FDI E-Commerce Guidelines: A Reflection of Loopholes and Repercussions

[By Samanth Dushyanth and Yashaswi Rohra]

The authors are final year students of Symbiosis Law School, Pune and can be reached at yashaswirohra@gmail.com.

Introduction

On 26th December 2018, Department for Promotion of Industry and Internal Trade (DPIIT), released Press Note No. 2 of 2018 (“Pn2”) introducing certain key changes to the Consolidated FDI Policy, 2017 (“FDI Policy”) in the e-commerce sector. Pn2 amends paragraph 5.2.15.2 (E-commerce activities) of the consolidated FDI Policy of India providing for these changes to come into effect from February 1, 2019.

The FDI Policy permits 100% FDI through the automatic route. However, FDI is not permitted in the inventory based model of e-commerce. A ‘marketplace based model’ refers to an e-commerce entity which provides the information technology platform and acts as an intermediary that facilitates trade between buyers and sellers.[i] An inventory based model on the other hand is defined to mean a model in which the e-commerce entity exercises ownership over the goods, and sells directly to the consumers (B2C).[ii]

The subsequently mentioned changes were introduced as an initiative to bridge the gap, since the current FDI Policy being a widely worded legislation provides a window for the large market players to circumvent the provisions.

Key changes

  1. Inventory Control

Pursuant to the Pn2, ownership or control both shall be the determining factors to differentiate between marketplace and inventory based model. Any control or ownership over the inventory shall render the business of the marketplace entity as an inventory-based model of e-commerce.

The control in the aforementioned change is further explained as the marketplace entity shall be ‘deemed’ to have control over the inventory of a seller , if more than 25% of the purchases of such seller are from the Marketplace Entity or its group companies. This statement leads to two possible interpretations:

Interpretation 1 – Sales generated by the vendor through the marketplace and its group companies.

Interpretation 2 – Purchases of the vendor through the marketplace and its group companies.

These interpretations arise due to the different kind of business models that exist in the market to which the government has failed to provide any clarification. Similarly, the earlier restriction on 25% sales on an e-commerce platform not originating from a single seller has been largely ineffective. Large e-commerce entities simply created more affiliated sellers (and ensured that sales from each remain under 25%). Pn2 has removed this requirement.

  1. Equity Participation

Pn2 dictates that a seller shall not be allowed to sell on the platform of the marketplace entity, if the marketplace entity or its group companies have any equity participation of the seller entity.[iii] The intent of the legislature with regards to this change is to prevent the e-commerce entities from exercising control over the pricing policy or inventory of the vendor. It does not explicitly state that both direct and indirect equity participation would count.

With this requirement, the government has sought to restrict the ability of e-commerce entities to have a minority equity stake in entities that act as sellers on their platforms.

However, the same is a blanket prohibition and may claim unintended victims.

  1. Level Playing Field

E-commerce entities are required to provide the same suite of services or facilities to all sellers under “similar circumstances”. Like any other business, e-commerce entities may wish to reward or provide enhanced services to suppliers/ vendors who stand out. [iv]

Interestingly, the Pn2 appears to recognize an existing practice of providing ‘cashbacks’, which is a system set out to selectively incentivise the customers to choose certain products and to reject other products leading to failure of smaller sellers and unfair competitive market. Pn2 considers this system as not being violative of the prohibition on e-commerce entities influencing the sale price of goods. Instead, only requires cashbacks to be given in a fair and non-discriminatory manner.

  1. Compliance

Pn2 of 2018 requires an e-commerce entity to furnish an annual certificate, confirming compliance with these guidelines by September 1 of every year. This however does not explain whether they will be required to perform any diligence of their own, or can they rely on self-certification by vendors.

  1. Exclusivity

Pn2 places a blanket restriction adversely impacting the exclusive arrangements between e-commerce marketplaces and manufacturing companies, to sell products exclusively on their online platforms. The ambiguity surrounding this restriction is regarding the question of how would the enforcement authorities determine if a seller has been “mandated” to sell its products exclusively on an e-commerce platform, or if the seller is choosing to do so voluntarily.

Recent Developments

Due to mass confusion amongst both e-commerce companies as well as parties interested in foreign investments, the DPIIT held a meeting with stakeholders including companies and groups that were affected by the said guidelines. On turning down demands of the deadline, the government convened the meeting to address the concerns of the e-commerce entities. As a consequence, the Union Minister of Commerce and Industry held a marathon meeting with online players on 26th June 2019. The meeting yielded a vague and ambiguous assurance that the institutional framework would be put in place only within a time frame of a year. However, the DPIIT clarified that the objective of conducting the meeting was not to bring about further changes to the existing FDI rules, but to assist with implementation of the guidelines laid down in Pn2.

