Background
Retail sector in
India is considered to be a sensitive sector especially due to factors, such as
(i) the employment it generates; (ii) unorganised clusters of traders iii)
inability to compete with large players iv) concentration of vote bank.
Accordingly, Government over the years has traded consciously and opened up FDI
in retail sector in truncated manner.
The Department of
Industrial Policy and Promotion (DIPP) of the Ministry of Commerce and
Industry, Government of India has issued Press Note No 2 (2018 Series) on 26th
December, 2018 (PN 2 of 2018). PN 2 of 2018 amends paragraph 5.2.15.2
(e-commerce activities) of the current ‘Consolidated FDI Policy’ of the DIPP
effective from 28th August, 2017 (FDI Policy), effective from 1st
February, 2019. Paragraph 5.2.15.2 (e-commerce activities) incorporates the
provisions of Press Note No 3 (2016 Series) dated 29th March, 2016
(PN 3 of 2016), pursuant to which foreign direct investment (FDI) up to 100%
was allowed under the automatic route in entities engaged in the marketplace
model of e-commerce, subject to compliance with certain conditions. However,
FDI in entities engaged in the inventory-based model of e-commerce was
expressly prohibited, and this continues to be the case as on date. A
marketplace-based model of e-commerce is a model of providing an information
technology platform by an e-commerce entity on a digital and electronic network
to act as a facilitator between buyer and seller. An inventory-based model of
e-commerce, on the other hand, is a model where inventory of goods and services
is owned by an e-commerce entity and is sold to the consumers directly.
It has been a bone
of contention of trade association that FDI component is creating an uneven
playing field to the disadvantage of millions of small business enterprises. It
is alleged that the e-retailers are engaged in predatory pricing policy and
subsidizing the prices with a view to oust brick and mortar shops from retail
trade.
While the
conditions contained in PN 3 of 2016 were introduced to bring some comfort to
brick and mortar retailers (small traders) and to ostensibly create a level
playing field for such retailers with their e-commerce counterparts, it was
felt in some quarters that the wording of PN 3 of 2016 was not stringent enough
and that the intended goal of such PN 3 of 2016 was not being achieved.
Complains were made to regulator that certain marketplace platforms were
violating policy by influencing the price of products and indirectly engaging
in inventory-based model. In order to ensure that rules are not circumvented
DIPP came up with PN 2 of 2018.
Some of the
important changes made by PN 2 of 2018 are highlighted in this article.
Scope and
applicability
PN 2 of 2018
proposes to amend para 5.2.15.2 dealing with e-commerce activities.
Accordingly, PN 2 of 2018 has no impact on following:
- Wholesale cash and carry
trading;
- Single brand retail trading
operating through brick and mortar stores;
- Multi brand retail trading;
- Indian entity with no FDI
engaged in online e-commerce business;
- Indian entity with FDI
engaged in manufacturing selling products in India through e-commerce.
Restrictions of PN
2 of 2018 are applicable to Indian e-commerce company having FDI. It does not
apply to home grown retail majors like Vijay Sales, Big Bazaar, Reliance Retail
etc. Thus, PN 2 of 2018 may assure level playing field against foreign capital but
does little to prevent small traders from predatory pricing and market
penetration policy adopted by Indian conglomerates.
PN 2 of 2018 is
applicable from 1st February, 2019. There is no express
grandfathering of existing structures. Moreover, since amendments seek to
clarify legislative intent, it is advisable that e-commerce companies comply
with new regulations. Some of the stringent conditions will require e-commerce
companies to rejig their business model.
Ownership and control over inventory
Policy
E-commerce entity
providing a marketplace will not exercise ownership or control over the
inventory i.e. goods purported to be sold. Such an ownership or control over
the inventory will render the business into inventory based model. Inventory of
a vendor will be deemed to be controlled by e-commerce marketplace entity if
more than 25% of purchases of such vendor are from the marketplace entity or
its group companies.
Comments
- Existing regulation i.e. PN
3 of 2016 provides that e-commerce entity providing a market place will not
exercise ownership over the inventory i.e. goods purported to be sold. Such an
ownership over inventory will render the business into inventory-based model.
- PN 2 of 2018 imposes an
additional condition and deems inventory of vendor to be controlled by
e-commerce marketplace entity if more than 25% of purchases of such vendor are
from market place entity or its group companies.
- Said condition seems to
plug in loophole in existing regulatory framework. Under existing regulatory
framework e-commerce entity can undertake B2B trading. Marketplace Entities
used one or more of their group entities to sell goods to sellers on a B2B
basis with such sellers in turn listing the goods on the Marketplace Entity’s
platforms for sale to retail customers.
- Going forward, e-commerce
entity will have to develop mechanism to track purchases of vendor listed on
its portal. If 25% limit is breached by vendor it will tantamount to violation
of FDI conditions for e-commerce entity. This is likely to be cumbersome
compliance as vendors may be reluctant to share their financial details.
