India: FDI In Construction Development: Analyzing The Law And Challenges

Last Updated: 9 October 2017
Article by B.R. Srinivas and Raghav Muthanna

'The best investment on earth is earth' - Louis Glickman [a widely known real estate investor and philanthropist]

The Indian real estate market continues to thrive despite regulatory changes, market fluctuations, inflation, tax and other barriers. It is reported that the real estate sector in India has attracted close to US$32 billion in private equity investment with the global capital inflow in the year 2016 alone standing at US$5.7 billion1.

The introduction of the Real Estate (Regulation and Development) Act, 2016, Benami Transaction Prohibition (Amendment) Act, 2016, the Real Estate Investment Trusts (Amendment) Regulation, 2016 and other legislations have brought about greater transparency in what was a largely unregulated sector till recently.

While there is significant clarity to domestic investors in relation to the hurdles that lie under the aforementioned legislations, there continues to remain some ambiguity and challenges on the hurdles faced by foreign investors in the real estate and construction development sector in India which is governed by the Foreign Direct Investment  Policy (FDI Policy) issued by the Department of Industrial Policy and Promotion (DIPP), read with the notifications and circulars issued by the Reserve Bank of India, from time to time.

The focus of this article is to highlight some of the challenges and concerns arising in foreign direct investment (FDI) in the construction development sector in India.

Construction Development vis-a-vis Real Estate Business:

The FDI Policy prohibits a foreign investor from undertaking 'Real Estate Business' in India. 'Real Estate Business' means dealing in land and immovable property with a view to earning profit therefrom but does not include activities constituting 'Construction Development'. 'Construction Development' includes development of townships, construction of residential/ commercial premises, roads or bridges, hotels, resorts, educational institutions, recreational facilities, city and regional level infrastructure and townships.

It is pertinent to note that Construction Development goes hand in glove with Real Estate Business and thus it is imperative to understand as to what would constitute 'Construction Development' and what would constitute 'Real Estate Business'. Identifying the same has led to certain ambiguities, some of which have been briefly highlighted below:

Issue 1: Sale of land acquired for business of the FDI Company

With the liberalization of FDI in the last two decades, FDI has been permitted in most sectors in India.  In order to advance their business needs, companies having FDI in India (FDI Company(ies)), often acquire immovable properties to establish and conduct their business/operations. These FDI Companies may intend to sell portions of their unutilized lands or various properties owned by them, in order to capitalize on their businesses. In this context, a question that arises is whether such sale/transfer of the said lands (on an as is basis, without any further development) by the FDI Company would amount to the FDI Company being engaged in 'Real Estate Business'. In other words, will an FDI Company holding lands (acquired by it for its business) upon selling or transferring the same, be deemed to be 'dealing in land with a view to earning a profit' which is expressly prohibited? 

It may be noted that the land intended to be sold by an FDI Company may already have certain infrastructure and facilities in place and that such land was in any case acquired by the FDI Company solely with the intention of carrying on its business. In terms of Section 9 of the Companies Act, 2013, a company registered in India has the 'power to acquire, hold and dispose of property, both movable and immovable. Therefore the sale of such lands by the FDI Company is within its powers to deal with its assets. A one off sale of an immovable property by an FDI Company is therefore well within the ambit of the provisions of law.

Notwithstanding the above, if the FDI Company undertakes the sale of  several properties  at around the same time, such activity may lead the authorities to believe that the FDI Company is dealing in land with a view to earning profits therefrom and as a result construe that the  said  FDI Company is engaging  in 'Real Estate Business', which is prohibited.

Issue 2: Leasing of land acquired for business of the Company

The FDI Policy expressly stipulates that earning of rent/ income on lease of property, not amounting to transfer2 will not qualify as 'Real Estate Business'.

In the above context, an FDI Company owning several properties in India (acquired by it for the purpose of carrying out its business), may opt to lease out its properties (including by way of a long term lease) with the intention of earning revenues therefrom. In such event, a question that arises is whether the FDI Company engaged in a particular sector where 100% automatic foreign investment is permitted (for instance automobile manufacturing) having several properties in India, can lease out its underutilized properties to third parties, especially if the said leasing activity relates to multiple properties.  A guiding factor in this regard could be the extent of revenue that is generated by such leasing activity, as compared to the revenue generated by the FDI Company from its core business (being manufacturing in the instant case). It appears that the intent of the DIPP may have been to enable the generation of income by way of lease/rent from developed projects only and not from land not being developed/ constructed. However, in the absence of any set standards or clarifications, the issue remains open for interpretation. 

In light of the abovementioned Issues 1 and 2, it is unclear on the number of such sale or lease transactions that may be carried out by an FDI company before it may be construed to be  engaged in  'Real Estate Business'. It would be appropriate if the DIPP issues a clarification or a guideline that addresses these concerns.

