The Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce and Industry, Government of India (GOI) recently released the consolidated foreign direct investment (FDI) policy circular of 2017 (New FDI Policy). The New FDI Policy is effective immediately from the date of its publication, i.e., 28 August 2017. The New FDI Policy supersedes the consolidated FDI policy of 2016 issued by the DIPP on 7 June 2016 (Erstwhile FDI Policy) and consolidates all the press notes issued by the DIPP post 7 June 2016 until 27 August 2017.
Key changes brought about in the FDI regime through the New FDI Policy have been set out in Part A below, and key changes by way of press notes/amendments to other laws and regulations, which have been consolidated in the New FDI Policy, have been set out in Part B below.
Part A: Key changes introduced through the New FDI Policy
1.FDI in LLPs: The Erstwhile FDI Policy was silent with respect to conversion of an FDI funded Limited Liability Partnership (LLP) into a company and vice versa. The New FDI Policy allows conversion of an FDI funded LLP operating in sectors/activities where (i) 100% FDI is allowed through the automatic route; and (ii) there are no FDI linked performance conditions, into a company, under the automatic route. Similarly, conversion of an FDI funded company operating in sectors/activities where (i) 100% FDI is allowed through the automatic route; and (ii) there are no FDI linked performance conditions, into an LLP, is permitted under the automatic route.
2. Downstream Investment Intimation: Under the Erstwhile FDI Policy, an entity was required to notify the Secretariat of Industrial Assistance (SIA), DIPP and Foreign Investment Policy Board (FIPB) of its downstream investment. The New FDI Policy requires such intimation to be made to the Reserve Bank of India (RBI) and the Foreign Investment Facilitation Portal.
Comment: With RBI as the intimating authority for downstream intimations under the New FDI Policy, we believe that the intimations are likely to be subject to greater scrutiny, which may not necessarily have been the case when the intimations were required to be made to SIA/DIPP/FIPB under the Erstwhile FDI Policy.
Further, the New FDI Policy is silent on whether the intimation has to be made to regional offices of RBI or the central office of RBI.
3. Cash & Carry Wholesale Trading: Press Note 12 (2015 series) dated 24 November 2015 (PN 12) allowed a wholesale/ cash & carry trader to undertake single brand retail trading, subject to the conditions related to FDI in single brand retail trading sector. This change was subsequently incorporated in the Erstwhile FDI Policy. The New FDI Policy, by doing away with the reference of ‘single brand’, allows wholesale/cash & carry traders to undertake retail trading by way of both single brand retail trading as well as multi brand retail trading, through the same entity, subject to prescribed conditions.
4. FDI in Single Brand Retailing:
(a) Press Note 5 (2016 Series) dated 24 June 2016 (PN 5) has relaxed the local sourcing norms for a period of 3 years from commencement of business i.e., opening of the first store for entities undertaking single brand retail trading of products having ‘state-of-art’ and ‘cutting-edge’ technology and where local sourcing is not possible. Thereafter, provisions of paragraph 188.8.131.52 (2) (e) of the New FDI Policy, dealing with local sourcing norms will be applicable.
Apart from consolidating the aforesaid changes in the New FDI Policy, the New FDI Policy further provides that a committee under the chairmanship of Secretary, DIPP, with representatives from NITI Aayog, concerned administrative ministry and independent technical expert(s) on the subject will examine the claim of applicants on the issue of the products being in the nature of ‘state-of-art’ and ‘cutting-edge’ technology where local sourcing is not possible and give recommendations for such relaxation.
Comment The setting up of a committee to determine whether the product is ‘state-of-art’ and possesses ‘cutting-edge’ technology is a welcome change. However, guiding parameters should be devised for the committee to determine whether a product is ‘state-of-art’ and possesses ‘cutting-edge’ technology. Further, such parameters should also be made publicly available, so that applicants are in a better position to ascertain whether their products are ‘state-of-art’ and have ‘cutting-edge’ technology.
(b) The Erstwhile FDI Policy permitted a manufacturer to sell its products manufactured in India through wholesale and/or retail, including through e-commerce, without government approval. Note ii to paragraph 184.108.40.206 of the Erstwhile FDI Policy, granted similar permission to an Indian manufacture (i.e. the owner of an Indian brand which manufactures in India at least 70% of its products in terms of value in house, and, sources at most 30% of its products from Indian manufacturers). The New FDI Policy does away with provisions in respect of an Indian manufacturer.
- : Since the term ‘manufacturer’ would have covered an ‘Indian manufacturer’ within its ambit, the replicated provisions in relation to Indian manufacturers have been done away with by the New FDI Policy,
5. FDI in E-commerce: The Erstwhile FDI Policy prohibited an e-commerce entity from permitting more than 25% of the sales effected through its market place from one vendor or its group companies. The New FDI Policy clarifies that the 25% of sales value must be computed per financial year.
