Indian Government Amends Foreign Direct Investment Policy (July 2016)

July 1, 2016

The Foreign Direct Investment Policy ("FDI Policy") is the primary regulation governing foreign investment in India. The Government of India ("Government") introduced several amendments to the FDI Policy through the annual Consolidated Foreign Direct Investment Policy Circular, 2016 issued on June 7, 2016 ("2016 FDI Policy") and a subsequent press note issued on June 24, 2016 ("Press Note")[1]. The 2016 FDI Policy supersedes the FDI Policy of 2015, which was issued by the Government in May 2015 ("2015 FDI Policy") and consolidates several amendments issued by the Government since May 2015. The Press Note effects changes to the 2016 FDI Policy.

For the purposes of this alert, it is relevant to note that under the FDI Policy, there are two routes for foreign strategic investors to invest in an Indian company:

• Government Route: Where the prior approval of the Government is required for foreign investment in certain specific business sectors or beyond certain prescribed investment thresholds; and
• Automatic Route: Where foreign investment is freely permitted without the prior approval of the Government.

This alert is a brief summary of the changes brought about by the 2016 FDI Policy and the Press Note:

1. Single Brand Retail Trading: Under the Press Note, Indian entities with foreign investment of 51% or more that are engaged in single brand retail trading involving ‘state-of-art’ or ‘cutting- edge’ technologies are exempted from the local sourcing requirement (of 30% of the value of the goods purchased) for a period of 3 years. The exemption is available only in circumstances where local sourcing of products is not possible. This exemption period will commence from the date of the opening of the first store.
2. Trading of Food Products: The Government has now permitted 100% foreign investment under the Government Route for entities engaged in retail trading of food products manufactured or produced in India (including through e-commerce).
3. Private Security Agencies: In addition to the change in the sectoral limit for foreign investment in this sector (set out in the table above), the 2016 FDI Policy has clarified that private securities agencies are entities providing private security services, including training of private security guards and deployment of armoured cars. Prior to this clarification, there was some ambiguity on whether all these activities would be treated as activities of a private security agency for the purposes of foreign investment. The entity would be required to comply with the [Indian] Private Security Agencies (Regulation) Act, 2005.  
4. Investment by Foreign Venture Capital Investors ("FVCIs"): The 2016 FDI Policy has clarified that FVCIs are permitted to invest in Venture Capital Funds or Category I Alternative Investment Funds registered with the Securities and Exchange Board of India ("SEBI") or Indian companies engaged in ten specified sectors[2] (e.g., biotechnology, nanotechnology, IT, infrastructure etc.).  FVCIs are now also permitted to invest in ‘start-up’ entities[3] engaged in any sector. This clarification has been made to make the 2016 FDI Policy consistent with the regulations issued by the Reserve Bank of India ("RBI") on foreign investment for FVCIs.
5. Courier Services: The 2016 FDI Policy reiterates that foreign investment in courier services is permitted up to 100% under the Automatic Route and is not subject to any foreign investment restrictions or conditions.
6. Defence: Under the 2016 FDI Policy, foreign investment of up to 49% is permitted under the Automatic Route. Foreign investment exceeding 49% was permitted in this sector only if such investment was likely to result in access by the Indian company to ‘modern’ and ‘state-of-art’ technology. Pursuant to the Press Note, the Government can now approve foreign investment exceeding 49% in this sector if it determines that such investment will result in access by the Indian company to ‘modern’ technology or for other reasons to be recorded by the Government. While this appears to be a relaxation of the 2016 FDI Policy requirements, the Government is yet to define the term ‘modern’. The revised FDI Policy also applies to entities involved in the manufacture of small arms and ammunition covered under the [Indian] Arms Act, 1959.

The following is a brief summary of the various amendments/notifications issued by the Government in the last year (after the 2015 FDI Policy was issued). These have now been consolidated and set out in the 2016 FDI Policy. We have separately discussed each of these amendments/notifications (as and when these came into effect) in our client alerts circulated since May 2015.  