Issue 3: Joint Development Agreement: Does mere contribution of land amount to construction development?

If an FDI Company proposes to commercially exploit any portion of its unused immovable property, it may do so by entering into a joint development arrangement with a developer. The developer may invest in and develop the property and upon completion of the said construction, an agreed portion of the developed area may be retained by the FDI Company, as its entitlement. In such arrangement, the FDI Company's only contribution to the said joint development, is land, and no construction activity is being carried out by the FDI Company. In this context, a question that may arise is:

'whether the mere contribution of land by the FDI Company towards such joint development would be sufficient for the FDI Company to be construed as being engaged in 'Construction Development' activity, permitted under the FDI Policy?'

Since the focus of the FDI Policy is on 'construction and development', it is imperative that the FDI Company (in the above context), must also be involved actively in the joint development activity, apart from contribution of the land. There is however no clarity on the extent of participation that the FDI Company (contributing land) must have in the said joint development, more so, if the said FDI Company is by itself not engaged in construction development business. 

Issue 4: Transfer of agriculture/ plantation property to a Body Corporate by an NRI/PIO

The FEMA Property Regulations3 places certain restrictions on acquisition and transfer of agricultural land and plantation property by non- residents (including PIO's and NRI's). In terms of the FEMA Property Regulations, while a Non Resident Indian (NRI) is permitted to transfer immovable property (including agricultural and plantation property) to a person resident in India, a Person of Indian Origin (PIO) is permitted to transfer agricultural land and plantation property, by way of gift or sale, only to a resident in India who is a citizen of India. This would mean that PIOs can transfer such agricultural or plantation land only to natural persons. It may be noted that in terms of the FEMA Act4, a person resident in India includes a body corporate and thus in light of the same, while an NRI can transfer agriculture and plantation property to a company or an LLP, a PIO can only transfer the same to an individual Indian citizen and not to a body corporate. It is unclear as to why this distinction has been made. It is quite possible that the aforesaid distinction is an inadvertent error, more so for the reason that the FDI Policy intends to bring about parity between NRIs and PIOs.

Issue 5: Contribution of Immovable Property by an NRI/PIO into an LLP

In terms of PN 75, any investment made by an NRI or a PIO, on a non-repatriation basis is to be treated on par with an investment made by a resident in India and the restrictions otherwise applicable to an NRI / PIO, would not apply to such investment (on a non-repatriation basis).

The LLP Act6 permits the contribution of immovable property as capital contribution by a partner, which may include an NRI or PIO. Taking into account that there are no restrictions on a domestic investor/resident under domestic laws, from transferring immovable property to an LLP, as capital contribution, the question that needs to be addressed is as follows:

'In light of PN 7, whether an NRI and/or a PIO can transfer immovable properties situated in India to an LLP, as his capital contribution into the LLP ?'

A majority view in this regard is that an NRI / PIO cannot contribute his immovable properties situated in India to an LLP, as capital contribution. One of the reasons for arriving at this conclusion is because of the provisions under FEMA 207, issued by the Reserve Bank of India, wherein the mode of payment of capital contribution by a foreign investor in an LLP, is specified as 'money contribution', by inward remittance through banking channels (without contemplating capital contribution by modes other than cash). 

Notwithstanding the above, there is no definitive view as to why an NRI / PIO must be differentiated from a resident investor, when the proposed investment is on a non-repatriation basis.

Conclusion:

Despite the few ambiguities and uncertainties, foreign investment in construction development has now been substantially liberalized, more so with the recent amendments introduced to the FDI Policy. Clarifications on the above issues and other grey areas may however need to be addressed by the DIPP in order to enable more foreign investment in the Construction Development sector.

B.R. Srinivas, Partner ( srini@duaassociates.com)

Raghav Muthanna, Associate ( raghav@duaassociates.com

*The views expressed are personal and may not necessarily reflect the views of the Firm.

Dua Associates, 130/1, 2nd Floor, Ulsoor Road, Bangalore 560042, India

Tel: +91 80 2558 8799

Fax: +91 80 2558 8801

Footnotes

1 Economics Times Report dated April 11, 2017.

2 The term 'transfer' has been defined in the FDI policy in an inclusive manner, to include, not only direct transfers by way of any sale, exchange or relinquishment of any asset, but also indirect transfer by way of transfer of shares of a company which owns any immovable property.

3 Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2000.

4 The Foreign Exchange Management Act, 1999.

5 Press Note 7 issued by the DIPP on May 12, 2015.

6 The Limited Liability Partnership Act, 2008.

7 Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India), Regulations, 2000.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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