- Regulation is not clear on
period for computing ‘25%’ threshold limit. Arguably, 25% of purchases should
be calculated for each financial year and reference to 25% should be in value
terms based on financial statement of vendor. Further, 25% of overall threshold
can be computed only after closure of financial year. This poses challenge on
e-commerce companies to test compliance before closure of financial year. Further,
regulation is not clear in case of computation of 25% threshold in case of
vendor engaged in trading of multiple goods. It is not clear whether 25%
threshold should be computed for that segment of goods traded on e-commerce
website or purchase on overall basis needs to be seen.
- Regulation stresses on
purchase aspect of vendor from e-commerce companies or its group companies and
has nothing to do with the aspect of vendor selling goods on market platform of
e-commerce companies. Accordingly, on plain reading – say Vendor A purchasing
goods in bulk
from group companies of Flipkart and selling on Amazon and offline in large
quantities and on Flipkart in small quantities, will render Flipkart to
violation of FDI norms.
- Restriction may put
limitation on Indian vendors who are not
recipient of FDI to look out for alternatives sources to procure goods.
Thus, PN 2 of 2018 indirectly regulates procurement pattern of non FDI
companies trading on e-commerce platform.
- Sellers may require to
broad base their procurement function and approach directly distributors or
manufacturer of products. This is likely to impact margins and supply chain
efficiency.
- Interestingly, PN 2 of 2018
permits e-commerce companies to provide support services in respect of
warehousing, logistics, order fulfilment, call centre, payment collection and
other services. Accordingly, it may be open for e-commerce company or group
company to provide indenting services to sellers and facilitate them to
purchase goods from distributor or manufacturers. Said services can be validly
provided as long as it is provided in fair and non-discriminatory manner.
- Regulation 2 of FEMA 20(R)
defines group company as follows:
“Group Company
means two or more enterprises which, directly or indirectly, are in a position
to
(a) Exercise 26 percent, or more of voting rights
in other enterprise; or
(b) Appoint more than 50 percent, of members of
board of directors in the other enterprise.”
- Definition of Group Company
is based on 26% shareholder threshold and power to appoint more than 50%
members of Board. This definition is in contradiction to definition of control
under Ind AS 110.
Ind AS definition of control is expansive and requires Company to give
consideration to shareholders agreement and right flowing to investor to
determine control. As against that, definition of group company in FEMA 20(R)
is more legalistic. Further, analyst believes that stringent condition is
likely to pave way to franchisee models.
Restriction on group company sellers to
participate on e-commerce platform
Policy
An entity having
equity participation by e-commerce marketplace entity or its group companies,
or having control on its inventory by e-commerce marketplace entity or its
group companies, will not be permitted to sell its products on the platform run
by such marketplace entity.
Comments
- Existing regulation i.e. PN
3 of 2016 provides that e-commerce entity will not permit more than 25% of the
sales value on financial year basis affected through its marketplace from one
vendor or group company.
- PN 2 of 2018 prohibits i)
entity having equity participation by e-commerce marketplace entity or its
group companies or ii) vendor on which e-commerce marketplace entity or its
group companies has control over inventory.
- On comparison of existing
and new regulation following are notable changes:
• Ban on entity in which e-commerce
marketplace entity or its group companies has equity participation to sell on
e-commerce platform.
• Ban on entity on which e-commerce
marketplace entity or its group companies has control over inventory to sell on
e-commerce platform.
• Other vendors (other than mentioned above)
can sell on e-commerce platform even if its sales amount to more than 25% of
sales value.
- PN 2 of 2018 has used
ambiguous term ‘equity participation’. Extant FDI Policy defines ‘capital
instrument’ as referring to equity shares, CCPS, CCDs and warrants. It is
therefore unclear whether the term “equity participation” refers solely to
equity investments or whether it includes investments using other instruments
(such as CCPS, CCDs or warrants) as well and its impact on conversion. Further
no threshold for equity participation is prescribed. Accordingly, holding of 1%
by specified entities will debar investee entity from trading in e-commerce platform.
- At times investing in
companies providing support services are driven by business and commercial
consideration. Since services are so interlinked, it may be a commercial
necessity to hold stake in service company to ensure quality of service and safeguard
reputation of e-commerce companies. Revised policy seems to give a total go-by
to business consideration and looks involvement of service company (with equity
participation of e-commerce company) as a sole driver.
• Many 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 establish further subsidiaries (Second Level JV
Entity). In light of the current guidelines on downstream investments, these
Second Level JV Entities or group entities are not subjected to similar
obligations as applicable to foreign direct investment in First Level JV
Entity. Use of term ‘equity participation’ raises issue whether restriction
will apply to First Level JV entity or even Second Level JV Entity. In contrast
to other clauses in PN 2 of 2018, this clause does not use the words equity
participation ‘directly or indirectly’.
