FDI in India: rules, routes and compliance for startups
Authored by - Souvik Das, Executive at Outsource360 The wire lands on a Thursday. Two million dollars from a Singapore fund, into a Bengaluru SaaS company's account, against a term sheet signed six weeks earlier. The founders update the investor deck, hire four engineers, and get on with building.
Fourteen months later a Series A lead's counsel sends the FEMA diligence list, and four things surface in a single afternoon.
The FC-GPR was filed on day forty-seven. The rule allows thirty. Nobody noticed, because the person who filed it treated the deadline as running from the date the money arrived rather than the date the shares were allotted, and the portal accepted the form anyway.
The Foreign Liabilities and Assets return has never been filed. Not once. The finance lead had read that it applies to companies with foreign investment and concluded, reasonably enough, that it was something the auditor handles at year end. It is not. It is a separate annual return to the Reserve Bank of India, due on 15 July, and the company has now missed two of them.
The Singapore fund has a limited partner registered in Hong Kong. Nobody mapped it, because nobody was asked to, and because two years ago the question would have been binary and close to unanswerable rather than proportionate and answerable. Since March 2026 it is a percentage question with a threshold and a reporting form attached.
And the shares were issued at a price the board lifted from the previous round's cap table, on advice that angel tax had been abolished so valuation no longer mattered. Half of that advice was right. The income-tax ceiling on share premium is gone. The exchange-control floor underneath the price is not, and it never moved.
None of this is exotic. It is the ordinary condition of an Indian startup that raised from a foreign investor without anyone owning the exchange-control file, and it is common enough that FEMA rectification has become a standing line item in Series A legal budgets. The money was always allowed. India permits foreign investment in a software company at one hundred per cent, with no approval, no cap and no conditions attached. What the law asks for in return is a set of filings on four different clocks, a price that clears a statutory floor, and an honest answer about who ultimately owns the investor.
Startups get the first part right and the second part late.
Most foreign direct investment (FDI) into Indian startups is permitted at 100 per cent under the automatic route, meaning no government approval is needed before the money comes in. The compliance sits after the investment rather than before it: Form FC-GPR within 30 days of allotment on the RBI's FIRMS portal, Form FC-TRS within 60 days of a share transfer, the annual Foreign Liabilities and Assets return by 15 July, and a valuation report under rule 21 of the FEM (Non-debt Instruments) Rules, 2019 fixing the floor price. Prior government approval is needed only for restricted and capped sectors and, under Press Note 2 of 2026, where a beneficial owner from a land-bordering country crosses the 10 per cent threshold or holds control.
That is the shape of it. What follows is which route applies to what, the caps a startup will actually collide with, how the land-border test changed in March 2026, why the price is a floor rather than a target, the four filings and their four clocks, and the order to fix an existing mess in.
On this page
The two routes, and why almost every startup is on the automatic one
The sectoral caps a startup will actually collide with
Press Note 2 of 2026 turned the land-border question into a percentage
The price is a floor, and abolishing angel tax did not remove it
Four filings, four different clocks
Downstream investment: the rule that catches startups on their second entity
Company or LLP, and what the choice costs later
Where the FDI file meets the rest of the compliance stack
What it costs to get this wrong
Two boundaries first. This article is about foreign investment into an Indian company that already exists: the route, the price, the filings and the reporting. Choosing and incorporating the entity in the first place is a different exercise, covered in company registration in India for foreign founders. The corporate mechanics of the round itself, from board resolutions to the shareholders agreement, sit in the startup funding rounds compliance checklist. This piece is the exchange-control layer running underneath both.
The two routes, and why almost every startup is on the automatic one
India's foreign investment regime has one statute, one set of rules, and one policy document sitting on top of them. The Foreign Exchange Management Act, 1999 is the statute. The Foreign Exchange Management (Non-debt Instruments) Rules, 2019, universally called the NDI Rules, are where the operative law lives. The Consolidated FDI Policy issued by the Department for Promotion of Industry and Internal Trade states the policy, and DPIIT press notes amend it between consolidations.
When those two diverge, the NDI Rules govern. A press note announces a change; it takes legal effect when the Ministry of Finance notifies a corresponding amendment to the NDI Rules. That gap has run to weeks or months during 2026, and it matters more than it sounds, as the land-border section below shows.
Everything else is a question of which of two doors the money comes through.
What the automatic route actually means
Under the automatic route, a foreign investor puts money into an Indian company without asking anyone first. No application, no approval, no waiting period. More than ninety per cent of India's FDI equity inflow comes through this door, and inflows for FY 2025-26 reached roughly US$58.85 billion, up about eighteen per cent on the year before.
Here's what founders consistently misread. Automatic does not mean unregulated. It means permission is granted in advance by the rules themselves, on conditions, and those conditions get checked afterwards through reporting rather than beforehand through approval. Miss the reporting and the investment doesn't become invalid, but it does become a contravention, which is a different and more expensive problem.
For a startup building software, running a services business, doing business-to-business commerce, manufacturing something, or operating in almost any sector a founder is likely to pick, the automatic route applies at one hundred per cent with no sectoral cap and no performance conditions.
