Update. DIPP favorably revisits crucial sectors: amends FDI Policy. CS Vinita Nair & CS Nitin Bohara

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1 Update DIPP favorably revisits crucial sectors: amends FDI Policy CS Vinita Nair & CS Nitin Bohara Corporate Law Services Division January 27, 2018 i Check at: Copyright: This write up is the property of Vinod Kothari & Company and no part of it can be copied, reproduced or distributed in any manner. Disclaimer: This write up is intended to initiate academic debate on a pertinent question. It is not intended to be a professional advice and should not be relied upon for real life facts.

2 With a view to liberalize and simplify the Foreign Direct Investment Policy, the Union Cabinet chaired by Prime Minister Shri Narendra Modi, approved a number of amendments in the relation to Foreign Direct Investment (FDI) at their meeting held on 10 th January, Further, the Department of Industrial Policy and Promotion (DIPP) through its press note no.1(2018 series) 2 released on 23 rd January, 2018 amended the Consolidated FDI Policy circular of 2017( FDI Policy ). The Reserve Bank of India (RBI) notification amending Para B of Regulation 16 of (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 is pending. The press note shall take effect from the date of FEMA notification. The amendments are discussed at l in this article. Prohibition of restrictive conditions regarding audit firms Background: The extant FDI policy does not have any provisions in respect of specification of auditors that can be appointed by the Indian investee companies receiving foreign investments. Proposal: It has been decided to provide in the FDI policy that wherever the foreign investor wishes to specify a particular auditor/audit firm having international network for the Indian investee company, then audit of such investee companies should be carried out as joint audit wherein one of the auditors should not be part of the same network. Amendment made in FDI Policy: Clause (h) of Para 5.2 dealing with Permitted Sectors has been replaced with the following: (h) Wherever the foreign investor wishes to specify a particular auditor/audit firm having international network for the Indian investee company, then audit of such investee companies should be carried out as joint audit wherein one of the auditors should not be part of the same network. Existing Para 5.2 (h) shall be renumbered as 5.2 (i) Impact Indian investee companies having Big 4 or their Indian affiliates as auditors based on insistence of foreign investor (pursuant to a clause in SHA or otherwise) will have to appoint an unrelated Indian firm as joint auditor. FDI in Investment Companies (1). Foreign investment into an Indian company engaged only in the activity of investing in the capital of other Indian company/ies

3 Background: Foreign investment into an Indian company, engaged only in the activity of investing in the capital of other Indian company/ies/ LLP and in the Core Investing Companies was allowed upto 100% with prior Government approval. Proposal: To align FDI policy on these sectors with FDI policy provisions on Other Financial Services. Thus, if the above activities are regulated by any financial sector regulator, then foreign investment upto 100% under automatic route shall be allowed; and, if they are not regulated by any Financial Sector Regulator or where only part is regulated or where there is doubt regarding the regulatory oversight, foreign investment up to 100% will be allowed under Government approval route, subject to conditions including minimum capitalization requirement, as may be decided by the Government. Amendment made in FDI Policy: Para dealing with Foreign investment into an Indian company engaged only in the activity of investing in the capital of other Indian company/ies (regardless of its ownership or control) Para of FDI Policy is amended to read as under: Remarks Foreign Investment in Investing Companies registered as Non-Banking Financial Companies (NBFC) with the Reserve Bank of India, being overall regulated, would be under 100% automatic route Foreign investment into an Indian company, engaged only in the activity of investing in the capital of other Indian company/ies/ LLP, will require prior Government approval, regardless of the amount or extent of foreign investment. 100% FDI under automatic route permitted for Investment Companies NBFCs registered Para of FDI Policy is amended to read as under: Remarks Foreign Investment in Core Investment Companies (CICs) and other investing companies, engaged in the activity of investing in the capital of other Indian company/ies/llp, is permitted under Government approval route. CICs will have to additionally follow RBI's regulatory framework for CICs Foreign investment into an Indian company, engaged only in the activity of investing in the capital of other Indian company/ies/ LLP, will require prior Government approval, regardless of the amount or extent of foreign investment Those companies, which are Core Investment Companies (CICs), will have to additionally follow RBI s Regulatory Framework for CICs. The provision relating to CIC and other investment companies remain intact. It is pertinent to note that CICs are also NBFCs and require registration in case of having total assets of not less than INR 100 crore either individually or in aggregate along with other CICs in the Group and which raises or holds public funds. On reading of Para

