An Indian company can attract foreign investment compliance requirements even when it has not received money directly from a foreign investor.

Many businesses understand the need for FEMA compliance when receiving Foreign Direct Investment (FDI). However, fewer realise that when an Indian company with foreign investment invests in another Indian company, additional regulatory requirements may arise.

This is known as Downstream Investment, and overlooking its compliance requirements can create problems during audits, fundraising, IPO preparation or business restructuring.

Let's understand the concept through some frequently asked questions.

Downstream investment refers to an investment made by an Indian entity that has foreign investment in it into another Indian entity.

For example:

• A foreign investor invests in Indian Company A.
• Company A subsequently invests in Indian Company B.
• The investment made by Company A in Company B is called downstream investment.

Depending on the ownership and control of Company A, the investment in Company B may also be classified as Indirect Foreign Investment under FEMA.

Direct Foreign Investment: A foreign investor directly invests in an Indian company.

Indirect Foreign Investment: An Indian company receives investment from another Indian entity whose foreign ownership or control meets the conditions prescribed under FEMA.

For example, Company B may have no foreign shareholders, but its investment received from Company A may still be considered indirect foreign investment.

This is why examining only the direct shareholders of a company may not be sufficient.

Not necessarily.

Although an investment by an Indian entity having foreign investment may qualify as downstream investment, the rules relating to indirect foreign investment depend on the ownership and control structure.

If the investing Indian company is owned and controlled by resident Indian citizens, the investment may not be treated as indirect foreign investment.

However, where the company is foreign-owned or foreign-controlled, additional FEMA requirements may apply.

A Foreign Owned or Controlled Company (FOCC) is generally an Indian company that is owned or controlled by persons resident outside India.

Foreign ownership broadly refers to holding more than 50% of the company's equity instruments.

Control includes the right to appoint the majority of directors or influence management and policy decisions through voting rights, agreements or other arrangements.

Important: Even where foreign shareholding is below 50%, a company may still be considered foreign-controlled depending on its management and decision-making rights.

Where downstream investment is treated as indirect foreign investment, the main reporting requirements generally include:

1. DPIIT Intimation

The prescribed intimation must be submitted within 30 days of making the downstream investment, even where shares have not yet been allotted.

2. RBI Form DI

Form DI must generally be filed through the RBI FIRMS portal within 30 days from the allotment of equity instruments.

Companies must also ensure compliance with applicable sectoral limits, pricing requirements and other foreign investment conditions.

Depending on the transaction, commonly required documents include:

• Board Resolution approving the investment.
• Shareholding pattern of the investing and investee companies.
• Foreign Ownership and Control (FOCC) analysis.
• Auditor's certificate, wherever required.
• Valuation report, if applicable.
• FEMA compliance declarations.
• Relevant investment agreements and supporting documents.

Maintaining proper documentation helps businesses complete reporting and respond to future regulatory queries.

No. Where downstream investment is treated as indirect foreign investment, the receiving company must comply with the applicable FDI policy.

Certain sectors permit foreign investment under the automatic route, while others may require government approval or have restrictions on foreign ownership.

Therefore, before making an investment, companies should verify whether the proposed business activity is permitted and whether any approval is required.

There are restrictions on the use of borrowed funds where the downstream investment is treated as indirect foreign investment.

Under the applicable FEMA framework, such investments generally cannot be funded through borrowings raised in the domestic market.

However, investment through eligible funds received from abroad or permitted internal accruals may be allowed, subject to the relevant conditions.

Companies should review their funding arrangements before undertaking the investment.

The Indian entity making the reportable downstream investment is generally responsible for the required DPIIT intimation and Form DI reporting.

The first-level investing Indian company also has responsibilities relating to compliance with the downstream investment rules, including applicable statutory auditor certification and reporting in the Directors' Report.

Proper coordination between the finance team, Company Secretary, auditors and professional advisors is therefore essential.

Failure to complete the prescribed reporting within the applicable timelines may result in regulatory non-compliance.

Depending on the nature of the default, the company may need to pay a Late Submission Fee (LSF) or consider other applicable regularisation procedures.

Unresolved compliance issues may also create difficulties during:

• Fundraising and investor due diligence.
• IPO preparation.
• Mergers and acquisitions.
• Corporate restructuring.
• Regulatory and banking reviews.

Importantly, paying a late filing fee does not automatically resolve any underlying violation of foreign investment conditions.

Yes. Startups and growing businesses frequently receive investment from domestic and foreign investors and subsequently invest in subsidiaries or other Indian companies.

For example, a startup that has received foreign funding may establish another Indian company for a new business activity.

Depending on the startup's foreign ownership and control, the investment in that subsidiary may trigger indirect foreign investment compliance.

Therefore, startups should examine FEMA requirements before establishing subsidiaries, making acquisitions or restructuring their business.

Businesses can reduce compliance risks by taking a few practical steps:

• Review foreign ownership and control before making investments.
• Identify whether an investment qualifies as indirect foreign investment.
• Verify applicable sectoral restrictions and approval requirements.
• Maintain proper valuation and investment documentation.
• Track DPIIT and RBI reporting deadlines.
• Conduct periodic FEMA compliance reviews.

The key takeaway: FEMA compliance is not only about where foreign money enters a company, but also about where that investment ultimately goes.

Early identification of these requirements can help businesses avoid unexpected compliance problems and support smoother expansion, fundraising and restructuring.

At Visak Financial Services Pvt. Ltd. (VFSL), we understand that foreign investment regulations can become complex when businesses operate through multiple companies or investment structures.

Our team provides practical guidance to help businesses understand their FEMA obligations, identify potential compliance gaps and take appropriate action.

Our FEMA advisory and compliance support services include:

• Downstream Investment Advisory: Assessing FEMA implications of investments between Indian entities.
• FOCC Analysis: Reviewing foreign ownership, shareholding structures and control arrangements.
• FEMA Reporting Assistance: Support with applicable DPIIT intimation and RBI Form DI filings.
• FDI Compliance Advisory: Reviewing investment conditions, sectoral restrictions and documentation.
• FEMA Health Checks: Identifying historical reporting gaps and potential regulatory concerns.
• Transaction and Due Diligence Support: Reviewing FEMA compliance during fundraising, acquisitions, IPO preparation and corporate restructuring.

Our approach focuses on helping businesses understand regulations, maintain proper documentation and identify compliance concerns before they become major obstacles.

At VFSL, we believe that proactive FEMA compliance creates a stronger foundation for sustainable business growth.

Planning a downstream investment, setting up an Indian subsidiary or reviewing your company's foreign ownership structure? Connect with VFSL for professional FEMA advisory and compliance assistance.

This article is published by Visak Financial Services Pvt. Ltd. (VFSL) for general information and educational purposes only and does not constitute legal, financial or regulatory advice.

The applicability of FEMA provisions depends on the ownership, control, sector and nature of the transaction. The relevant laws, RBI directions and reporting requirements may change from time to time.

Readers should verify the latest applicable regulations and obtain professional advice before making investment or compliance decisions. VFSL shall not be responsible for actions taken solely on the basis of this article.