Regulatory Framework on FDI in E-Commerce

• Introduction

With the stated aim of clarifying the foreign direct investment (‘FDI’) regime for e-commerce activities, the Department of Industrial Policy and Promotion (‘DIPP’) has issued Press Note No. 3 (2016 Series) on March 29, 2016 (‘Press Note’). Prior to the Press Note, the Consolidated Foreign Direct Investment Policy issued by DIPP (‘FDI Policy’) allowed 100% FDI under the automatic route (i.e. without requiring prior approval of the Government of India) in business to business (B2B) e-commerce activities, but did not permit FDI in multi-brand retail trade activity through online e-commerce. In such a regulatory landscape, the ‘marketplace’ model became popular; under the marketplace model, the marketplace entity provided a technology platform to connect buyers and sellers and did not itself undertake any trading activity. Such entities received FDI without any prior approvals from the Government of India. The regulatory framework for e-commerce has now been altered by the Press Note in the manner discussed below.

• Salient Features

i. FDI up to 100% under the automatic route is now permitted in the ‘marketplace’ model (definition discussed below in paragraph (iv) of the section on New Definitions), subject to certain conditions, including those described below.

ii. FDI is not permitted in the ‘inventory-based’ model (definition discussed below in paragraph (iii) of the section on New Definitions).

iii. Subject to the conditions in the FDI Policy applicable to the services sector and applicable laws / regulations, security and other conditionalities, FDI up to 100% is also permitted, under the automatic route, in entities engaged in the sale of services through e-commerce.

iv. Other noteworthy aspects of the new framework for e-commerce include:

        a. the inclusion of goods coupled with services within the purview of e-commerce;

        b. the clarification that marketplace entities are permitted to provide ancillary services such as delivery, logistics etc.;

        c. marketplace entities not being permitted to have sales of more than 25% from one seller / vendor; and

        d. marketplace entities being restricted from directly or indirectly influencing the sale price of goods/ services and being required to maintain a level playing field.

• New Definitions

The Press Note has introduced the following new definitions:

i. E-commerce: E-commerce means “buying and selling of goods and services including digital products over digital & electronic network”.1 The definition of e-commerce includes buying and selling of goods and services (including digital products) within its purview. At the same time, paragraph 3.0 of the Press Note suggests that the services sector is outside the purview of the Press Note and continues to remain eligible for 100% FDI under the automatic route. The interplay of the definition of e-commerce read with paragraph 3.0 of the Press Note suggests that the Press Note may not apply to entities merely providing services including digital products, except where they are buying and selling both, goods and services.

ii. E-commerce Entity: An e-commerce entity has been defined to mean “a company incorporated under the Companies Act, 1956 or the Companies Act, 2013 or a foreign company covered under section 2(42) of the Companies Act, 2013 or an office, branch or agency in India as provided in section 2(v)(iii) of the Foreign Exchange Management Act, 1999, owned or controlled by a person resident outside India and conducting the e-commerce business.”

It is not clear why the Government felt the need to include, within the definition of e-commerce entity, a foreign company or a branch or agency in India, when the conditions in the Press Note are applicable only to FDI investment, which is a very specific route of investment in an Indian incorporated entity under the Foreign Exchange Management Act, 1999 and the rules and regulations notified thereunder ( ‘FEMA Regulations’).

An office or branch of a foreign company is merely a form of presence of the foreign company itself, the establishment and operation of which is separately regulated under FEMA Regulations. This kind of presence i.e. a foreign company or an office, branch or agency of a foreign company in India does not actually receive FDI, and therefore inclusion of these kinds of entities in the Press Note (which is intended to govern conditions for FDI in the e-commerce sector) is unclear. Also, given that the definition is restricted to companies and does not specifically include limited liability partnerships (‘LLP’), it is not clear if it is intended to exclude LLPs from the purview of the Press Note, implying that an LLP cannot conduct permissible e-commerce activities.

iii. Inventory Based Model of E-commerce: This model has been defined under the Press Note 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”. The Press Note does not permit FDI in entities that operate under an inventory based model of e-commerce.

iv. Marketplace Based Model of E-commerce: The Press Note defines this model as “providing of an information technology platform by an e-commerce entity on a digital & electronic network to act as a facilitator between buyer and seller.” This is the model that is popular in the market and which has been adopted by various aggregation platforms, more prominently for online hotel / room reservations, taxi booking services and online shopping.

• Relaxations Provided for the Marketplace Model

i. Marketplace entity allowed to provide support services to sellers in respect of warehousing, logistics, order fulfillment, call centre, payment collection and other services: This clarification is very welcome. Even before the Press Note was issued, a marketplace entity could have engaged in all these activities. However, the specific clarification included in the Press Note brings in more transparency in implementing the policy. The ability for e-commerce entities to provide these kinds of services could result in greater efficiencies as services ancillary to marketplace operations are commonly housed in different legal entities. We expect marketplace entities to be more optimistic about consolidating these functions within a single entity in light of this clarification.

ii. Express Recognition of Marketplace Model: There has been an increasing trend amongst investors to be a little more cautious about investing or increasing their investments in the Indian e-commerce space. While profitability has been a commercial issue and may continue to be an issue in the foreseeable future, there has also been some circumspection that has resulted from the absence of an express policy statement regarding FDI in the e-commerce sector, negative publicity around FDI in e-commerce and queries that have previously been raised by the regulators.

