This article is written by Afif Khan, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions), from Lawsikho, as a part of his coursework. He is a 2nd year (4th semester), Faculty of Law, Aligarh Muslim University.
The year 2019 witnessed some big changes to the FDI policy coming in force vis-a-vis the e-commerce sector. These new changes are welcomed mostly by the sellers affiliated to the e-commerce industry but loathed by the two big e-commerce giants, namely, Amazon and Flipkart. To be more compliant with the new rules there are some structural changes that Amazon did.
This article seeks to explain the new changes to the FDI policy, the need behind these changes, and the restructuring done by Amazon to comply with the new rules.
What is an FDI policy?
The word FDI stands for ‘Foreign Direct Investment’. It means that when a firm or a business entity located in one country makes an investment in a business located in another country.
The FDI policy is made and regulated in India by the Department of Industrial Policy & Promotion.
There are currently two ways or two routes through which one can invest in India.
The first is the government route for which prior government approval is needed. The second is the automatic route for which no government approval is needed.
Currently, the FDI policy for the e-commerce sector allows 100% FDI for marketplace model through automatic route. This means that an e-commerce entity does not need prior approval from the government before making any investment in India. However, it does not allow FDI for inventory based model of e-commerce.
Further, the current FDI policy only allows engagement of e-commerce entities in a Business to Business (B2B) e-commerce model and not in a Business to Consumer (B2C) e-commerce model.
A Business to Business (B2B) e-commerce model is a model in which the transaction is between two businesses. This mostly happens at a wholesale level. A common example of a business to a business transaction is of Microsoft providing computers to a law firm.
A Business to Consumer (B2C) e-commerce model is a model in which the transaction is between an online retailer/business entity to a consumer, directly. A common example of this model is a suit retailer selling suits online directly to consumers.
What was the need for these changes?
For long, sellers have been complaining against Amazon and Flipkart for flouting FDI norms and giving preferential treatment to some sellers.
Recently, the All India Online Vendor’s Association (AIOVA) had made a complaint to the Competition Commission of India (CCI) accusing Amazon to give preferential treatment to its own sellers Apario and Cloudtail. Apart from this, there have been Flipkart affiliated sellers earlier that requested the CCI to set-up a fair-trade regulatory body to oversee the sector.
The Government also received continuous complaints that some marketplace entities were violating the FDI policy by influencing the prices of products and indirectly engaging in inventory based model of e-commerce.
This new policy is seen as a protectionist policy that helps offline retailers. Since it is the election year, some people are also seeing this as politically motivated due to its protectionist nature.
FDI policy on e-commerce through the ages
The FDI policy on e-commerce was first pronounced by the Government of India in the year 2000 through Press Note 2 (2000 Series). It permitted 100% FDI in Business to Business (B2B) activities. Then, to further provide clarification to the FDI rules the Government issued Press Note 3 (2016 Series). Then, finally, it issued the new Press Note 2 (2018 Series) for reasons stated above.
What is the new FDI policy on e-commerce?
The Department of Industrial Policy & Promotion introduced certain conditions to the already existing FDI policy on e-commerce through Press Note No. 2 (2018 series) on 28th December 2018. It aimed to amend the paragraph 126.96.36.199 of the consolidated FDI policy of 28th August 2017. The new amendments have taken effect from 1st February 2019. Following this, The Department of Industrial Policy & Promotion also provided clarification to these amendments through a press note released on 4th January 2019.
Before going into the policy I would like to define what e-commerce and e-commerce entity means according to the FDI policy.
- E-commerce: E-commerce means buying and selling of goods and services including digital products over digital & electronic network.
- E-commerce entity: E-commerce entity means 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 FEMA 1999, owned or controlled by a person resident outside India and conducting the e-commerce business.
The guidelines prior to the aforementioned amendments stated inter alia that:-
- For e-commerce entities engaged in an inventory based model, FDI is not permitted. (Inventory model means a model where an e-commerce entity engages in the selling of goods and services directly to the customers and owning the inventory of the said goods and services.)
- For e-commerce entities engaged in a marketplace model, 100% FDI is permissible. (Marketplace model means a model where an e-commerce entity only engages as a facilitator between buyers and sellers by providing an information technology platform.)
There are five major changes made by the Press Note No. 2 (2018 Series). These five major changes amend clauses 4, 5, and 9 of paragraph 188.8.131.52.4 and add two new clauses that are 11 and 12, to paragraph 184.108.40.206.4 titled “other conditions’’.
These changes are:-
- Clause 4: It says that a marketplace model based e-commerce entity will not exercise ownership or control over the inventory of goods it aims to sell. The ownership or control over such inventory of goods will render it as an inventory based model if more than 25% of sales of such business are coming from a single seller.
- Clause 5: It removed the earlier clause that disallowed an e-commerce entity to have 25% of sales in a financial year coming from one seller or their group companies and replaced it with a clause that prohibits an entity or its group companies to have an equity share in a vendor’s company that intends to sell on the said e-commerce entity.