When the government route is triggered
The government route, often called the approval route, requires clearance before the investment. Applications go through the Foreign Investment Facilitation Portal, which routes the file to the administrative ministry for the relevant sector. Timelines aren't statutory and vary widely by sector and by how complete the first submission is.
Four things pull an investment onto this route. The sector is capped and the proposed investment exceeds the automatic-route slice of that cap. The sector requires approval regardless of size, as multi-brand retail and digital media do. The investment triggers the land-border test discussed below. Or the target sits in a prohibited sector, in which case the approval route isn't an alternative at all, because there is nothing available to approve.
One recent change is worth knowing if you manufacture. DPIIT introduced a sixty-day processing commitment in March 2026 for proposals in specified manufacturing areas, including capital goods, electronic components, and polysilicon and ingot-wafer production, where the applicant keeps majority shareholding and control with resident Indian citizens. That's the first hard timeline the approval route has carried, and it doesn't extend to other sectors.
Which instruments count as FDI, and which do not
FDI means investment in "equity instruments" as the NDI Rules define that term, and the definition is narrower than most founders assume. It covers equity shares, fully and mandatorily convertible preference shares, fully and mandatorily convertible debentures, and share warrants.
The word doing the work is "mandatorily". A preference share converting at the investor's option is not an equity instrument under the NDI Rules. It is debt, and it falls under the external commercial borrowing framework instead, with its own eligibility, pricing and end-use restrictions. Optionally convertible instruments are a recurring source of accidental contravention in early rounds, because the term-sheet language a US or Singapore investor's counsel drafts by reflex often contemplates optional conversion.
Two carve-outs matter to startups in particular.
Convertible notes are available, but only on conditions. A DPIIT-recognised startup can issue a convertible note to a non-resident where the amount is at least Rs 25 lakh in a single tranche, the note converts into equity or is repaid within ten years, and the startup operates in a sector where one hundred per cent FDI is permitted under the automatic route with no performance conditions attached. Reporting is by Form CN within thirty days of issue. Let the DPIIT recognition lapse and the note becomes a contravention rather than an instrument, which is one practical reason to keep DPIIT Startup India registration current even after the tax benefits have been claimed.
Employee stock options granted to a non-resident employee are permitted, count within the sectoral cap, and are reported on Form ESOP. Founders who relocated abroad and kept their options routinely forget this one.
The sectoral caps a startup will actually collide with
Most cap tables published online run to forty rows and go stale within a quarter. The list below is deliberately shorter: the sectors a startup or a growth-stage company in India is realistically going to sit in or drift into, with the position as at the date at the top of this article.
Check any figure that decides a deal against the current Consolidated FDI Policy and the NDI Rules as amended, because caps move by notification and several moved during 2026.
Sector or activity | Cap | Route |
Software, IT services, SaaS, most professional and B2B services | 100% | Automatic |
Manufacturing (other than defence, tobacco and other listed exceptions) | 100% | Automatic |
B2B e-commerce and the marketplace model | 100% | Automatic |
Inventory-based e-commerce selling to Indian consumers | Prohibited | - |
Insurance companies and insurance intermediaries (excluding LIC) | 100% | Automatic, subject to IRDAI |
Telecom services | 100% | Automatic |
Single-brand retail trading | 100% | Automatic |
Multi-brand retail trading | 51% | Government |
Pharmaceuticals, greenfield | 100% | Automatic |
Pharmaceuticals, brownfield | 100% | Automatic to 74%, government beyond |
Private-sector banking | 74% | Automatic to 49%, government beyond |
Defence manufacturing | 100% | Automatic to 74%, government beyond |
Satellite manufacturing and operation, ground and user segment | 100% | Automatic to 74%, government beyond |
Launch vehicles, associated systems and spaceports | 100% | Automatic to 49%, government beyond |
100% | Automatic | |
Digital media streaming news and current affairs | 26% | Government |
Print media publishing news and current affairs | 26% | Government |
Two entries there are new enough that most advice written before mid-2026 has them wrong.
Insurance went to one hundred per cent under the automatic route by a Ministry of Finance notification dated 2 May 2026, amending the insurance entry in Schedule I of the NDI Rules. The previous cap was seventy-four per cent. Intermediaries, meaning brokers, third-party administrators and surveyors, are covered at one hundred per cent as well. The Life Insurance Corporation stays capped at twenty per cent. Everything remains subject to approval and verification by the Insurance Regulatory and Development Authority of India, so the exchange-control door opening does not mean the sectoral regulator's door has.
And the space sector caps date from the February 2024 amendment, which split what had been a single restrictive entry into three bands. Component manufacturing is the fully open one, at one hundred per cent automatic. A satellite operator is not.
The sectors where FDI is prohibited outright
Nine activities take no foreign investment at all, by either route: lottery business, whether government or private and including online lotteries; gambling and betting, including casinos; chit funds; Nidhi companies; trading in transferable development rights; real estate business and construction of farm houses; manufacturing of cigars, cheroots, cigarettes and other tobacco substitutes; atomic energy; and railway operations, other than the permitted areas of railway infrastructure.
