Liberalization Of India’s Foreign Direct Investment Policy On Single-Brand Retail

History

Prior to 2006, the government of India prohibited FDI in both single-brand and multi-brand retail trading.

In February 2006, the Indian government decided to open up India’s retail sector to FDI and, subject to certain conditions, permitted FDI up to 51 percent in single-brand retail trading companies. This policy was made effective by a press note dated February 10, 2006, issued by the Department of Industrial Policy and Promotion (“DIPP”) of the government of India.

Over the years, there have been recommendations to further liberalize the Indian government’s policy regarding FDI in retail trading, including to increase the permissible level of FDI in single-brand retail operations and to open up the multi-brand retail sector to FDI. These moves were heralded by several multi-brand retailers (such as Walmart) because the liberalization would present multi-brand retailers with a prime opportunity to enter India’s approximately US$450 billion retail sector. Such moves were, however, resisted by various stakeholders and political parties in India.

In November 2011, the Cabinet of India, the decision-making body of the Indian government, decided to permit up to 100 percent FDI in single-brand retail trading and up to 51 percent FDI in multi-brand retail trading. Unfortunately for foreign retailers, the Cabinet’s November 2011 decision produced a considerable political backlash in India. Consequently, the Indian government reversed course and indefinitely suspended plans to reform the retail sector.

Recognizing that the political backlash was focused on the multi-brand aspect of the proposed retail-sector reform, by a press note dated January 10, 2012, the DIPP notified the Cabinet’s decision to permit FDI up to 100 percent in the single-brand retail sector, subject to the prior approval of the Foreign Investment Promotion Board (“FIPB”) of the Indian government and certain other conditions. FDI in multi-brand retail trading continues to be prohibited.

Rationale For Liberalization

According to the DIPP, the rationale for permitting FDI in single-brand retail trading was “attracting investments in production and marketing, improving the availability of such goods for the consumer, encouraging increased sourcing of goods from India, and enhancing competitiveness of Indian enterprises through access to global designs, technologies and management practices.” Underlying this stated rationale is the fact that, globally, single-brand retail follows a 100 percent-ownership business model, and major global retailers have been reluctant to establish their presence in India because of the restrictive policy environment. This is evidenced by the fact that in the last five years, FDI of only US$44.45 million (constituting approximately 0.03 percent of the total FDI inflows) was received in the single-brand retail trading sector in India. Further, while a 51-percent-ownership cap enables a foreign investor to pass “ordinary resolutions” (i.e., matters that are required to be approved by shareholders representing more than 50 percent of the share capital of a company) but not “special resolutions” that require at least a 75 percent majority, enhancing the cap to 100 percent provides the foreign investor the ability to have full ownership and control of a company.

Conditions For 100 Percent FDI In Single-Brand Retail

Effective as of January 10, 2012, up to 100 percent FDI in single-brand retail trading companies is permitted subject to the following conditions:

1. Products to be sold must be of a “single-brand” only.

2. Products must be sold under the same brand internationally (i.e., products should be sold under the same brand in one or more countries other than India).

3. Single-brand retail trading would cover only products that are branded during the manufacturing process.

4. The foreign investor must be the owner of the brand.

• At the moment, the Indian government has not provided any guidance on the meaning of the term “owner.” The general understanding is that the foreign investor should not merely have marketing or distribution rights in respect of the product, but, instead, the foreign investor should have ownership rights in the brand under which the product is being sold.
• Nevertheless, how the Indian government might ultimately interpret “ownership rights” remains unclear. Most foreign investors route their investments through an entity formed in a jurisdiction that has entered into a double taxation avoidance treaty with India, such as Mauritius. If a foreign investor grants its Indian retail subsidiary the exclusive right to market products in India under a certain brand and, for example, the Mauritius-entity owner of the Indian retail company is wholly owned by the foreign investor who ultimately owns the intellectual property rights to the brand, it is possible that such an arrangement would satisfy the promulgated brand-ownership requirement. If, however, such Mauritius entity were only partially owned by a foreign investor who ultimately owns the intellectual property rights to the brand, the position may be different. A joint-venture relationship in respect of an Indian retail company might be further complicated if the parent entities of direct shareholders have divided control rights in a manner that does not mirror the economic rights.