4 and , registered CICs should have been permitted to accept FDI. However, the ministry has retained the provisions. Impact The amendment gives an impression that CICs will not be able to receive FDI under automatic route and that only NBFCs registered as Investment Companies will be permitted under automatic route. The intent of amendment was that activities that are regulated by any financial sector regulator, foreign investment upto 100% under automatic route shall be allowed. In that case, CICs registered with RBI (total assets of not less than INR 100 crore either individually or in aggregate along with other CICs in the Group and which raises or holds public funds) should also get the benefit of availing FDI under 100% automatic route as the same will be regulated by RBI, a financial sector regulator. With the amendment, all NBFC investment companies can accept FDI and can make downstream investment in permitted sectors. This is a huge change. Foreign investment in Investment Vehicles was anyways permitted as per Regulation 5 (8) read with Schedule 8 of FEMA Regulations. Investment Vehicles are also regulated by SEBI, a financial sector regulator and therefore, should be able to receive FDI under 100% automatic route. Competent Authority for FDI proposals examining countries of concern Background: As per the existing procedures, FDI applications involving investments from Countries of Concern, requiring security clearance as per the extant FEMA 20, FDI Policy and security guidelines, amended from time to time, are to be processed by the Ministry of Home Affairs (MHA) for investments falling under automatic route sectors/activities, while cases pertaining to government approval route sectors/activities requiring security clearance are to be processed by the respective Administrative Ministries/Departments, as the case may be. Proposal: Investments in automatic route sectors, requiring approval only on the matter of investment being from country of concern, FDI applications would be processed by Department of Industrial Policy & Promotion (DIPP) for Government approval. Cases under the government approval route, also requiring security clearance with respect to countries of concern, will continue to be processed by concerned Administrative Department/Ministry. Amendment made in FDI Policy: Para (ix) of FDI Policy relating to competent authority for granting Government approval:

5 (ix) (a) Activity/ Sector: Applications involving investments from Countries of Concern falling under automatic route sectors/activities, requiring security clearance as per the extant FEMA 20, FDI Policy and security guidelines, as amended from time to time. Administrative Ministry/ Department: Department of Industrial Policy and Promotion (ix) (b) Activity/ Sector: Cases pertaining to Government approval route sectors/activities requiring security clearance as per the extant FEMA 20, FDI Policy and security guidelines, as amended from time to time (ix) Activity/ Sector: Applications involving investments from Countries of Concern which presently include Pakistan and Bangladesh, requiring security clearance as per the extant FEMA 20, FDI Policy and security guidelines, amended from time to time. Administrative Ministry/ Department: Ministry of Home Affairs Administrative Ministry/ Department: Nodal Administrative Ministries/Departments Provisions Relating to Issue/ Transfer of Shares: Background: As per the extant FDI policy, issue of equity shares against non-cash considerations like pre-incorporation expenses, import of machinery etc. is permitted under Government approval route. Proposal: Issue of shares against non-cash considerations like pre-incorporation expenses, import of machinery etc. shall be permitted under automatic route in case of sectors under automatic route. Amendment made to FDI Policy: Clause (iv) of Para 6 of Annexure 3 on Conversion of ECB/Lump sum Fee/Royalty etc. into Equity Issue of equity shares for sectors requiring Government approval under the FDI policy is allowed under the Government route for the following: I. import of capital goods/ machinery/ equipment (excluding second-hand machinery), subject to compliance with the following conditions: a) Any import of capital goods/machinery Issue of equity shares under the FDI policy is allowed under the Government route for the following: (I) import of capital goods/ machinery/ equipment (excluding second-hand machinery), subject to compliance with the following conditions: (a)any import of capital goods/machinery etc.,

