect also needs to be considered while dealing with downstream investment especially, and when payment models such as earn-out models are proposed to be implemented.

FIPCs and pricing guidelines
Also, if investment by FOOEs in OCIs is not to be treated as downstream investment, and assuming that there is no embargo on investment by FOOEs in OCIs, then to what extent FIPCs and pricing guidelines will be applicable also needs to be considered.

If pricing guidelines are applicable on conversion of the OCIs into equity shares (ie, at the time of downstream investment), then the same may not be beneficial from a FOOE's perspective since at the time of subscribing OCIs, the FOOE will be unable to comprehend the exact number of equity shares to be received by it.


Regulations related to downstream investment are a welcome change since indirect foreign investment is another important method through which investments can be made.

However, when considering a deal involving downstream investment, several issues require careful consideration otherwise taking such deal to its logical conclusion may turn out to be an uphill task.

For further information on this topic please contact Sudish Sharma or Sonali Srivastava at Lakshmikumaran & Sridharan by telephone (+91 11 4129 98000) or email ([email protected] or s[email protected]). The Lakshmikumaran & Sridharan website can be accessed at