Real estate business is the entry that misleads people. It does not mean the sector is closed. Construction-development projects, townships, roads, bridges and Real Estate Investment Trusts registered with the Securities and Exchange Board of India all sit outside the prohibition and take foreign investment. What is barred is dealing in land and buildings as a trading activity, and earning rent from them, which is a much narrower thing than "property".
Franchise, trademark, licensing and management-fee arrangements in a prohibited activity are barred too. A gaming company cannot get around the gambling prohibition by taking foreign money into an Indian entity that licenses its brand to the operator.
The e-commerce trap, and the July 2026 export carve-out
The e-commerce rule is the one that catches consumer startups, and it isn't really a cap. It's a business-model rule.
A foreign-funded e-commerce entity may run a marketplace, connecting buyers with independent sellers and taking a fee, at one hundred per cent under the automatic route. It may not own the inventory it sells. The moment the platform holds title to goods and sells them to Indian consumers, it is an inventory-based B2C model, and FDI in that model is prohibited, because permitting it would open multi-brand retail through the back door. The related conditions matter as much as the headline: a marketplace can't control the price of goods sold on it, and no single vendor group may account for more than a defined share of platform sales.
That held for a decade. It changed in one direction in July 2026.
Press Note 3 of 2026, issued 23 July 2026 and operationalised by a Directorate General of Foreign Trade notification dated 5 August 2026, permits FDI in inventory-based e-commerce where the goods are manufactured or produced in India and held exclusively for export. The conditions are tight. The activity has to run through a separately incorporated Exporter-on-Record entity registered with the DGFT, not through an existing marketplace entity. Goods are procured against a confirmed export order from a buyer outside India. Export stock is identified, segregated and tracked in a digital repository. Domestic sellers are paid within seven days of acceptance. And returned or rejected consignments can't be sold into the Indian market, with the Exporter-on-Record carrying the reverse-logistics cost.
Fair warning on the naming. Press Note 3 of 2026 is about e-commerce exports. Press Note 3 of 2020 is the land-border restriction that most of the internet still calls "PN3". They are unrelated instruments with almost the same name, and the confusion is now showing up in professional advice.
Press Note 2 of 2026 turned the land-border question into a percentage
If one thing on this page is worth reading twice for a startup raising from a fund with a global limited-partner base, it is this section.
What Press Note 3 of 2020 did
In April 2020, with valuations depressed by the pandemic, DPIIT issued Press Note 3 to stop opportunistic acquisitions of Indian companies. It required prior government approval for any investment by an entity of a country sharing a land border with India, or where the beneficial owner of the investment was situated in or was a citizen of such a country. India's land neighbours are China, Pakistan, Bangladesh, Nepal, Bhutan, Myanmar and Afghanistan.
The instrument had two features that made it hard to live with. It applied to any investment, of any size, with no de minimis threshold. And "beneficial owner" wasn't defined in the press note, so the safe reading was the widest one: trace ownership all the way up, and if any thread reached a land-border country, apply for approval.
For an Indian startup this rarely showed up as a Chinese investor writing a cheque. It showed up as a Delaware or Cayman fund with one Asian limited partner, and counsel unable to say with confidence that approval wasn't required. Approvals ran long. Some rounds were restructured. Some quietly didn't close.
The 10 per cent beneficial-ownership test
The Union Cabinet approved a recalibration on 10 March 2026, and DPIIT issued Press Note 2 of the 2026 series on 15 March 2026, inserting a new paragraph 3.1.1(d) into the Consolidated FDI Policy. The Ministry of Finance had already overhauled rule 6(a) of the NDI Rules by a notification dated 1 May 2026.
Three changes came together.
Beneficial ownership now has a definition, borrowed from the Prevention of Money-laundering Act, 2002 framework and the rules under it, which set thresholds of ten or fifteen per cent of shares, capital or profits depending on the type of investing entity. That replaces the open-ended trace with a defined test.
The test is applied at the level of the investing entity, rather than chased indefinitely upstream. This is the practical relief. A fund's own ownership is the thing being measured.
And where a land-border beneficial owner stays below the threshold and does not hold control, the investment proceeds under the automatic route, subject to a reporting requirement in a format to be prescribed by a DPIIT standard operating procedure, and subject as always to the sectoral cap and entry route that would otherwise apply.
Control is the part that no percentage saves you from. Approval remains required where the land-border beneficial ownership crosses the threshold, or enables control over the investing entity, or enables ultimate effective control over the Indian investee company. Control here isn't only shareholding. Veto rights, board nomination rights, affirmative-vote lists and contractual arrangements can all establish it, which is exactly why a minority stake with a heavy reserved-matters schedule can fail a test that a larger passive stake would pass.
Early signs are that the relaxation is working as intended. Roughly Rs 4,896 crore of investment across twenty-nine projects had come through under the eased framework by August 2026.
Why this is a diligence question about your investor's investors
Two operational points for founders, both easy to get wrong.
