Introduction

The government recently amended(1) India's foreign direct investment (FDI) policy in order to further liberalise foreign investment caps (shareholding caps) and other conditions applicable to FDI in several industry sectors. This update broadly summarises the key changes.

In a nutshell, the rules governing foreign investment in India are contained in the Foreign Exchange Management Act 1999 and regulations issued by the Reserve Bank of India (RBI) pursuant to the act (collectively, the 'Foreign Exchange Management Act regulations'). Separately, the government (through the Department of Industrial Policy and Promotion (DIPP)) set out its FDI policy. The policy is issued in the form of press notes and periodically consolidated into one document. The FDI policy has been adopted by the RBI and enacted under relevant Foreign Exchange Management Act regulations.

As per the Foreign Exchange Management Act regulations and the FDI policy, FDI in India can be made either under the automatic route (without government approval) or the approval route (with prior government approval). In addition, the FDI policy imposes various sector-specific foreign investment caps and conditions applicable before and after foreign investment.

Key amendments

Manufacturing sector

The amendment clarifies that FDI in the manufacturing sector is permitted under the automatic route, without any foreign investment caps or FDI-linked conditions. In addition, the amendment permits manufacturers with foreign investment to sell their manufactured products in India through wholesale or retail (including through e-commerce) under the automatic route. Wholesale and retail activities (including e-commerce) not undertaken by manufacturers are subject to foreign investment caps or FDI-linked conditions under the FDI policy.

Through this change, the government is seeking to motivate industries to support the 'Make in India' initiative and encourage manufacturers to sell to customers in India, instead of importing products from other countries.

Construction sector

The amendment has liberalised the conditions applicable to FDI in the construction sector. In particular, there is no longer a requirement to have:

  • a minimum floor area of 20,000 square metres before a project is eligible for foreign investment; or
  • a minimum capitalisation of $5 million in the investee company within six months of commencement of the project.

Further, before the amendment foreign investors could exit only on completion of the project or after the development of trunk infrastructure (eg, roads, water supply, drainage and sewerage) – whichever was earlier. The amendment now permits foreign investors to exit before the completion of these activities, subject to compliance with a three-year lock-in period from the date of each tranche of foreign investment. Further, even during the lock-in period, foreign investors can now transfer their stake to another non-resident entity. The amendment also states that each phase of a construction project must be construed as a separate project for the purposes of the FDI policy. This allows an earlier exit option for foreign investors after completion of each phase of a project. This liberalisation seeks to address the housing shortage faced by the poor and mitigate the cash crisis in the construction sector.

In addition, the government imposed a separate restriction on foreign investment in completed projects (where 100% foreign investment is permitted under the automatic route for operating and managing townships, malls, shopping complexes and business centres). The amendment has imposed a three-year lock-in period from each tranche of foreign investment in completed projects.

Real estate business

The FDI policy prohibits foreign investment in real estate business, the construction of farm houses and trading in transferable development rights. However, the amendment has clarified that the income earned from renting or leasing property will not constitute real estate business as long as it does not amount to a transfer.(2) Previously, the DIPP issued a clarification(3) pursuant to which it permitted leasing and sub-leasing arrangements within a group of companies so that they could carry out business activities. Now, the government has altogether excluded leasing from the scope of real estate business and hence it will be permitted under the automatic route.

Defence sector

The unamended FDI policy permitted up to 49% foreign investment in the defence sector under the approval route and beyond 49% with the Cabinet Committee on Security's prior approval. Additionally, portfolio investment and investment by foreign venture capital investors was restricted to 24%.

The amendment has relaxed the aforementioned conditions and allowed foreign investment up to 49% under the automatic route and above 49% under the approval route. No separate cap is specified for portfolio investments and investments by foreign venture capital investors.

The above dispensation is available only when manufacturers obtain an industrial license under the (Indian) Industries (Development & Regulation) Act 1951. The amendment has also removed several FDI-linked conditions that applied in the defence sector (eg, requiring the majority of a company's directors and key management to be Indian residents). The change seeks to simplify the investment conditions in the defence sector further and support the 'Make in India' initiative. The liberalisation also seems to be aimed at establishing a sound defence manufacturing base with full-fledged maintenance and lifecycle support in order to reduce India's dependence on imports in this regard.

Broadcasting sector

Under the unamended FDI policy, FDI in teleports, direct-to-home services, cable networks, mobile television and headend in the sky broadcasting services was limited to 49% under the automatic route and up to 74% with government approval. FDI in cable networks (not in relation to upgrading networks for digitalisation or addressability) was restricted to 49% under the automatic route. The amendment has increased the cap for foreign investment for the above categories to 49% under the automatic route and up to 100% under the approval route. The amendment has further increased the foreign investment cap from 26% to 49% under the approval route for entities involved in terrestrial broadcasting (FM radio) and the uplink of news channels. Moreover, up to 100% foreign investment is now permitted for the uplink of non-news television channels and the downlink of television channels under the automatic route – something which was previously permitted only under the approval route.

