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This article has been written by Aditya Saurabh, pursuing a Diploma in Business Laws for In-House Counsels from LawSikho.

Introduction

Foreign Direct Investment (FDI) plays an important role in channelizing the transfer of capital and technology in e-commerce sectors, which act as a digital platform that provides greater access to sellers in remote areas of the country to reach widespread consumers. Due to FDI, it is believed that the growth rate of e-commerce in India is increasing rapidly and is thus promoting the economic growth of the country. India has developed FDI Policy in e-commerce to ensure that the FDI is properly regulated, there is ease in doing business and marketplaces provide a level playing field to all participants. 

However, due to the recent tightening guidelines for FDI contained in Press Note No. 2 (2018 series), released by the erstwhile Department of Industrial Policy and Promotion (DIPP), now referred to as the Department for Promotion of Industry and Internal Trade (DPIIT), the Indian e-commerce sector especially the dominant players of it, i.e., Amazon and Flipkart were badly hit by the changes. These changes have now been incorporated in the FDI Policy vide Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Fifth Amendment) Regulations, 2019, dated 31 January 2019, Notification No.FEMA.20(R) (6)/2019-RB.

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While the intention of the Government would be to ensure fair play in the marketplace, there is a need to analyse the stakeholder’s response to these changes. It is also important to understand these current FDI norms, which are not entirely free from the lacunae and require further clarifications by the Government in the near future.

Current changes in FDI norms

In India, FDI is governed by the Foreign Exchange Management (Transfer or Issue of Security to Persons Resident Outside India) Regulations, 2017; also known as TISPRO Regulations, which lays down two routes of investment in India: Automatic Route and Government Route. Under the Automatic Route, the investor does not require any approval from the Government of India for the investment, whereas the approval of the government is a prerequisite for investment under the Government Route. 

Further, e-commerce entities are classified into two models: Marketplace-based model, where the e-commerce entity acts as a platform between the buyers and the sellers and it does not exercise ownership over the goods sold on the platform; and Inventory-based model, where the e-commerce entity owns the goods sold on the platform. 

Currently, key highlights as per the Press Note 2 (2018 series) are:

  • Under the automatic route, FDI in the marketplace-based model of the e-commerce sector is allowed upto 100%, and the same is disallowed in the inventory-based model of e-commerce. 
  • Marketplace e-commerce entities are only permitted to enter into transactions with sellers registered on its platform on a Business to Business (B2B) basis, i.e., where the transaction is between two businesses.
  • The e-commerce marketplace entity or its group companies are not allowed to have any equity participation or control in the selling entity; thus prohibiting such marketplaces from selling products of such entities on their platform. 
  • The e-commerce marketplace entity is not allowed to exercise ownership or control on the inventory as such control or ownership will cause the e-commerce entity to become an inventory-based model. Further, not more than 25% purchases of the vendor (selling entity) can come from one marketplace or its group companies and the onus of ensuring it is now on the e-commerce platform.
  • The e-commerce entity is mandated to provide services (such as logistics, warehousing, advertisement, payments, financing, etc.) to the selling entity at an arm’s length and in a fair and non-discriminatory manner.
  • The e-commerce marketplace entity is prohibited from mandating Exclusivity on any seller. 
  • The e-commerce marketplace entity is not allowed to influence, directly or indirectly, the sale price of goods sold by deep discounts. Further, ‘cashbacks’ to customers has not been recognised as violative of influencing the sale price of goods by the e-commerce entity and rather only requires cashback to be given in a fair and non-discriminatory manner.
  • The e-commerce marketplace entity is required to display the contact details of the selling entity to the customers so that customer satisfaction is directly looked at by the seller. Also, the warranty and guarantee of goods and services is the responsibility of the seller.
  • The e-commerce marketplace entity is required to furnish proof of compliance with the FDI guidelines by submitting a certificate and a report of the statutory auditor to the Reserve Bank of India before 30th September of every year. 

Reasons to change FDI norms

The current FDI norms via Press Note 2 (2018 series) was released after various concerns and complaints against the e-commerce entities (namely, Flipkart and Amazon) were made by the small brick and mortar traders, the trader’s association such as the Confederation of All India Traders (CAIT) and the All India Online Vendors Association (AIOVA). 