The first is timing. A press note amends policy; the NDI Rules amendment gives it legal effect, and the standard operating procedure prescribing the reporting format has to exist before the reporting can be done in the prescribed way. Where the paperwork is still catching up with the policy, the safe course is to document the beneficial-ownership analysis contemporaneously and file the reporting the moment the format is published, rather than to treat the announcement as though it were self-executing.
The second is that this is now a term-sheet question. The information you need sits with the investor, not with you, and the time to ask is before signing rather than during Series A diligence eighteen months later. A short representation from the fund on land-border beneficial ownership as a percentage, plus confirmation that no land-border person holds control over the fund, converts an unanswerable question into a documented one. Ask for it in writing. Keep it with the round file.
The price is a floor, and abolishing angel tax did not remove it
Here is the misconception that cost the company in the opening scenario the most.
Rule 21 of the NDI Rules sets the pricing guidelines, and they run in one direction. Where equity instruments are issued to a person resident outside India, or transferred from a resident to a non-resident, the price cannot be lower than the fair value. Where instruments move the other way, from a non-resident to a resident, the price cannot be higher than fair value.
The logic is consistent once you see it: the rule always operates so that foreign exchange isn't shortchanged coming in and value isn't over-extracted going out.
Fair value has to be worked out using an internationally accepted pricing methodology on an arm's length basis, certified by a chartered accountant, a SEBI-registered Category I merchant banker, or a practising cost accountant. For an unlisted company, the valuation report has to be dated within ninety days of the allotment. A report commissioned for a term sheet in March and used for an allotment in August has expired, and this is one of the most common diligence findings on an otherwise clean round.
Now the part that has changed.
Section 56(2)(viib) of the Income-tax Act, 1961, the provision everyone called angel tax, taxed the excess of the issue price over fair market value in the hands of the issuing company. The Finance (No. 2) Act, 2024 made it inapplicable to shares issued on or after 1 April 2025, for every class of investor, resident and non-resident alike. The Income-tax Act, 2025 does not carry it forward.
So the tax ceiling above the price is gone. The exchange-control floor beneath it is not.
That asymmetry is the whole point. Under the old regime a startup was squeezed between two valuations: FEMA said don't price below fair value, income tax said don't price above fair market value, and the two used different methodologies. Founders spent real money reconciling them. Removing angel tax removed the upper constraint, and a premium valuation now raises no income-tax charge under the old provision. It did nothing to the lower one. Issuing shares to a foreign investor below the rule 21 fair value remains a FEMA contravention, and the advice that "valuation doesn't matter any more" is the single most dangerous half-truth circulating in Indian startup finance right now.
There's a related trap on the way out. A foreign investor exiting cannot be assured a fixed return. Any exit at an assured price, or with a guaranteed buyback at a predetermined amount, converts what was equity into debt in substance, and the NDI Rules do not permit it. Put options in a shareholders agreement have to be drafted so the exit price is the fair value at the time of exercise, not a number fixed at entry.
Four filings, four different clocks
The reporting is where startups actually fail, and the reason is mundane: the four filings have four different trigger events and four different deadlines, and no single one of them is anybody's full-time job.
All of the transaction-based forms go through the Single Master Form on the Reserve Bank of India's FIRMS portal.
Filing | Triggered by | Deadline |
Form FC-GPR | Issue of equity instruments to a person resident outside India | 30 days from the date of allotment |
Form FC-TRS | Transfer of equity instruments between a resident and a non-resident | 60 days from transfer or receipt of consideration, whichever is earlier |
Form CN | Issue of a convertible note by a DPIIT-recognised startup | 30 days from issue |
Form DI | Downstream investment by a foreign-owned or controlled company | 30 days from allotment in the downstream entity |
Form ESOP | Grant of employee stock options to a non-resident | 30 days from grant |
Form LLP-I | Capital contribution to an LLP by a non-resident | 30 days from receipt |
FLA return | Any outstanding foreign liability or asset as at 31 March | 15 July each year, on the FLAIR portal |
Three details on that table are worth pulling out, because each of them is a live failure mode.
The FC-GPR clock starts at allotment, not at receipt of funds. Money can sit in a company's account as share application money for weeks before the board allots, and the thirty days run from the board's act. Startups get this backwards in both directions, filing too early against money not yet allotted, or assuming the clock started when the wire cleared.
The FLA return is separate from everything else. It goes to the RBI on the FLAIR portal, it captures the position as at 31 March, and it is due on 15 July regardless of whether the accounts have been audited. Provisional figures are accepted by the deadline, with a revised return carrying audited figures due by 30 September. The deadline for FY 2025-26 was extended to 31 July 2026, but an extension in one year is not a pattern to plan around. Any entity that has received FDI or made overseas investment in any year, and still has an outstanding balance on 31 March, files. That includes a company whose foreign investor exited years ago if a foreign liability remains on the balance sheet.
