India: Changing Landscape Of The Indian Foreign Direct Investment Policy

Last Updated: 28 September 2017
Article by Seema Jhingan, Neha Yadav and Saniya Kothari

The foreign direct investment ("FDI") policy of India has in the recent past witnessed a series of reforms introduced by the Government with the aim of increasing FDI inflows into India inter alia by liberalizing FDI in various sectors and streamlining the approvals processes. According to the Ministry of Commerce and Industry, FDI inflows hit an all-time high of USD 60.1 billion in 2016-17 as compared to FDI inflows of USD 55.6 billion for the year ending March 2016, (as against record high of USD 139 billion FDI inflows in China in 2016).

The abolishment of the Foreign Investment Policy Board ("FIPB"), allowing start-ups to issue convertible notes (a debt instrument) to non-residents under the FDI regime, and notification of a new consolidated FDI policy circular of 2017 dated August 28, 2017 ("FDI Policy-2017") consolidating the changes brought in since 2016 and also introducing certain new changes, have been amongst the most notable changes introduced this year, as discussed in brief below. 

A.              Abolishment of FIPB; New SOP for processing of FDI applications.

In line with the budget speech of the Finance Minister earlier this year, the abolishment of FIPB has been notified by the Government vide its office memorandum dated June 5, 2017. The FDI approvals would now be granted by the administrative ministries/departments ("Competent Authority"), as more particularly specified in the said office memorandum and Standard Operating Procedure ("SOP") released by Department of Industrial Policy & Promotion ("DIPP") on June 29, 2017. For instance, FDI proposals in sectors like mining, broadcasting, print media, civil aviation, satellites, telecommunications, banking, pharmaceuticals, would be approved by the relevant sector specific ministries/departments. Additionally, certain applications involving investments from Countries of Concern (like Pakistan and Bangladesh) or applications seeking investment in defence, telecommunications, broadcasting, satellite etc. would need security clearance from the Ministry of Home Affairs. DIPP has been notified as the Competent Authority to approve FDI proposals in the trading sector. In cases of sectors where there is a doubt about the Competent Authority, DIPP will identify the Competent Authority for processing of the application. The earlier requirement of proposals for FDI above Rs. 5,000 crore requiring consideration of the Cabinet Committee on Economic Affairs, however, continues to apply. 

FDI proposals are required to be filed online on the revamped FIPB Portal (now Foreign Investment Facilitation Portal), which will thereafter be e-transferred by DIPP to the Competent Authority for necessary action. Submission of a physical copy would not be required if the online proposal has been signed digitally. DIPP will also circulate the proposal online to RBI, and proposals requiring security clearance would be additionally referred to the Ministry of Home Affairs. All proposals would also be forwarded to the Ministry of External Affairs and the Department of Revenue for information and comments. The SOP, thereafter, goes into step by step timelines for submission of comments by the consulted ministries/departments/RBI and expects the entire approval process to take approximately 8 weeks from the date of filing of a complete application with the Competent Authority and about 10 weeks for applications requiring security clearance.

B.              Issuance of Convertible Notes by Start-Ups.

Earlier this year, RBI by its notification dated January 10, 20171 permitted start-ups to issue 'convertible notes' to foreign investors, which was defined as an instrument evidencing receipt of money initially as debt, which is (a) repayable at the option of the holder, or (b) convertible into such number of equity shares of such startup company, within a period not exceeding five years from the date of issue of the convertible note, upon occurrence of specified events as per the agreed terms and conditions. Issuance of such convertible notes is, however, subject to certain prescribed conditions, such as:

(i)                The convertible notes should be for a minimum amount of Rs. 25 Lacs in a single tranche.

(ii)               If the startup is in a sector where FDI requires Government approval, issuance of convertible notes to a non-resident or any transfer of such convertible note would also require Government approval.

(iii)              Issue of shares against convertible notes is to be in accordance with the Schedule 1 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000, which inter alia prescribe certain pricing guidelines. Similarly, acquisition or transfer of convertible notes between residents and non-residents would also need to be in accordance with the pricing guidelines prescribed by RBI, thereby treating them at par with other FDI instruments.

(iv)              The remittance of consideration can also be received in an escrow account which can continue until the requirements are completed (i.e. remittance of consideration into the issuer's account and issuance of convertible notes to the investor) or a period of 6 months, whichever is earlier.

The above regulations have now been reflected in the FDI Policy – 2017, bringing the FDI policy in line with the RBI regulations. This is a welcome move for start-ups, as the FDI policy till now, had only recognized equity shares or equity linked instruments (such as compulsorily convertible debentures or preference shares) as FDI compliant instruments, and instruments which were non-convertible or optionally convertible into equity shares were considered as 'debt' instruments and therefore subject to external commercial borrowing norms. This policy change caters to the particular needs of the start-ups, where foreign investors are more attracted to instruments which do not necessarily require them to take the equity risk of a fledgling start-up, but at the same time allows them to share the upside if the start-up does well. It is for this reason that instruments like convertible notes have become very popular in other countries who have a more established start-up base.

