During hearing on a public interest litigation in Delhi high court on October 31, the Enforcement Directorate (ED) said it is investigating alleged violation of the Foreign Exchange Management Act (FEMA) against Amazon and Flipkart. The charge is that these companies have violated the extant norms for foreign direct investment (FDI) guidelines as contained in Press Note (PN) 3 (2016-17).
The PN 3 allows 100% FDI in the ‘marketplace’ model for e-commerce. An entity working on this model offers a platform to sellers and buyers to conduct transactions. It acts as a facilitator by offering them services such as booking orders, raising invoices, arranging deliveries, collecting payments, etc. It can’t own stocks and can’t sell directly to the consumer.
The above permission is subject to riders. The marketplace entity cannot permit more than 25% of total sales on its platform from a single vendor or its group companies. Further, it can’t directly or indirectly influence the sale price.
For an entity owning stocks and undertaking direct selling to the consumers (‘inventory’ model), FDI is prohibited.
To understand whether the companies are complying with the regulations or not, let us closely look at how they conduct themselves in the supply chain.
In step-I, a foreign company operating in the marketplace model appoints entities majority-owned by it as wholesalers and distributors. Under the extant rules, 100% FDI is permitted in wholesale cash and carry business. So, it can have full ownership and control over the wholesale business.
These wholesalers/distributors invest heavily in the creation of procurement/sourcing, handling, storage, distribution and all other infrastructure necessary to execute a transaction. They buy a wide variety of items in bulk from the brand owners/manufacturers, including those located in foreign jurisdictions.
In step-II, the wholesalers sell to vendors at a discounted price [depending on the item, the discount could go up to 50-75%]. In step-III, the vendors sell the stuff on the online marketplace owned by the foreign major, for which all relevant functions — booking orders, raising invoices, arranging deliveries, collecting payments, handling rejections, etc., — are carried out by the latter.
The rules under PN 3 provide for a single vendor accounting for up to 25% of total sales on the market platform. So, there can be a total of four entities — each with a slice of 25%. This enables the owner of the platform to exercise better control.
It may thus be seen that from sourcing, purchase, handling, stocking, distribution and sale to consumer, almost all essential components in the supply chain are handled by the e-commerce major (read, Amazon/Flipkart) and its subsidiaries. The vendor who is supposedly selling on the platform has absolutely no substantive role in conducting the transaction.
Now, if the vendor has no role [no value addition to make] then, the e-commerce company might as well exclude or drop him. But, under the existing ecosystem, it can’t even contemplate doing so; for, the moment it does that, it will be deemed to be under the inventory model wherein the entity undertakes direct sale to the customer (B2C), and FDI is prohibited.
The e-commerce major recognises the inevitability of engaging with vendors only to remain in compliance with the regulations. These vendors are retained merely for documentation to show that the ownership of stock rests with them. These could even be paper entities or proxy sellers.
With this backdrop, let us get back to the charge. Are the foreign majors violating the foreign exchange regulations under FEMA? Can the ED investigation substantiate the charge? Will the court endorse it?
The investigation and legal proceedings will take their own sweet time. Meanwhile, a cursory assessment would lead one to conclude that they need not worry.
Any violation of FEMA would arise only if it can be proved that foreign investment has come in violation of the guidelines. The PN 3 allows 100% FDI in marketplace model for e-commerce and investment is made on this very platform. Although, in reality, the e-commerce company holds the stock and is engaged in B2C as well, it will be nearly impossible to prove.
This is because the way provisions under each category, in other words the marketplace and inventory models, have been crafted, the dividing line between the two is thin. The only differentiating factor is the ‘ownership’ of the stock which the foreign major can easily circumvent. While, giving shape to the architecture, the ingenious bureaucrats have taken appropriate care to ensure that MNCs do not play foul of the prescribed guidelines.
The moot point is, 100% FDI in retail is already permitted — camouflaged under a fancy nomenclature — ‘marketplace’. Clearly, the Narendra Modi government is committed to FDI in retail, which is indeed the way forward. India needs FDI to augment and strengthen our handling, processing, storage, distribution and quality control infrastructure, upgrade technologies, give more choice to consumers at affordable prices and create jobs.
Yet, it does not want to let this be made explicit to the public at large as it feels that such a categorical admission would antagonise BJP’s core constituency — the trader class, consisting mainly of the ubiquitous ‘mom-and-pop’ stores. The fear is unfounded as foreign investors in retail pose no threat to ‘mom-and-pop’ stores; in fact, the latter can co-exist with the former and even grow.
The government should rid itself of this mindset and make a clear-cut pronouncement. It should put in place a uniform policy to allow 100% FDI in retail without any riders. All artificial distinctions such as marketplace versus direct selling, online versus offline, food versus non-food, etc., should go.
Now that the country is already in election mode, a decision on this, if at all, can be expected only in 2019 after formation of a new government.
(The writer is a policy analyst)