6 etc., made by a resident in India, has to be in accordance with the Export/Import Policy issued by Government of India/as defined by DGFT/FEMA provisions relating to imports b) The application clearly indicating the beneficial ownership and identity of the Importer Company as well as overseas entity. c) Applications complete in all respects, for conversions of import payables for capital goods into FDI being made within 180 days from the date of shipment of goods. II. pre-operative/pre-incorporation expenses (including payments of rent etc.), subject to compliance with the following conditions: a) Submission of FIRC for remittance of funds by the overseas promoters for the expenditure incurred. b) Verification and certification of the preincorporation/pre-operative expenses by the statutory auditor c) Payments should be made by the foreign investor to the company directly or through the bank account opened by the foreign investor as provided under FEMA Regulations. d) The applications, complete in all respects, for capitalization being made within the period of 180 days from the date of incorporation of the company General Conditions (i). All requests for conversion should be accompanied by a special resolution of the company (ii). Government's approval would be subject to pricing guidelines of RBI and appropriate tax clearance. made by a resident in India, has to be in accordance with the Export/Import Policy issued by Government of India/as defined by DGFT/FEMA provisions relating to imports. (b)the application clearly indicating the beneficial ownership and identity of the Importer Company as well as overseas entity. (c) Applications complete in all respects, for conversions of import payables for capital goods into FDI being made within 180 days from the date of shipment of goods. (II) pre-operative/pre-incorporation expenses (including payments of rent etc.), subject to compliance with the following conditions: (a) Submission of FIRC for remittance of funds by the overseas promoters for the expenditure incurred. (b) Verification and certification of the preincorporation/pre-operative expenses by the statutory auditor. (c) Payments should be made by the foreign investor to the company directly or through the bank account opened by the foreign investor as provided under FEMA Regulations. (d) The applications, complete in all respects, for capitalization being made within the period of 180 days from the date of incorporation of the company. General conditions: (i) All requests for conversion should be accompanied by a special resolution of the company. (ii) Government s approval would be subject to pricing guidelines of RBI and appropriate tax clearance. (iii). For sectors under automatic route, issue of equity shares against import of capital goods/ machinery/ equipment (excluding

7 second-hand machinery) and preoperative/pre-incorporation expenses (including payments of rent etc.) is permitted under automatic route subject to compliance with respective conditions mentioned above, and reporting to RBI in form FC-GPR as per procedure prescribed under the FDI policy. Construction Development: Townships, Housing, Built-up Infrastructure and Real Estate Broking Background: FDI is not permitted in an entity which is engaged or proposes to engage in real estate business, construction of farm houses and trading in transferable development rights (TDRs). Real estate business means dealing in land and immovable property with a view to earning profit there from and does not include development of townships, construction of residential/ commercial premises, roads or bridges, educational institutions, recreational facilities, city and regional level infrastructure, townships. Further, earning of rent/ income on lease of the property, not amounting to transfer, will not amount to real estate business. Proposal: To clarify that real-estate broking service does not amount to real estate business and is therefore, eligible for 100% FDI under automatic route. Amendment made in FDI Policy: Notes under Para of FDI Policy Following new clause (vi) inserted: (vi). Notwithstanding anything contained in Para above, it is clarified that realestate broking service does not amount to real estate business and 100% foreign investment is allowed in the activity under automatic route. Civil Aviation Background: As per the extant policy, foreign airlines are allowed to invest under Government approval route in the capital of Indian companies operating scheduled and nonscheduled air transport services, up to the limit of 49% of their paid-up capital. However, this provision was presently not applicable to Air India, thereby implying that foreign airlines could not invest in Air India. Proposal: To do away with this restriction and allow foreign airlines to invest up to 49% under approval route in Air India subject to the conditions that: i. Foreign investment(s) in Air India including that of foreign Airline(s) shall not exceed 49% either directly or indirectly

8 ii. Substantial ownership and effective control of Air India shall continue to be vested in Indian National. Amendment made in FDI Policy: Para of FDI Policy dealing with Civil Aviation. Remarks (iii) The policy mentioned at para (c) above is not applicable to M/s Air India Ltd. Clause (d) inserted in Other Conditions: In addition to the above conditions, foreign investment in M/s Air India Ltd. shall be subject to the following conditions: (i). Foreign investment(s) in M/s Air India Ltd., including that of foreign airline(s), shall not exceed 49% either directly or indirectly (ii). Substantial ownership and effective control of M/s Air India Ltd. shall continue to be vested in Indian Nationals (iii) The policy mentioned at para (c) above is not applicable to M/s Air India Ltd. No such provision Accordingly, foreign airlines can invest in Air India subject to other conditions specified in (c) and (d). Foreign investors, other than foreign airlines, can invest subject to conditions specified in (d). Single Brand Product Retail Trading Background: Extant FDI policy on SBRT allows 49% FDI under automatic route, and FDI beyond 49% and up to 100% through Government approval route. Proposal: To permit 100% FDI under automatic route for SBRT. Amendment made in FDI Policy: Para of FDI Policy is amended to read as under: Sector/Activity % of Equity/FDI Cap Entry Route Single Brand product 100% Automatic retail trading 1. Foreign Investment in Single Brand product retail trading is aimed at attracting 1. Foreign Investment in Single Brand product retail trading is aimed at attracting

