Aerospace & Defence: 74% Cap, Offset Policy

India's Defence Sector: From Closed Market to Strategic Investment Destination

India's aerospace and defence sector has undergone a radical transformation over the past decade. From a market where foreign direct investment was capped at 26% until 2014, the sector now permits up to 74% FDI under the automatic route and 100% through the government approval route — one of the most significant liberalisations in India's FDI policy landscape.

The numbers tell the story. India's defence budget for FY 2026-27 stands at INR 7.85 lakh crore (approximately USD 91 billion), making India the world's fourth-largest military spender. Defence production value is expected to exceed INR 1.60 lakh crore (USD 19 billion) in 2025-26, with exports reaching INR 23,622 crore (USD 2.8 billion) in FY 2024-25 — a 34-fold increase over a decade. The government targets domestic defence manufacturing valued at INR 3 lakh crore (USD 35 billion) and exports of INR 50,000 crore (USD 6 billion) by 2028-29.

For foreign aerospace and defence companies, India represents a unique convergence of scale (the world's largest arms importer until recently), policy intent (Make in India, Atmanirbhar Bharat), and structural opportunity (a manufacturing ecosystem that is rapidly maturing). But the regulatory environment is complex, layered, and unlike any other FDI sector in India. This guide covers every dimension that a foreign defence or aerospace company must understand before entering the Indian market.

FDI Policy Framework: The 74% Cap and Beyond

The current FDI framework for defence was established through Press Note 4 (2020 Series) dated September 17, 2020, and codified in the Consolidated FDI Policy Circular of 2020. The framework has two tiers:

Automatic Route: Up to 74%

Foreign investment up to 74% is permitted under the automatic route for companies seeking new defence industrial licences. No prior approval from the Government of India or RBI is required for the investment itself. However, the entity must obtain an industrial licence from the Department for Promotion of Industry and Internal Trade (DPIIT) under the Industries (Development and Regulation) Act, 1951, which is a separate regulatory approval.

Key conditions for the 74% automatic route:

• The investee company must be incorporated in India under the Companies Act, 2013
• Management of the company must be in Indian hands — majority of the Board of Directors and the Chief Executive must be resident Indian citizens
• The company must satisfy the security and strategic requirements as prescribed by the Ministry of Defence
• All manufacturing must take place in India

Government Approval Route: Up to 100%

FDI beyond 74% — up to 100% — is permitted through the government approval route wherever it is likely to result in access to modern technology in the defence sector. The application is processed by DPIIT in consultation with the Ministry of Defence (MoD). The threshold for "modern technology" is not defined in the policy but is evaluated on a case-by-case basis by the Foreign Investment Facilitation Portal (FIFP).

In practice, 100% FDI has been approved in limited cases where the foreign investor brings proprietary technology that is not available domestically. The government evaluates factors including the strategic significance of the technology, its non-availability in India, the investor's commitment to technology transfer, and the impact on India's self-reliance objectives.

Existing Licence Holders: The 49% vs 74% Distinction

An important policy distinction exists between new and existing defence licence holders. The 74% automatic route FDI limit applies specifically to companies seeking new defence industrial licences. For companies that already hold defence industrial licences — many of which were issued under the earlier 49% FDI regime — the automatic route limit remains at 49%. The government has indicated that reforms to raise this to 74% for existing licence holders are expected, but as of March 2026, the distinction remains in force. Foreign companies planning to acquire existing Indian defence manufacturers should verify the applicable FDI limit based on the target company's licence vintage and any subsequent amendments.

FDI Limits by Procurement Category

An important nuance: the FDI limit that applies to a defence company depends on the procurement category under which it intends to supply to the Indian armed forces:

This means a foreign company with 74% FDI in an Indian JV can participate in Buy (Indian) and Buy and Make (Indian) categories, but is excluded from the most favoured IDDM category (which gets priority in procurement) unless it reduces its stake to 49% or below.

Industrial Licensing Requirements

Unlike most sectors in India where industrial licensing has been abolished, defence manufacturing mandatorily requires an industrial licence from DPIIT. This is a critical regulatory gate — no defence manufacturing can commence without a valid licence.