And late filing has a defined price rather than an open-ended risk. The Late Submission Fee for a delayed FEMA filing is calculated as Rs 7,500 plus 0.025 per cent of the amount involved, multiplied by the number of years of delay, under the RBI's revised framework. The route stays available for up to three years from the due date. Past that, the LSF window closes and the matter moves to compounding, which is slower, costlier and disclosable.
Getting this right is mostly a calendar problem rather than a legal one, and it sits naturally alongside the rest of the annual filing stack in the annual ROC compliance calendar. Companies that keep the exchange-control calendar with their outsourced finance function, whether that's a virtual CFO or a retained compliance team, tend not to miss these. Companies that leave it with whoever is least busy tend to.
Downstream investment: the rule that catches startups on their second entity
This one arrives about eighteen months after the first foreign round, and almost nobody sees it coming.
Once a foreign investor holds more than fifty per cent of an Indian company's equity, or holds the right to appoint a majority of its directors or otherwise control its policy decisions, the company becomes a foreign-owned or controlled company. The consequence is that when that company invests in another Indian company, the investment is indirect foreign investment, and it carries the entire FDI framework with it.
Concretely: your subsidiary's sector cap applies, your subsidiary's entry route applies, and the rule 21 pricing guidelines apply to the price at which the subsidiary issues shares to you. A parent putting money into its own wholly-owned Indian subsidiary has to obtain a valuation and respect a floor, which strikes most founders as absurd the first time they hear it, and is nonetheless the rule.
Reporting is by Form DI within thirty days of allotment in the downstream entity, and it is filed by the investee company, not the parent.
Three fact patterns produce this in practice. A startup that raised heavily from one foreign fund and crossed fifty per cent without registering the change in status. A group that incorporated a second entity to hold a new product line or to ring-fence a regulated activity. And an acquisition, where a foreign-owned Indian company buys a domestic competitor and treats it as a domestic transaction, which it no longer is.
Worth noting that the test is ownership or control, not ownership alone. A company where foreign investors hold forty-two per cent but can appoint a majority of the board is foreign-controlled, with all the downstream consequences, and the cap table alone won't tell you.
Company or LLP, and what the choice costs later
Startups that expect foreign capital sometimes ask whether an LLP is simpler. On formation and annual filings it is. On foreign investment it is materially more restrictive, and the restriction is structural rather than procedural.
Foreign investment into an LLP is permitted under the automatic route only where the LLP operates in a sector in which one hundred per cent FDI is allowed under the automatic route and there are no FDI-linked performance conditions attached to that sector. A great many sectors satisfy that, including software and most services. But an LLP cannot issue convertible instruments, because it has no share capital to convert into. That rules out the entire preference-share and convertible-note toolkit that venture rounds are built on.
An LLP also can't grant options over equity in the way a company grants ESOPs, which becomes a hiring constraint well before it becomes a fundraising one.
The practical consequence is that an LLP works for a foreign-owned services or consulting operation drawing capital from its parent, and works badly for anything intending to raise institutional venture capital. Converting an LLP to a company later is possible and routinely done, but it is a transaction with its own tax and stamp-duty consequences, and it is far cheaper to start in the right structure. The trade-offs across the three common forms are set out in private limited versus LLP versus OPC.
Capital contributions from a non-resident into an LLP are reported on Form LLP-I within thirty days of receipt, and disinvestment on Form LLP-II.
Where the FDI file meets the rest of the compliance stack
The FEMA diligence request never arrives alone. It arrives as one tab of a spreadsheet, and the tabs on either side of it are the ones that determine how long the round takes.
This is the part founders underestimate. A foreign investor's counsel is not testing whether the company is a good business. They're testing whether the equity being bought is clean, and cleanliness is a property of the whole documentation stack, not of the share register.
Employment contracts and HR compliance are the tab that most often adds weeks. Since the four labour codes came into force in November 2025 and the central rules were notified on 8 May 2026, a written appointment letter in the prescribed format is a statutory obligation owed to every employee before they start work, not a courtesy for senior hires. Foreign investors read that list closely, because reclassification exposure and missing appointment letters are quantifiable liabilities that land on a closing balance sheet. The full picture is in employment contracts and HR compliance for Indian startups.
Intellectual property assignment sits next to it, and for a foreign investor it is often the first question rather than a later one. Under section 17 of the Copyright Act, 1957 an employer is first owner of what an employee creates in the course of employment, and the default runs the other way for contractors. A company whose product was built substantially by contractors without written IP assignments is selling equity in something it does not entirely own. Trademarks follow the same logic, which is why trademark registration tends to be pulled forward when foreign money is involved.
The employee-versus-contractor classification question is a third. It is an employment issue, a tax-withholding issue and an IP-ownership issue simultaneously, and a long-tenured "consultant" with a company laptop, a manager and a standup slot is a finding in all three.
Then the statutory basics: ROC filings current, GST registration in place where turnover or supply type requires it, tax returns filed, and the first-year obligations in the statutory compliance checklist for founders actually met rather than deferred. Where the company processes personal data at any scale, the Digital Personal Data Protection Act, 2023 position gets asked about too.
