Policy on FDI in E-commerce – Government shifts the goalposts

Vishnu Chandran January 16, 2019

The Department of Industrial Policy & Promotion has, through Press Note No. 2 of 2018 dated December 26, 2018 (“Press Note 2”), revised the policy relating to Foreign Direct Investment (“FDI”) in e-commerce, which could have significant ramifications to the sector. While the Press Note 2 as well as the subsequent response to the media comments issued by the government on January 3, 2019 (“Response Note”) termed the revisions as merely clarificatory in nature, some of these “clarifications” have, in effect, changed the rules of the game.

At the outset, there is no change to the limit of FDI in e-commerce pursuant to the Press Note 2, and 100% FDI under the automatic route (i.e. without any approvals from the government) continues to be permitted in the marketplace model of e-commerce (wherein the e-commerce entity merely provides the trading platform and facilitates transactions between buyers and sellers), while the inventory based model of e-commerce (wherein the e-commerce entity owns the goods sold in its platform) continues to be out of bounds for FDI. However, certain conditions for FDI in marketplace model have been now made more stringent which might result in a rethink of the business models of the entities engaged in the marketplace model of e-commerce which have received FDI (each a “Marketplace Entity”), as discussed below.

* Under the existing regulations, the main check to ensure distinction between the marketplace and inventory based model of e-commerce was the condition that a Marketplace Entity cannot exercise ownership over the goods purported to be sold in its platform. The Press Note 2 has made the above condition more stringent by providing that the Marketplace Entity shall not exercise “ownership or control” over such inventory. Further, a provision has been added (“Deeming Provision”) that the inventory of a seller would be deemed to be controlled by the Marketplace Entity if such seller purchases more than 25% of its goods from the Marketplace Entity or its group companies. In this regard, “group companies” means a group of 2 or more enterprises, wherein one or more such enterprises are, directly or indirectly, in a position to (a) exercise 26% or more of voting rights in such other enterprise(s); or (b) appoint more than 50% of the members of board of directors in such other enterprise(s).

Since a Marketplace Entity was permitted under the existing regulations to enter into transactions with sellers registered on its platform on a B2B basis, some of the Marketplace Entities used to have arrangements with the sellers on its platform whereby the goods to be listed on the Marketplace Entity’s platform would be first sold to the sellers (affiliated to the Marketplace Entity or otherwise) by the Marketplace Entity or its group companies, thus providing additional revenue stream for the Marketplace Entities. Pursuant to the insertion of the Deeming Provision, the magnitude of such arrangements will come down substantially, as a seller would have to arrange for majority of its procurement from elsewhere.

It is, however, not clear as to how the Marketplace Entity should ensure that the purchases of the sellers on its platform are sufficiently broad-based – whether a mere certification from the sellers to the Marketplace Entity suffice or would there be an obligation on the Marketplace Entity to verify the books of the sellers in this regard. The above could also have unintended negative consequences on the sellers on the e-commerce platform. For instance, a seller (even one dealing with the Marketplace Entity on an arm’s length basis) would now be forced to procure its goods from other sources even if the commerciality dictates otherwise.

Interestingly, due to unclear drafting, there is another possible reading of the Deeming Provision that if more than 25% of the sale of goods of any seller is generated through a Marketplace Entity’s platform, then such Marketplace entity would be deemed to control the inventory of the vendor, and a clarification from the government in this regard would be helpful.

* Under the existing regime, the Marketplace Entity was not permitted to generate more than 25% of the value of sales through its platform in a financial year from one seller or such seller’s group companies. This conditionality has now been removed (presumably because of the easy workaround of creating multiple affiliate sellers that the Marketplace Entities employed). In its place, a new condition has been added that a seller cannot sell goods

through a Marketplace Entity’s platform if such seller has equity participation or if its inventory is controlled by such Marketplace Entity or its group companies.

The above condition should result in the ceasing of the existing practice of group or downstream companies of Marketplace Entities (and thereby the Marketplace Entities indirectly) selling products through the marketplace platform. There are also question-marks on the future of private labels or white labels of the Marketplace Entity or its affiliates being sold on the platform of such Marketplace Entity. While the Response Note, with regards to the private labels, mentions that Press Note 2 does not impose any restriction on the nature of products which can be sold on the e-commerce marketplace, the position is far from being clear. The major Marketplace Entities have several popular private labels and it would be a shame if such products cannot be sold through their e-commerce platforms owing to the above restriction.

In addition, clarification is also welcome on whether the “equity participation” would include even indirect investment in a seller by a Marketplace Entity through an intermediate entity in which the Marketplace Entity holds less than 26% stake (so as not to render such entity as a group company).

* To ensure that the Marketplace Entities deal with the sellers on their platform in a fair and non-discriminatory manner, Press Note 2 provides that the services which could be provided by a Marketplace Entity to the sellers such as warehousing, logistics, payment collection, financing, among others, as well as the popular practice of offering cashbacks to customers should be provided on an arms-length basis and in a fair and non-discriminatory manner. It has been clarified that if the terms of services provided to a seller are not similar to those offered to other sellers under similar circumstances, then such practice will be deemed unfair and discriminatory.

However, there is no clarity on how the similarity of circumstances of two sellers should be determined. The vagueness of the current language offers scope for creative interpretation and the Marketplace Entities could continue to have differential treatment of sellers pointing out their “dissimilarity of circumstances”. For instance, two sellers could be differentiated based on their difference in sale volumes, nature of products sold, the conditions for the use of platform, among others.

* A Marketplace Entity has now been prohibited from mandating any exclusivity obligations on a seller, whereby the seller is forced to sell its items exclusively on such Marketplace Entity’s platform.

The determination of whether such exclusivity is “mandated” by the Marketplace Entity is, however, going to be tricky. In this regard, merely a written agreement for exclusive arrangement should not be regarded as the clinching evidence of such prohibited behavior since often a seller may want to engage a Marketplace Entity to exclusively sell its goods

for certain commercial benefits in return.

* The Marketplace Entities are required to comply with the conditions under Press Note 2 from February 1, 2019. Most of the major Marketplace Entities in India would have to significantly overhaul their existing business models and complex structures to comply with the new conditions, and the above deadline offers them too short a time to implement such changes. Therefore, the deadline would certainly need to be extended.

To conclude, the success of a policy, especially one which has billions of invested capital riding on it, should be gauged by its stability, clarity, and transparency. One may note that vague and unclear drafting continues to afflict the FDI policy on e-commerce in India. Further, any major change to the existing policy without the necessary “grandfathering” provisions tends to make the current and future investors nervous about investing in India, much like the period post the Vodafone tax fiasco. By not objecting to the businesses of the Marketplace Entities thus far, in spite of there being noises around their legitimacy from various quarters, the government had accorded its passive stamp of approval to these business models, and the Marketplace Entities would rightly feel shortchanged with the revised conditions (and even more so after the sector receiving unprecedented foreign capital in the recent past).

The biggest beneficiaries of the new policy, other than (of course) the small retailers in India, would be large Indian business conglomerates and retail chains wanting to enter the e-commerce sector as they wouldn’t have to operate under the restrictive policy framework for e-commerce entities having FDI. In addition, the policy creates significant barriers for start-ups operating in the sector since it might be more difficult for them to attract foreign capital.

It is hoped that the above issues are addressed by the government in the FDI policy and the new National E-commerce Policy which is expected to be rolled out in the near future.

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