The law regulating foreign direct investment (“FDI”) in e-commerce in India has evolved considerably in recent years. From the Press Note 3 in 2016 to the more current Press Note 2 of 2018 (“PN2”) and the draft national e-commerce policy, the Government of India has created a framework and sought to define the contours of FDI in e-commerce. This is a delicate balance as India strives to remain an attractive destination for foreign investment while simultaneously attempting to safeguard the interests of domestic Indian traders.

Over the last few years, there has been considerable debate regarding foreign investment in the e-commerce space and whether it is consistent with the spirit of the existing policy framework which otherwise tightly regulates FDI in retail & wholesale trading. Press Note 3 in 2016 and the more recent PN2 appear to have been issued in this background. While PN2 largely reiterates the positions as were set out in Press Note 3 of 2016, some new conditions have also been introduced – which in turn may have given rise to some unintended consequences.

Meaning of ‘equity participation’: PN2 restricts an entity having equity participation by an e-commerce marketplace entity or its group companies from selling its products on the platform run by the said marketplace entity. While PN2 imposes this restriction, it is not clear what equity participation means. If interpreted literally, equity participation would mean ‘any’ equity participation, irrespective of the quantum – even if such foreign investment in the seller entity is otherwise permitted by law. This creates an anomaly, especially if another provision of law allowed such equity participation.

The 25% rule: Prior to PN2 becoming effective, an e-commerce entity was required not to permit more than 25% of the sales value in a financial year from any one vendor or its group companies. However, post implementation of PN2, this restriction on quantum of sales on the marketplace platform seems to now have been linked to purchases made by a vendor from the marketplace entity or its group company instead of sales made by a vendor through the marketplace. As it stands under PN2, if more than 25% of purchases of a vendor are from the marketplace entity or its group companies, then the marketplace entity will be deemed to exercise control over the inventory of the vendor, thereby rendering the business into inventory based model, in which FDI is not currently permitted.

The practical implementation of this rule may need to be considered as the marketplace entity is not likely to have the information to determine whether each seller on its platform is in compliance with this requirement. The marketplace entity (having FDI) seems to be running the risk of non-compliance if a seller exceeds the said 25% threshold while making purchases for its own business. Also, compliance with PN2 is required to be certified in respect of an e-commerce entity by its statutory auditor on an annual basis – which requirement for certification by the statutory auditor does not seem to have been included in the formal amendment to the relevant FEMA regulations. Having said that, every marketplace entity would need to examine the feasibility of checking compliance with the 25% rule vis-à-vis each of the sellers on its marketplace and put in place appropriate mechanisms to monitor such compliance.

While PN2 is aimed at protecting consumer interests as well as interests of domestic traders, one hopes that the investor sentiment remains buoyant and that India continues to be an attractive destination for foreign investment.