Regulatory clarification on bonus shares provide a template to boost capital inflows

An article titled “𝐑𝐞𝐠𝐮𝐥𝐚𝐭𝐨𝐫𝐲 𝐜𝐥𝐚𝐫𝐢𝐟𝐢𝐜𝐚𝐭𝐢𝐨𝐧 𝐨𝐧 𝐛𝐨𝐧𝐮𝐬 𝐬𝐡𝐚𝐫𝐞𝐬 𝐩𝐫𝐨𝐯𝐢𝐝𝐞 𝐚 𝐭𝐞𝐦𝐩𝐥𝐚𝐭𝐞 𝐭𝐨 𝐛𝐨𝐨𝐬𝐭 𝐜𝐚𝐩𝐢𝐭𝐚𝐥 𝐢𝐧𝐟𝐥𝐨𝐰𝐬” authored by our Senior Partner, Vaibhav Kakkar and Associate, Anuj Garg, has been published by moneycontrol.com.

Over the course of 2025, the Central Government and the RBI have made significant changes to the Indian foreign exchange laws, offering more flexibility and clarity for all concerned stakeholders. These changes include allowing Indian exporters to more easily settle their transaction in Indian Rupees (instead of US Dollars), clarifying the applicability of various FEMA conditions/restrictions on foreign owned and controlled Indian companies, etc.

Press Note 2 of 2025 – A Step in the Right Direction

One such notable change is the Press Note No. 2 (2025 Series) (the ‘Press Note’) issued by the DPIIT on 7th April. Pursuant to the same, it has been clarified that that an Indian company engaged in an FDI prohibited sector is allowed to issue bonus shares to its existing foreign shareholders, subject to there being no change in the shareholding percentages of the foreign shareholders and the issuance being in compliance with applicable companies and securities laws.

Presently, the sectors prohibited for FDI include the following – lottery, gambling and betting, chit funds, Nidhi company, trading in transferable development rights, real estate business or construction of farm houses, manufacturing of tobacco products, atomic energy, railways and foreign technology collaborations in lottery and gambling/betting businesses. It is apposite to mention that FDI used to be earlier permitted in several of these prohibited sectors, and it was only subsequently prohibited.

In accordance with general legal principles, any FDI received by Indian companies when the same was permitted was grandfathered upon the prohibition coming into force. It is in that context that this clarification assumes relevance and will provide much needed relief and clarity for the companies operating in these FDI prohibited sectors.

Previously as well, the FDI Policy did allow all Indian companies to issue bonus shares to their existing foreign shareholders, subject to adherence with the applicable sectoral cap. Due to the sectoral cap restrictions applicable to companies engaged in FDI prohibited sectors, there was some regulatory ambiguity on whether such companies could issue bonus shares in compliance with the applicable foreign exchange laws. The Press Note has now provided express clarity on this persisting issue. Pertinently, the Press Note positions the permission as a mere clarification to the existing law, and not as a change in the regulatory framework.

The basis for the clarification likely could be the fact that a bonus issuance does not entail any further inflow of funds. Now, Indian companies engaged in FDI prohibited sectors will be able to effectively capitalise their existing reserves. This clarification will also provide them with another avenue for cash distribution to their shareholders (both foreign and Indian). For instance, basis information available in public domain, it can be observed that one prominent listed company engaged in the tobacco space had recently applied for a clarification before the RBI, for undertaking such a bonus issuance of shares to its existing foreign shareholders.

The clarification under the Press Note will be effective upon issue of appropriate FEMA amendment notifications. It is indeed a welcome step as it will streamline compliances for all companies engaged in FDI prohibited sectors and generally bolster the investment climate.

Case for Extending Benefits of the Clarification to Investments from Land Bordering Countries

The restriction around investments from countries sharing a land border with India, pursuant to Press Note No. 3 of 2020 (‘PN3’), subsists as a regulatory hurdle for foreign investors and India Inc. alike, specifically large conglomerates and PE funds. In the absence of clarity regarding the meaning of ‘beneficial ownership’, the applicability of PN3 continues to remain a regulatory grey area.

In line with the clarification issued under the Press Note, one would hope that a similar permission for issuance of bonus shares is given to Indian companies with existing foreign shareholders from land bordering countries. Moreover, given the recent downtrends in the capital and stock markets across the globe, it would be desirable that rights issue of shares to such investors from land bordering countries is also generally allowed applying the same legal principle as the Press Note (i.e., that the shareholding of the foreign shareholders is not effectively increasing pursuant to the issuance). This could be a right step towards incentivising further capital inflows into India, which would be critical in these times of global economic instability.

At present, Indian companies which received investments from investors from land bordering countries (whether prior to or post the introduction of PN3) are unable to effectively raise further capital. This not only adversely impacts the foreign investors but also the Indian company and its domestic Indian shareholders. This also significantly affects the ability of such Indian companies to continue their growth trajectory and could have larger macro-economic implications in the long run.

A rights issue of shares – where there is no change in the approved foreign shareholding percentage – is generally permitted under FEMA. That said, in case of rights issue to shareholders from land bordering countries, practically, we have seen the Government insisting on a prior approval being obtained. These PN3 approvals are not easily forthcoming and generally involve long-drawn timelines.

Since a rights issue provides all existing shareholders (whether Indian or foreign) with the opportunity to subscribe to additional equity shares, it would be logical if the permission provided under the Press Note is extended to bonus and rights issue of shares to existing shareholders from land bordering countries. For addressing any policy concerns, similar safeguards around no change in shareholding percentages can be prescribed for any such issuances. The Government can also consider capping the overall size of the rights issue or restricting this permission to certain non-strategically important sectors in the initial stages.

Conclusion

In sum, the clarifications issued under the Press Note are a positive step forward and could potentially pave the way for similar reforms in other areas, particularly Indian companies which have existing shareholders from land bordering countries. Recognising the need for capital inflows into India, this might be the ripe time for the Government to partially relax the PN3 restrictions by permitting Indian companies to undertake bonus and rights issue of shares to existing investors from land bordering countries, without requiring a prior government approval.