9 investments in production and marketing, improving the availability of such goods for the consumer, encouraging increased sourcing of goods from India, and enhancing competitiveness of Indian enterprises through access to global designs, technologies and management practices. 2. FDI in Single Brand product retail trading would be subject to the following conditions: a) Products to be sold should be of a 'Single Brand' only b) Products should be sold under the same brand internationally i.e. products should be sold under the same brand in one or more countries other than India c) 'Single Brand' product-retail trading would cover only products which are branded during manufacturing d) A non-resident entity or entities, whether owner of the brand or otherwise, shall be permitted to undertake 'single brand' product retail trading in the country for the specific brand, either directly by the brand owner or through a legally tenable agreement executed between the Indian entity undertaking single brand retail trading and the brand owner. investments in production and marketing, improving the availability of such goods for the consumer, encouraging increased sourcing of goods from India, and enhancing competitiveness of Indian enterprises through access to global designs, technologies and management practices. 2. FDI in Single Brand product retail trading would be subject to the following conditions: (a) Products to be sold should be of a Single Brand only. (b) Products should be sold under the same brand internationally i.e. products should be sold under the same brand in one or more countries other than India. (c) Single Brand product-retail trading would cover only products which are branded during manufacturing. (d) A non-resident entity or entities, whether owner of the brand or otherwise, shall be permitted to undertake single brand product retail trading in the country for the specific brand, directly or through a legally tenable agreement with the brand owner for undertaking single brand product retail trading. The onus for ensuring compliance with this condition will rest with the Indian entity carrying out single-brand product retail trading in India. The investing entity shall provide evidence to this effect at the time of seeking approval, including a copy of the licensing/franchise/sub-licence agreement, specifically indicating compliance with the above condition. The requisite evidence should be filed with the RBI for the automatic route and to competent authority for cases involving approval.

10 e) In respect of proposals involving foreign investment beyond 51%, sourcing of 30% of the value of goods purchased, will be done from India, preferably from MSMEs, village and cottage industries, artisans and craftsmen, in all sectors. The quantum of domestic sourcing will be self-certified by the company, to be subsequently checked, by statutory auditors, from the duly certified accounts which the company will be required to maintain. This procurement requirement would have to be met, in the first instance, as an average of five years' total value of the goods purchased, beginning 1st April of the year of the commencement of the business i.e. opening of the first store. Thereafter, it would have to be met on an annual basis. For the purpose of ascertaining the sourcing requirement, the relevant entity would be the company, incorporated in India, which is the recipient of foreign investment for the purpose of carrying out single-brand product retail trading. f) Subject to the conditions mentioned in this Para, a single brand retail trading entity operating through brick and mortar stores, is permitted to undertake retail trading through e- commerce g) Single brand retail trading entity would be permitted to set off its incremental sourcing of goods from India for global operations during initial 5 years, beginning 1st April of the year of the opening of first store, against the mandatory sourcing requirement of 30% of purchases from India. For this purpose, incremental sourcing will mean the increase in terms of value of such global sourcing from India for that single brand (in INR) terms in a particular financial year from India over the preceding financial year, by the non-resident entities undertaking single brand retail trading, either directly or through their (e) In respect of proposals involving foreign investment beyond 51%, sourcing of 30% of the value of goods purchased, will be done from India, preferably from MSMEs, village and cottage industries, artisans and craftsmen, in all sectors. The quantum of domestic sourcing will be self-certified by the company, to be subsequently checked, by statutory auditors, from the duly certified accounts which the company will be required to maintain. This procurement requirement would have to be met, in the first instance, as an average of five years total value of the goods purchased, beginning 1st April of the year of the commencement of the business i.e. opening of the first store. Thereafter, it would have to be met on an annual basis. For the purpose of ascertaining the sourcing requirement, the relevant entity would be the company, incorporated in India, which is the recipient of foreign investment for the purpose of carrying out single-brand product retail trading. (f) Subject to the conditions mentioned in this Para, a single brand retail trading entity operating through brick and mortar stores, is permitted to undertake retail trading through e-commerce. g) No such provision.