None of these are FDI rules. All of them are read during FDI due diligence, and a company that has treated compliance as a series of separate annual chores rather than a single maintained file will spend the difference in legal fees at the worst possible moment.
What it costs to get this wrong
Exchange-control failures have an unusual shape. They rarely stop a transaction, and they rarely produce the maximum penalty. What they do is convert a closing into a negotiation, and they price into the deal in ways that don't appear on any penalty schedule.
Failure | Where liability comes from | Shape of the exposure |
FC-GPR or FC-TRS filed late | Reporting requirement under the NDI Rules | Late Submission Fee of Rs 7,500 plus 0.025% of the amount per year of delay, available for up to three years |
Filing missed beyond the LSF window | Section 13, FEMA, 1999 | Compounding through the RBI, or adjudication with penalty up to three times the amount involved |
FLA return never filed | Annual return requirement under FEMA | A contravention for each year missed; commonly regularised through compounding |
Shares issued below the rule 21 floor price | Pricing guidelines, NDI Rules | Contravention of the amount of the shortfall; typically remedied by refund of the difference plus compounding |
Valuation report older than 90 days at allotment | Pricing guidelines, NDI Rules | A diligence finding that forces a fresh valuation and, where the number moved, a price adjustment |
Land-border approval not obtained where required | Rule 6(a), NDI Rules and Consolidated FDI Policy | The most serious category: the investment itself was not permitted, and unwinding may be the only route |
Downstream investment unreported | Rule 23 and Form DI reporting | Contravention at the investee level, often compounded across several years at once |
Optionally convertible instrument treated as FDI | Definition of equity instruments, NDI Rules | Recharacterised as borrowing; tested against the ECB framework, which it usually fails |
Compounding deserves a word, because founders hear the term and assume the worst. It's a settlement mechanism, not a prosecution. An application goes to the RBI, currently through the PRAVAAH portal, with a fee of Rs 10,000 plus GST, and the RBI is required to dispose of it within one hundred and eighty days of receipt. Once the compounding amount is paid, section 15(2) of FEMA provides that no proceeding may be initiated or continued in respect of the compounded contravention. That finality is the point. A compounded contravention is closed, disclosable and quantified, which is a far better thing to hand an investor than an open one.
The real cost is usually elsewhere. It is the six to eleven weeks a rectification adds to a round, the indemnity that stays in the share purchase agreement, and the escrow that doesn't release for eighteen months.
The order to fix this in
If you've read this far and recognised your own company, the sequence below is the one that produces the least expensive outcome. It is deliberately ordered: each step tells you whether the next one matters.
Build the register first. Every foreign investment the company has ever received, with the date of receipt, the date of allotment, the instrument, the amount, the investor and the jurisdiction. Most startups don't have this in one place, and everything downstream depends on it.
Check the sector and the route for each entry, as they stood on the date of that investment rather than today. Caps move, and an investment is tested against the position at the time.
Reconcile every entry against the filings actually made. Pull the FIRMS records. Compare allotment dates against filing dates, not against receipt dates.
Run the land-border analysis on every non-resident investor on the register, applying the threshold and control tests at the level of the investing entity. Document the conclusion in writing, with the source of the ownership information, and date it.
Pull the valuation reports and check each one against its allotment date for the ninety-day window, and each price against the floor. This is where price adjustments surface, and they get worse the longer they sit.
Check whether the company has become foreign-owned or controlled, on ownership or on control, and whether it has made any downstream investment since that happened.
Confirm the FLA position for every year since the first foreign investment landed, including any year in which a foreign liability remained outstanding after the investor had exited.
Quantify what is late, calculate the Late Submission Fee where the three-year window is still open, and file. LSF is cheaper, faster and less disclosable than compounding. Nothing is gained by waiting.
For anything outside the LSF window or outside its scope, prepare the compounding application. Do it before diligence starts rather than during it, because a compounded contravention is a closed item and a pending one is a negotiating lever in the investor's hand.
Put the calendar somewhere it will survive staff turnover. FC-GPR at allotment, FC-TRS at transfer, FLA every July, valuation refreshed inside ninety days of any allotment. This is the step that stops the whole exercise repeating in two years.
Steps one through seven are diagnostic and can be done internally in a week by someone with access to the records. Steps eight and nine are where professional help earns its fee, because the calculation, the drafting and the RBI correspondence all reward having done it before.
Frequently asked questions
Does a startup need government approval to take foreign investment?
Usually not. Most sectors a startup operates in, including software, IT services, professional services, B2B commerce and most manufacturing, permit one hundred per cent FDI under the automatic route with no prior approval. Approval is required only where the sector is capped or restricted, where the sector is prohibited, or where the land-border beneficial-ownership test under Press Note 2 of 2026 is triggered.
What is the difference between the automatic route and the government route?
The automatic route grants permission in advance through the rules themselves, subject to conditions checked afterwards through reporting. The government route requires an application through the Foreign Investment Facilitation Portal and clearance from the relevant administrative ministry before the investment is made. More than ninety per cent of India's FDI inflow comes through the automatic route.
How long do we have to file FC-GPR?
