Budget 2018: Why the new FDI rules could prove to be a damp squib

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The Union Cabinet chaired by the Prime Minister granted its approval to the amendments to the Foreign Direct Investment (FDI) Policy, with the aim to further liberalise the policy and to attract FDI.

A press release was issued by the government on January 10, 2018 providing the details of the amendments. This piece tries to capture some of the missed opportunities that could [and should] have been dealt with by the Government.

The Press Release mandates that a Single Brand Retail Trade (SBRT) entity is now permitted to set off its incremental sourcing of goods from India for global operations during the initial five years, beginning April 1 of the year of the opening of the first store.

This is against the mandatory sourcing requirement of 30 percent of purchases from India, mentioned earlier.

Incremental sourcing has been defined here to mean the increase in terms of a value of such global sourcing from India for that single brand (in INR terms) in a particular financial year over the preceding financial year, either directly or through their group companies.

Post the completion of a five-year period, the SBRT entity will be required to meet the 30 percent sourcing norms directly towards its India’s operation, on an annual basis.

As a result of the above, an SBRT entity will have a period of five years prior to which it is mandated to comply with the 30 percent local sourcing norms.

This will ease the burden on companies to ensure that the average local sourcing remains at 30 percent in the first five years itself, which was the case earlier.

However, on the aspect of incremental sourcing, there is no clarity on the treatment of an SBRT, if in the subsequent year the sourcing from local markets is reduced over the previous year, even if the SBRT entity is meeting the 30 percent local sourcing norm post the five-year period.

This will enable the overseas retailers to explore the Indian markets for sourcing purposes, while already having a setup in India.

Where sourcing remains a challenge, there could be opportunities at capacity building.

It would also be interesting to analyze the application of the above condition if a foreign investor who initially held 100 percent of an SBRT entity, later decides to divest some shareholding to a resident Indian, such that the foreign shareholding in the Indian entity is reduced to (say) 26 percent.

Whether the initial requirement of the SBRT entity’s compliance with the 30 percent local sourcing norm will continue to apply, is also currently ambiguous.

Further, the government has clarified that real-estate broking services do not amount to real estate business and is, therefore, eligible for 100 percent FDI under the automatic route.

Relief on FDI in Real Estate Broking

This has been a welcome clarification from the Government, as currently the FDI Policy provides: Real estate business means dealing in land and immovable property with a view to earning profit therefrom and does not include development of townships, construction of residential/ commercial premises, roads or bridges, educational institutions, recreational facilities, city and regional level infrastructure, townships….

The phrase ‘dealing in land and immovable property’ has been vulnerable to an interpretation that even the real estate broking agencies were ‘dealing in immovable property’ with a view to earn a profit.

While the clarifications help in reducing the confusion, it could have been more beneficial had the word ‘dealing’ been appropriately replaced.

Lastly, the FDI Policy, in its existing form, provides that the definition of the term ‘medical device’ as contained in the policy will be subject to an amendment in the Drugs and Cosmetics Act.

The press release provides that given the definition (of medical devices) as contained in the FDI policy is comprehensive in itself, it has been decided to drop the reference to the Drugs and Cosmetics Act.

Further, it has also been decided to amend the definition of ‘medical devices’ as contained in the FDI Policy. This change will not be of much help and, is likely to create further confusion, unless the definition of ‘medical devices’ is amended.

Also, given that the Medical Devices Rules, 2017 have only become effective starting January 1, 2018, it will be critical that the new definition to be proposed is in-sync with that set out in the Medical Devices Rules.

This is imperative to avoid dual interpretation of the term. However, the definition of ‘medical devices’, as set out in the Medical Devices Rules, 2017 itself has references to the Drugs and Cosmetics Act.

Therefore, while the FDI Policy has deleted the reference to Drugs and Cosmetics Act, any linkage to the Medical Devices Rules, 2017 will make such revision redundant.

In a nutshell, this is yet another lost opportunity for the government to bring in the much-needed clarity on certain ambiguous provisions under the current regime.

In the view of the authors, these changes will not have a great impact on the FDI inflow, and may eventually turn out to be a damp squib for the Government’s yet another attempt to attract FDI.moneycontrol