The long-awaited rules permit full foreign ownership of sites that connect online buyers to sellers -- similar to the model pioneered by Internet giant eBay.
However, foreign direct investment in "inventory-based" sites that sell their own stock is forbidden, the Department of Industrial Policy and Promotion said on Tuesday.
In practice, India's e-retailers already considered this to be the case, acting as technological platforms that connect buyers and sellers rather than selling their own products.
Even Amazon does not sell its own stock directly to shoppers in India.
Despite the regulatory fuzziness, domestic marketplace sites such as Flipkart and Snapdeal have attracted billions of dollars in overseas investment.
"This announcement brings current business structures on the right side of the law," Devangshu Dutta, chief executive of Third Eyesight, a retail consultancy in Delhi, told AFP.
While the new rules will end much of the uncertainty, the government has also imposed restrictions that may cause headaches for some online retailers.
Under the new rules, a single seller can only account for up to 25 percent of sales, the department said.
This could cause problems for some of the big sites which, while technically marketplaces, are reportedly home to a handful of super-sellers that provide the lion's share of their products.
Aggressive discounting wars by India's Internet retailers may also be under threat, as the rules say they are not allowed to "directly or indirectly influence the sale price of goods or services".
"There were no conditions (before) -- now it looks like some of the players may have to restructure the agreements with their sellers to be compliant. It's not very easy," said Paresh Parekh, a tax partner in retail and consumer products at EY.
Some retailers welcomed the new rules, including Kunal Bahl. He founded Snapdeal, one of India's biggest Internet shopping sites.
"Great to see the guidelines around 100% FDI in ecomm marketplaces. Glad the govt recognises and supports an industry transforming India," he tweeted.
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