Application Process

All applications are filed online through the DPIIT G2B (Government to Business) Portal. The process involves:

1. Online application: Submit the application form with details of the proposed product(s), manufacturing process, capacity, investment, and promoter credentials. All applications are processed electronically — no physical submissions
2. Inter-ministerial consultation: DPIIT circulates the application to the Ministry of Defence, Ministry of Home Affairs, and the relevant State Government for comments
3. Licensing Committee review: The Licensing Committee considers the application based on inter-ministerial comments and recommends grant, rejection, or deferment
4. Licence issuance: Upon approval, the licence is issued electronically with a QR code

Key Requirements

• The applicant must be an Indian company (incorporated in India) or partnership firm
• The management of the applicant must be in Indian hands — majority of the Board and the Chief Executive must be resident Indian citizens
• Licensable items are listed in Annexure-I of Press Note 1 (2019 Series) and include arms, ammunition, explosives, military vehicles, radar systems, communication equipment for military use, and other defence-specific products
• Licence validity is 15 years (extended from 3 years under the ease-of-doing-business reforms)
• Processing timeline: approximately 5 months from the date of registration

Defence Offset Policy: Mechanics, Multipliers, and Challenges

India's Defence Offset Policy, introduced in 2005 and currently governed by the Defence Acquisition Procedure 2020 (DAP 2020), requires foreign vendors winning large defence contracts to reinvest a portion of the contract value back into India's defence ecosystem.

When Offsets Apply

Offset obligations are triggered for capital acquisitions in the following categories:

• Buy (Global): Outright purchase from a foreign vendor where the estimated cost is INR 300 crore (approximately USD 36 million) or more
• Buy and Make with Transfer of Technology: Purchase from a foreign vendor followed by licensed production, where the foreign exchange component meets the INR 300 crore threshold

The standard offset obligation is 30% of the estimated acquisition cost for Buy (Global) or 30% of the foreign exchange component for Buy and Make with ToT. The Defence Acquisition Council (DAC) may prescribe higher percentages for strategically important acquisitions.

Offset Discharge Methods

Foreign vendors can discharge their offset obligations through multiple avenues:

The multiplier system is designed to incentivise technology transfer and FDI over simple product purchases. A multiplier of 3.0x means that every USD 1 of actual investment counts as USD 3 toward the offset obligation — making FDI and technology transfer the most capital-efficient discharge methods.

Offset Banking

Vendors can "bank" offset credits — meaning they can accumulate credits before a contract is signed, or carry forward excess credits from one contract to another. This provides flexibility for companies with ongoing India relationships across multiple programmes.

Penalties for Non-Discharge

If a vendor fails to meet its annual offset discharge plan, a penalty of 5% of the unfulfilled obligation is levied. The undischarged amount is redistributed over the remaining contract period. Penalties can be recovered from the bank guarantee of the main procurement contract or deducted from amounts payable under the contract.

Policy Challenges

Despite its ambitions, India's offset policy has faced significant implementation challenges. Between March 2021 and March 2025, only one new offset contract was signed — indicating deep structural friction in the policy's execution. Common challenges include difficulty identifying eligible Indian offset partners with sufficient capability, lengthy approval processes for proposed offset discharge activities, disputes over valuation of offset credits, and the administrative burden of documentation and compliance. The government has been reviewing the offset framework, and significant reforms are expected. In 2020, offsets were eliminated for government-to-government (G2G) defence deals and inter-governmental agreements (IGA), simplifying these procurement routes.

Defence Acquisition Procedure 2020 (DAP 2020)

The DAP 2020, effective from October 1, 2020, is the master document governing all defence procurement in India. For foreign companies, understanding DAP 2020 is essential because it determines how the Indian military buys equipment and therefore defines the market entry pathways.

Key Procurement Categories

DAP 2020 prioritises domestic manufacturing through a hierarchy of procurement categories:

1. Buy (Indian-IDDM): Highest priority. Products that are indigenously designed, developed, and manufactured with minimum 50% indigenous content. FDI cap: 49%
2. Buy (Indian): Products manufactured in India with minimum 50% indigenous content on cost basis. FDI cap: 74%
3. Buy and Make (Indian): Initial purchase followed by licensed production in India. FDI cap: 74%
4. Buy (Global - Manufacture in India): Global procurement with requirement to manufacture in India. FDI cap: 74%
5. Buy (Global): Outright purchase from foreign vendor. No FDI cap for the vendor, but attracts offset obligations if the contract exceeds INR 300 crore
6. Make-I, Make-II: Government-funded (Make-I) or industry-funded (Make-II) indigenous development. FDI cap: 49%

Strategic Partnership Model (SPM)

The SPM, introduced in DAP 2016 and refined in DAP 2020, is designed for high-value, complex platforms where India seeks to develop strategic manufacturing capabilities. Under SPM, the Ministry of Defence selects an Indian Strategic Partner (SP) who then partners with a foreign Original Equipment Manufacturer (OEM) for technology transfer and manufacturing.

The initial SPM segments include fighter aircraft, helicopters, submarines, and armoured fighting vehicles. The Indian SP must be a private sector company with majority Indian ownership (FDI cap of 49%). The foreign OEM provides the platform design, technology, and know-how through a technology transfer agreement.

Production-Linked Incentive (PLI) Scheme

The government's PLI scheme for the defence sector provides financial incentives for domestic manufacturing. The scheme, notified in 2021, is designed to attract both domestic and foreign investment into India's defence manufacturing ecosystem.

