India: Recent Developments In FDI On E-Commerce

Last Updated: 15 February 2019
Article by Sagar Maru and Rishabh Sheth

The FDI policy on e-commerce, first pronounced through Press Note 2 of 2000, permitted 100% FDI in business to business ("B2B") e-commerce activities. With a view to clarify the already existing policy framework, after extensive stakeholder consultations, Press Note 3 was issued by DIPP in 2016 dated 29 March 2016 ("PN 3 of 2016"). Under the PN 3 of 2016, FDI in e-commerce sector was permitted under 100% automatic route for entities that carry out business on B2B basis and function on a marketplace based model of e-commerce. The marketplace based model of e-commerce was defined under PN 3 of 2016 to mean providing of information technology platform by an e-commerce entity on a digital & electronic network to act as a facilitator between buyer and seller. Under the aforesaid press note, FDI was not permitted under automatic route in entities engaged in business to consumer ("B2C") model and in the inventory based model of e-commerce. Inventory based model of e-commerce was defined under to mean an e-commerce activity where inventory of goods and services is owned by e-commerce entity and is sold to the consumers directly. B2C e-commerce, that is multi-brand retail through inventory based model, has all along remained prohibited for FDI.

The restrictions imposed by PN 3 of 2016 did not achieve the purpose of the regulator to restrict FDI in inventory based e-commerce model since the aforesaid restrictions were being circumvented by peculiar arrangements. Consequently, the Department of Industrial Promotion and Policy ("DIPP") issued Press Note No. 2 (2018 Series) dated 26th December 2018 ("PN 2 of 2018") imposing further restrictions on such e-commerce entities which have recently come into force on 1st February, 2019 and are analyzed hereunder.

Under PN 2 of 2018 like in PN 3 of 2016, the FDI in e-commerce sector is permitted under 100% automatic route for B2B model in marketplace based model of e-commerce and not permitted in B2C model and in the inventory based model of e-commerce. The definition of marketplace based model of e-commerce and inventory based model of e-commerce remains unchanged.

The provisions of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017 (Notification No. FEMA. 20 (R)/20 17-RB dated November 07, 2017) ("TISPRO Regulations") were amended pursuant to   Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations, 2019  dated 31st January 2019 (hereinafter referred to as the "Amendment Regulations") to bring the TISPRO Regulations in line with PN 2 of 2018.

Following are some of the important changes brought by the PN 2 of 2018:

  1. Ownership of Inventory

    1. Earlier the B2B e-commerce marketplace entities having FDI ("FDI Entity") were treated as inventory based model if they exercised "ownership" over the inventory. Now under PN 2 of 2018 they shall be treated as inventory based model if the FDI Entity exercised "ownership or control". The term "control" is not defined under the PN 2 of 2018. Further it is silent whether the control is direct or indirect.
    2. Under PN 3 of 2016 read with the FDI Policy of 2017, the FDI Entity was not permitted to effect more than 25% of the sales from one vendor or its group company on a financial year basis. Now under PN 2 of 2018, if 25% of the sales of the vendor are effected on the platform of the FDI Entity then the FDI Entity will be deemed to have control over the inventory sold by such seller. The period of computation of such sales is not specified either in PN 2 of 2018 or the Amendment Regulations.
    3. This would also mean that the FDI entity must ascertain the total volume of sales of each of its vendors to ensure compliance.
  1. Equity Participation in the seller entities
    1. Under PN 2 of 2018, sellers are restricted to sell their products on platforms run or provided by a marketplace entity if such marketplace entity or its group companies have equity participation in the sellers or control over the inventory. There was no such condition under the PN 3 of 2016.
    2. The PN 2 of 2018 is silent on the whether the equity participation is direct or indirect. In the absence of clarity, a view can be taken that it would not cover indirect equity participation since where the PN 2 of 2018 intended to cover "indirect" control it has clearly spelt that out (for example in clause (ix)).
    3. The percentage of equity participation is also not provided for. Further, an issue would arise on the threshold of equity participation i.e. whether holding even one share constitutes equity participation. In absence of clarification a possible view would be that even single share would constitute equity participation.
    4. An issue also arises whether equity participation would include convertible preference shares, debentures or warrants within its purview. In the absence of specific clarification, it is possible to take a view that till the time convertible instruments are converted into equity shares, the convertible should not be treated as equity participation.
    5. The Consolidated FDI Policy 2017 defines 'Group Company' to mean two or more enterprises which, directly or indirectly, are in a position to: (i)exercise twenty-six percent or more of voting rights in other enterprise; or (ii)appoint more than fifty percent of members of board of directors in the other enterprise.
  1. Exclusivity
    1. Under PN 2 of 2018, FDI Entity is restricted from compelling any vendor to sell its products, exclusively on the platform of FDI Entity.
  1. Fairness Requirement:

    1. FDI Entity is not permitted to directly or indirectly influence the sale price of the goods or services and to maintain level playing field.
    2. Services such as logistics, warehousing, advertisement/marketing, payments, financing etc. provided by the FDI Entity or entities where FDI Entity has direct or indirect equity participation or common control to the vendors selling goods on platform of FDI Entity will have to be non-discriminatory, fair and on arm's length basis. Further, any cashback offers provided by the group companies of FDI Entity will have to be fair and non-discriminatory.
    3. FDI Entities due to backing of global investors are in position to offer deep discounts or entail in predatory pricing which the local retailers cannot compete with. The aforesaid requirement of maintaining level playing field and to have fair and non-discriminatory terms shall benefit the local retailers not having backing of global investors.
  1. Certification of compliance of the provisions of PN 2 of 2018

    1. The PN 2 of 2018 has introduced a new provision for marketplace entities to provide a certificate, along with a report of a statutory auditor, to the Reserve Bank of India (the "RBI"), confirming compliance with the guidelines under the PN 2 of 2018, by the 30th of September every year, for the preceding financial year.
    2. The aforesaid requirement of certification does not form part of the Amendment Regulations. As per the Consolidated FDI Policy of 2017 in case there is conflict between the press note and the notification issued by RBI, the RBI notification will prevail. Unless the RBI regulations are suitably amended a view may be possible that the aforesaid certification is not compulsory.
    3. For financial year 2018-19, the compliance certificate shall be required to be submitted to the RBI by 30th September 2019.

Thanks to Manisha Paranjape for overseeing this article

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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