The allegations were pertaining to the flouting of the provisions of the TISPRO Regulations, thereby affecting the interests of the small traders of India. Some of the allegations on e-commerce entities were:

  • Giving preferential treatment by e-commerce entities such as Amazon to its own sellers like Appario and Cloudtail. 
  • Influencing the prices of products by deep discounting and indulging in predatory pricing.
  • Indirectly engaging in an inventory-based model of e-commerce as Flipkart was selling products that were owned by its erstwhile subsidiary company WS Retail.
  • Forming a dominant position by e-commerce entities in the market by entering into exclusive deals such as that with OPPO, VIVO, XIAOMI, etc.

The changes were thus important to ensure fair play is maintained on the platform and in the market.

Impact on e-commerce giants (Amazon and Flipkart)

This new amendment in FDI policy that was to come into effect on the 1st of February 2019, was called ‘regressive’ by the U.S based e-commerce giant Walmart and US-India Strategic Partnership Forum (USISPF) as according to them it would have created an unfair playing field between foreign and domestic entities and thus would have harmed the growth of Indian online retail market. However, to avoid losses and anticipated exit from the Indian market the e-commerce giants operating in India, i.e., Amazon and Flipkart made significant structural changes as they could not have afforded to lose the second-largest market in the world.

Amazon

The future of Amazon was compromised after the no-equity participation rule and the 25% purchases from one marketplace rule as they were selling products and services through its alpha sellers like Cloudtail India and Appario Retail and held major stakes in them. Due to the new FDI policy, the biggest e-tailers of Amazon: Appario Retail and Cloudtail India had to stop their activities and Amazon had to cut down the percentage stake in these firms and shape accordingly. Due to this, various products remained unavailable like the Echo range of smart speakers.

Amazon sold 25% of its share in Cloudtail India to Prione Business Services Pvt., which is run by N.R Narayana Murthy’s Catamaran Ventures, thus increasing their stake in Cloudtail India from 51% to 76%, and reducing the non-Indian arm of the US retailer, called Amazon Asia-Pacific Resources Ltd’s stake to 24% from 49%. This created an indirect equity stake in Cloudtail India by Amazon. Similarly, Appario Retail, which is a joint venture company in which the Patni Group held 51% stake and Amazon Asia-Pacific Resources Ltd held 48%, the equity participation of Amazon was reduced to below 25%. After these restructuring processes, these sellers made a comeback on the Amazon platform.

Therefore, Amazon created indirect equity participation in Cloudtail India and Appario Retail through its non-Indian arm and by reducing such equity participation below 26%, it made the Amazon Asia-Pacific Resources Ltd. (non-Indian arm) no longer the group companies of Amazon India. As per the RBI Notification No. RBI/2013-14/356, dated November 01, 2013, a ‘Group company’ means two or more enterprises which, directly or indirectly, are in a position to exercise twenty-six percent or more of voting rights in other enterprises; or appoint more than fifty per cent, of members of the board of directors in the other enterprise. By selling 25% of its shares to Catamaran Ventures, Amazon India made it compliant with the new FDI rules.

Flipkart 

Flipkart was less impacted due to the new FDI rules as their affiliated seller WS Retail had stopped its business with it, prior to the release of these FDI rules. It was reported that the products sold at Flipkart by WS Retail (affiliated seller of Flipkart) were purchased from Flipkart and around 75 percent of the business in the Flipkart came from WS Retail. This would have made Flipkart into an inventory-based model as it exercised ownership or control over the inventory or the goods purported to be sold. Further, two co-founders of Flipkart started WS Retail and then controlled 46% of the equity in it. Currently, WS Retail is no longer a seller on Flipkart and thus Flipkart has no equity participation in its vendors. Flipkart has since then started to diversify its list of sellers. 

In order to comply with the 25% purchases from one marketplace rule, Flipkart has built a ‘layer of B2B entities’, by appointing half a dozen intermediaries who buy goods from Flipkart and sell them to the preferred sellers like SuperComNet, Omni-Tech Retail and RetailNet who in turn, sell them on Flipkart. Therefore, the aforementioned 25% rule is not hit by the new policy as these purchases are not made from the marketplace entity or its group companies ‘directly’.

Further, Walmart (a US giant) that owns Flipkart and has acquired 77% share in it, makes it the controlling stakeholder. Walmart, in order to comply, cannot after this policy sell its inventory online as the e-commerce entity will be said to have control or ownership on its inventory and will thus fall under the purview of the new policy.

Thus, the e-commerce giants took a considerable hit due to the implementation of the new FDI Policy. Amazon’s shares listed on Nasdaq fell by 5.38% to $1626.23, losing $45.22 billion in market capitalisation and Walmart’s share price on NYSE fell by 2.06% to $93.86, losing $5.7 billion in market capitalisation. Recently, in the fiscal ended March 31, 2020 revenue of Amazon India’s wholesale unit fell 70% to Rs 3,387 crore, due to this new FDI policy.