• Policy is likely to put a break on Amazon
from selling products from subsidiaries like Cloudtail and Appario, Flipkart
from selling products through its investee company WS Retail unless e-commerce
major restructures their business model.
No exclusivity
Policy
E-commerce
marketplace entity will not mandate any seller to sell any product exclusively
on its platform only.
Comments
- Condition seems to be one
way in terms of requiring e-commerce entity to sell product exclusively on its
platform. Condition does not restrict seller to approach e-commerce company to
sell its product exclusively on its platform.
- This condition will put
check on practices of selling mobile phones and white goods on exclusive basis.
Accordingly, it will no longer be open for Flipkart to have exclusive partnership
of selling smartphones like Xiaomi and Oppo. Exclusive sale was perceived to be
concentration of power in hands of few and detrimental to the interest of small
traders.
- Said condition puts
practice of selling private label products say Amazon kindle, Amazon Echo, MarQ
range of electronic goods in doubt. Private label products are in-house brands
of e-commerce company. Reason for promoting private label products is to earn
high margin and seek repetitive customers as private label products are exclusively
sold by e-commerce companies. E-commerce
entities seek to sell private label products at discounted price vis-à-vis
compete and try to lure customers.
- On plain reading, there is
no bar on sellers to sell products exclusively on e-commerce platform. DIPP in
its press release has clarified that present policy does not impose any
restriction on the nature of products which can be sold on the marketplace.
Level playing field
Policy
E-commerce entities
providing marketplace will not directly or indirectly influence the sale price
of goods or services and shall maintain level playing field. Services should be
provided by e-commerce marketplace entity or other entities in which e-commerce
marketplace entity has direct or indirect equity participation or common
control, to vendors on the platform at arm’s length and in a fair and
non-discriminatory manner. Such services will include but are not limited to
fulfilment, logistics, warehousing, advertisement/marketing, payments,
financing etc. Cash back provided by group companies of marketplace entity to
buyers shall be fair and non-discriminatory. For the purposes of this clause,
provision of services to any vendor on such terms which are not made available
to other vendors in similar circumstances will be deemed unfair and
discriminatory.
Comments
- PN 3 of 2016 merely
stipulates that e-commerce entities providing marketplace will not directly or
indirectly influence the sale price of goods or services and shall maintain
level playing field. PN 2 of 2018 imposes additional conditions on e-commerce
companies and its investee company to provide services to vendors on platform
at arm’s length on fair and non-discriminatory manner. Policy deems that
provision of services to any vendor on such terms which are not made available
to other vendors in similar circumstances will be deemed unfair and
discriminatory.
- Policy seems to plug
practices of predatory pricing policy and subsidising the prices. Going forward
it will be difficult to provide cash back, fast delivery, etc., to select set
of sellers. All the service providers will have to open up such services for
all the sellers on its platform.
- Use of terms ‘arm’s
length’, ‘fair and non-discriminatory’ and ‘similar circumstance’ are
subjective and is likely to give rise to further frictions. It is equally true
in a market place; all sellers can’t be treated similarly. It is natural for
business to give preferential treatment to set of customers who are top
customers. Person selling miniscule quantity cannot be compared with customer
selling substantial quantity. Use of the word ‘similar circumstances’ should be
construed in right perspective.
- Policy requires cash back
to be provided to buyers and services to be provided to sellers to be fair and
non-discriminatory. Policy does not seem to restrict buyer/seller to be
provided better services if they are paying a premium/price to avail
preferential service. Accordingly, services like prime membership are unlikely
to be affected by new regulation.
Report to RBI
Policy
E-commerce
marketplace entity will be required to furnish a certificate along with a
report of statutory auditor to Reserve Bank of India, confirming compliance of
above guidelines, by 30th of September of every year for the
preceding financial year.
Comments
- Regulation places
additional obligation on statutory auditor to certify compliance with new
guidelines. This will be an onerous task given subjectivity involved in
guidelines.
Concluding Remarks
Revised regulation
seeks to provide level playing field to small traders and protect them from
foreign capital. Changes come at a time when
investments in e-commerce are at record high. Acquisition of controlling
stake by Walmart in Flipkart at whopping USD 16 billion raised bar of
e-commerce industry in India. Research firm Crisil has estimated that nearly
35-40% of e-retail industry sales, amounting to Rs 35,000-40,000 crore, could
be impacted due to the tightened policy. It is further estimated that Brick and
Mortar business will gain 150-200 bps topline boost. Media5 has
reported that new regulations are draconian and a bigger retrograde move than
even Vodafone tax issues. It will not only impact e-commerce sector but also
FDI inflow in other sectors because regulations can change overnight. One
believes that DIPP will come out with clarification and allay all fears.
