FDI In Restaurants: A Gateway To Enhanced Customer Experience

1. INTRODUCTION

India is renowned worldwide for its unparalleled hospitality, deeply rooted in the cultural ethos of 'Atithi Devo Bhava, which translates to "The guest is God". The term 'hospitality' encompasses a range of services such as accommodation, dining, wellness, recreational activities and the like.

According to recent statistics¹, the market size of the hospitality industry in India is projected to be approximately USD 24.61 billion by the end of 2024 and is anticipated to reach USD 31.01 billion by 2029, growing at a CAGR of 4.73%. The food service sector in particular, is expected to grow at a CAGR of 8.1% during 2024-2028. While this sector did see a dent during the COVID-19 pandemic, it has seen a remarkable spur in investments in the last couple of years.

This article lays emphasis on FDI in industries operating restaurants and coffee shops, in particular.

2. FDI² AND BUSINESS MODEL COMPLEXITIES

To capitalize on the recent trend of product diversification and considering the increased potential for customer outreach, the business models used in the restaurant industry have also evolved. Below are some recent trends that have emerged over the past few years:

1. Products offered: Restaurants and similar establishments have significantly broadened their range and variety of products over the years, driven by rising customer expectations for a superior experience. Products offered include branded and packaged food products (of a single brand or multi brand), other unbranded ready-to-eat products, sale of merchandise in addition to the traditional food and beverages etc. In addition to sales of products, many restaurants also offer referral programs, limited time offers, anniversary discounts, loyalty points to customers etc. as a promotional gimmick.
2. Sales: The different models used to make the products available to end customers have evolved as well. Products are sold by restaurants and coffee shops: (A) in person, through restaurants/ stores (which may be further set up as grab-and-go establishments, fine dine restaurants, self-service establishments, kiosks, etc.); and (B) through e-commerce platforms, including quick commerce platforms, mobile applications etc., own websites of business houses and sale through B2B and B2C models.
3. Procurement: The products supplied to customers are either manufactured/ prepared in-house i.e. selfmanufactured and/ or contract manufactured or purchased from third party vendors and sold to customers through retail sales. Various factors influence these decisions such as cost analysis, availability of manpower, legal and regulatory landscape etc.

Depending on the business model adopted by the restaurant/ coffee shop, the sectors (as categorized under the Foreign Exchange Regulations) that would be relevant for it are as follows:

1. Quick Service Restaurants (QSRs): Any cafeteria/ restaurant serving food and beverages through the traditional method of preparing it in its own kitchen (or through a cloud kitchen basis its specifications) orthrough an e-commerce platform (like Swiggy, Zomato etc.), would be considered as a quick service restaurant (QSR) in which FDI is permitted up to 100% under automatic route without any attendant sectoral conditions (given it is not a listed sector).
   
   A common example of this model could be where the baristas of a coffee shop prepare beverages in the outlet or where unbranded ready to eat food like sandwiches, croissants, pastries etc. is served to customers of a coffee shop, which may have been prepared either in the outlet itself or in a cloud kitchen/ third party vendor's kitchen, based on the specifications provided by the coffee shop. These products may either be sold in the outlet or through e-commerce models like company website, Swiggy, Zomato etc. and all such arrangements would fall within the purview of QSR.
   
   
2. Manufacturing³: Several restaurants / coffee shops sell packaged food products (such as: roasted coffee, cookies, bakery products, savoury items) and merchandise (like coffee mugs, book- marks, t-shirts, badges, coffee equipment like french press, frothers, mixers etc.) under their own brand name. If these are manufactured in house or through contract manufacturers in India, the activity would fall within the ambit of manufacturing sector. If the contract manufacturers are situated outside India or products are purchased from third parties in finished form and subsequently sold to customers, it would be considered as retail trade (elaborated below) under the Foreign Exchange Laws.
   
   100% FDI is permitted under the automatic route in the manufacturing sector. The prescribed sectoral conditions include (i) the requirement of carrying out contract manufacturing activities in India (if the products are contract manufactured); and (ii) execution of a legally tenable contract with such contract manufacturers. Further, direct sale to consumers (through both online and offline channels) is permitted for products manufactured in compliance with the foregoing conditions.
   
   Over the years, there have been various judicial pronouncements on the contours of a 'manufacturing process, primarily due to the indirect tax benefits accorded for engaging in manufacturing activities. While the evaluation is always fact specific, the primary principles are: whether the process brings out a complete transformation in the original article so as to produce a commercially different article or commodity? Whether the process renders a commodity fit for use which is otherwise not fit? Given the favourable FDI regime under the manufacturing sector, these principles are being adopted for navigating the Foreign Exchange Regulations as well. Several players in the restaurant industry have altered their models to ensure that a manufacturing process is undertaken based on the above principles before sale to the customers, rather than buying products in finished form and selling to customers, which would then require them to comply with stringent retail norms.
   
   
3. Retail Trade: Retail trade is the activity of acquiring a product from a vendor/ wholesaler in finished form and selling it to customers. Conditionalities under the Foreign Exchange Regulations differ depending on whether the entity is engaged under single brand product retail trading ("SBRT") or multibrand product retail trading ("MBRT"). As the names suggest, if all products are sold under a single brand, the activity would constitute SBRT and where the products of multiple brands are offered (like a grocery store), the activity would constitute MBRT.
   