6. Fresh Approval for additional FDI: Under the Erstwhile FDI Policy, additional FDI into the same entity within the approved foreign equity percentage/or into a wholly owned subsidiary did not require fresh approval. The New FDI Policy has capped the additional FDI to a cumulative amount of INR 5,000 crore, beyond which, fresh approval will be required to be sought.
7. FDI linked performance conditions: Presently, FDI is permitted in LLPs operating in sectors/activities where: (i) 100% FDI is allowed through the automatic route; and (ii) there are no FDI linked performance conditions. While the Erstwhile FDI Policy was silent on what constituted FDI linked performance conditions, the New FDI Policy has defined FDI linked performance conditions as sector specific conditions for companies receiving foreign investment.
Comment: The Erstwhile FDI Policy was silent on what constituted FDI linked performance conditions. Upon having sought informal clarifications from the DIPP on what constituted FDI linked performance conditions, we were given to understand that milestones or other conditions connected with foreign investment, including any exit conditions or repatriation conditions as prescribed under the Erstwhile FDI policy with respect to any sector, will be treated as FDI linked performance conditions. On the other hand, one could have argued that only such conditions which are performance related are likely to get covered within the ambit of FDI linked performance conditions. The New FDI Policy puts this debate to rest by introducing the definition of FDI linked performance conditions. However, the definition introduced is so wide that most of sectors will be covered within its ambit.
Part B: Key changes by way of SOP / press notes / amendments to other regulations
Set out below are key changes which have been introduced to the FDI regime by way of SOP/ press notes / amendments to other regulations, and have been consolidated in the New FDI Policy.
8. FIPB Abolishment: Pursuant to the abolishment of the FIPB vide office memorandum dated 5 June 2017 issued by the Department of Economic Affairs, Ministry of Finance; DIPP released a standard operating procedure on 29 June 2017 (SOP), listing out, inter alia, the competent sectoral authorities which have been entrusted with the powers of granting FDI approval. (For more details on this, please refer to our Newsflash dated 30 June 2016). To this extent, the New FDI Policy reflects the changes introduced by the SOP.
Comment: The process and procedure for filing and processing of FDI proposals, and the time limits and internal mechanisms for monitoring the processing of FDI proposals, have not been incorporated in the New FDI Policy and will continue to be governed in terms of the SOP.
9. FDI in Startups: RBI has amended Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (FEMA 20) vide FEMA 20 (Fifteenth Amendment) Regulations, 2016 dated 10 January 2017, to allow startups to issue convertible notes to foreign investors. Earlier, FDI in startups could only be made by foreign venture capital investors by subscribing to equity or equity linked instruments or debt instruments. (For more details on this, please refer to our Newsflash dated 18 January 2017).
10. Pension Sector: RBI has amended FEMA 20 vide FEMA 20 (Sixteenth Amendment) Regulations, 2016 dated 4 November 2016, to restrict the ownership and control of an Indian pension fund at all times to resident Indian entities as determined by the GOI/ Pension Fund Regulatory and Development Authority (PFRDA), as per the rules/regulation issued by them from time to time. This marks a significant change from the Erstwhile FDI Policy which permitted foreign ownership or control of a pension fund, provided prior governmental approval was sought.
11. FDI in Other Financial Services: Under the Erstwhile FDI Policy, FDI in non-banking financial companies (NBFC) under the automatic route was permitted only in 18 specific activities, subject to minimum capitalization norms prescribed under the Erstwhile FDI Policy. Press Note 6 (2016 Series) dated 25 October 2016, allows 100% FDI under the automatic route in any financial services activities, so long as they are regulated by financial sector regulators, viz., RBI, SEBI, PFRDA or any other regulator as may be notified by GOI, subject to minimum capitalisation norms prescribed by such regulator. Accordingly, the requirement of complying with the minimum capitalisation norms prescribed under the FDI policy has been done away with.For financial services activities which are not regulated or where there is doubt regarding regulatory oversight, FDI up to 100% will be allowed with prior government approval, subject to such prescribed conditions including minimum capitalisation requirements.
Comment: While the New FDI Policy specifically states that 100% FDI is allowed in regulated financial services activities, DIPP has taken the view that FDI in systematically important core investment companies (CIC-ND-SI) shall fall under the approval route, even though CIC-ND-SIs are regulated by RBI.
Further, the DIPP should further amend the New FDI Policy to clarify that 100% FDI under the automatic route would be allowed in an entity which is ‘regulated’ by a financial service regulator but not ‘licensed’ by any financial service regulator. This may become important for entities like Alternative Investment Fund managers who are regulated by Securities Exchange Board of India (SEBI) under the SEBI (Alternative Investment Funds) Regulations, 2012 even though they are not licensed by SEBI.
