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Legal Capsule:Consolidated FDI Policy onE-Commerce by Economic Laws Practice

The Department of Industrial Policy and Promotion (DIPP) has issued Press Note 2 on 26 December 2018 (Press Note), which has amended the Consolidated FDI Policy issued on 28 August 2017 (FDI Policy)  in relation to foreign direct investments in the e-commerce sector. The changes are material and may significantly impact the structure and business models of various e-commerce marketplaces (E-commerce Marketplace) which are owned by entities with foreign direct investments (E-commerce Entity).

EQUITY PARTICIPATION IN SELLERENTITIES

The most significant change has been the addition of the stipulation that any entity shall not be permitted to sell its products on an E-commerce Marketplace run by an E-commerce Entity if:
- The E-commerce Entity or its group companies 1 have an “equity participation” in such entity; or
- The E-commerce Entity or its group companies have control over the inventory of such entity.

Our View: A number of e-commerce entities operating in India have made (or entities controlled by them have made) investments in entities (First Level JV Entity) that are owned and controlled by an Indian resident. The First Level JV Entities generally have subsidiary(Second Level JV Entity) in which it owns majority shareholding. In light of the guidelines on downstream investments, since the First Level JV Entity is owned and controlled by Indian residents, the entire investment in the Second Level JV Entity is deemed to be resident investment and there is no indirect FDI in the Second Level JV Entity. This enables the Second Level JV Entity to sell goods to the end consumer (i.e. B2C trading) without being subject to the restrictions on retail trading under the FDI Policy.

Now, if an E-commerce Entity or its group companies have any “equity participation” in a company, such company shall not be permitted to sell goods on the E-commerce Marketplace.

The question is whether in the structure mentioned above, Second Level JV Entities would be deemed to have “equity participation” by E-commerce Entities or its group companies. This is particularly complicated by the usage of the term “equity participation” in Clause (v) of Paragraph 5.2.15.2.4 and the usage of the term“direct or indirect equity participation” in the Clause (ix) of Paragraph 5.2.15.2.4. The DIPP needs to clarify whether any existing structures are ‘grandfathered’ and shall be permitted to continue with their holding structures, since the Press Note does not state that it shall have a retrospective effect.

The DIPP also needs to clarify whether “equity participation” refers solely to equity investments or whether it includes investments using convertible instruments (such as compulsorily convertible preference capital or debentures)which is not uncommon in such structures.

APPLICABILITY OF 25% THRESHOLD NOW ON PROCUREMENT BY SELLER ENTITIES

Earlier, the FDI Policy stipulated that an E-commerce Entity shall not permit more than 25% of the sales value on a financial year basis from one seller or its group companies (Earlier Condition). The Earlier Condition has been omitted and the Press Note states that an E-commerce Entity shall be deemed to control the inventory of a seller (which is prohibited by the FDI Policy) if more than 25% of the purchases of such seller are from the E-Commerce Entity or its group companies (New Condition).

Our View: Sellers that predominantly procure products from an E-commerce Entity (or any of its group companies) may seek to comply with the New Condition by procuring products directly from other wholesalers, distributors or manufacturers. This may mean that each of such sellers may be required to build additional channels / relationships such that they comply with the New Condition. This may also place significant compliance burden for E-Commerce Entities as any non-compliance by sellers may lead to a contravention of the FDI Policy / Foreign Exchange Management Act, 1999 by E-commerce Entities. An unintended consequence of this rule could be that an Indian seller (without any foreign investment) that procures its products from the wholesale venture of any group entity of an E-commerce Entity will have to diversify its sourcing channels. This may impact their margins.Further, the Press Note does not clarify whether the 25% threshold is to be reckoned on the basis of transactions in a financial year or otherwise(though it is likely that it is to be reckoned on sales in a financial year, as had been specified in the Earlier Condition).

A view that is emerging amongst some market participants (which requires further analysis) is that since an E-commerce Entity cannot ‘control’inventory, sale of products bearing private labels of E-commerce Entities will be prohibited on such E-commerce Marketplace. However, it is submitted that the facts in each case would have to be examined to determine whether an E-commerce Entity possesses ‘control’ over inventory and merely because a  product shares a trademark with the E-Commerce Entity should not ipso facto mean that the E-Commerce Entity possesses control over inventory.

NO EXCLUSIVITY

An E-commerce Entity cannot require any seller to sell its products exclusively on its E-commerce Marketplace only.

MORE STIPULATIONS TO ENSURE LEVEL PLAYING FIELD FOR ALL SELLERS

The FDI Policy now stipulates that if an E-commerce Entity or any entity in which the E-commerce Entity has “direct or indirect equity participation” or is under common control,provides any services (including logistics,warehousing, payments, etc), such services should be provided to sellers in a fair and non-discriminatory manner. ‘Cashback’ offers to buyers are required to be given on a fair and non-discriminatory basis.

Our View: In spirit, an E-commerce Entity should endeavour to run the E-commerce Marketplace as a ‘level playing field’ by not favouring any particular sellers and undertaking transactions on an arm’s’ length basis. Once the Reserve Bank of India issues the appropriate notification to incorporate the provisions of the Press Note to the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017, any breach by an E-commerce Entity of such condition could be proceeded against as a breach of the provisions of the Foreign Exchange Management Act, 1999,which is punishable by up to three times of the amount up to thrice the sum involved in such contravention with a further penalty which may extend to INR 5,000 for every day after the first day during which the contravention continues.

REPORT TO THE RESERVE BANK OF INDIA

E-commerce Entities are required to furnish a certificate along with the report of the statutory auditor to the effect that the E-Commerce Entity is in compliance with the provisions under the FDI Policy applicable to e-commerce sector.

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