Short answer: a foreign parent can lend to its Indian subsidiary as an external commercial borrowing (ECB) without RBI approval. Since 16 February 2026 the rules are much simpler: any non-resident can lend, related-party loans are allowed at arm's length, the all-in-cost ceiling has gone for loans of three years' average maturity or more, and the subsidiary needs a Loan Registration Number (LRN) before drawing down. Whether debt beats equity then turns on tax: 20% withholding on interest (or a treaty rate of 10% to 15%), the 30% of EBITDA cap on deductible interest paid to the parent where it exceeds ₹1 crore, and a transfer pricing test of the interest rate.
| Equity shares | Compulsorily convertible debentures or preference shares | Loan (ECB) |
|---|
| FEMA category | Foreign direct investment | Foreign direct investment | External commercial borrowing |
| Reported on | FC-GPR within 30 days of allotment | FC-GPR within 30 days of allotment | Form ECB 1 before drawdown; ECB 2 on drawdown and servicing |
| Returns to parent | Dividend, out of post-tax profit | Coupon (interest on CCDs, dividend on CCPS) until conversion | Interest, deductible within limits |
| Getting the money back | Buy-back, capital reduction or sale | Converts to equity; not redeemable for cash | Repayment on the agreed schedule |
| Pricing rules | FEMA fair value floor on issue | Conversion price or formula fixed upfront, at or above fair value at issue | Market rate, arm's length |
Equity and its reporting sequence are covered in foreign share capital infusion and the FC-GPR sequence. This note is about the other two.
The Reserve Bank of India (RBI) notified the Foreign Exchange Management (Borrowing and Lending) (First Amendment) Regulations 2026 (Notification No. FEMA 3(R)(5)/2026-RB, dated 9 February 2026), in force from their publication in the Gazette on 16 February 2026. They replace much of the old ECB framework. ECBs that already had an LRN stay on their old terms, but their reporting moves to the new timelines.
What the framework now says
| Parameter | Position from 16 February 2026 |
|---|
| Eligible borrower | Any person resident in India, other than an individual, incorporated or established under a Central or State Act and permitted to borrow under that Act |
| Recognised lender | Any person resident outside India, plus overseas branches of RBI-regulated lenders and financial institutions in an IFSC. The old tests for a "foreign equity holder" lender (such as a 25% direct holding) are gone |
| Related-party loan | Permitted, on an arm's length basis |
| Borrowing limit (automatic route) | The higher of USD 1 billion of outstanding ECB, or total borrowing, external and domestic, of up to 300% of net worth on the last audited standalone balance sheet |
| Minimum average maturity | 3 years. Manufacturing companies may borrow at 1 to 3 years, up to USD 150 million outstanding |
| Cost | In line with prevailing market conditions. The all-in-cost ceiling is removed; ECBs under three years' average maturity remain subject to the trade credit ceiling |
| Currency | Any foreign currency, or rupees; currency can be switched |
| Drawdown | Only after the LRN is obtained through the designated authorised dealer (AD) bank |
The removal of the foreign-equity-holder test matters most to groups where the lender is a sister company or a regional treasury entity rather than the direct shareholder. Previously that needed a common overseas parent and specific conditions; now it is a related-party loan that must be at arm's length.
End-use: what the money cannot be used for
The old list of restricted uses, which included working capital and general corporate purposes unless longer maturities were met, has been replaced by a single negative list. ECB proceeds cannot be used for:
- chit funds or Nidhi companies;
- real estate business or construction of farmhouses, with carve-outs for industrial parks, townships, SEZs, construction-development projects, infrastructure and property for the borrower's own use;
- agriculture and plantation, with specified exceptions;
- trading in transferable development rights;
- transacting in listed or unlisted securities, except for mergers, demergers, schemes or acquisitions of control;
- repaying a domestic rupee loan that was itself for a restricted purpose or is classified as a non-performing asset;
- on-lending for any of these.
For an operating subsidiary funding salaries, equipment or working capital, the end-use question will usually be straightforward. Rupee proceeds must reach a rupee account with the AD bank by the end of the month after receipt.
Reporting
| Form | When |
|---|
| Form ECB 1 | To obtain the LRN, before the first drawdown |
| Revised Form ECB 1 | Within 7 calendar days from the end of the month in which a change to the loan terms took effect |
| Form ECB 2 | Within 7 calendar days from the end of any month in which there was a drawdown or debt servicing |
Form ECB 2 used to be monthly, within seven working days, whether or not anything had happened. It is now event-based. A borrower that misses four consecutive quarters of returns after a scheduled drawdown or repayment can be classified as untraceable, and reported to the RBI and the Directorate of Enforcement. Late reporting can be regularised by paying a late submission fee under RBI's guidelines. The ECB returns sit alongside the rest of the subsidiary's FEMA filings, covered in the FEMA filings foreign-funded companies miss.
Debentures or preference shares that are fully, compulsorily and mandatorily convertible into equity are equity instruments under the Foreign Exchange Management (Non-Debt Instruments) Rules 2019. They are issued as FDI, not ECB:
- the conversion price, or the formula for it, is fixed at issue, and cannot result in a price below fair value at the time of issue;
- they are reported on FC-GPR within 30 days of allotment;
- no LRN, no ECB 2, no maturity or end-use rules from the ECB framework;
- sectoral caps and the entry route apply, as for equity.
