Restrictions on FDI in e-commerce are influenced by both economic and political considerations. As e-commerce’s influence grows, policymakers have aimed to balance foreign investment with domestic interests, resulting in stringent conditions for e-commerce entities with foreign ownership.

As a result of these socio-economic and political factors, 100% FDI is permitted only in the marketplace model, whereas FDI is restricted in the inventory-based model. In a marketplace model, the e-commerce entity only provides an information technology platform on a digital network and merely facilitates transactions between sellers and end customers.

In an inventory-based model, the e-commerce entity owns or controls the inventory of goods and services sold on the platform and sells them to the consumers directly. While the definitions of “e-commerce” and “marketplace model of e-commerce” under Indian foreign exchange laws include services within their ambit, the regulators have clarified that the sale of services through e-commerce, on a standalone basis, is not subject to e-commerce conditionalities.

Similarly, business-to-business (B2B) e-commerce is governed by conditions applicable to wholesale cash-and-carry trading, and not by the specific e-commerce conditionalities prescribed under the Indian foreign exchange laws. Hence, the crux of the issue is to prohibit the inventory model of e-commerce.

Evolution of the law

Over the years, India has liberalised the regulatory regime governing the e-commerce industry. In 2000, FDI in e-commerce was first permitted in B2B e-commerce. However, in view of the concerns of small brick-and-mortar retailers, the government has consistently maintained that FDI in business-to-consumer (B2C) or inventory-based e-commerce is not allowed.

In 2015, the government permitted entities undertaking single brand retail trading through brick-and-mortar stores to undertake single brand retail trading through e-commerce. In addition, it allowed manufacturers producing goods in India to sell such products to end customers through e-commerce platforms.

However, barring these limited relaxations, FDI in inventory-based B2C e-commerce and multi-brand retail trading through e-commerce continues to remain prohibited, protecting traditional retail.

In 2016, the government introduced regulatory measures under Press Note 3 of 2016 (PN3) to address the growing concerns of offline retailers. PN3 formally recognised the distinction between marketplace and inventory-based models of e-commerce, confirming that 100% FDI is permitted in the marketplace model (subject to several restrictions) while FDI is prohibited in the inventory-based model.

PN3 allowed e-commerce entities to provide support services to sellers and required them to maintain a level playing field, but barred them from influencing the prices of goods sold on the platform, or from permitting more than 25% of sales through one vendor or its group companies (25% sales limit).

Another slew of restrictions was introduced under Press Note 2 of 2018 (PN2), modelled on the framework set out in PN3, aimed to ensure that e-commerce businesses remain true marketplaces, restricting e-commerce entities to transition into inventory-based operations, which could affect traditional local offline retailers.

PN2 introduced restrictions on e-commerce entities from exercising “control” on inventory, and barred any equity participation in sellers by e-commerce entities or their group companies. While PN2 removed the 25% sales limit, it introduced a restriction on procurement of more than 25% of goods by a seller from the e-commerce entity or its group companies, beyond which threshold the sellers’ inventory will be deemed to be controlled by the e-commerce entity.

In addition, it prohibited e-commerce entities from mandating sellers to sell products exclusively on their platforms. Further, it required e-commerce entities or their group companies offering support services to the sellers to provide such services in a fair and non-discriminatory manner. Such PN2 restrictions continue to govern FDI in the e-commerce industry today.

Compliance an evolution

E-commerce players have continually structured and restructured their operations to navigate this dynamic and complex regulatory framework while catering to the growing consumer demand for online retail.

With the aim to stay compliant with the conditions set out in relation to the marketplace model of e-commerce and the prohibition of FDI in the inventory-based model, Indian e-commerce entities have adopted various models, including: (1) a licensing model, where the operational control of e-commerce platforms is licensed to Indian entities to which the Indian foreign exchange requirements do not apply; (2) an Indian-owned and controlled model where the platform entities are structured as Indian owned and controlled entities to which FDI-related restrictions do not apply; and (3) a true marketplace model, where the platform entity, which has received FDI, refrains from any inventory control or influence over pricing, remaining in strict compliance with the law.

In addition, amid the growing drive towards public listing of e-commerce startups in India, many e-commerce entities are looking to increase the ownership of domestic investors and dilute foreign shareholding to steer clear of regulatory restrictions.

These structures are primarily designed to remain compliant with the law. However, amid the burgeoning of e-commerce, traditional retailers have raised concerns around deep discounts, exclusivity arrangements, and the preferential treatment of certain sellers by large e-commerce entities.

Remarkably, such concerns, which the Indian foreign exchange laws seek to allay, extend beyond foreign-backed entities to large domestic e-commerce players and retailers. In this context, it seems perplexing that the restrictions primarily target entities with FDI while similarly positioned domestic players escape such regulatory oversight.

Many of these concerns, such as pricing strategies and preferential treatment, have significant overlaps with, and are more appropriately addressed under, competition law and consumer protection frameworks, rather than being treated solely as FDI-related issues.

Conclusion

Changing FDI norms have significantly shaped and contributed to the growth of the e-commerce industry so far. As the e-commerce industry continues to expand, the regulatory framework should be further aligned to facilitate sustained progress and innovation, creating a robust foundation for future growth of the industry.

This article was originally published in Asia Business Law Journal on 26 November 2024 Co-written by: Raghubir Menon, Regional Practice Head – Mumbai – M&A and Private Equity; Ekta Gupta; Partner; Rooha Khurshid, Senior Associate. Click here for original article

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