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Consolidated FDI Policy: A Welcome Move

07 April, 2010
In an attempt to simplify the rules and regulations pertaining to the foreign direct investment (“FDI”) policy, the Department of Industrial Policy and Promotion (“DIPP”), Ministry of Commerce and Industry, Government of India, issued a consolidated FDI policy (the “Circular”) on March 31, 2010. The Circular which became effective from April 1, 2010 consolidates and more importantly, subsumes, all prior press notes / press releases / clarifications issued by the DIPP as on March 31, 2010 and reflects the current policy framework on FDI.
 
A press release issued by the Ministry of Commerce and Industry on March 31, 2010 quotes Mr. Anand Sharma, Union Minister of Commerce and Industry:
 
“One of the most significant aspects is that all the Press Notes issued in the past will be rescinded with the issue of this Press Note, which would now comprise the single document on FDI policy.  As such, this marks the inception of a whole new chapter on FDI policy”
 
The press release clarifies that the Circular is a mere consolidation / compilation and does not intend to change the existing legal framework. Any changes notified by the Reserve Bank of India from time to time would have to be complied with. Further, in the event of any need / scope of interpretation of the Circular, the relevant Foreign Exchange Management Act, 1999 (“FEMA”) notification / rule / regulation would prevail.
 
Also, the Government has decided to update the FDI policy on a six monthly basis, by issuing a new circular which would supersede all prior press notes and circulars. Hence, this Circular would be superseded with a circular to be issued on September 30, 2010.

Industry Specific changes
 
Venture Capital Funds (“VCF”) and Trusts
 
Earlier, a SEBI registered foreign venture capital investor (“FVCI”) was allowed to invest in a domestic VCF registered under the SEBI (Venture Capital Fund) Regulations, 1996 under the automatic route (i.e. without any approval being required). Accordingly, there was no distinction with respect to accepting foreign investment from an FVCI for a VCF, structured either as a company or as a trust. With this Circular, the position seems to have changed:
 
a.       An FVCI can now invest in a VCF (that is set up as a trust registered under the Indian Trust Act, 1882) upon obtaining a prior government approval. 
 
b.       Investment in a trust which is not registered with SEBI as a VCF is not permitted.
 
These changes impede a commonly used ‘unified’ structure and severely restrict the structural alternatives available for such funds. Another concern that may arise is on account of ambiguity as to whether in case of a ‘unified’ structure that is already in place and in the absence of any grandfathering provision in the Policy, if an FVCI (registered prior to April 1, 2010) has to invest in the units of a VCF (registered prior to April 1, 2010) whether any further governmental approval would be required. Such investments were being made under the automatic route thus far.
 
Agriculture
 
Investment in agriculture was allowed upto 100% under the automatic route in various specified forms of agriculture including development of seeds, aquaculture and cultivation of vegetables and mushrooms under control conditions and services related to agro and allied sectors etc. However, the Circular has added certain conditions for companies dealing with the development of transgenic seeds/vegetables, namely:
 
        Such companies shall comply with laws enacted under the Environment (Protection) Act on genetically modified organisms;
 
        Import of genetically modified material shall be governed by the conditions laid down vide notifications issued under Foreign Trade (Development and Regulation) Act, 1992;
 
        Activities relating to the use of genetically engineered cells and material shall be subject to the receipt of approvals from Genetic Engineering Approval Committee (GEAC) and Review Committee on Genetic Manipulation (RCGM);
 
        Import of materials shall be in accordance with National Seeds Policy; and
 
        The company shall comply with any other law / regulation / policy relating to genetically modified material.
 
Research and Development
 
The circular provides for 100% FDI in “research and development excluding basic research and setting of R&D / academic institutions which would award degrees / diplomas / certificates”.
 
The exclusion of “basic research and setting of R&D / academic institutions which would award degrees / diplomas / certificates” is confusing.
 
        Is the intent just to exclude ‘basic research’ and if so what is meant by ‘basic research’?
 
        Along with basic research, is “setting of R&D / academic institutions which would award degrees/ diplomas / certificates” also to be excluded, thereby restricting investment in the education sector?
 
The answer to the second question could not possibly be in the affirmative, because it has been generally understood, communicated and clarified by the Parliament that there is no restriction on foreign investment in the education sector under the FDI policy.  The Circular also specifically states that any sector/industry that is not specifically mentioned is eligible to receive 100% foreign investment under the automatic route. The education sector has not been specifically mentioned, and therefore would be under the 100% automatic route.  However, the unfortunate drafting of the language quoted above would still throw up questions and doubts unless it is amended or clarified.
 
