Rule 2 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Rule 2 of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 sets out when an investment by a person resident outside India is foreign direct investment and when it is foreign portfolio investment, what counts as "foreign investment" for the cap, what a "listed Indian company" is, and how the "sectoral cap" is measured. These meanings decide which Schedule applies and whether a cap is breached.
This article is based on the Rules as notified on 17 October 2019 (S.O. 3732(E)) as amended by the notifications named in this article; the latest amendment consulted is S.O. 4870(E) dated 2 September 2026. Amendments made after that date should be checked in the Gazette. No official consolidated text exists, so the clauses below were read from the 2019 notification with each amendment applied. If a live shareholding needs classifying, our FEMA advisory service can do it for you.
FDI is investment through equity instruments by a person resident outside India in an unlisted Indian company, or in ten per cent or more of the post issue paid-up equity capital, on a fully diluted basis, of a listed Indian company. Foreign portfolio investment is investment of less than ten per cent. A holding that was FDI stays FDI if it later falls below ten per cent. The sectoral cap is a composite limit covering direct foreign investment on a repatriation basis and indirect foreign investment, unless provided otherwise.
FDI: rule 2(r)
Rule 2(r) defines "FDI" or "Foreign Direct Investment" as investment through equity instruments by a person resident outside India in an unlisted Indian company; or in ten per cent or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company. Two parts follow:
- Note: if an existing investment by a person resident outside India in equity instruments of a listed Indian company falls to a level below ten per cent of the post issue paid-up equity capital on a fully diluted basis, the investment shall continue to be treated as FDI.
- Explanation: fully diluted basis means the total number of shares that would be outstanding if all possible sources of conversion are exercised.
None of the nineteen amending notifications changes clause (r), clause (t) or clause (m). The Reserve Bank's Master Direction - Foreign Investment in India (updated up to June 15, 2026) repeats the definition in paragraphs 2.8 to 2.8.2.
Foreign portfolio investment and FPI: rules 2(t) and 2(u)
Rule 2(t) defines "foreign portfolio investment" as any investment by a person resident outside India through equity instruments where the investment is less than ten per cent of the post issue paid-up share capital, on a fully diluted basis, of a listed Indian company, or less than ten per cent of the paid-up value of each series of equity instrument of a listed Indian company. Rule 2(u) defines an "FPI" or "Foreign Portfolio Investor" as a person registered under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014. That is the instrument the Rules name; the reader should check the SEBI regulations currently in force. Our guides on foreign portfolio investment in India and the SEBI FPI regulations cover the registration side.
| Holding in a listed Indian company | Classification under rule 2 |
|---|---|
| Less than ten per cent of post issue paid-up share capital (fully diluted), or of each series | Foreign portfolio investment |
| Ten per cent or more of post issue paid-up equity capital (fully diluted) | FDI |
| FDI later falling below ten per cent | Continues to be treated as FDI |
| Any investment in an unlisted Indian company | FDI |
Foreign investment: rule 2(s)
"Foreign investment" is any investment made by a person resident outside India on a repatriable basis in equity instruments of an Indian company or to the capital of an LLP. Two additions apply:
- Explanation: if a declaration is made by a person as per the Companies Act, 2013 about a beneficial interest being held by a person resident outside India, then even though the investment may be made by a resident Indian citizen, it shall be counted as foreign investment. S.O. 1802(E), the Foreign Exchange Management (Non-debt Instruments) (Amendment) Rules, 2022 (12 April 2022), substituted the Explanation so that it reads "as per the provisions of the Companies Act, 2013 or any other applicable law, as the case may be".
- Note: a person resident outside India may hold foreign investment either as FDI or as FPI in any particular Indian company.
The Master Direction restates this in paragraphs 2.11 to 2.11.3 and adds that issue or transfer of a "participating interest or right" in oil fields to a person resident outside India is treated as foreign investment. That wording is also in Explanation 3 to rule 6(a), inserted by S.O. 2174(E) of 1 May 2026; see our article on rule 6.
"Investment" in rule 2(ac) means to subscribe, acquire, hold or transfer any security or unit issued by a person resident in India, and extends to depository receipts issued outside India and, for an LLP, to capital contribution or profit shares. "Investment on repatriation basis" (rule 2(ad)) means one whose sale or maturity proceeds, net of taxes, can be repatriated out of India. For the Act's own meanings of resident and non-resident persons, see section 2 of the FEMA, 1999.