Thirty days from the date of allotment of the equity instruments, filed through the Single Master Form on the RBI's FIRMS portal. The clock runs from allotment, not from the date the funds were received, which is the single most common error on this filing.
What happens if we miss an FDI filing deadline?
For up to three years past the due date, the filing can be regularised by paying a Late Submission Fee, calculated as Rs 7,500 plus 0.025 per cent of the amount involved multiplied by the years of delay. Beyond that window, the contravention has to be compounded with the RBI, and unresolved contraventions can be adjudicated with a penalty of up to three times the amount involved under section 13 of FEMA, 1999.
Who has to file the FLA return, and when?
Any Indian company, LLP, registered partnership, SEBI-registered alternative investment fund or public-private partnership that has received foreign direct investment or made overseas investment in any year and still has an outstanding foreign liability or asset as at 31 March. It is filed on the RBI's FLAIR portal by 15 July, with provisional figures if the accounts are not yet audited, and a revised return with audited figures by 30 September.
Can a foreign investor buy shares at any price they agree with us?
No. Rule 21 of the NDI Rules sets fair value as a floor for an issue or a transfer to a non-resident, and as a ceiling for a transfer from a non-resident to a resident. Fair value has to be certified by a chartered accountant, a SEBI-registered Category I merchant banker or a practising cost accountant, using an internationally accepted methodology, and for an unlisted company the report must be dated within ninety days of the allotment.
Angel tax was abolished. Does valuation still matter for foreign investment?
Yes, and this is a common and expensive misunderstanding. The abolition of section 56(2)(viib) removed the income-tax charge on share premium above fair market value with effect from 1 April 2025, and the Income-tax Act, 2025 does not carry the provision forward. It has no effect on the FEMA pricing guidelines, which set a floor below the price rather than a ceiling above it. Issuing shares to a foreign investor below rule 21 fair value is still a contravention.
Our investor is a US fund with an Asian limited partner. Do we need approval?
That depends on the percentage and on control, and since Press Note 2 of 2026 it is an answerable question. Where a beneficial owner from a land-bordering country holds below the prescribed threshold in the investing entity and holds no control over that entity or ultimate effective control over your company, the investment can proceed under the automatic route with reporting. Above the threshold, or where control exists, prior government approval is still required. Ask the fund for a written representation at term-sheet stage.
Can our startup issue convertible notes to a foreign investor?
Only if the startup holds current DPIIT recognition, the note is for at least Rs 25 lakh in a single tranche, it converts into equity or is repaid within ten years, and the sector permits one hundred per cent FDI under the automatic route without performance conditions. Form CN is filed within thirty days of issue. If the DPIIT recognition has lapsed, the instrument is a FEMA contravention.
Is FDI allowed in an LLP?
Yes, under the automatic route, but only where the LLP is in a sector permitting one hundred per cent FDI automatically with no FDI-linked performance conditions. An LLP cannot issue convertible preference shares, convertible debentures or convertible notes, and cannot grant ESOPs over equity, which makes it a poor fit for a company intending to raise institutional venture capital. Contributions are reported on Form LLP-I within thirty days.
Our foreign investor now holds 55 per cent. Does anything change?
Yes. The company is now a foreign-owned or controlled company, and any investment it makes into another Indian company is indirect foreign investment carrying the full FDI framework, including the sectoral cap and entry route of the downstream company and the rule 21 pricing guidelines. Downstream investments are reported on Form DI within thirty days by the investee company. The same status can arise below fifty per cent where foreign investors hold control through board or veto rights.
Can we promise a foreign investor a fixed return on exit?
No. An assured return or a guaranteed buyback at a predetermined price makes the instrument debt in substance, which the NDI Rules do not permit for an equity instrument. Put options are permitted where the exit price is the fair value determined at the time of exercise, and drafting them as a fixed multiple or a fixed internal rate of return is the drafting error that gets caught.
Which sectors are completely closed to FDI?
Nine: lottery business, gambling and betting including casinos, chit funds, Nidhi companies, trading in transferable development rights, real estate business and construction of farm houses, manufacture of cigars and cigarettes and other tobacco substitutes, atomic energy, and railway operations other than the permitted infrastructure areas. The prohibition extends to franchise, licensing, trademark and management arrangements in these activities.
Can a foreign-funded e-commerce company hold its own inventory?
Not for sale to Indian consumers. That is the inventory-based B2C model and FDI in it is prohibited. Foreign-funded platforms may operate as marketplaces at one hundred per cent under the automatic route without owning the goods sold. Since Press Note 3 of 2026, dated 23 July 2026, FDI is permitted in inventory-based e-commerce for exports of India-manufactured goods, through a separately incorporated Exporter-on-Record entity registered with the DGFT, against confirmed export orders, with returned stock barred from the domestic market.
How much FDI does India actually receive?
FDI equity inflows for the financial year 2025-26 were approximately US$58.85 billion, an increase of about eighteen per cent over the previous year, on DPIIT figures. More than ninety per cent of it comes through the automatic route.
What does compounding cost and how long does it take?
