FDI in retail: complications galore
Alishan Naqvee

The Government's decision to allow foreign direct Investment up to 100 per cent in single brand retail trading comes with a few riders, which require to be spelled out in unambiguous terms

The press note issued in this regard permits foreign investment up to 100 per cent in single brand retail trading activities, subject to additional condition that all ventures having FDI above 51 per cent should source at least 30 per cent of the value of products sold by them from Indian small industries/village and cottage industries, artisans and craftsmen (called 'Suppliers' hereinafter). The Government has prescribed self-certification by the company and its statutory auditor's verification to ensure compliance with the 30 per cent sourcing stipulation.

'Small industries' are defined by the press note to mean industries which have a total investment in plant and machinery not exceeding USD 1 million at the time of installation, without providing for depreciation. If at any time, the valuation exceeds USD 1 million, the industry would cease to qualify as a 'small industry'.

All such venture would also continue to comply with the basic conditions attached to any single brand retail trading venture, such as prior Government approval for investment by the owner of the brand, branding of products during manufacturing and existing international sales of the brand.

Potential Complications:

The Government has indicated that it would continue to push for further relaxation in FDI regime, and the current policy revision appears to be another step in this direction. Unfortunately, the conservative approach of 'taking one step at a time' that the Government adopts concerning relaxation in retail trading regulations compels it to introduce qualifications and conditions not tried and tested earlier or elsewhere. This approach led to introduction of basic requirements attached to single brand retail trading, which eventually discouraged many brand owners from investing under the route. Consequently, the average FDI received in India under the said route during the last few years has reportedly been less than USD 10 million per year.

The new press note is also worded in a manner that can give rise to various complications, especially considering that FDI in 'Single Brand' retail trading has been permitted keeping in view the luxury and premium goods segment. For example:

1. Protection and answerability: Many brand owners have already expressed their concerns over trustworthiness and seriousness of Suppliers in maintaining the quality and in protecting the intellectual property rights as well as the technical knowhow that the brand owners would have to share while engaging them in manufacturing processes. Product pilferage, additional production for flea markets, timely delivery and quality control also remain matters of concerns. Due to small nature of these Suppliers, the brand owners would also face difficulty in securing meaningful performance and other financial guarantees that could work as deterrent against non-performance and breach by them.

2. 30 per cent sourcing requirement: The condition of sourcing 30 per cent of the value of products does not clarify whether the local sourcing can be used merely for supply of raw material or the local Suppliers should also participate in manufacturing process, or part of it. The reference to small industries/village and cottage industries, artisans and craftsmen seems to imply participation in manufacturing process. However, if it is interpreted to be manufacturing process necessarily, the policy may close the doors for many single brand owners as their products may not be such that they can be partially manufactured at different units and the cost of equipment per se can exceed USD 1 million for any single small industry unit manufacturing such products from start to finish.

3. Products sold: It is unclear whether the 30 per cent sourcing criterion needs to be met on an each product basis, or on a gross basis taking into account the value of the entire product range of any brand owner. A brand owner, for example, may have product lines including clothes, perfumes and accessories. Whether an overall compliance by sourcing 30 per cent of the annual inventory value from Suppliers would suffice, or 30 per cent of each product line also needs to adhere to the requirement, is unclear.

4. Definition of small industries: The definition of 'small industries' may hurt the very industries which perform well, as the definition itself restricts them from growing bigger without losing out on existing business from brand owners. Any growth would also cause difficulties for brand owners in having to look for new and smaller suppliers, qualifying within the definition of 'small industries'.

Furthermore, the criterion for being a small industry is specified in US$ terms. With constant foreign exchange fluctuations, many industries having investment in plant and machinery close to US$ 1 million may travel in and out of the definition of 'small industries' overnight, without any act or omission on their part. The brand owners could face regulatory repercussions of such an almost force majeure event.

5. Artisans and craftsmen: No definition or qualification criterion for artisans and craftsmen is provided by the policy. Technically, the brand owners making payments equivalent to 30 per cent of the value of products to individuals, whom they consider to be artisans and craftsmen, would satisfy the 30 per cent sourcing requirement of the policy. Absence of clear parameters (such as trade /service tax registrations, etc. prescribed by the policy with respect to wholesale trading) can result in misuse of this provision, and resultant failure of the policy in extending the intended benefits to the small industries, village and cottage industries.

6. Self certification: It is unclear whether the 'self certification' is required by the Suppliers or by the brand owners. The use of the word 'company' tends to suggest that the requirement of self certification is prescribed for the brand owners. This compliance would give palpitations to a number of brand owners as they would not know or be informed of plant and machinery enhancements by their small industry Suppliers, yet they may face related repercussions.

7. Frequency of internal compliance assessments: The policy requires constant diligence by the brand owners to ensure compliance with 30 per cent sourcing requirement, and implies that their small industry Suppliers are in fact 'small industries' as per the definition. The requirement for self certification and verification by statutory auditor appears to suggest an annual exercise. However, the policy stipulation "if at any point of time, this valuation is exceeded, the industry shall not qualify as a small industry for this purpose" suggests ouster of any small industry from its definition immediately, without waiting till end of the year. The change in status of any small industry in between two self certifications or verifications by statutory auditors could have retrospective repercussions for brand owners.

It is also unclear whether the requirement that 30 per cent of the value of the products sold shall be sourced through Suppliers, should be met on a daily, weekly, monthly or on an annual basis.

The policy could specify a minimum level of diligence by the brand owners to protect themselves against regulatory complications and administrative actions, especially in events beyond their control.

As a respite, the Government has assured that it may consider revisions to the policy to create a friendlier and conducive investment climate. One can expect significant discussion on the topic in the coming days.

(Alishan Naqvee is Partner, LexCounsel, Law Offices)