For the First time consolidated guidelines in respect of Foreign Direct Investment in India has been introduced. Circular states that it is merely a consolidation of various scattered FDI listing and it also has sunset clause. However close look of the new circular shows that this is not merely a consolidation of the existing guidelines/polices. In the write up below some of such issues arising on consolidation has been discussed.

1. Issues in Consolidated DIPP Guidelines
By CA Paras K Savla
Executive Summary
For the First time consolidated guidelines in respect of Foreign Direct Investment in
India has been introduced. Circular states that it is merely a consolidation of various
scattered FDI listing and it also has sunset clause. However close look of the new
circular shows that this is not merely a consolidation of the existing
guidelines/polices. In the write up below some of such issues arising on
consolidation has been discussed.
Background
Post liberalisation, Indian policy on Foreign Direct Investment (FDI) is largely governed by
various press notes issued by the Department of Industrial Policy and Promotion (“DIPP”),
Ministry of Commerce and Industry, Government of India. Further these press notes have
been amended & modified from time to time. For the first time scattered press notes have
been attempted to be consolidated. The circular 1/2010 dt 31-3-2010 effective from 1-4-2010
consolidates, subsumes all prior policies / regulation on FDI which is contained in Foreign
Exchange Management Act, 1999 (FEMA), RBI regulations under FEMA and Press
Notes/Press releases/Clarifications issued by DIPP. Further it is clarified that this circular is
merely consolidation/ compilation and comprehensive listing of most matters on FDI and is
not intended to make changes in the extant regulation.
Issues in consolidated Circular
On close look to the said circular it is observed that this circular is merely not an old wine in
new bottle, but in process it has also added some ingredients and has also created
dichotomy at some places as infra:
1) Term FDI has been replaced with ‘Capital’ at various places. Capital means equity shares,
fully, compulsorily & mandatorily convertible preference shares (FCCP) and debentures
(FCCD). It is specifically provided that instruments like warrants, partly paid shares etc are
not considered as capital and cannot be issued to non-resident.
Till now FDI was reckoned with respect to the equity participation. But with the new definition
not only equity but also FCCP / FCCD would be considered to arrive at the specified echelon
limit. Practically conversion ratio and price of FCCP / FCCD is dependent of numerous
factors like growth, profitability etc of the Indian corporate post investment. However, now
Indian corporate would be required to crystallise conversion terms especially price upfront at
the time of issue.
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2. In past, on case to case basis, issue of warrants, partly paid shares to non-residents, was
allowed with the approval of FIPB. But consolidated circulars put blanket ban on issue of
such instruments. Further, term ‘warrant’ has not been defined. It takes different meaning
under different laws.
2) Under pre-consolidated policy, SEBI registered foreign venture capital investor (VCFI) is
allowed to invest in SEBI registered venture capital fund (VCF) under automatic route.
Further such VCF have option either to clothed itself under company or trust structure.
But consolidated circular lays that VCFI can invest in VCF-Trust, registered under Indian
Trust Act, 1882 only after obtaining permission from Government. There is blanket ban to
invest in unregistered VCF-Trust.
Further in absence of any grand fathering clause, ambiguity is caused, in respect existing
VCFI for investment in VCF-Trust. Whether Government permission would be required for
investment by VFCI to VCF-Trust (both formed prior to 1-4-2010), which were earlier under
automatic route?
3) 100 per cent FDI is allowed in specified agricultural and animal husbandry activities only.
However in respect of companies dealing with development of transgenic seeds / vegetables
additional conditions have been imposed viz. compliance of various Environment
(Protection) Act or any other laws on genetically modified organism, materials in force,
Foreign Trade (Development & Regulation) Act, 1992 for import of genetically modified
material, respective approvals from Genetic Engineering Approval Committee / Review
Committee on Genetic Manipulation etc. Further consolidated circular is silent whether these
new conditions are applicable to existing institution or only to new institution?
4) 100 per cent FDI is allowed under automatic route in the Research and Development
Services excluding basic Research and setting of R & D / academic institutions which would
award degrees / diplomas/certificates.
However there is no clarity on the exclusion. Is the intent to exclude basic research or
academic institute? Another issue is what is meant by basic research? On referring whole of
the circular a view can be formed that, as such, education sector is under 100 per cent
automatic route since no mention of any restriction is found.
5) 100 per cent FDI is allowed in Development of Township, Housing, Built-up infrastructure
and Construction-development projects, subject to certain condition & restriction as to
minimum area, minimum capitalisation, period of investment etc.
However till now investee company is solely responsible for obtaining all necessary
approvals from local authority / State Government, payment of charges and complying
various laws, rules / regulations for the time being in force. It is now provided that investor as
well as investee company would be responsible as to obtaining of necessary approvals,
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3. payment of necessary charges and compliance of various laws, rules / regulation. It is also
provided that concerned State Government / Municipal / Local body who approves building /
development plans, would monitor compliance of various conditions by the developer.
