Delhi High Court seeks clarity on FDI in online retail businesses

    Delhi High Court seeks clarity on FDI in online retail businesses

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    In a recent petition filed before the Delhi High Court, The All India Footwear Manufacturers & Retailers Association (AIFMRA) has alleged violation of FDI norms by e-commerce marketplaces, pointing to substantial foreign investments in most of such businesses.
    A single-judge bench of Justice R S Endlaw of the Delhi High Court has sought a response from the government over the petition which seeks direction from the Delhi High Court to initiate investigations into e-commerce websites selling footwear. The plea copy states that the websites are conducting businesses through the internet as “Online Stores”, which was in “Complete Violation” of the Government of India’s FDI policy.

    The case and its precedents

    “These entities are evading the law by creating a complex and convoluted business structure by creating a facade of a market place model. The e-commerce entities are taking undue advantage of the footwear retailers and manufacturers present in the physical world as they are getting discounts on the very product being sold by the members of the Petitioner Association,” the AIFMRA plea states. “This has lead a consumer to only utilize the Petitioner’s shop as footwear trial rooms and showrooms,” it adds.

    The petition impeded the Enforcement Directorate (ED), (RBI), Department of Industrial Policy & Promotion, Ministry of Finance and Ministry of corporate affairs as respondents.

    E-commerce websites sell directly to consumers and the court observed that various state governments have treated these transactions by e-commerce market place models as sales. The court recorded that the judgment of the United States’ court also treats the same to be sales for transaction purposes. Since, FDI in multi-brand retail sales is banned by the country’s FDI policy, there is a prima facie violation of the Government of India’s FDI policy. It has therefore asked the Government to file its response to such sales within two weeks. The next hearing for the case will be on October 14, 2015.

    The rule book and the twist

    Looking at the case, let’s now look at the FDI policy in Retail — the way it stands and how it being interpreted. As the rule says, 100 percent FDI is allowed in B2B operations. So most e-commerce companies have set B2B (Business to Business) companies that are vested with technology, inventory and promoter ownership. In other words, this is the company that receives the foreign investment and is also exempt from the FDI norm since this is not the company that customers engage with. What customers engage with is the B2C company (Business to Consumer), which issues the invoices and deals with consumers. It is the B2C company that is subject to FDI norms; it manages to benefit from the foreign investment routed through the B2B company.
    According to All India Footwear Manufacturers & Retailers Association, this is also a clear violation of Foreign Exchange Management Act (FEMA).

    So what does this mean?
    This move could bring into question all the existing businesses that are backed by investments from American, Chinese and Japanese funds and retailers. Even though virtual retailers term themselves as marketplaces, these companies handle the inventory, logistics, warehousing, sales and delivery of products to consumers, making them exactly like any other retailer. The Indian government, while barring FDI in brick and mortar retail, has so far turned a blind eye to the foreign funded business models of virtual retailers. The court’s judgement cites no difference in the business done by virtual retailers and physical retailers and hence calls into question the dual policy of the government. The move could effectively stop all retail sales done on ecommerce websites before Diwali.

    Looking at the future
    The 135 page FDI document just like Indian Constitution, has several arbitrary, discretionary clauses and loop holes making it difficult to interprete white grey or black list. Alternatively, it could call for an overhaul of the policy allowing full FDI in all retailers – a development that could meet with stiff political opposition.

    Even e-commerce companies understand the thin line they are treading. in its quarterly filing to SEC had recently stated: “In India, the government restricts the ownership or control of Indian companies by foreign entities involved in online multi-brand retail trading activities. Although we believe these structures and activities comply with existing laws, they involve unique risks. There are substantial uncertainties regarding the interpretation of PRC and Indian laws and regulations, and it is possible that the government will ultimately take a view contrary to ours.”
    “If our international activities were found to be in violation of any existing or future PRC, Indian or other laws or regulations or if interpretations of those laws and regulations were to change, our businesses in those countries could be subject to fines and other financial penalties, have licenses revoked, or be forced to shut down entirely,” it added.