Key Features

• Incentive rate: 3-8% of incremental sales over a 5-year period, depending on the product category and the extent of value addition
• Eligible products: Specific defence items identified by the MoD, including drone systems, radar and electronic warfare systems, communication equipment, armoured vehicles and their subsystems, and various ammunition types
• Minimum investment threshold: Varies by category — typically INR 10-100 crore
• Local value addition requirement: Minimum 50% domestic value addition on cost basis over the scheme period

For foreign companies, the PLI scheme creates a strong economic case for establishing manufacturing operations in India rather than exporting finished products — especially when combined with the procurement preference given to Buy (Indian-IDDM) and Buy (Indian) categories under DAP 2020.

Innovation and R&D Ecosystem

iDEX (Innovations for Defence Excellence)

iDEX is the MoD's flagship innovation platform, designed to engage startups, MSMEs, and academia in developing defence technologies. The budget allocation for iDEX in FY 2025-26 is INR 449.62 crore, including the ADITI (Acing Development of Innovative Technologies with iDEX) sub-scheme that provides grants of up to INR 25 crore per innovator for critical technologies including satellite communications, AI, quantum technology, and autonomous systems.

Foreign companies can partner with iDEX challenge winners for co-development and co-production, or invest in Indian defence technology startups to build supply chain relationships.

Defence Testing Infrastructure Scheme (DTIS)

The government has established Defence Testing Infrastructure nodes in key industrial corridors — the UP Defence Corridor (Uttar Pradesh) and the Tamil Nadu Defence Corridor — providing shared testing facilities that reduce the capital cost of entry for manufacturers.

Entry Strategies for Foreign Companies

Foreign aerospace and defence companies typically enter India through one of the following structures:

Joint Venture with Indian Partner (Most Common)

A JV with an Indian defence company — either a public sector Defence Public Sector Undertaking (DPSU) or a private sector company — is the most common entry route. The foreign company holds up to 74% (automatic route) or 100% (government approval route for modern technology). The Indian partner provides local market knowledge, government relationships, manufacturing infrastructure, and workforce.

Key considerations: The Indian partner's management must remain in Indian hands (majority board representation and Indian resident CEO). The JV must obtain a separate industrial licence from DPIIT. Transfer pricing documentation is critical for all technology transfer fees, licensing royalties, and intercompany transactions between the JV and the foreign parent.

Wholly Owned Subsidiary (For Technology Leaders)

Foreign companies with proprietary, cutting-edge technology that is not available domestically may apply for 100% FDI through the government approval route. This is appropriate for companies that want full operational control and are willing to make significant technology commitments. The approval process is longer (6-12 months) and requires demonstrating that the technology qualifies as "modern technology" under the FDI policy.

Offset-Driven Investment

For foreign OEMs with existing or anticipated offset obligations from large defence contracts, establishing a manufacturing JV in India serves a dual purpose: it creates a platform for participating in Indian procurement (Buy Indian category) and simultaneously provides a mechanism for discharging offset obligations through FDI (with a 3x multiplier). This is among the most capital-efficient entry strategies.

Technology Licensing and Transfer

Rather than establishing a manufacturing presence, some foreign companies opt for technology licensing to an Indian partner. The licensee manufactures under the foreign company's design and brand, paying licensing fees and royalties. This approach avoids the operational complexity of running an Indian entity but limits the foreign company's control and profit margins. Technology transfer can also count toward offset obligations.

FEMA and RBI Compliance

All FDI in India's defence sector must comply with FEMA regulations:

• FC-GPR filing: FC-GPR must be filed within 30 days of share allotment to report the foreign investment to RBI through the FIRMS portal
• Pricing compliance: Shares must be issued at or above the fair market value determined by a SEBI-registered merchant banker using the DCF method (for unlisted companies)
• Annual returns: FLA returns must be filed by July 15 each year
• Sectoral cap monitoring: The investee company must ensure that aggregate foreign investment does not exceed the applicable cap (74% for automatic route, or the specifically approved percentage for government route cases)

For defence sector investments exceeding INR 5,000 crore, additional scrutiny under India's national security review framework may apply, particularly for investments from countries sharing a land border with India (covered under Press Note 3 of 2020).

Tax Considerations

Corporate Tax

Defence manufacturing companies incorporated in India can opt for the concessional corporate tax rate of 15% (effective rate 17.16% including surcharge and cess) under Section 115BAB if incorporated after October 1, 2019 and commencing manufacturing by March 31, 2024 (extended timelines may apply for specific sectors). Note: the Section 115BAB window closed on 31 March 2024; new defence manufacturers must use Section 115BAA (22% / 25.17% effective). Otherwise, the standard rates of 22% (effective 25.17%) under Section 115BAA or 30% (effective 34.94%) apply.