As the Government’s policy is now expressly stated, it will address concerns raised by various trade associations in their petitions before multiple judicial forums, where it is being argued that the marketplace model is not recognized under the FDI Policy and therefore not eligible for FDI. In our view, this argument was flawed since the FDI Policy cannot be expected to positively list every business model or opportunity that emerges in this fast moving technology rich environment. On the contrary, paragraph 6.2 of the FDI Policy specifically clarifies that FDI is allowed up to 100% under the automatic route in sectors and activities not listed in the FDI Policy. Hence, merely because the marketplace model was not expressly mentioned in the FDI Policy, did not imply that such activity was not eligible to receive FDI prior to the Press Note. If each of its ingredients were eligible for FDI investment, such sector/activity was always eligible to receive FDI.

• Restrictions on the Marketplace Model

i. Marketplace entity cannot exercise ownership over the inventory (goods purported to be sold), as ownership of the goods would result in an inventory based model: While it is clear that ownership of goods by a marketplace entity is not permitted under the Press Note, the scope of the term ‘exercise ownership’ used in paragraph 2.3(iv) of the Press Note is unclear.

ii. Not more than 25% of the sales from one vendor/ its group companies: This condition may affect the business model of certain e-commerce entities, where a significant percentage of sales are often made by one large reseller. Marketplace operators may now have to limit sales made by these resellers to ensure compliance with the Press Note. Such large resellers are therefore impacted despite the Press Note not being applicable to them. While the Press Note does not expressly clarify as to how and when the 25% limit on sales is to be computed, we expect that such compliance will be reviewed on an annual basis. Similar annual checks at the end of the financial year are prescribed in the FDI Policy on wholesale trading where the wholesale entity cannot sell more than 25% of its wholesale turnover to a group company.

iii. Post sales, delivery of goods and customer satisfaction to be seller’s responsibility: There seems to be an inconsistency between this obligation of the seller and the ability of the marketplace entity to provide ancillary support services. On the one hand, the Press Note permits a marketplace entity to provide logistics and ancillary services, while on the other it requires that following the sale, delivery of goods will be the seller’s responsibility. It is likely that the Press Note intended to clarify that the responsibility for all post-sale obligations is that of the seller, and not the marketplace entity. However, contractually, the seller should be free to provide such services in the manner it deems fit (including through an agreement with the marketplace entity, in which case the marketplace entity would be contractually liable to the seller for such services).

iv. Warranty/ guarantee of goods and services sold to be seller’s responsibility: This condition appears to stem from the requirement that goods/ services not be owned by the marketplace entity. This condition seems more in the nature of a clarification rather than a change in the legal position given that a marketplace entity would not usually provide any warranty / guarantee in respect of goods/ services; which warranties / guarantees are usually extended by the manufacturer / service provider.

v. Marketplace entity will not directly or indirectly influence the sale price of goods/ services and will maintain a level playing field: This condition is one of the key changes introduced by the Press Note and is likely to have a significant impact on marketplace entities and their business models. Popular marketplaces invest meaningfully to promote their platform to make it attractive for customers and sellers. Unlike brick and mortar stores which are able to promote their marketplace / shops in numerous ways that can be seen and felt by a customer, there are only a limited number of ways in which an online marketplace entity can promote its virtual presence. The broad language of the Press Note makes it even more difficult for a marketplace entity to promote its platform.

With regard to the obligation to maintain a ‘level playing field’, more than one interpretation may be possible. One school of thought is that this requirement is intended to apply to the sellers on the e-commerce platforms inter-se, such that the marketplace is not built around a single large / dominant seller, which seller is then accorded preferential treatment over other sellers by the marketplace entity. Another reading of this provision could be that the requirement is intended to apply to sellers on the e-commerce platforms vis-à-vis brick and mortar stores, such that brick and mortar stores are not unduly disadvantaged by e-commerce platforms through the actions of such e-commerce platforms, such as through offering discounts / incentives / promotional pricing on goods sold through such platforms. It is however difficult for a marketplace entity to ensure a level playing field with respect to brick and mortar stores, particularly given the inherent differences between the two mediums.

• Conclusion

The Press Note is a step in the right direction by the Government and has introduced much needed and anticipated clarity on FDI in the e-commerce sector.

The conditionalities and restrictions imposed by the Press Note (which states that it shall take immediate effect) are prospective in nature and are not stated to apply to FDI already received by entities engaged in e-commerce activities. Any marketplace e-commerce entities which now intend to receive FDI would need to ensure that such FDI is received in compliance with all conditions of the Press Note. Likewise, any entities with existing FDI (received prior to the issuance of the Press Note) but which intend to receive additional FDI, would need to ensure that the conditions prescribed by the Press Note are complied with going forward. To this end, it may serve well for all existing e-commerce companies to revisit their business models and ensure that their business models are aligned to the Press Note as soon as possible.