Foreign Direct Investments in the E-Commerce Sector

INTRODUCTION

India has one of the fastest growing e-commerce markets in the world with a consistent upward trajectory that can be observed by the cumulative 5% growth that it experiences each year.[1] E-commerce markets possess immense potential to contribute to the economy in three ways: (i) creation of jobs; (ii) improvement in the quality of products; and (iii) creation of emphasis on consumer selection and choice. The Indian e-commerce market is estimated to become a USD 200 billion market by 2026.[2]

This note analyses the regulations pertaining to the e-commerce sector in India, with a specific focus on foreign investments, and attempts to contextualise the interplay between such regulations.

REGULATIONS WITH REGARD TO FOREIGN INVESTMENT IN E-COMMERCE

Foreign direct investment (‘FDI’) in India is regulated by the Foreign Exchange Management Act, 1999 (“FEMA”).[3] The Government of India issues policy pronouncements on FDI through press notes and releases with the help of the Department of Industrial Policy and Promotion (“DIPP”) and the Ministry of Commerce and Industry.

Press Note in 2015

In 2015, the DIPP released Press Note 12 of the 2015 series which allowed FDI in single brand retail trading (“SBRT”) through physical stores in India.[4]

Press Note in 2016

A huge shift was brought in the e-commerce industry by Press Note 3 of the 2016 Series.[5] This press note was implemented specifically to deal with big-tech companies like Amazon and Flipkart by allowing such large e-commerce entities to engage in business-to-business (“B2B”) e-commerce but excluding them from business-to-consumer (“B2C”) e-commerce.

The regulation held significance as it provided important definitions and differentiated between ‘inventory-based model’ and ‘marketplace-based model’. Press Note 3 of the 2016 Series also clarified that up to 100% FDI is allowed via the automatic route for marketplace-based models, whereas FDI is prohibited for e-commerce entities operating on an inventory-based model. It also dealt with sales through group companies, and restricted the sales percentage affected through its marketplace from a single vendor or group companies to 25%.

Press Note in 2018

Press Note 2 of the 2018 series[6] mandated e-commerce entities to adopt the inventory-based model in cases where it exercises control and ownership over the inventory. Here, it was stated that an e-commerce marketplace will be deemed to own inventory if more than 25% of the goods from one vendor is controlled by it or its group companies. This principle was further extended by this press note 2 of the 2018 series whereby it barred entities from selling products on platforms where the e-commerce marketplace has an equity stake or control over the inventory of such entity.

Current Law

The Indian Government, in 2020, released the Consolidated Foreign Direct Investment Policy, 2020 (“FDI Policy 2020”)[7] which combines all the changes made in the prior amendments. These changes have also been reflected in the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019[8] which regulates the e-commerce retail market. Moreover, to protect consumers in the e-commerce marketplace, the Government implemented the Consumer Protection (E-Commerce) Rules, 2020 (“ECR”)[9] which works in consonance with the Consumer Protection Act, 2019 (“CPA”).[10]

INTERPRETATION OF LAW WITH REFERENCE TO MULTIPLE LEGISLATIONS: PREVALENT AMBIGUITY

FDI Policy for Service Sector under Inventory Based Model of E-Commerce

Press Note 3 of the 2016 Series had captured the distinction created between ‘inventory-based model’ and ‘market-based model’ of e-commerce which were defined in the following manner:

To that end, the FDI Policy 2020 replicates Press Note 3 of the 2016 Series by stating that:

1. FDI under the marketplace model of e-commerce is permitted up to 100% via the automatic route.
2. FDI is not permitted for the inventory-based model of e-commerce.

In this context, it is important to note that the FDI Policy 2020 includes both ‘goods’ and ‘services’ under its definition of the inventory-based model of e-commerce. Although, FDI is not extended for the inventory-based model of e-commerce, a proviso in the FDI policy 2020 mentions that foreign investment is permitted via the automatic route for services for all models of e-commerce.[11] This has led to a conflict with respect to the interpretation of ‘FDI in inventory-based model’ services and created a potential grey area in law. Thus, in practice, it has been observed that some companies have offered inventory-based services and FDI has been permitted in those companies using a purposive interpretation of the law. This is an issue that needs to be addressed at the earliest by the Indian regulatory authorities.

Applicable Instruments for B2B and B2C E-Commerce

The ECR defines ‘e-commerce entity’ as “any person who owns, operates or manages digital or electronic facility or platform for electronic commerce, but does not include a seller offering his goods or services for sale on a marketplace e-commerce entity”. Clearly, the ECR excludes B2B e-commerce from its ambit. Furthermore, ‘user’ is defined as “any person who accesses or avails any computer resource of an e-commerce entity” which leads to the conclusion that the application of ECR is limited to B2C e-commerce.

This interpretation is supplemented by the CPA which excludes a person who avails a service for a ‘commercial purpose’. Commercial purpose has been further clarified under the proviso of its definition to exclude “use by a person of goods bought and used by him exclusively for the purpose of earning his livelihood, by means of self-employment”. The Supreme Court of India, in the case of Shrikant Mantri v. Punjab National Bank[12] held that, “to determine what constitutes ‘commercial purpose’ is a question to be decided on the facts of each case. It is not the value of the goods that matters but the purpose to which the goods bought are put to use.”[13] Hence, the regulation of the ECR and the CPA is limited to B2C e-commerce.