Customs and GST

Defence imports by the Indian armed forces are exempt from customs duty under specific notifications. However, imports by private defence manufacturers are subject to standard customs duty rates unless covered by specific exemptions. GST on defence supplies is generally 18%, though government contracts may have specific GST treatment.

Transfer Pricing

Transfer pricing is a particular focus area for defence JVs, especially for technology transfer fees, technical assistance charges, design and engineering services, and management fees paid to the foreign parent. All intercompany transactions must be at arm's length with contemporaneous documentation. The Indian tax authorities actively audit defence sector transfer pricing.

Current Market Opportunities

The Indian defence market offers specific opportunities for foreign aerospace and defence companies in 2026:

The government's push for self-reliance (Atmanirbhar Bharat) and the increasing positive indigenisation lists — which specify items that can only be procured from Indian manufacturers after specified dates — create a structural imperative for foreign companies to establish Indian manufacturing rather than relying on exports to India.

For foreign defence and aerospace companies evaluating India entry, our FDI advisory service provides comprehensive support covering FDI structuring, industrial licensing, FEMA compliance, and post-investment regulatory management. See also our guide on FDI sectoral caps for the complete list of sector-specific limits and our automatic route vs government approval comparison for a detailed analysis of both FDI routes.

Defence Corridors and Manufacturing Infrastructure

The Government of India has established two dedicated Defence Industrial Corridors to create concentrated manufacturing ecosystems:

Uttar Pradesh Defence Corridor

The UP Defence Corridor spans six nodes: Agra, Aligarh, Chitrakoot, Jhansi, Kanpur, and Lucknow. The corridor has attracted investment commitments exceeding INR 15,000 crore from both domestic and foreign companies. Infrastructure includes shared testing facilities, dedicated industrial land parcels, plug-and-play manufacturing units, and expedited clearance mechanisms. For foreign companies, the corridor offers a ready ecosystem with supply chain proximity and government support.

Tamil Nadu Defence Corridor

The Tamil Nadu corridor covers Chennai, Coimbatore, Hosur, Salem, and Tiruchirappalli. Tamil Nadu's existing automotive and precision engineering base provides a natural transition into defence manufacturing. The corridor has attracted investments exceeding INR 13,000 crore. Several global aerospace companies already have manufacturing operations in Tamil Nadu, creating a cluster effect that benefits new entrants.

Benefits for Foreign Investors

• Land availability: Pre-identified industrial land with defence manufacturing zoning, eliminating the typically lengthy land acquisition process
• Testing infrastructure: Shared testing and certification facilities under the Defence Testing Infrastructure Scheme (DTIS), reducing capital expenditure for individual companies
• Talent pool: Both corridors are located near major engineering institutions and existing manufacturing hubs, ensuring access to skilled workforce
• Supply chain density: Co-location with other defence manufacturers creates natural supply chain relationships and reduces logistics costs
• Single-window clearance: State governments offer facilitation cells for defence corridor investments, streamlining regulatory approvals

Compliance and Reporting Obligations

Foreign-invested defence companies in India face multiple ongoing compliance requirements beyond the initial licensing and FDI approvals:

Annual Capacity Verification

DPIIT requires annual returns from industrial licence holders reporting production capacity, actual production, and capacity utilisation. Non-filing or persistent underutilisation can lead to licence review or cancellation.

End-Use Monitoring

Defence products manufactured under industrial licence are subject to end-use restrictions. The company must maintain records of all sales and ensure that products are not diverted to unauthorised end-users or exported without appropriate export licences from the Department of Defence Production.

Security Clearances

Key management personnel in defence manufacturing companies require security clearances from the Ministry of Home Affairs. For foreign nationals holding management positions (permitted within the Indian management control requirements), the clearance process can take 6-12 months. Companies should factor this timeline into their hiring and operational plans.

Technology Transfer Restrictions

Any technology received from a foreign parent or partner for defence manufacturing in India is subject to end-use restrictions. Re-export of technology, designs, or technical data requires specific approvals. Companies must maintain detailed records of technology access and usage for audit by both the MoD and DPIIT.

Key Takeaways

• FDI up to 74% is permitted under the automatic route for new defence industrial licence holders; 100% is available through the government route for modern technology access
• Industrial licensing from DPIIT is mandatory for all defence manufacturing — there is no exemption regardless of FDI level
• Offset obligations of 30% apply to Buy (Global) contracts exceeding INR 300 crore, with FDI and technology transfer earning up to 3x multipliers
• The effective FDI cap depends on the procurement category: Companies seeking to participate in the highest-priority IDDM category are limited to 49% FDI, while Buy (Indian) and Buy and Make (Indian) categories allow up to 74%
• India's defence budget of INR 7.85 lakh crore and production target of INR 3 lakh crore create a large and growing market, but success requires navigating DAP 2020 procurement categories, industrial licensing, offset mechanics, and FEMA compliance simultaneously