The application fee is Rs 10,000 plus GST, filed with the RBI through the PRAVAAH portal. The RBI is required to dispose of an application within one hundred and eighty days of receipt. The compounding amount itself depends on the nature and duration of the contravention. Once paid, section 15(2) of FEMA closes the matter and no further proceedings may be initiated or continued on it.
Does insurance really allow 100 per cent FDI now?
Yes, for insurance companies and insurance intermediaries other than the Life Insurance Corporation, under the automatic route, following the Ministry of Finance notification of 2 May 2026 amending Schedule I of the NDI Rules. The previous cap was seventy-four per cent. LIC remains at twenty per cent. Every investment is still subject to approval and verification by the Insurance Regulatory and Development Authority of India, so exchange-control clearance is not the same as regulatory clearance.
References
Foreign Exchange Management Act, 1999, sections 13 and 15, penalties for contravention and finality of compounding, indiacode.nic.in.
Foreign Exchange Management (Non-debt Instruments) Rules, 2019, including rule 6(a) on investments involving land-bordering countries, rule 21 on pricing guidelines, rule 23 on downstream investment, and Schedule I on sectoral caps and entry routes, Ministry of Finance, dea.gov.in.
Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2026, notification dated 1 May 2026, revising rule 6(a) and aligning the beneficial-ownership test with the Prevention of Money-laundering framework.
Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2026, notification dated 2 May 2026, revising the insurance entry in Schedule I to permit 100 per cent foreign investment in insurance companies and intermediaries under the automatic route, with the Life Insurance Corporation retained at 20 per cent.
Foreign Exchange Management (Non-debt Instruments) (Third Amendment) Rules, 2026, notified 12 June 2026, extending Schedule III to all individual persons resident outside India.
Department for Promotion of Industry and Internal Trade, Press Note No. 2 (2026 Series), issued 15 March 2026, inserting paragraph 3.1.1(d) of the Consolidated FDI Policy on investments involving beneficial owners from land-bordering countries, following Cabinet approval of 10 March 2026, dpiit.gov.in.
Department for Promotion of Industry and Internal Trade, Press Note No. 3 (2020 Series), issued 17 April 2020, requiring government approval for investments from entities of countries sharing a land border with India.
Department for Promotion of Industry and Internal Trade, Press Note No. 3 (2026 Series), issued 23 July 2026, permitting FDI in inventory-based e-commerce for export of India-manufactured goods, operationalised by Directorate General of Foreign Trade Notification No. 27/2026-27 dated 5 August 2026, dgft.gov.in.
Department for Promotion of Industry and Internal Trade, amendment to the FDI policy on the space sector approved February 2024, setting 74 per cent automatic for satellite manufacturing and operation, 49 per cent automatic for launch vehicles and spaceports, and 100 per cent automatic for components and sub-systems.
Department for Promotion of Industry and Internal Trade, FDI factsheets and equity inflow data for FY 2025-26, dpiit.gov.in.
Reserve Bank of India, Single Master Form and FIRMS portal reporting requirements for Forms FC-GPR, FC-TRS, CN, DI, ESOP, LLP-I and LLP-II, firms.rbi.org.in.
Reserve Bank of India, Late Submission Fee framework for delayed reporting under FEMA, as revised with effect from 2026, computed as Rs 7,500 plus 0.025 per cent of the amount involved per year of delay and available for up to three years.
Reserve Bank of India, annual return on Foreign Liabilities and Assets, due 15 July for the position as at 31 March, with revised audited return by 30 September, filed on the FLAIR portal, rbi.org.in.
Reserve Bank of India, Directions on compounding of contraventions under FEMA, 1999, application through the PRAVAAH portal with a fee of Rs 10,000 plus GST and disposal within 180 days of receipt.
Finance (No. 2) Act, 2024, rendering section 56(2)(viib) of the Income-tax Act, 1961 inapplicable to shares issued on or after 1 April 2025, and the Income-tax Act, 2025 (Act No. 30 of 2025), which does not carry the provision forward, incometaxindia.gov.in.
Copyright Act, 1957, section 17 on first ownership of work made in the course of employment, copyright.gov.in.
Disclaimer
This article is for educational and general business information purposes only and does not constitute professional legal, financial, or tax advice. It states the Indian foreign exchange and FDI position as it stood on the date above. Sectoral caps, entry routes, reporting formats, fee formulas and thresholds change by notification, press note and amendment, sometimes several times in a year, and several of the instruments described here were notified during 2026. Two points are flagged as unsettled at the date of writing and are treated as such in the text: the standard operating procedure prescribing the reporting format for sub-threshold land-border investments under Press Note 2 of 2026, which should be checked in its published form before any reporting is attempted; and the extent to which each press note discussed has been given effect through a corresponding amendment to the NDI Rules, which governs when a policy change becomes legally operative. Any figure, cap, route, form or deadline that decides a transaction should be verified against the Consolidated FDI Policy and the NDI Rules as currently amended. Consult a qualified lawyer or chartered accountant before acting on anything set out here.
Comments