Clarifications needed in FDI norms

In the clarifications released by DIPP on 3rd January, 2019, it was stated that the Press Note 2 (2018 series), did not bring new changes but was only to reiterate the policy provisions to ensure better implementation of the policy in letter and spirit. However, it does not seem so.

Although the Government has clarified the misconception regarding the prohibition of the sale of private labels, i.e., the brands developed in-house by the e-commerce marketplace entity, that no restriction is imposed on the nature of the products sold through the platform. There are certain issues over which clarification has remained unanswered. 

25% Purchases (Control over Inventory)

In the Press Note 2, under ‘Other Conditions’ as per clause (iv), “inventory of a vendor will be deemed to be controlled by e-commerce marketplace entity if more than 25% of purchases of such vendor are from the marketplace entity or its group companies”, which will render the business into the inventory-based model. Thus, not more than 25% of purchases of the vendor (selling entity) can come from one marketplace or its group companies, which makes the compliance complicated as e-commerce entities will have to ascertain the total volume of purchases and sales of each of the vendors to ensure compliance.

For Illustration: Suppose X, a vendor engaged in selling kitchen appliances, makes 150 purchases from Amazon, out of the total purchases made by it from different e-commerce platforms, which is 400. This violates the Press Note 2 provisions of 25% purchases and in order to assess it, the X vendor’s details of their sales and purchases on/from all the e-commerce entities with which they are sharing a business relationship would be required.

This thus enables the e-commerce entity (for eg. Amazon) to manipulate their stronghold in the market to the detriment of other competitors as the e-commerce entity would have a lot of data on the quantum of sales made by their competitors. Furthermore, it would be difficult to ascertain whether the product purchased from one e-commerce marketplace is sold on the same e-commerce marketplace as in the above illustration, out of total of 400 purchases any purchased product can be sold on Amazon, and it is not obvious that the 150 purchases made from Amazon are sold on Amazon. This could make the establishment of ‘control over inventory’ dubious and more complex.

Furthermore, since the ‘25% sales threshold’ is no longer in existence, without violating the ‘25% purchases threshold’ an e-commerce entity can make 100% sales through only one vendor thereby exercising control over the inventory or goods purported to be sold. This shall make an e-commerce entity having a foreign investment engage in a B2C business model which is prohibited by FDI Policy. It will also eliminate the other vendors selling the same products by enabling the e-commerce entities to give preferential treatments to one vendor.

For Illustration: Suppose X, a vendor engaged in selling kitchen appliances, makes 100 purchases from Amazon, out of the total purchases made by it from different e-commerce platforms, which is 500. Even in a situation where the sales of Amazon in a financial year is 100, all of which is affected by one vendor X, the purchases only amounted to 20% from Amazon, which is well below the 25% purchase threshold. 

Further, this clause (iv) states that the inventory should not be controlled by the e-commerce entity but no clarity regarding the definition of ‘control’ is provided in this context. It is also difficult to define control as the distinction between warehousing arrangements intended to promote handling efficiency and speed, and arrangements intended to give indirect control is difficult to ascertain.

Equity participation

In Press Note 2, under ‘Other Conditions’ as per clause (v), an entity having equity participation by the e-commerce entity or its group companies will not be allowed to sell its products on the platform. It is important to note here that the term ‘equity participation’ has not been clarified as to whether such participation is required to be direct or indirect, and if there is a minimum threshold or no equity participation is allowed by the e-commerce marketplace entity. This affects the compliance to be performed by the e-commerce, the breach of which could attract hefty monetary penalties under S. 13 of the Foreign Exchange Management Act, 1999 (FEMA).

In order to comply with the FDI rule changes as per Press Note 2, e-commerce companies such as Amazon and Walmart’s Flipkart have restructured their equity participation in the sellers or create complex structures and now only indirectly own stakes. Indian Government’s spokesperson has said that the government will consider revising the policy once again to target these structures as even indirect stake should not be allowed, after continued pressure from sellers and associations such as CAIT. However, no such changes have been notified yet. If such changes are notified, even more layering by e-commerce entities will be created which will add up compliance costs and increase complexity in taxation. This also hampers the idea of the ease of doing business in India.