Listed Indian company: rule 2(ag), as substituted in 2024
As notified, rule 2(ag) read: an Indian company which has any of its equity instruments or debt instruments listed on a recognised stock exchange in India. S.O. 332(E), the Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2024 (24 January 2024), substituted the clause. It now reads: an Indian company which has any of its equity instruments or debt instruments listed on a recognised stock exchange in India and on an International Exchange; "unlisted Indian company" is construed accordingly.
The same notification inserted two supporting definitions:
- Rule 2(aaa), "International Exchange": a permitted stock exchange in permissible jurisdictions which are listed at Schedule XI.
- Rule 2(aka), "permissible jurisdiction": a jurisdiction notified by the Central Government under sub-clause (f) of sub-rule (3) of rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005.
These tie the definition to the direct listing scheme explained in our articles on rule 34 and Schedule XI and eligibility, voting rights and pricing.
A caution on reading. Taken word for word, the substituted clause (ag) requires listing in India and on an International Exchange. The Master Direction (updated up to June 15, 2026) prints a shorter form in paragraph 2.21: an Indian company which has any of its equity instruments listed on a recognized stock exchange in India. The two do not match. This article states clause (ag) as the Gazette notification of 24 January 2024 gives it; the reader should confirm the current meaning against the official text before relying on it, because the ten per cent test in rules 2(r) and 2(t) turns on whether a company is listed.
Sectoral cap: rule 2(am), and FDI linked performance conditions: rule 2(m)
"Sectoral cap" means the maximum investment, including both foreign investment on a repatriation basis by persons resident outside India in equity instruments of a company or the capital of an LLP, as the case may be, and indirect foreign investment, unless provided otherwise. This is the composite limit for the Indian investee entity. As notified, the clause read "in equity and debt instruments"; S.O. 4355(E), the Foreign Exchange Management (Non-debt Instruments) (Amendment) Rules, 2019 (5 December 2019), omitted "and debt". Two Explanations stand as notified:
- FCCBs and depository receipts having an underlying in the nature of debt are not included in the sectoral cap.
- Any equity holding by a person resident outside India resulting from conversion of any debt instrument under any arrangement is reckoned under the sectoral cap.
The Master Direction repeats the definition in paragraphs 2.27 to 2.27.2. "FDI linked performance conditions" (rule 2(m)) means the sector specific conditions in Schedule I for companies receiving foreign investment. Caps for particular sectors are in the Table of Schedule I, explained in our article on Schedule I paragraph 3 and the Table articles that follow it.
A worked example
Nordvik Holdings, a company incorporated abroad, buys 8 per cent of the post issue paid-up equity capital of Lakshya Components Limited, a company that is listed in India. That is below ten per cent, so it is foreign portfolio investment. A later purchase takes Nordvik to 12 per cent on a fully diluted basis: the holding is now FDI. If Nordvik sells down to 9 per cent, the Note to rule 2(r) keeps the investment as FDI. Lakshya's sectoral cap is measured on all foreign investment on a repatriation basis, direct and indirect, together.
Need help with foreign investment classification?
Whether a holding is FDI or portfolio, and whether a cap is being respected across direct and indirect holdings, often needs a reading of the shareholding pattern. Our FEMA advisory team can review it with you.
Key takeaways
- FDI is any equity-instrument investment in an unlisted Indian company, or ten per cent or more of a listed company on a fully diluted basis; below ten per cent in a listed company is foreign portfolio investment.
- A holding that was FDI continues as FDI even if it falls below ten per cent.
- Foreign investment means investment on a repatriable basis, and includes a resident citizen's holding for which a beneficial-interest declaration names a non-resident.
- The sectoral cap is a composite limit including indirect foreign investment; "and debt" was omitted from the definition on 5 December 2019.
- The 2024 definition of "listed Indian company" differs from the Master Direction's wording; confirm against the official text.
Read next
- Rule 2 of the FEM (Non-debt Instruments) Rules, 2019: equity instruments, convertible notes, non-debt instruments and units
- Rule 2 of the FEM (Non-debt Instruments) Rules, 2019: Indian company, control, startup and investor classes
- FPI investment and transfer: rules 10 and 11
- FPI investment limits: sectoral and overall
Disclaimer: Based on the Gazette text of the instrument this article names, as notified and as amended by the notifications named in the article (for the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 the latest amendment consulted is S.O. 4870(E) dated 2 September 2026), as consulted on 2 October 2026. There is no official consolidated text; the provisions were read with each amendment applied. Sectoral caps, entry routes, conditions, forms and time limits change by notification, press note and circular; later changes should be checked on the Gazette, DPIIT and Reserve Bank sites. This article is general information, not legal advice; check the official text before acting.