Foreign Direct Investment Policy : Recent Changes

The Government of India, vide Press notes 4, 5 and 6 (2013 series), has notified changes in the Foreign Direct Investment Policy, which was cleared by the Cabinet early this month. The amendments include increase in the sectoral investment limits across different sectors, easing of conditions for multi-brand retail and a more restrictive definition of ‘control’ of a company.

Following is a discussion on these Press Notes:

Press Note No.4 (2013 series): Change in definition of “Control”

The concept of "control" arises in several different contexts in corporate transactions. For instance, it is used to determine whether a mandatory open offer requirement arises under the SEBI Takeover Regulations. It also arises in the context of competition law, the merger control regime, and foreign direct investment (“FDI”) while dealing with the question of downstream investments by Indian companies that were owned or controlled by foreign investors, and most recently, in the Companies Act, 2013. In fact, Section 2(27) of the newly enacted Act also defines the term ‘Control’.

Under the policy of foreign direct investment framed by Department of Industrial Policy and Promotion (“DIPP”) the existing definition of 'control' was an objective definition that linked control to power to appoint majority of directors. The definition as was given in the policy prior to the amendment is produced below:

“A Company is considered as “controlled ” by resident Indian citizens if the resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens, have the power to appoint a majority of its directors in that company.”

However, after a reconsideration of the existing policy on the definition of control under the FDI regime, the Cabinet Committee on Economic Affairs (“CCEA”), on 22nd August 2013, has approved the proposal of the Department of Industrial Policy & Promotion (DIPP) for amendment of the existing definition of 'control' under the Foreign Direct Investment (FDI) policy.

Pursuant to the amendment, the scope of 'control' has been significantly expanded under the new definition to include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements".

For the sake of clarity, the new definition is reproduced below:

“Control shall include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements”

Analysing these amendments, one can conclude that among others, the key reasons for the amendment are to align this new definition with the Companies Act, 2013 and the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeover) Regulations, 2011.This change may have a much larger impact on structure FDI transactions in India. Another implication of this amendment is the new resulting concept of a ‘foreign controlled company’. What this means is that even the mere existence of veto or affirmative rights in favour of non-residents could lead to the Operating-cum-Investing Company being regarded as a 'foreign controlled company’.

However, some degree of comfort may be drawn from the recently approved Jet - Etihad transaction where the Indian regulators cleared the investment by Etihad in Jet Airways with certain affirmative rights that are not being regarded as 'acquisition of control'.

Press Note No.5 (2013 series): Changes into the conditions of FDI in Multi brand retail

As is common knowledge, the long discussed and debated matter of FDI in Multi-brand retail was given green signal by the Indian Government in September, 2012 vide press note 5 of 2012 issued by the policy maker Department of Industrial Policy and Promotion (“DIPP”). The FDI Policy allows upto 51% FDI in multi brand retail. This means that foreign retail giants like Carrefour, Tesco and Walmart can set up hypermarket chains with an Indian joint venture partner to enter into the retail business in India.

Where the modified policy had been notified, there still remained some ambiguity in some of the conditions stipulated for FDI in Multi Brand Retail Trade (“MBRT”) which are now clarified through this Press Note 5 of 2013.

1. Back-end Infrastructure: The FDI policy for MBRT required a minimum of 50% of the total FDI to be invested in the back-end infrastructure of the MBRT company receiving FDI within three years of receiving first tranche of FDI. The Note 5 of 2013 provides for a limit on such requirement of investment into the back-end infrastructure and has limited it to 50% of the first tranche only and such first tranche shall be of US $100 million. Therefore, the amendment provides that any subsequent investment in the back-end infrastructure would be made by the MBRT retailer as needed depending upon its business requirements and the mandatory requirement of minimum 50% would not be applicable on such further investments.

2. Minimum Sourcing Requirement: The other significant change in FDI policy with regard to the MBRT addresses the issue of minimum mandatory sourcing requirement. The MBRT companies with FDI were earlier required to source at least 30% of the value of procurement of the manufactured/processed products from Indian micro, small and medium enterprises (“small industries”) which have total investment of not increasing USD 1 Million in Plant & Machinery. This requirement has been revised with respect to the limit on total investment in small industries which has now been increased to a maximum of USD 2 Million’. It is, however, interesting to note here that the ‘small industry’ status would be reckoned only at the time of first engagement with the retailer and such industry shall continue to qualify as a small industry for this purpose even if it outgrows the said investment of USD 2 Million during the course of its relationship with the said retailer. Hence, effectively this is to say that once an industry qualifies as a ‘small industry’, it will continue to remain so for that particular retailer, even if it were to cross the prescribed limit of USD 2 million, although, for the new retailers, that same industry shall not qualify under this bracket of ‘small industry’ for the purpose of the procurement of this 30%.

In addition to this, it has been clarified that sourcing from agricultural co-operatives and farmers co-operatives would also be considered in this category of 'small industry'.

3. Geographical restrictions: the amendments in the FDI policy with respect to MBRT has now empowered the respective State Governments to take decision on notification of towns and cities beyond the earlier restrictions whereby MBRT companies having FDI could only set up retail sales outlets in cities with population of more than 10 lakh (1 million) as per 2011 census. Therefore, the respective State Governments can now make rules to relax the geographical restrictions to allow MBRT companies with FDI to set-up shops in cities and town with population less than 10 lakh (1 million) as per 2011 census.

Press Note No.6 (2013 series): Change in sectoral caps of different sectors

The DIPP has also notified the Cabinet’s decision to change the sectoral caps of different sectors for receiving FDI which are given as below:

1. In Telecom Services, the FDI cap has now been revised to 100% for the FDI. (Entry Route - Automatic upto 49% and beyond 49% Government Approval).

2. For Asset Reconstruction companies, the FDI Cap has been revised to 100% of the paid up capital of the ARC for FDI & FII. (Entry Route- Automatic upto 49% and beyond 49% Government Approval)

3. For the Test Marketing Industry, the entry route for the FDI cap which was already 100%, has been made automatic by virtue of the deletion of the very para relating to the FDI Cap.

4. For Credit Information Companies, the FDI sectoral cap has been revised to 74% and the Entry route for the same has been made Automatic from the prior status of Government Approval.

5. For the Defence Industry, while the FDI Cap remains the same, the entry route has been amended to the investment upto 26% requiring Government approval, and above 26% requiring approval of the Cabinet Committee on Security (CSS) on case to case basis, which is to ensure the access to modern and ‘state- of- art’ technology in the country.

6. In the Tea Plantation Sector, while there has been no change in the FDI caps, the condition of compulsory divestment of 26% in favour of Indian partner/ Indian public within a period of 5 years, has been dispensed with.

7. Under the Single Brand Retail sector, the FDI Cap has not been revised but there has been an amendment in the entry route which now stands at upto 49% FDI through the automatic route and above 49% through the Government Approval route.

8. In the sectors relating to Petroleum and Natural Gas, Courier services, Commodity Exchange, Infrastructure companies in the Securities Market and Power Exchanges, the government has eased the FDI norms by doing away with the approval procedure from the government route and the investments can now be brought through automatic route.