DIPP’s Revised FDI Policy for E-commerce: Changing the Rules of the Game

[Baibhav Panda is a recent law graduate from KLE Law College, Bengaluru and is presently a legal trainee at Nucleus Software Limited]

On 26 December 2018 the Department of Industry and Promotion (DIPP), Ministry of Commerce and Industry issued Press Note 2 (2018 series) introducing changes to the conditions that would be applicable to the e-commerce entities. The press note now amends para 5.2.15.2 (e-commerce activities) of the Consolidated FDI Policy which had been in effect since 28 August 2017. The changes announced in Press Note 2 of 2018 would become effective from 1 February 2019.

Press Note 3 (2016 series) dated 29 March 2016 expressly prohibited foreign direct investment (FDI) in the inventory-based model and the same has been incorporated in the recently issued Press Note 2, which means no relaxation has been given in the inventory-based model. The provision permitting 100% FDI in marketplace model of e-commerce remains same.

The Press Note 3 of 2016 contained a provision under which FDI in e-commerce (B2C model) was permitted subject to compliance with certain conditions. However, due to its ineffectiveness, the provision has been omitted in Press Note 2 of 2018. To provide more context, e-commerce entities can now only engage in business to business (B2B) e-commerce and not in business to customer (B2C) e-commerce.

The sole purpose of the refinement in the FDI policy relating to e-commerce activities is to check the predatory pricing and deep discounting that have been offered by the online retail behemoths like Amazon and Flipkart which has been detrimental to the business interests of the offline retailers and other retailers in the market.

Important takeaways from the recently issued press note

Ownership or control over the inventory

Press Note 3 of 2016 prohibited e-commerce entities from exercising “ownership”[i] over the inventory, i.e., goods purported to be sold. But, in the recently released press note the position has slightly changed, i.e., the e-commerce entities are prohibited from exercising “control” and “ownership”[ii] over the inventory. With the changes brought out recently, it will be a major test for the e-commerce entities to differentiate the marketplace-based model of e-commerce from the inventory-based model of e-commerce. In other words, earlier “ownership” was a parameter for the test but now “control” will be taken into account. Earlier, e-commerce entities were permitted to generate not more than 25% of the sales value through their marketplace platform from one vendor or the vendor’s group companies.

In 2013, the Reserve Bank of India (RBI) issued a notification to clarify what a “group company” is. “Group company” means two or more enterprises, which directly or indirectly are in a position to:

(i) exercise 26%, or more of voting rights in other enterprise.

(ii) appoint more than 50%, of members of board of directors in the other companies.

The latest press note states that the vendor will not be allowed to sell its products on the marketplace entity’s (e-commerce) platform if the vendor’s inventory is deemed to be in control of the marketplace entity or its group companies. Also, the “25% threshold on sale”[iii] which earlier existed in the Press Note 3(2016 series) has been omitted.

Equity Ownership

Restrictions have been imposed on the vendors that prohibits them from selling on the marketplace entity’s platform if such a marketplace entity or its group companies hold any stake or has an equity participation in the vendor.

No preferential treatment

Pursuant to the latest press note, the marketplace entity has been prohibited from selling a product of the vendor exclusively on its own platform. No preferential treatment is to be given to a particular vendor.

Fair dealings

The latest press note prescribes that the marketplace entities shall not engage in influencing the prices of the goods or services, be it directly or indirectly, and maintain a playing al level playing field. This condition was also incorporated in Press Note 3 of 2016.

To clear out the confusion and ambiguity, DIPP has issued a clarification in the latest press note that the services may be provided to the vendors on an e-commerce platform only at arm’s length and in a fair and non-discriminatory manner by:

(a) Marketplace entities; or

(b) Other entities in which the e-commerce market entity has direct or indirect equity participation or common control.

These services may include but shall not be limited to only warehousing, logistics, advertising, marketing, payments and financing etc. One of the most striking features of the Press Note is the provision of cashback. The press note prescribes the use of the cashback by the group companies of a marketplace entity in a fair and non-discriminatory manner only.

Submission of certificate of compliance to the RBI

The e-commerce marketplace entity will now be required to submit a certificate along with the report of the statutory auditor to the RBI confirming compliance with the guidelines under the press note by 30 September each year for the preceding financial year.

Analysis

The changes that have been introduced in Press Note 2 of 2018 become effective from 1 February 2019, but its release without any consultation or discussion with e-commerce companies or other stakeholders has drawn out ambiguity in the provisions of the press note itself.