12. FDI in Infrastructure Companies in the Securities Market: Under the Erstwhile FDI Policy, FDI in ‘infrastructure companies in the securities market’ was permitted up to 49% under the automatic route, subject to certain conditions. Press Note 1 (2017 Series) (PN 1), while retaining the sectoral cap, has done away with the existing conditions associated with the FDI, while at the same time making such FDI including investment by Foreign Portfolio Investors, subject to the Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 (SECC Regulations), and Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996 and other guidelines/ regulations issued by the GOI, SEBI and the RBI.
Comment: FDI conditions in ‘infrastructure companies in the securities market’, which have been done away with by the New FDI Policy are :(i) no Foreign Institutional Investor (FII) shall acquire shares of a recognised stock exchange otherwise than through secondary market; and (ii) no person resident outside India, directly or indirectly, either individually or together with persons acting in concert, shall acquire or hold more than 5% of the paid up equity share capital in a recognised clearing corporation. The aforementioned conditions are, however, contained in the SECC Regulations. Accordingly, even though the conditions have been removed from the New FDI policy by way of PN 1, they are still applicable in terms of the SECC Regulations.
13. Liberalization of the FDI policy in key sectors:
(a) Defence: Under the Erstwhile FDI Policy, FDI was permitted up to 49% under the automatic route and beyond 49% under the government route on a case to case basis where it was likely to result in access to modern and ‘state-of-art’ technology in India. PN 5 allows 100% FDI in the defence sector, where up to 49% is permitted under the automatic route and beyond 49% is permitted under the government route when it results in access to modern technology in India or ‘for other reasons’. Further, the sectoral caps and conditions have now been extended to manufacturing of small arms and ammunitions under (Indian) Arms Act 1959.
(b) Pharmaceuticals: Under the Erstwhile FDI Policy no FDI was permitted in brownfield pharmaceutical projects without governmental approval. PN 5 permits 100% FDI in brownfield pharmaceutical projects, where up to 74% FDI is permitted under the automatic route and beyond 74% is permitted under the government route, subject to prescribed conditions including non-compete, fixing production of National List of Essential Medicines and maintaining research and development expenses.
(c) Broadcasting Carriage Services & Cable Networks: Under the Erstwhile FDI Policy, FDI up to 49% under the automatic route was permitted in broadcasting carriages services and cable networks, beyond which government approval was required. PN 5 seeks to liberalised these sectors by permitting 100% FDI under the automatic route.
(our Newsflash dated 27 June 2016).
14. Deferred Consideration: RBI amended FEMA 20 vide FEMA 20 (Seventh Amendment) Regulations, dated 20 May 2016 to allow deferment of purchase consideration up to 25% of the total consideration, in transactions involving share transfers between residents and non-residents, within a period of 18 months from the date of transfer agreement. Alternatively, the buyer and seller may enter into an escrow arrangement for an amount not more than 25% of the total consideration for a period not exceeding 18 months from the date of the transfer agreement. Prior to the amendment, any transfer of shares inter-se residents and non-residents for deferred consideration would have triggered RBI approval.
15. Remittance against Pre-Incorporation Expenses: Under the Erstwhile FDI Policy equity shares could be issued against pre-incorporation expenses, under the government route, subject to compliance with certain conditions. RBI amended FEMA 20 vide FEMA 20 (Eleventh Amendment) Regulations, 2016 dated 24 October 2016 to allow wholly owned subsidiaries set out by non-resident entities, operating in a sector where (i) 100% foreign investment is allowed in the automatic route; and (ii) there are no FDI linked conditionalities, to issue equity shares, preference shares, convertible debentures or warrants against pre‑incorporation/ pre-operative expenses, subject to conditions prescribed.
16. Branch office, Liaison office or Project Office or any other place of business in India (Offices): Under the Erstwhile FDI Policy, prior approval of the RBI was required for establishment of Offices in India. PN 5 does away with the requirement of seeking prior approval of the RBI for establishment of Offices in India, if the principal business of the entity establishing the Office is defence, telecom, private security or information and broadcasting, in cases where government approval or license/permission by the concerned ministry/regulator has already been granted.
The New FDI Policy has introduced certain key changes as highlighted above, with an intent to provide an investor-friendly climate to foreign players. However, certain ambiguities which existed under the Erstwhile FDI Policy continue to remain under the New FDI Policy. For instance, owing to the broad definition of real estate business i.e., dealing in land and immovable property with a view to earning profit, there is no clarity on whether consultancy or brokerage will be covered under the ‘real estate business’. Further, while the policy defines the term ‘manufacturing’, it is silent on the definition of ‘manufacturer’. Therefore, it is unclear whether an entity will be deemed to be a manufacturer even if it outsources a part of its manufacturing activities to third parties or relies on contract or toll manufacturing in India. The policy is also silent on whether an entity undertaking single brand retail trading will be allowed to undertake retailing of its sub brands.
We expect a series of reforms and clarifications through press notes in the days to come in line with the government’s initiatives such as ‘Make in India’ and improving the ease of doing business in India. It is hoped that the ambiguities currently existing under the FDI regime will also be gradually resolved.