- Clause 9: It adds to the earlier clause and mandates that services (such as logistics, warehousing, advertisement, payments, financing, etc.) provided by the e-commerce entity to vendors selling on the said entity should be provided at “an arm’s length” and in a fair and non-discriminatory manner. It also mandates that cash-backs provided by the e-commerce entity to buyers should also be in a fair and non-discriminatory manner.
This means that an e-commerce entity can’t tie-up with vendors for exclusive deals in return of low-profit margins for vendors. The clause also explains fair and non-discriminatory manner as a practice in which the same benefits are offered to different vendors in similar circumstances.
- Clause 11: This is a new clause added to the consolidated FDI policy of 28th August 2017. It expressly prohibits any marketplace entity to have ‘exclusive’ tie-ups with the vendors. This means that an e-commerce entity can’t mandate a vendor to only sell its products on the said marketplace. (No more Oneplus-Amazon or Redmi-Flipkart liaison)
- Clause 12: This is again, a new clause that requires an e-commerce entity to furnish proof of compliance with the FDI guidelines. Such a proof will consist of a certificate and a report of the statutory auditor of the Reserve Bank of India. This clause mandates that such proof has to be submitted for the previous financial year before 30th September of every year.
It is important to shed some light on the clarification issued subsequent to Press Note No. 2 (2018 Series) that delves into the nature of these changes. The Government says in the clarificatory note that these changes are not new but only a reiteration of the Government’s stance on what the FDI policy is. As stated above, the Government kept receiving complaints from sellers and other entities regarding the flouting of norms by the e-commerce entities and hence, to make the e-commerce entities fully compliant with the FDI policy, the government issued Press Note 2 (2018 Series.
What has Amazon done to comply with new changes?
Amazon has a joint venture called Cloudtail with NR Narayana Murthy’s Catamaran Ventures in which Amazon earlier owned a 49% equity stake. To comply with the new guidelines Amazon sold 25% of its own shares to Prione Business Services Pvt., a company that is run by Catamaran Ventures making its stake at 24% in Cloudtail.
What is the effect of rejigging by Amazon?
A company is said to be a ‘group company’ if “two or more enterprises, which, directly or indirectly, are in a position to exercise 26% or more voting rights in the other enterprise or can appoint more than 50% of the members of the board of directors in the other enterprise”.
Hence, by selling 25% of its shares to Catamaran Ventures, Amazon has excluded itself and more precisely Cloudtail from being hit by the aforementioned definition of a group company and hence making it compliant with the new FDI rules.
Is Amazon the only victim of the new FDI policy?
No, Flipkart is the other major ‘victim’ of the new FDI policy of the Government.
In May, last year, Walmart (a US giant) acquired a 77% share in the Indian company Flipkart giving Walmart the controlling stakeholder and hence putting Flipkart under the purview of the new policy.
To comply with the new FDI policy, in particular, the rule that puts a 25% cap on buying directly from one seller, Flipkart has built a ‘layer of B2B entities’. It has built this layer by appointing half a dozen intermediaries whose function is to buy goods from Flipkart wholesale and sell them to the preferred sellers like SuperComNet, Omni-Tech Retail and RetailNet who will, in turn, sell them on Flipkart. This will frustrate the aforementioned 25% rule as buying and selling through intermediaries will not be called ‘direct’ and hence will not be hit by the new policy.
What are the disadvantages to Amazon and Flipkart due to the new FDI policy?
Amazon and Flipkart have been deeply impacted due to the new FDI policy. Firstly, it is reported that Amazon and Flipkart together lost $ 50 Bn. in market capitalization with Amazon’s share price falling by 5.38% on NASDAQ and Flipkart’s by 2.06% on the New York Stock Exchange.
Secondly, online sales worth Rs.35,000 to Rs.40,000 crores, which makes up for 35-40% of the online retail industry could be impacted through the new policy for the fiscal year 2020.
Thirdly, as a consequence of the new policy, Amazon and Flipkart won’t be able to have exclusive tie-ups with sellers for sales of a particular product, and which in turn will make it difficult for these stores to offer big discounts which were one of the reasons why these stores were preferred by consumers over offline retailers.
What are the benefits to other parties, particularly the brick and mortar stores?
The move has been welcomed by the brick and mortar store owners who have been complaining of deep-discounting done by the big e-commerce entities in India.
Between fiscal years 2014 to 2018, the brick and mortar grew by 13% to 13 lakh crore while the e-commerce in India grew at 40% to a 1 lakh crore industry.
This move will give the offline retailers some ease of pressure that they face from deep-discounting done by the online retailers. Further, it is reported by CRISIL, a rating agency, that in the fiscal year 2020, it is estimated that Brick and Mortar retailers could have gains of about Rs. 10,000-12,000 crores.
Apart from the brick and mortar stores, Snapdeal and the Confederation of All India Traders (CAIT) have also welcomed the new move.
As highlighted above, Amazon has already done rejigging to comply with the new norms while Flipkart has built an intermediary network to bypass the 25% rule, all of this done in a matter of 3 months.
The new FDI policy while it does give the brick and mortar stores a temporary hike, and the foreign investment backed online firms like Amazon and Flipkart a temporary setback, this impact, however, is not permanent.
Thanks Very well written 🙂