Private banking sector

The amendment has introduced full fungibility of foreign investment in the private banking sector. After the issue of a resolution by the board of directors and a special resolution by the shareholders, portfolio investors can collectively make investments up to the composite sectoral limit of 74% of the total paid-up capital. The limit for an individual portfolio investor remains at 10% of the total paid-up capital.

In a July 30 2015 circular the government introduced composite foreign investment caps. However, the private banking sector was explicitly kept out of the ambit of the circular (for further details please see "Liberalisation of foreign investment laws: composite caps introduced"). The government has clearly changed its stance since then.

Plantation sector

Under the unamended FDI policy, only FDI in tea plantations was allowed, and even that was subject to government approval. Now, up to 100% FDI in tea, coffee, rubber, cardamom, palm oil tree and olive oil tree plantations is permitted under the automatic route.

Single brand retailing, wholesale trading and duty free shops

The amendment has introduced several changes aimed at easing and simplifying foreign investment in retail trade.

Sourcing requirements

According to the FDI policy, if foreign investment in an entity undertaking single brand retail trading (SBRT) exceeds 51%, at least 30% of the value of the goods must be sourced from India. Before the amendment was introduced, this sourcing requirement had to be met in the first instance, by averaging the total value of the goods sourced from India during a five-year period, beginning on April 1 of the year during which the first tranche of FDI was received. Thereafter, this requirement had to be met annually. Under the amendment, the sourcing requirement must now be met annually from the date on which the first store is open. The amendment further provides that where it is impossible to source goods locally due to the need for state-of-art or cutting edge technology, the government may relax the sourcing requirements.

E-commerce

The unamended FDI policy prohibited entities with foreign investment that were engaged in SBRT from carrying out retail trading through e-commerce. This requirement has now been removed and any entity involved in SBRT can sell its products through e-commerce.

Indian brands and manufacturers

The amendment provides that Indian brands with foreign investment can undertake SBRT. As a corollary, certain conditions relating to foreign brands (eg, the requirement that products proposed to be sold under SBRT be sold under the same name as sold internationally and that non-resident entities making investments act as brand owners or pursuant to legally tenable agreements with the brand owners) are now inapplicable to Indian brands with foreign investment which carry out SBRT.

Duty free shops
The amendment permits up to 100% foreign investment under the automatic route in duty free shops located and operated in the customs bonded area of India. Duty free shops cannot engage in any retail trading activity in the domestic tariff area of India.

Wholesale trading and SBRT

The unamended FDI policy prohibited an entity with foreign investment that conducted wholesale/cash-and-carry trading from opening retail shops in order to sell directly to consumers. Now, a single entity (with foreign investment) can undertake both SBRT and wholesale/cash-and-carry trading, as long as both sides of the business comply with the conditions set out in the FDI policy regarding wholesale/cash-and-carry trading and SBRT. The entity engaged in SBRT and wholesale/cash-and-carry trading must maintain separate account books for these two sides of the business and will be audited by the statutory auditors.

Air transport services and other services under civil aviation sector

Under the amendment, up to 49% foreign investment in regional air transport service is permitted under the automatic route. The amendment has increased the foreign investment cap to 100% under the automatic route for investment in entities engaged in non-scheduled air transport services and ground handling services.

Other sectoral foreign investment caps

Foreign investment caps in satellite establishments and operations has now increased from 74% to 100% under the approval route. Further, the foreign investment cap for credit information companies has increased to 100% under the automatic route.

Other changes

In addition to the aforementioned sector-specific changes, the following changes have been made to the FDI policy.

Investment by non-resident Indians

Non-resident Indians have special dispensation under the FDI policy and the Foreign Exchange Management Act regulations, and investments made by them on a non-repatriable basis are treated as domestic investments. The amendment has extended the above dispensation to companies, trusts and partnership firms which are incorporated outside India and owned and controlled by non-resident Indians.

It is pertinent to note that a similar dispensation was available to overseas corporate bodies (ie, companies, partnership firms and society or other corporate bodies) which were at least 60% owned by non-resident Indians. This dispensation was withdrawn by the government in 2003 due to allegations of irregular ownership of overseas corporate bodies and following a review and investigation carried out by the Securities and Exchange Board of India and the RBI.

Investment in limited liability partnerships

Under the unamended FDI policy, foreign investment in limited liability partnerships (LLPs) was permitted pursuant to government approval and only in sectors where 100% FDI was otherwise allowed under the automatic route and no FDI-linked performance conditions applied. Further, foreign investment in LLPs was subject to several other FDI-linked conditions. The amendment has removed such restrictions and FDI in LLPs is now permitted under the automatic route, provided that the LLP is operating in sectors where 100% FDI is allowed under the automatic route and no FDI-linked performance conditions apply.