1. The Press Note prescribes that the e-commerce marketplace entity will not mandate any seller to sell any product exclusively on its platform only. This appears as a restriction only if the “exclusive arrangement” is imposed by the marketplace entity from its side. It means that the vendor is not prohibited from voluntarily selling its product exclusively on its platform.

2. The Press Note prescribes that the services should be provided by e-commerce marketplace entity or other entity in which the e-commerce marketplace entity has direct or indirect equity participation or common control, to the vendors on the platform at arm’s length and in a fair and non-discriminatory manner.

Suppose the e-commerce marketplace entity has a minor stake in another company, i.e., vendor but does not exercise control over the board of directors of that company. The question that arises in this reference is whether this requirement be applicable to the e-commerce marketplace entity even if it does not have control over the other company.

3. Some of the provisions incorporated in Press Note 3 of 2016 that were in the interests of the e-commerce entities have been removed in the latest Press Note. To provide more context, the cashback provision in the latest press note appears to be the only exception now. It reads as under:

“Cash back provided by group companies of marketplace entity to buyers shall be fair and non-discriminatory. For the purposes of this clause, provision of services to any vendor on such terms which are not made available to other vendors in similar circumstances will be deemed to be fair and discriminatory.”[iv]

The Press Note remains silent on what constitutes “similar circumstances” and what is the degree of flexibility and preferential treatment that can be permitted.

4. Even if the changes have been introduced in the FDI it lacks the redressal mechanism and penalties in case the e-commerce entities fail to comply or adhere with the said rules.

Implications of the change in policy

Business perspective

The two e-commerce giants Amazon and Flipkart are likely to be most affected with these changes in the policy and they need to alter in their respective business models to comply with the guidelines.

Amazon works closely with vendors like Cloudtail and Appario which constitute majority of Amazon’s sales. Cloudtail is a joint- venture between Amazon and Narayan Murthy’s Catamaran Ventures and Appario is a joint venture between Amazon and Patni group. On the other hand, Flipkart’s largest vendor is Retailnet and WS retail.  Both Amazon and Flipkart have inventories which are valued at 2000-2500 crore rupees which might have to be disposed of before the guidelines come into effect on 1 February 2019. Taking the case of Amazon, it might even mean selling off its stakes in Appario and Cloudtail for compliance with the regulation. The sellers who had exclusive arrangements with the e-commerce marketplace platforms have to exit from such arrangements and sell their products on multiple platforms to address the rule.

On the brighter side, the traditional brick and mortar sellers are the biggest winners who had lost much of the business in recent years as the likes of Amazon and Flipkart had attracted customers with cashbacks and discounts. The new guidelines aim to maintain a check by restricting the discounts and cashbacks and will enable the brick and mortar businesses to regain confidence and customers.

Consumer perspective

The changes brought out in the policy for e-commerce activities implies that the customers have to part with the heavy discounts that were offered by the online retailers. The position prior to the Press Note was that e-commerce platforms took the responsibility of the post sales of a product or service. The Press Note prescribes that it will be the responsibility of the seller when it comes to warranty/guarantee of goods and services sold on the e-commerce marketplace platform. The question that arises is how, after the business models of the e-commerce entities are altered, the sellers will deal with complaints and requests of the customers and how they will be efficient as the e-commerce companies have been in the past.

Conclusion

The changes brought out in the recent Press Note is a great sign but more needs to be done. DIPP has made issued clarifications but then there is room for more in that some of the provisions are still ambiguous and confusing and moreover it is open to interpretation. Before it becomes effective on 1 February 2019, it is important that it be reviewed again so that the language become clear. Also, extending the timeline would be another option so that e-commerce companies are fully compliant.

This episode has highlighted the need for a regulatory body to oversee that the e-commerce entities operating on the online marketplace platform are not involved in malpractices, predatory pricing and heavy discounting and that they are compliant with the rules. The draft e-commerce policy would determine how the e-commerce entities operate with the limitations and what impact they would have on the revenues and profits.

Baibhav Panda

[i] Paragraph 2.3, Other Conditions (iv) of Press Note 3 (2016 series).

[ii] Paragraph 5.2.15.2.4, Other Conditions (iv) of Press Note 2 (2018 series).

[iii] Paragraph 2.3, Other Conditions (v) of Press Note 3 (2016 series).

[iv] Paragraph 5.2.15.2.4, Other Conditions (ix) of Press Note 2 (2018 series).

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