Cash and Carry Wholesale Trading
 
The Circular has introduced guidelines for wholesale trading / cash and carry wholesale trading. While the FDI limit has been maintained at 100%, the DIPP has introduced certain guidelines which companies involved in wholesale trading need to adhere to in order to receive foreign investment.
 
The Circular provides that in order to determine whether the sale is a wholesale trading or not, one needs to consider the type of customers to whom the sale is made as opposed to the size or volume of sale. Accordingly, sale for the purpose of trade, business and profession, as opposed to personal consumption, would be regarded as wholesale trading.
 
The guidelines provide that in order to be eligible for 100% FDI:
 
(i)      Companies undertaking wholesale trading must obtain requisite permits from governmental authorities;
 
(ii)    The sale by wholesale trading companies can only be made to entities (other than governmental entities), which:
 
a)       hold sales tax / VAT / excise / service tax registration; or
 
b)       hold trade licenses / registrations / certificates from governmental authorities (including local self-government) reflecting that such entity is engaged in the business involving commercial activity; or
 
c)       hold permits from governmental authorities for undertaking retail trade; or
 
d)       are institutions having certificate of incorporation or registration as society or a trust.  
 
The guidelines further go on to clarify that a wholesale trader receiving foreign investment is prohibited from setting up a retail shop which directly cater to the consumers. The guidelines permit wholesale trading between group companies only to the extent of 25% of the turnover of such wholesale trading company provided that such sale is for internal use.
 
The intention behind the introduction of these guidelines seems to be to ensure that no foreign investment is received in the retail sector (which, barring single-brand retail, falls under the negative list) in the guise of investment in wholesale trading / cash and carry wholesale trading. It is also pertinent to note that the guidelines contained in the Circular seem to draw inspiration from the 2004 decision of the Hon’ble High Court of Delhi in the case of Federation of Associations of Maharashtra & Ors. v. Union of India & Ors., which, at great lengths, discussed the distinction between retail trade and wholesale cash and carry trade.
 
FDI in lottery, gambling and betting sector: Clarification
The government has in the past (Press Note 5 of 2002) clarified that foreign investment and foreign technology collaboration in any form are completely prohibited in the lottery business, gambling and betting sector. However, there existed certain ambiguity as to whether foreign licensing of franchise / trademark / brand name, management contract, etc., are permitted in the lottery business, gambling and betting sector. The Circular has made clear that foreign investment in any form, foreign technology collaboration in any form including licensing for franchise, trademark, brand name, management contract is also completely prohibited for lottery business, gambling and betting activities.  

Issues pending consideration:
 
There are several issues related to the FDI policy which are yet to be clarified, some of which even the press release of March 31, 2010 acknowledges:
 
(a)     Foreign investment in Limited Liability Partnerships (LLPs): Recent news reports suggest that the Government may allow foreign investment in LLPs upto 49% with prior approval of the FIPB. However, the Circular is silent on this aspect and we expect the Government to release its policy on LLPs very soon.
 
(b)     Issuance of partly paid shares/warrants. Now that warrants and partly paid up shares have been specifically prohibited, it would seem that even the FIPB would not be able to approve their issuance to foreign investors.  This move may be a pre-cursor to a definitive legal framework that the government may introduce on the issuance of such securities.
 
(c)     Clarifications on issues related to Press Notes 2, 3 & 4 of 2009: Leading banks in the country (such as HDFC Bank and ICICI Bank) were concerned about the applicability of Press Notes 2, 3 and 4 of 2009, which classify them as ‘foreign banks’. From a recent news report, we understand that the Department of Economic Affairs (“DEA”) in the Union Finance Ministry has clarified that the guidelines would apply to the banks only prospectively.
 
However, the applicability of the Press Notes per se to the banking companies is an issue yet to be decided. It has been reported that the Department of Financial Services (“DFS”) within the ministry and DEA seem to have divergent opinions on the same. While the DFS believes that the press notes should not be applicable to the banking sector, the DEA does not agree.
 
(d)     Tightening of FDI norms: Another news report claims that the finance ministry has proposed to tighten the FDI policy with respect to downstream investment by firms with foreign minority shareholding. The proposal envisages that an investing or an operating company with foreign investment less than 50%, would be permitted to make downstream investment only in sectors where 100% foreign investment is allowed under the automatic route.  This would imply that downstream investment in sectors with caps would require FIPB approval. The finance ministry believes that the existing regime could result in breach of FDI caps (or foreign investment in prohibited sectors), thereby rendering the government policy of having FDI caps in various sectors redundant.
 
The simplified policy framework will add a certain degree of transparency, predictability and clarity to the FDI regime and will reduce the regulatory burden as well. However, there is still a lot more that can be done to truly consolidate the existing FDI policy.

 


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Consolidated FDI Policy: A Welcome Move

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