LLPs with FDI can also make downstream investments in another company or LLP in sectors where 100% FDI is allowed under the automatic route and no FDI-linked performance conditions apply. This was prohibited before the amendment. The amendment also requires LLPs with foreign investment making downstream investments to comply with certain formalities which were previously applicable to companies only. However, it is unclear how some of these conditions will apply to LLPs (as investors and investees). For instance, one such condition requires that "[d]ownstream investment by way of induction of foreign equity in an existing Indian Company to be duly supported by a resolution of the Board of Directors as also a shareholders agreement, if any". However, LLPs do not have board of directors or shareholders' agreements; therefore, this condition may be inappropriate for downstream investments in LLPs.

The amendment has also for the first time defined the terms 'owned' and 'control' with respect to LLPs.

Downstream investments by companies

While on the one hand, the amendment has liberalised the FDI policy by allowing downstream investments by LLPs, on the other hand, the amendment has restricted downstream investments by Indian companies with foreign investment. Under the amendment, Indian companies with foreign investments can make downstream investments in other Indian companies or LLPs only in sectors where 100% FDI is allowed under the automatic route and no FDI-linked performance conditions apply. Under the unamended FDI policy, Indian companies with foreign investment were permitted to make downstream investment in other Indian companies without being subject to the above condition.

The provisions of the unamended FDI policy which specifically discussed the manner in which Indian companies with foreign investment could make downstream investments in other Indian companies without being subject to the above condition have not been voided by the amendment. Accordingly, there is a conflict between the existing provision of the unamended FDI policy and the new provision introduced by the amendment. This will perhaps be clarified by the government in future press notes and clarifications.

FDI in shell companies

Under the unamended FDI policy, government approval was required for FDI in an Indian company with no operations or downstream investments (ie, a shell company). The generally followed practice and interpretation was that FDI in an Indian company which was set up to undertake activities permitted under the automatic route did not require government approval and was not deemed to be a shell company. The amendment clarifies that government approval is not required for foreign investment in an Indian company with no operations or downstream investments when such investment is made to undertake activities which are under the automatic route and have no FDI-linked performance conditions.

Miscellaneous

As per the unamended FDI policy, government approval was required to establish an Indian company with foreign investment (in sectors or activities with foreign investment caps) without the ownership(4) or control(5) of a resident entity. Similarly, government approval was required to transfer ownership or control of an Indian company (in sectors or activities with foreign investment caps) that was owned or controlled by resident Indian citizens and Indian companies that were owned or controlled by resident Indian citizens. The amendment provides that government approval is required only for Indian companies operating under the approval route.

Investment through share swaps in sectors where FDI is permitted under the automatic route is now permitted. Previously, all FDI by share swaps required government approval.

The amendment has also increased the Foreign Investment Promotion Board (FIPB) threshold for considering FDI proposals. The minister of finance (in charge of the FIPB) will now consider proposals up to Rs50 billion, instead of the previous limit of Rs30 billion. Therefore, the Cabinet Committee on Economic Affairs will consider only investment proposals of more than Rs50 billion, as well as investment proposals referred to it by the FIPB.

Comment

The amendment marks a significant departure from the government's approach towards changes to the FDI policy. Now, instead of amending the FDI policy in a piecemeal manner, the government has significantly amended the FDI policy, which – apart from the new restrictions imposed and discussed above – is likely to be received positively by foreign investors. To ease the process for foreign investors, the government has also directed the DIPP to issue a booklet consolidating the FDI-related instructions contained in various government press notes and notifications.

For further information on this topic please contact Abhishek Saxena at Phoenix Legal by telephone (+91 11 4983 0000) or email (abhishek.saxena@phoenixlegal.in). The Phoenix Legal website can be accessed at www.phoenixlegal.in.

Endnotes

(1) Press Note 12/2015 series, dated November 24 2015. Available at: http://dipp.nic.in/English/acts_rules/Press_Notes/pn12_2015.pdf.

(2) 'Transfer' has been defined in Press Note 12/2015 to mean:

  • the sale, exchange or relinquishment of the asset;
  • the extinguishment of any rights therein;
  • compulsory acquisition under any law;
  • any transaction allowing the possession of immovable property to be taken or retained as part performance under Section 53A of the Transfer of Property Act, 1882;
  • any transaction (by acquiring shares in the company or by way of any agreement); or
  • any arrangement or any other means which has the effect of transferring or enabling the enjoyment of any immovable property.

(3) D/o IPP File No 12/15/2009, dated September 15 2015.

(4) As per the FDI policy, a company is considered to be owned by resident Indian citizens if more than 50% of the capital in it is beneficially owned by resident Indian citizen or Indian companies, which are ultimately owned and controlled by resident Indian citizens.

(5) As per the FDI policy, control includes the right to appoint a majority of the directors or control management or policy decisions, including by virtue of shareholding or management rights or shareholders' agreements or voting agreements.

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