  1. Amazon

In compliance with the new guidelines, Amazon reduced its ownership stake in Cloudtail from 49% to 24% of total shareholding. With the compliance clock ticking over Amazon’s head, it is expected to similarly offload its stake in Appario.

Amazon India’s Pantry service faced a temporary suspension following the release of the Pn2. NASDAQ-listed Amazon and NYSE-listed Walmart reported a combined loss of 50 billion dollars in the week following the implementation of the regulations.

Over a dozen small scale vendors exited or suspended their accounts on Amazon in the month of June 2019, since they were unable to manage deliveries and logistics on their own after the new policy came into effect.

  1. Flipkart

Flipkart’s sales volume reduced by a third and its delivery time increased significantly as an immediate consequence of the implementation of the regulations.

As a response, Flipkart appointed half a dozen companies as intermediaries between its wholesale unit and some preferred sellers, to get around the 25% cap on direct purchases. Prior to the appointment of these intermediaries, some of the above-mentioned sellers had already reduced direct purchasing from Flipkart by 10%.

The Draft National E-commerce Policy: The Next Step

DPIIT released a draft National E-commerce Policy for public consultation in July 2019.The policy aims set in stone the guidelines laid down in the Pn2. The key highlights of the policy are as follows:

  • With an absence of a universally accepted definition the term ‘e-commerce’, ‘electronic-commerce’ and the ‘digital economy’ can be used interchangeably. As per the 2019 policy, e-Commerce includes buying, selling, marketing or distribution of goods (including digital products) and services (through electronic network).
  • The new policy also aims to demarcate what constitutes a marketplace model and what comprises an inventory-based model of sale and distribution. The FDI policy, also takes into account interests of domestic manufacturers/traders/sellers/MSMEs/start-ups.
  • The draft Policy of 2019 also proposes a fair trading system following which, it states “Online marketplaces should not adopt business models or strategies which are discriminatory, that is, which favour one or few sellers/traders operating on their platforms over others”, this being in contradictory to practices of ‘cashbacks’ which largely causes smaller sellers to be side-lined.[v]
  • The policy mandates “fair and non-discriminatory treatment of all the stakeholders, including MSMEs and start-ups, operating on a marketplace” since MSMEs and start-ups cannot afford significant marketing campaigns.

Conclusion

With e-commerce taking over market sales and playing a major role in the economy, the DPIIT since 2016 has been striving to achieve an airtight policy for e-commerce entities. With the release of the Pn2 in 2018, the DPIIT sought to rectify the same, ensure free and fair marketing conditions, and protection of small scale local vendors. A lot of the proposed changes seem to be targeted towards addressing complaints relating to legal structures adopted by some of the largest foreign-owned e-commerce marketplaces in India.

These changes are expected to also have a meaningful impact on the e-commerce sector as a whole, however there exists a need for further clarifications regarding whether the 25% inventory cap is on sales or purchases; whether there can be indirect equity control or what if the exclusivity is not mandated by the marketplace entities and a stringent framework for the implementation of the FDI policies. In addition, the new guidelines have also had an impact on the digital payments sector to adopt a fair and non-discriminatory approach. With the enforcement of the new Pn2 Guidelines, the market faced severe economic as well as logistical repercussions which not only had a lasting impact on the e-commerce giants but also severely impacted many small scale vendors operating on these platforms leading to the voluntary exiting of these vendors from the platform.

While there is a need for the government to implement regulations pertaining to B2C sales in India, it should do so keeping in mind the need for regulatory certainty and consistency.

Endnotes

[i] 2.15.2.2 (iv), Review of policy on Foreign Direct Investment (FDI) in e-commerce, Press Information Bureau, Government of India, Ministry of Commerce & Industry, 26 December, 2018.

[ii] 2.15.2.2 (iii), Review of policy on Foreign Direct Investment (FDI) in e-commerce, Press Information Bureau, Government of India, Ministry of Commerce & Industry, 26 December, 2018.

[iii] “New e-commerce framework: A silver lining for SMEs, poses some challenges”, Nishtha Mehta & Karen Issac, available at https://economictimes.indiatimes.com/small-biz/policy-trends/new-e-commerce-framework-a-silver-lining-for-smes-poses-some-challenges/articleshow/68281014.cms?from=mdr

[iv] Review of FDI Policy in E-Commerce, Trilegal, 07 January 2019, available at https://www.trilegal.com/pdf/create.php?publication_id=14&publication_title=review-of-fdi-policy-in-e-commerce

[v] Draft national e-commerce policy for encouraging FDI in online marketplace only, Business Standard, February 23, 2019, Available at https://www.business-standard.com/article/pti-stories/draft-national-e-commerce-policy-for-encouraging-fdi-in-online-marketplace-only-119022300371_1.html

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