That said, the real impact of this policy change depends on the number of start-up companies which would be able to take its benefit, as it is only available to private companies recognized as a start-up in accordance with DIPP's notification dated May 23, 2017. As per this notification, an entity would be considered as a start-up for a period of up to 7 years (or 10 years in case of biotechnology sector) from the date of its incorporation, if it's turnover for any of the financial years since incorporation has not exceeded Rs. 25 crores, and if it is working towards "innovation, development, or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation". Further, to be recognized as a start-up and avail the benefits, an entity is required to register itself with DIPP by submitting an application (with prescribed documents) online.

C.              Consolidated FDI Policy of 2017.

The DIPP on August 28, 2017 released the new FDI Policy-2017, consolidating the recent changes brought in the FDI policy. A brief snapshot of certain major changes is given below:

(i)                Conversion of a Company into LLP and vice versa: The FDI Policy – 2017, permits conversion of an Limited Liability Partnership ("LLP") with FDI into a company, and conversion of a company with FDI into an LLP, under the automatic route, as long as the said LLP or company, is operating in a sector where 100% FDI is allowed under automatic route and where there are no FDI-linked performance conditions. A definition of 'FDI Linked Performance Conditions' has also been added, to mean sector specific conditions for companies receiving foreign investment.

(ii)               Limit on additional FDI within approved foreign equity percentage or wholly owned subsidiary: Under the erstwhile FDI policy for the government route sector, any additional foreign investment into the same entity (which has already received government approval) within an approved foreign equity percentage or into a wholly owned subsidiary did not require prior government approval i.e., such approved entities could have generally received foreign investment exceeding Rs. 5000 crore without additional approval as long as (i) the earlier investments in the entity were government approved and (ii) such additional investments are within the approved foreign equity percentage. However, the FDI Policy-2017, has modified this paragraph and stated that additional foreign investment up to cumulative amount of Rs 5000 crore within the approved foreign equity percentage/or into a wholly owned subsidiary, would not require prior government approval. Therefore, by implication, any additional foreign investment beyond the said limit of Rs. 5,000 crores would require a fresh government approval.

(iii)              Single Brand Retail Trading: In case the proposed FDI in a single brand retail trading ("SBRT") entity is beyond 51%, sourcing of 30% of the value of goods purchased, has to be done from India. However, the Press Note 5 of 2016, dated June 24, 2016 allowed SBRT entities undertaking trading of products having 'state-of-art' and 'cutting-edge' technology and where local sourcing is not possible, to seek exemption from these sourcing norms for a period of 3 (three) years from opening of its first store. Thereafter, the sourcing norms would become applicable. The FDI Policy-2017, reflects this change and further provides that examination of claims of applicants (and recommendations of relaxations) on the issue of products being in the nature of 'state-of-art' and 'cutting-edge' technology, where local sourcing is not possible would be undertaken by a committee under the Chairmanship of Secretary, DIPP.

In the absence of clear definitions on what constitutes "state-of-art" and "cutting-edge" technology, constitution of this committee would allow applicants to approach the committee with their individual case and seek exemptions. However, to bring in further clarity, the Government should consider coming out with certain basic guidelines or qualifying parameters on the basis of which such applications would be examined and approved by the committee.    

(iv)             Wholesale Trading entity permitted to undertake both single brand and multi-brand retail trading: Earlier, a wholesale/cash & carry trader was not allowed to undertake retail trading in the same entity, which restriction was later relaxed and an entity undertaking wholesale trading was permitted to undertake single brand retail trading provided it maintained separate books of accounts for these two areas of business. The FDI Policy -2017 replaces the reference to "single brand retail trading" by "retail trading", thereby allowing a wholesale/cash and carry trader to undertake both single brand and multi-brand retail trading in the same entity.

(v)                          E-Commerce – Clarification on computation of 25% sales value cap: Last year saw detailed guidelines on FDI in the e-commerce sector being brought in by the Government, which inter alia restricted an e-commerce entity from permitting more than 25% of the sales affected through its marketplace from one vendor or their group companies. This restriction has been further clarified in the FDI Policy-2017 to be calculated as 25% of value of sales, on a financial year basis.

D.              Concluding Remarks.

The last couple of years have seen a flurry of reforms aimed at making the FDI policy more streamlined and investor friendly. The extent of actual impact of the changes, however, remains to be seen. For instance, while the FDI liberalizations being brought in are indeed welcome, the much touted institutional change of abolishment of FIPB which is expected to cut away the bureaucracy and red tape hurdles faced by applicants under the erstwhile regime, may just be a classic case of old wine in a new bottle, given the number of ministries/departments which continue to remain involved in the FDI approval process. That said, due credit needs to be given to the Government, for bringing in all these measures and initiatives to facilitate foreign investment inflows into the country. However, whether the FDI inflows will continue to be on an upward swing on March ending 2018 in the backdrop of shaky Indian economy impacted by the effects of demonetization and confusions created by GST is yet to be seen.


1 Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Fifteenth Amendment) Regulations, 2016

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Seema Jhingan
Neha Yadav
Saniya Kothari
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