Services to vendors under similar circumstances

In the Press Note 2, under ‘Other Conditions’ as per clause (ix), e-commerce entities in order to ensure a level playing field are required to provide the same provision of services to all sellers under ‘similar circumstances’, otherwise would be deemed unfair and discriminatory. It is important to note here that this is difficult to comply with as the criterion to determine ‘similar circumstances’ is not clarified, which is also different from ‘same circumstances’, and thus opens a wide area of interpretation over each circumstance.

Further as a part of business strategy or as a reward, any business including an e-commerce entity may wish to provide enhanced services to the sellers or vendors. For example, where the vendor voluntarily enters into an exclusive deal with the e-commerce entity, marketing advertising, faster delivery, discounts, etc. services can be wished to be provided by the e-commerce entity to fulfil the business objectives. This should not be curtailed by a policy and clarification over this is necessary.

Exclusivity

In Press Note 2, under ‘Other Conditions’ as per clause (xi), e-commerce entities are prohibited from mandating any seller to sell products exclusively on its platform. It is important to note here that the compliance with such provision is difficult to be checked as a vendor may consciously decide after taking into consideration his marketing strategies to sell his products exclusively on one platform. One such example is the OnePlus brand on Amazon. Thus, this may also require clarity as to the add-up mechanisms to check whether such exclusivity is due to coercion by the e-commerce entity or due to the free will of the vendor. Otherwise, how would the exclusivity be determined?

Compliance before RBI

In Press Note 2, under ‘Other Conditions’ as per clause (xii), e-commerce entities are required to furnish a certificate along with a statutory audit before the Reserve Bank of India before 30th September of every year. It is important to note here that certain compliances are to be performed even by the vendors as per the 25% purchases compliance rule, over which clarity was required.

A consequence of change in FDI norms

For online and offline vendors/sellers/brands

The changed FDI norms that curb unfair and discriminatory practices, intend to bring a great level playing field for both online as well as offline brands and sellers who were troubled due to the preferential treatment and predatory pricing mechanisms of these e-commerce marketplaces. Due to the level playing field, most of the customers that ran after online shopping due to cheaper rates may favour physical stores as the product prices will become almost uniform.

For customers

The changed FDI norms impose a duty on the e-commerce entity to clearly provide the contact details of the seller on its website and also the customer satisfaction to be the responsibility of the seller. This would mean better consumer relationship management (CRM) practices by the seller and since the problems and questions will be heard directly by the seller, better satisfaction.

Further, due to the changed FDI norms that prevent mandated exclusive deals, the sellers and e-commerce entities will be disallowed from exclusively selling a product and may thus have to sell their products at all marketplaces. Thus, the customers may enjoy more options in an e-commerce marketplace.

However, due to the changed FDI norms on equity participation and 25% purchases rule, the unbelievably cheap deals on the e-commerce marketplace will no longer be available to customers. This is because now the products will be directly sold by the seller, and no earlier mechanism would be followed where the e-commerce platforms used to buy products at bulk from manufacturers at a heavy discount and then sold them at a lower cost to the sellers on which they had stakes. These sellers used to sell the discounted products on the respective e-commerce platforms at low prices due to low marginal costs. Thus, helped in deep discounting which is no longer to be practised.

For foreign-funded e-commerce entities

The changed FDI norms create an unlevel playing field as it only impacts the marketplaces which are funded by foreign persons such as Flipkart and Amazon, and tends to exclude the domestic marketplace entities such as Paytm Mall, Snapdeal, etc. The Government’s intention to create a level playing field in the Indian e-commerce sector and to ensure fairness and justice seems to have failed by not taking the domestic entities within this ambit due to which the domestic entities may indulge in unethical business practices.

Conclusion

The Press Note 2 (2018 Series) was released with the objective to ensure a level playing field between the FDI powered e-commerce companies and the small/big, online/offline traders. But, the objective of the level playing field itself seems to have failed due to the limited ambit of the FDI policy which does not cover the domestic entities, thus not restricting them from unethical practices. Its enforcement was thought to affect the flexibility of e-commerce platforms that would have forced them to be fair and non-discriminatory; but, the e-commerce giants have with certain restructuring and due to the loopholes present in the new policy easily circumvented the policy.

Further, the policy nowhere addresses the issue of big discounts offered by the banks, credit card companies and payment aggregators on the e-commerce platforms, as it attracts many customers creating an unlevel playing field. Thus, it would not be wrong to say that e-commerce entities have great potential and support in the Indian market to grow. The effectiveness of the new FDI policy thus would depend upon how the loopholes and grey areas are curbed with clarifications and additions in its provisions.

References

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