11 group companies. After completion of this 5 years period, the SBRT entity shall be required to meet the 30% sourcing norms directly towards its India s operation, on an annual basis Deleted 3. Application seeking permission of Government. Note: (i). Conditions mentioned at Para (2) (b) & (2) (d) will not be applicable for undertaking SBRT of Indian brands (i) Conditions mentioned at Para (2) (b) & (2) (d) will not be applicable for undertaking SBRT of Indian brands. (ii). Indian brands should be owned and controlled by resident Indian citizens and/or companies which are owned and controlled by resident Indian citizens. (iii). Sourcing norms will not be applicable up to three years from commencement of the business i.e. opening of the first store for entities undertaking single brand retail trading of products having 'state-of-art' and 'cutting-edge' technology and where local sourcing is not possible. Thereafter, provisions of Para (2) will be applicable. A Committee under the Chairmanship of Secretary, DIPP, with representatives from NITI Aayog, concerned Administrative Ministry and independent technical expert(s) on the subject will examine the claim of applicants on the issue of the products being in the nature of 'state-ofart' and `cutting-edge' technology where local sourcing is not possible and give recommendations for such relaxation. (ii) Indian brands should be owned and controlled by resident Indian citizens and/or companies which are owned and controlled by resident Indian citizens. (iii)sourcing norms will not be applicable up to three years from commencement of the business i.e. opening of the first store for entities undertaking single brand retail trading of products having state-of-art and cutting-edge technology and where local sourcing is not possible. Thereafter, provisions of Para (2) (e) will be applicable. A Committee under the Chairmanship of Secretary, DIPP, with representatives from NITI Aayog, concerned Administrative Ministry and independent technical expert(s) on the subject will examine the claim of applicants on the issue of the products being in the nature of state-ofart and cutting-edge technology where local sourcing is not possible and give recommendations for such relaxation. Power Exchanges Background: Extant policy provides for 49% FDI under automatic route in Power Exchanges registered under the Central Electricity Regulatory Commission (Power Market) Regulations, However, FII/FPI purchases were restricted to secondary market only.

12 Proposal: To do away with this provision, thereby allowing FIIs/FPIs to invest in Power Exchanges through primary market as well. Amendment made in FDI Policy: Para regarding "Other Conditions" for foreign investment in Power Exchanges The present clause (i) "Fll/FPI purchases shall be restricted to secondary market only;" stands deleted Pharmaceuticals Background: Definition of medical device as contained in the FDI Policy would be subject to amendment in the Drugs and Cosmetics Act. Proposal: As the definition as contained in the policy is complete in itself, it was decided to drop the reference to Drugs and Cosmetics Act from FDI policy. Further, it has also been decided to amend the definition of medical devices as contained in the FDI Policy. Amendment made in FDI Policy: Note (ii) of Para of FDI Policy. (ii) Medical Device means: a) any instrument, apparatus, appliance, implant, material or other article, whether used alone or in combination, including the software, intended by its manufacturer to be used specially for human beings or animals for one or more of the specific purposes of: (i) diagnosis, prevention, monitoring, treatment or alleviation of any disease or disorder (ii). diagnosis, monitoring, treatment, alleviation or assistance for, any injury or disability; (iii). investigation, replacement or modification or support of the anatomy or of a physiological process ii. Medical device meansa. any instrument, apparatus, appliance, implant, material or other article, whether used alone or in combination, including the software, intended by its manufacturer to be used specially for human beings or animals for one or more of the specific purposes of- (aa) diagnosis, prevention, monitoring, treatment or alleviation of any disease or disorder; (ab) diagnosis, monitoring, treatment, alleviation of, or assistance for, any injury or handicap; (ac) investigation, replacement or modification or support of the anatomy or of a physiological process; (iv). (v). (vi). supporting or sustaining life; disinfection of medical devices control of conception (ad) supporting or sustaining life; (ae) disinfection of medical devices; (af) control of conception,

13 and which does not achieve primary intended action in or on the human body or animals by any pharmacological or iimmunological or metabolic means, but which may be assisted in its intended function by such means; and which does not achieve its primary intended action in or on the human body or animals by any pharmacological or immunological or metabolic means, but which may be assisted in its intended function by such means; b) an accessory to such an instrument, apparatus, appliance, material or other article; c) in-vitro diagnostic device which is a reagent, reagent product, calibrator, control material, kit, instrument, apparatus, equipment or system, whether used alone or in combination thereof intended to be used for examination and providing information for medical or diagnostic purposes by means of examination of specimens derived from the human bodies or animals. (iii) the definition of medical device at Note (ii) above would be subject to the amendment in Drugs and Cosmetics Act. (iii) the definition of medical device at Note (ii) above would be subject to the amendment in Drugs and Cosmetics Act. Conclusion Permitting 100% FDI under automatic route in NBFC-IC and SBRT is surely a welcome amendment. Other amendments that are clarificatory in nature are also facilitating.