Anything optionally or partly convertible is ECB and must comply with the ECB rules in full. That distinction catches groups that add a redemption option to a CCD "for flexibility".
For income tax, a CCD is debt until it converts. Its coupon is interest: deductible for the subsidiary, subject to withholding, to transfer pricing, and to the interest limitation rule below. A CCPS pays a dividend, which is not deductible. That is the whole reason groups choose CCDs over CCPS: equity treatment for FEMA, interest treatment for tax, until conversion.
Interest paid to the parent is subject to tax deduction at source under Section 195 of the 1961 Act, now the non-resident table in Section 393(2) of the Income-tax Act 2025.
Domestic rate. Interest on money borrowed in foreign currency is taxed at 20% under Section 115A of the 1961 Act (Section 207 of the 2025 Act), plus surcharge and 4% cess. The concessional 5% rate that used to apply to ECB interest applied only to borrowings made before 1 July 2023, so it is not available for a new loan. A rupee-denominated loan from the parent falls outside that 20% provision, and the rate that applies should be confirmed before the first interest payment, since the treaty rate will often be lower in either case.
Treaty rates, from the treaty texts, where the parent is the beneficial owner:
| Lender resident in | Treaty rate on interest (non-bank lender) |
|---|
| United States | 15% (10% for banks) |
| United Kingdom | 15% (10% for banks) |
| Singapore | 15% (10% for banks) |
| UAE | 12.5% (5% for banks) |
| Netherlands | 10% |
| Japan | 10% |
| Germany | 10% |
The same documentation applies as for other payments to the parent: a tax residency certificate, Form 41, a no-PE declaration, and Forms 145 and 146 at each remittance. Where tax is not deducted, the interest is disallowed until it is.
Section 94B of the 1961 Act, now Section 177 of the Income-tax Act 2025 ("Limitation on interest deduction in certain cases"), is India's thin capitalisation rule.
| Element | Rule |
|---|
| Who | An Indian company (or a PE of a foreign company) paying interest on debt to a non-resident associated enterprise |
| Threshold | Applies where that interest exceeds ₹1 crore in the year |
| Disallowance | Interest in excess of 30% of EBITDA, or the interest paid to associated enterprises, whichever is less |
| Deemed associated-enterprise debt | A loan from a third party where the parent provides an explicit or implicit guarantee, or deposits matching funds |
| Carry forward | Disallowed interest carried forward for 8 years, deductible within the limit in those years |
| Excluded | Banks and insurance companies, and specified finance companies |
The practical consequence for a subsidiary in its early years is severe. A company with little or negative EBITDA has almost no headroom, so interest paid to the parent above ₹1 crore is largely disallowed at the start, precisely when the loan was meant to help. The carry-forward softens it, but eight years is not unlimited, and the interest has still borne withholding tax in full in the parent's hands.
A loan from the parent is an international transaction, and the interest rate must be at arm's length (Section 92 of the 1961 Act, Section 161 of the 2025 Act). FEMA now asks the same question, since a related-party ECB must be on an arm's length basis.
The usual approach benchmarks the rate against what the subsidiary could borrow for on its own credit standing: a credit rating for the subsidiary, or a synthetic one, and comparable loans or bond yields in the same currency and tenor. The officer's questions are predictable: is the rate consistent with the subsidiary's standalone risk, is the currency the one the business actually needs, and would an independent borrower have taken this much debt at all?
The safe harbour rules (Rule 10TD, now Rule 89 of the 2026 Rules) do not help here. Their loan category covers loans advanced by an Indian company to its overseas wholly-owned subsidiary, not borrowing from a parent. The interest is reported in the transfer pricing accountant's report, set out in Form 3CEB, now Form 48.
- Model the EBITDA first. If the subsidiary's EBITDA will not support the interest for several years, the deduction is largely deferred and debt loses much of its tax advantage over equity.
- Compare the two tax rates. Interest is deducted in India at the company's rate and taxed in the parent's hands at the treaty rate; a dividend comes out of post-tax profit and bears the dividend treaty rate. The comparison with paying a dividend to the parent should be done in numbers, not assumed.
- Keep the debt-equity ratio defensible. A subsidiary funded almost entirely by parent debt invites the question whether part of it is really equity.
- Put the terms in writing before drawdown. A loan agreement, rate, repayment schedule and LRN, all in place before the first rupee arrives.
- Plan the exit. An ECB can be converted into equity without meeting the minimum average maturity, subject to the Non-Debt Instruments Rules and pricing. Repaying it from fresh equity also releases the maturity requirement.
This note sets out the general position as at 23 September 2026 under the FEMA borrowing and lending regulations as amended by Notification No. FEMA 3(R)(5)/2026-RB, the Income-tax Act 1961 and the Income-tax Act 2025. The ECB framework, the RBI's reporting guidelines and the late submission fee are revised by circular; the treaty rate depends on the lender's residence and beneficial ownership; and the interest limitation depends on the subsidiary's actual EBITDA. Confirm the regulation text with the AD bank and model the tax position before the loan agreement is signed.