   
   1. SBRT:
      
      
      • If a restaurant purchases packaged food products/ merchandise from third party vendors, affixes its brand and sells them to customers or has the products manufactured through contract manufacturers outside India and sells to customers in India, whether through physical stores or through e-commerce platforms, the activity would fall within the ambit of SBRT sector.
      • Under the Foreign Exchange Regulations, if SBRT is undertaken in respect of food products manufactured and/or produced in India, FDI of 100% is permitted under the Government route. While there is no specific clarity on SBRT of food products manufactured outside India, a plain interpretation suggests that if the food products are manufactured and/or produced outside India, FDI of 100% is permitted under the automatic route. This interpretation may not, however, align with the intention of the legislature as it would encourage the import of goods manufactured outside India rather than incentivizing local production.
      • The sectoral conditions are, however, more stringent for SBRT as compared to the manufacturing sector. For instance, if the foreign investment is beyond 51%, sourcing of 30% of the value of products sold will have to be done from India, preferably from MSMEs etc. An SBRT entity operating through brick-and-mortar stores can also undertake retail trading through ecommerce. However, if FDI is brought into a restaurant business selling only through e-commerce, it would need to open a brick-and within two years from date of start of online retail.
   2. MBRT:
      • Where food products and merchandise of different brands are sold, the activity would be construed as MBRT. The sectoral conditions prescribed under the Foreign Exchange Regulations for MBRT are most stringent.
      • Foreign investment of only up to 51% is permitted under the Government Route for entities engaged in MBRT. Key conditions include: requirement of minimum foreign investment of USD 100 million, requirement of a sizable⁴ minimum investment in 'back-end infrastructure', minimum sourcing requirements⁵ from MSMEs etc., and retail trading by means of e-commerce is not permitted, unless the entity is also engaged in manufacturing in India.
      • A question that often arises whether mineral water and other accompaniment (such as chips, ketchup sachets and soft drinks) sold by a restaurant as part of its offering to customers would result in the business being categorized as MBRT. While a conservative view could be that such sales of accompaniments would be construed as MBRT, a more acceptable view is that if such products are being offered purely as part of the service offered by the restaurant, are not independently sold and do not significantly contribute to the revenue of the restaurant, sale of such products, even though of separate brands, would not constitute MBRT. The Foreign Exchange Regulations, however, do not provide express clarity on this aspect.

3. MULTI-SECTORAL BUSINESS: MANNER OF EVALUATION

Given the business models now followed by restaurants and coffee shops offer an enhanced experience to customers, it is likely for their activities to fall under multiple sectors under the Foreign Exchange Regulations and consequently compliances under different sectors may be required. For example, an international coffee chains opening coffee shops in India would, on the face of it, fall under the QSR sector selling beverages and food in its outlet may be construed; but would also need to comply with requirements under the manufacturing sector if it is selling packaged food products and merchandise manufactured by it and under the SBRT sector, if products are imported by it.

From a sectoral cap standpoint, given QSRs, SBRT (so long as it is not in relation to retail of food products manufactured in India) and manufacturing are all sectors in which 100% FDI is permitted under the automatic route, businesses combining any of these sectoral activities may not face an issue so long as the prescribed sectoral conditions can be complied with. However, if products are offered by a restaurant which constitute MBRT or SBRT in relation to food products manufactured in India, approval of the Government of India would be required before any foreign investment is raised.

4. CONCLUSION

While the Foreign Exchange Regulations provide clarity on the regulatory landscape for making investments in entities operating restaurant/ cafeterias/ coffee shops, multiple other factors such as intricate ownership structures and varied operational standards will also need to be evaluated before evaluation foreign investments in the sector. Navigating these complexities requires thorough diligence in each part of the business and strategic planning.

Footnotes

1. Published by India Brand Equity Foundation (IBEF), a trust established by the Department of Commerce, Ministry of Commerce and Industry, Government of India.

2. Foreign direct investment (“FDI”) in an Indian entity is governed primarily by the Foreign Exchange Management Act 1999, Foreign Exchange Management (Non-Debt Instruments) Rules 2019, and the Consolidated FDI Policy 2020 (“FDI Policy”) published by the Department for Promotion of Industry and Internal Trade (the “DPIIT”), read with the press notes issued by the DPIIT from time to time, and other policy statements issued by the Government of India (collectively, the “Foreign Exchange Regulations”).

3. The term ‘manufacturing' is defined under the Foreign Exchange Regulations to mean “bringing about a change in a non-living physical object or article orthing which results in transformation of the object or article orthing into a new and distinct object or article or thing having a different name, character, and use; or a change in its chemical composition.”

4. At least 50 per cent of the total foreign investment brought in the first tranche of USD 100 million, shall be invested in ‘back-end infrastructure' within three years.

5. At least 30 per cent of the value of procurement of manufactured or processed products purchased shall be sourced from Indian micro, small and medium industries.

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.