Indian Government Amends Foreign Direct Investment Policy

August 29, 2013

The Government of India (“Government“) has approved several amendments[1] to India’s consolidated foreign direct investment policy (“FDI Policy“)[2]. These amendments are effective as of August 22, 2013. Apart from amending foreign direct investment policy with respect to a number of Indian business sectors, the rules in relation to downstream investments have also been changed. The primary changes to the FDI Policy (“2013 Amendments“) are discussed in this client advisory.

Background

Foreign investments into India take two principal forms: (i) foreign direct investment (“FDI“) through the acquisition/subscription of shares or other securities in an Indian company; and (ii) investments by foreign institutional investors (“FIIs“) registered with the Securities and Exchange Board of India (“SEBI“) through recognised stock exchanges in India.

Under the FDI Policy, there are two FDI routes:

• Government Route: For investment in business sectors in which foreign investment requires prior approval from the Government[3]; and
• Automatic Route: For investment in business sectors in which foreign investment does not require prior approval from the Government.

Revised FDI Policy

The 2013 Amendments amend the foreign investment policy in a number of business sectors. The previous and revised policies concerning certain key business sectors are set forth in the table below:

Single Brand Retail Trading

The FDI Policy permitted only one non-resident entity (being the owner of the brand or with rights to such brand through a legally binding agreement) to invest in Indian entities engaged in retail trading of goods of that particular brand. Therefore, if more than one non-resident entity had rights to that brand, only one of them was permitted to invest in India. The 2013 Amendments now permit more than one non-resident entity (as long as the non-resident entity owns the brand or has rights to that brand through a legally binding agreement) to invest in Indian entities engaged in single brand retail trading of goods of that particular brand. This amendment permits flexibility in transaction structures where, for example, more than one foreign entity has been provided with a license for India or where both the owner and a licensee of a specific brand want to invest in India.

Multi Brand Retail Trading

In September 2012 the Government permitted up to 51% FDI in the multi-brand retail trading sector subject to the prior approval of the Government.[9] Multi brand retail trading companies having foreign direct investment (“MBRTC“) were required to comply with a number of conditions in relation to the use of the investment proceeds and the sourcing of products.

Investment in Back-end Infrastructure: Previously, MBRTCs had to invest at least 50% of the total FDI proceeds in ‘back-end infrastructure’ such as processing, manufacturing, distribution, design improvement, quality control, packaging, logistics, storage, ware-house and agriculture market produce infrastructure. The 2013 Amendments have now clarified that at least 50% of the first tranche of USD 100 million (which is the minimum FDI amount for MBRTCs) is required to be invested in ‘back-end infrastructure’.

Local Sourcing: MBRTCs were previously required to source at least 30% of their manufactured and processed products from ‘small industries’ in India. Small industries referred to manufacturers and processers in which the total investment in plant and machinery did not exceed USD 1 million. MBRTCs were expected to discontinue sourcing from any manufacturing and processing entity if such entity breached the USD 1 million investment threshold. Owing to widespread criticism regarding this requirement, the 2013 Amendments have now permitted MBRTCs to source their products from any manufacturing and processing entity (including agricultural and farmer cooperatives) as long as such entity’s investment in plant and machinery is within USD 2 million at the time of its first engagement with the MBRTC. MBRTCs will not have to discontinue sourcing from such an entity if the total investment in plant and machinery of that entity subsequently exceeds the USD 2 million threshold.

Location of Outlets: MBRTCs had previously been permitted to establish outlets in cities with a population of more than 1 million. State governments now have the flexibility to permit the establishment of such outlets in other areas that they deem fit. Consequently, State governments can now decide both, (a) whether to permit MBRTCs to operate in their State; and (b) the locations within the State where such MBRTCs can establish outlets.

Definition of Control  

The FDI Policy specifies the method for calculating the extent of indirect foreign ownership in an Indian company. In general, the FDI Policy regarding downstream investments is as follows:

• An investment made by an Indian company that is (a) owned and controlled by resident Indian citizens, and/or (b) owned and controlled by Indian companies which are in turn owned and controlled by resident Indian citizens, does not constitute foreign investment.
• An investment made by an Indian company that is owned and/or controlled by non-residents or non-resident entities constitutes foreign investment.

Prior to the 2013 Amendments, a company was considered to be ‘controlled’ by resident Indian citizens if such resident Indian citizens (or Indian companies that are owned and controlled by such resident Indian citizens) had the power to appoint a majority of directors in that company.

The definition of control has now been amended and widened considerably and brought in line with the definition of ‘control’ under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. ‘Control’ is now defined as the right to appoint a majority of directors or to control the management or policy decisions by virtue of shareholding, management rights, shareholder agreements or voting agreements. This amendment will impact investment structures wherein the foreign investor has ‘controlling’ rights only by virtue of contractual rights alone. Agreements providing for rights concerning management and policy decisions may now be reviewed by regulatory authorities. If any such rights are determined to be conferring ‘control’ to the foreign shareholder over an Indian company, that will impact related downstream investments of that Indian company as such investments will now be deemed indirect foreign investment. We understand that the revised definition of control will apply prospectively.