Comparatively, the FDI Policy, 2020 has a lower threshold for ‘e-commerce entity’ which has been defined as “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”. Moreover, the FDI Policy 2020 explicitly recognises B2B e-commerce under its ambit.[14] However, certain exceptions have been carved out to exclude B2C e-commerce when certain conditions are met.[15] These conditions can be classified in a two-fold manner:

1. B2C e-commerce which is related to the manufacturing sector under Paragraph 5.2.5 of the FDI policy 2020.
2. B2C e-commerce which is concerned with SBRT under Paragraph 5.2.15.3 of the FDI Policy, 2020.

Penalty Guidelines for B2C E-Commerce

As mentioned above, there are certain B2C e-commerce businesses operating under the current guidelines which will fit within both the ECR and the FDI Policy, 2020. The penalty regulations for the FDI Policy, 2020 are guided by Section 13 of FEMA whereas similar penal provisions for the ECR are guided by Section 88 of CPR. The penalties are indicated below:

SINGLE AND MULTI-BRAND RETAIL TRADING

The FDI Policy, 2020 defines SBRT as a brand which is marketed to sell different products under one brand and permits such enterprises to have 100% FDI via the automatic route. SBRTs are also allowed to trade through e-commerce routes under the FDI Policy, 2020. However, there are certain conditions to be met. For example, SBRT companies with more than 51% FDI are required to mandatorily ensure that at least 30% of the value of their goods is sourced from India.

On the other hand, the FDI Policy, 2020, defines Multiple Brand Retail Trading (“MBRT”) as a platform which caters to multiple brands and sells various products through the platform. Interestingly, unlike SBRTs, MBRTs are allowed FDI up to 51% only with prior government permission. The States and Union Territories, however, would be allowed to make their own choices regarding the implementation of the policy. Further, there are certain conditions under the FDI Policy, 2020 which must to be met by foreign investors in addition to the 51% cap and government approval requirements:

1. Foreign investors are mandated to invest USD 100 million in India and stores are permitted only in areas with a minimum of 10 lakh population.
2. 50% of the money invested as FDI must be re-invested for ‘back-end infrastructure’ within 3 years of the investment.
3. The domestic sourcing requirement for MBRT is that foreign investors must ensure that at least 30% of the value of procurement of manufactured/processed products purchased is sourced from Indian micro, small and medium industries requirement for MBRT.
4. Companies with FDI, engaged in the activity of MBRT, are not permitted to trade by means of e-commerce.

CONCLUSION

The changes made with regard to foreign investment in the e-commerce sector suggest that the government wants to strictly regulate the market by implementing a stringent set of regulations. To that end, there needs to be an impetus on providing clarity on the rules governing inventory based model companies and aligning the definition of e-commerce entity with the instruments provided for protecting the consumers. It is, therefore, important that the government takes note of these issues and brings forth an amendment to avoid ambiguity in the governance of the e-commerce marketplace and facilitate ease of business for the various stakeholders in India.

Please reach out to Praveen Raju and Renuka Abraham for queries.

[1] “India’s e-commerce market to grow at 5% rate per annum, says govt” (mint, 3 Aug 2021) <https://www.livemint.com/industry/retail/indias-e-commerce-market-continues-to-grow-at-5-rate-per-annum-says-govt-11627997023595.html> accessed 29 March 2023.

[2] “E-commerce industry in India” (India Brand Equity Foundation (IBEF), Ministry of Commerce and Industry) <https://www.ibef.org/industry/ecommerce> accessed 29 March 2023.

[3] Foreign Exchange Management Act, 1999 (Ministry of Law and Justice) <https://www.indiacode.nic.in/bitstream/123456789/1988/1/A1999_42.pdf> accessed 24 April 2023.

[4] Press Note No. 12 (2015 Series) (Ministry of Commerce and Industry) <https://dpiit.gov.in/sites/default/files/pn12_2015%20(1).pdf> accessed 29 March 2023.

[5] Press Note No. 3 (2016 Series) (Ministry of Commerce and Industry) <https://dpiit.gov.in/sites/default/files/pn3_2016_0.pdf> accessed 24 April 2023.

[6] Press Note No.2 (2018 Series) (Ministry of Commerce and Industry) <https://dpiit.gov.in/sites/default/files/pn2_2018.pdf> accessed 29 March 2023.

[7] Consolidated Foreign Direct Investment Policy, 2020 (Ministry of Commerce and Industry) <https://dpiit.gov.in/sites/default/files/FDI-PolicyCircular-2020-29October2020_1.pdf> accessed 29 March 2023.

[8] Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 (Ministry of Finance) <https://thc.nic.in/Central%20Governmental%20Rules/Foreign%20Exchange%20Management%20(Non-debt%20Instruments)%20Rules,%202019.pdf> accessed 29 March 2023.

[9] Consumer Protection (E-Commerce) Rules, 2020, (Ministry of Consumer Affairs, Food and Public Distribution) <https://consumeraffairs.nic.in/sites/default/files/E%20commerce%20rules.pdf> accessed 24 April 2023.

[10] Consumer Protection Act, 2019 (Ministry of Law and Justice) <https://egazette.nic.in/WriteReadData/2019/210422.pdf> accessed 29 March 2023.

[11] Paragraph 5.2.15.2.4, FDI Policy, 2020.

[12] 2022 SCC OnLine SC 218.

[13] Civil Appellate No. 11397 of 2016.

[14] Paragraph 5.2.15.2.4 (ii), FDI Policy, 2020.

[15] Paragraph 5.2.15.2.1, FDI Policy, 2020.