1. Composite Caps: Under previous FDI Policies, there were investment caps or ceilings in specific industry sectors beyond which foreign investors were not permitted to invest. For example, there was a 74% cap on investment in private banks. Within these overall caps, there were further sub-ceilings for various categories of foreign investors (i.e., a regular foreign investor, a foreign portfolio investor, etc.). The sub-ceilings within the overall sectoral cap have been eliminated and the 2016 FDI Policy now only provides for composite caps for foreign investment across sectors.
2. Foreign investment through Partly-Paid Shares and Warrants: Foreign investment by way of partly-paid shares and warrants can now be made under the Automatic Route in industry sectors that are eligible for foreign investment under the Automatic Route. Under the 2015 FDI Policy, the prior approval of the Government was required for subscribing to partly-paid shares or warrants. This enables foreign investors to acquire an interest in an Indian company with the ability to fund the company fully at a later stage. Some of the key conditions that investors must comply with at the time of subscribing to partly-paid shares or warrants are: (a) the total price for these instruments must be determined at the time of their subscription; (b) at least 25% of the total consideration must be received upfront; and (c) the balance consideration must be received within 12 months for partly-paid shares and within 18 months for warrants. 
3. Share Transfers between Non-Residents: A non-resident is permitted to transfer shares of an Indian company to another non-resident without the need to comply with the pricing guidelines of the RBI. These pricing guidelines apply to transfer of shares of an Indian company between residents and non-residents and vice-versa. There are also no reporting requirements for a transfer of shares between non-residents. There was, however, some ambiguity on whether the prior approval of the Government was required for a transfer of shares of an Indian company between two non-residents if that company is engaged in a Government Route sector. The 2016 FDI Policy now expressly clarifies that prior approval of the FIPB will be required for a transfer of shares of an Indian company between two non-residents only if that company is engaged in a sector under the Government Route.
4. Real Estate Investment Trusts & Infrastructure Investment Trusts: The 2016 FDI Policy now states that real estate investment trusts, infrastructure investment trusts and alternative investment funds are recognized as eligible entities for receiving foreign investment. The establishment and operation of these trusts and funds are regulated by the SEBI. These trusts provide a tax efficient means for investment in capital intensive sectors and incentivize greater foreign investment.
5. Limited Liability Partnerships: The 2016 FDI Policy states that foreign investment is now permitted in limited liability partnerships ("LLPs") without Government approval in business sectors where 100% foreign investment is permitted under the Automatic Route. In addition, LLPs are permitted to make further downstream investments in any company or LLP in India engaged in a business sector where 100% foreign investment is permitted under the Automatic Route. While this has been done to bring LLPs at par with companies under the FDI Policy for the purpose of receiving foreign investment, LLPs continue to be subject to certain restrictions under the [Indian] Limited Liability Partnership Act, 2008. For example, debt investment in LLPs continues to be prohibited.
6. Pre-Commencement of Business Foreign investment: The 2016 FDI Policy states that foreign investment in a company not engaged in any business activity and with no downstream investments (at the time that foreign investment is received by such company) is permitted under the Automatic Route if such company proposes to engage in activities that are otherwise permitted under the Automatic Route. Previously, foreign investment in any company without operations required prior approval of the Government.
7. Changes in Sectoral Caps and Conditions: In addition to the changes discussed above, the Government has introduced several amendments over the last year to increase sectoral caps for foreign investment and to simplify investment conditions. For example, foreign investment caps applicable to insurance companies, pension funds, defence manufacturing and construction have been increased, conditions imposed on single brand retail trading entities with foreign investment have been simplified and the Government’s position on foreign investment in entities engaged in e-commerce activities has been clarified. The 2016 FDI Policy incorporates all these changes, amendments and clarifications[4].

   [1]   Press Note 5 (2016 Series) dated June 24, 2016

   [2]   As notified in the Annexure to Schedule 6, Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (Notification No. FEMA 20/2000-RB dated 3rd May 2000).

   [3]   A "start-up" has been defined under the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 to mean (i) an entity incorporated/registered in India for a period of up to 5 years from the date of its incorporation/ registration; (ii) having a  turnover, in any financial year, of less than INR 250,000,000 (approx. USD 3.67 Million) and (iii) working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.

   [4]   For further detailed analysis on these changes please refer to our client alerts dated May 18, 2016 http://www.gibsondunn.com/publications/Pages/India-Legal-and-Regulatory-Update.aspx  and October 21, 2015 http://www.gibsondunn.com/publications/Pages/Legal-Developments-in-India–2015-Nine-Month-Update.aspx