6) 100 per cent foreign owned NBFC with a minimum capitalisation of US $50 million can set
up step down subsidiaries for specified NBFC activities, without any restriction on number of
operating subsidiaries and without bringing in additional capital.
Guidelines for downstream investment by investing Indian companies owned or controlled by
non –resident entities specifically provided that Indian companies into which downstream
investments are made by such company will have to comply with the relevant sectoral
conditions on entry route, conditionalities and caps with regard of the sector in which the
subject Indian Companies are operating.
Harmoniously reading above, 100 per cent down stream NBFC subsidiary of 100 per cent
foreign owned NBFC will require additional minimum capitalisation of US $ 50 million.
7) Similarly various conditions also have been introduced with respect of Cash & Carry
Wholesale Trading / Wholesale trade. Erstwhile FDI policy allows 100% FDI in cash-and-
carry wholesale formats and 51% FDI in single-brand retailing with few restrictions.
Circular provides Cash & Carry Wholesale trading/Wholesale trading, would mean sale of
goods/merchandise to retailers, industrial, commercial, institutional or other professional
business users or to other wholesalers and related subordinated service providers. Whereas
wholesale trading would, accordingly, be sales for the purpose of trade, business and
profession, as opposed to sales for the purpose of personal consumption.
The yardstick to determine whether the sale is wholesale or not would be dependant on the
type of customers to whom the sale is made and not the size and volume of sales.
Wholesale trading would include resale, processing and thereafter sale, bulk imports with
export/ex-bonded warehouse business sales and B2B e-Commerce.
It has laid further guidelines for Cash & Carry Wholesale Trading/Wholesale Trading (WT) as
under:
(a) For undertaking WT, requisite specified licenses/registration/ permits, as specified under
the relevant Acts/Regulations/Rules/Orders of the State Government/Government Body/
Government Authority/Local Self-Government, needs to be obtained.
(b) Except in case of sales to Government, sales made by the wholesaler would be
considered as ‘cash & carry wholesale trading/wholesale trading’ with valid business
customers, only when WT is made to the following entities:
(i) holding sales tax/ VAT registration/service tax/excise duty registration; or
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4. (ii) holding trade licenses i.e. a license/registration certificate/membership
certificate/registration under Shops and Establishment Act reflecting that the
entity/person holding the license/ registration certificate/ membership certificate, as
the case may be and, is engaged in a business involving commercial activity; or
(iii) holding permits/license etc. for undertaking retail trade (like tehbazari and similar
license for hawkers) from Government Authorities/Local Self Government Bodies; or
(iv) institutions having certificate of incorporation or registration as a society or
registration as public trust for their self consumption.
(An Entity to whom WT is made, may fulfill any one of the 4 conditions.)
(c) Full records indicating all the details of such sales like name of entity, kind of entity,
registration /license/permit etc. number, amount of sale etc. should be maintained on a
day to day basis.
(d) WT of goods would be permitted among companies of the same group. However, such
WT to group companies taken together should not exceed 25% of the total turnover of
the wholesale venture and the wholesale made to the group companies should be for
their internal use only.
(e) WT can be undertaken as per normal business practice, including extending credit
facilities subject to applicable regulations.
(f) A Wholesale/Cash & carry trader cannot open retail shops to sell to the consumer
directly.
Except condition (d) all conditions are largely procedural in nature. Erstwhile guidelines
didn’t have any restriction on sales to group companies and accordingly till now FDI had
been made in the back end supplies. But this new restriction would require rethinking of
various existing structures and raze expansion plans of the various entities proposing to
bring FDI.
8) Under the pre-consolidated period, an individual FII investing through the FDI scheme
route could pick up to 100% of the allowed FDI in a sector. Further under the portfolio route
FIIs can individually acquire up to 10% equity in an Indian company though the aggregate
FII limit is pegged at 24%. This limit can however be raised further after obtaining
shareholders approval in sectors where higher FDI is allowed.
The consolidated circular now mentions that an individual FII will not be allowed to pick up
more than 10% equity in an Indian company even if it is coming as a foreign direct investor.
Again there is no mention about increasing FII investment limits beyond 24% under portfolio
route by passing appropriate resolution. This raises doubt whether now FII investment limit is
pegged at 24% only?
Conclusion
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5. In light of the above discussion, new, so called consolidated policy, is certainly not merely a
consolidation of current policy. Addition of new ingredients to the existing policy may require
tweaking of existing structure and also may require altering future plans. But certainly
attempt to consolidate FDI policy under single paper is a welcome move. Time would only
state whether new circular which would be brought effective from 1st October 2010 would
clear the anomalies or would create further issues.
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