5. In respect of proposals involving FDI beyond 51 percent, it is mandatory for at least 30 percent of the value of products sold to have been sourced from (a) Indian small industries, (b) Indian village and cottage industries, and/or (c) Indian artisans and craftsmen.

• Several elements of this requirement remain unclear. First, will raw materials, rather than finished products, be allowed to count toward the “30 percent of the value of the products sold” requirement? Second, does the “value” mean the sales price or the aggregate production cost of the products? Third, what will be the applicable time period for measuring compliance with this requirement? Finally, will the Indian government be willing to grant exemptions to this requirement for genuine commercial reasons?
• “Small industries” is defined as industries that have a total investment in plant and machinery not exceeding US$1 million.

• The valuation of the total investment refers to the value of the plant and machinery at the time of installation, without providing for depreciation.
• If at any point in time, this valuation is exceeded, the industry will not qualify as a “small industry” for this purpose.
• At the moment, the Indian government has not provided any guidance on the meaning of the term “industries.” Consequently, it is unclear whether “industry” is a sector of a particular market, a particular manufacturing operation owned and/or operated by a single owner, or a particular manufacturing operation owned and/or operated by a group of owners. Furthermore, it is unclear as to whether multiple plants owned by the same owner or by multiple owners within the same market sector should be aggregated for the purposes of the US$1 million threshold.

• The term “village industries” has not been defined in the DIPP’s press note. The term has been defined under another Indian statute, the Khadi and Village Industries Commission Act, 1956, as an industry that is located in a “rural area,” produces any goods or renders any services with or without the use of power and in which the fixed capital investment per head of an artisan or worker does not exceed Indian Rupees 100,000 (or, in the case of an industry located in a hilly area, Indian Rupees 150,000), or such other sum as may be specified by the Indian government from time to time. At this moment, it is unclear whether this definition will be applicable for purposes of interpreting the press note.
• Compliance with this condition will be ensured through self-certification by the company and will be subsequently checked by the statutory auditors of the company from the certified accounts that the company is required to maintain.

We expect that the issues identified above will be resolved over a period of time through policy clarifications or clarifications provided by the Indian government in the context of specific factual situations.

Approval Process

A foreign investor must apply to the Secretariat for Industrial Assistance of the DIPP in order to seek the approval of the Indian government. The application must specifically identify the product or product categories that are proposed to be sold under a single brand, and any addition to the product or product categories to be sold under the single brand would require a fresh approval of the Indian government. Applications will be processed by the DIPP, which will determine whether the products proposed to be sold satisfy the aforementioned conditions. Thereafter, the application will be considered by the FIPB for final government approval.

Impact

The liberalization of FDI in India’s single-brand retail sector should benefit foreign retailers as well as Indian consumers. The conditions imposed by the Indian government on such FDI should also provide a stimulus to small industry in India. According to the U.S.-India Business Council (“USIBC”), India’s single-brand retail market is valued at approximately US$7 billion and is expected to reach a value of US$20-25 billion over the next five years. Furthermore, there are approximately 300 million “middle-class” individuals with a purchasing power parity of US$30,000 per year according to the USIBC’s data. This otherwise attractive market should now be significantly more attractive for foreign single-brand retailers, as they will no longer be forced to share profits and control with India-based companies as a condition to enter the market.

Although the Indian government has not expressly defined the term “single brand,” it can be inferred from the DIPP’s press note and the government’s enforcement history that foreign companies are permitted, through their ownership in Indian companies, to sell goods in India that are sold internationally under one brand name (e.g., Reebok, Nike and Adidas). The marketing of different products under a single “brand” is also permitted. For example, Apple would be permitted to own an Indian company that would market iPads, iPods, and iMacs under the “Apple” brand. However, a company that has multiple product lines that it markets under distinct brands (e.g., a company that has a different brand for marketing each of fashion goods, wines and spirits, and jewelry) would require separate approvals from the FIPB in respect of the goods to be sold in India under each brand.

While certain conditions under the liberalized policy may be onerous (e.g., sourcing of at least 30 percent of the value of the products sold from small industries), foreign retailers interested in entering India’s growing single-brand retail market should begin evaluating their investment strategies.