Foreign investment in Indian retail

The Indian retail market is ranked as one of the most attractive retail destinations globally. Press Note 3 of 2006 permits up to 51% foreign investment in an Indian company in the retail sector with prior approval from the Foreign Investment Promotion Board (FIPB), provided: (i) the products to be sold are of a single brand; (ii) the products are sold under the same brand internationally; and (iii) the products are branded while they are being manufactured. Additionally, any retail company with foreign investment must seek the FIPB’s approval for every new product or product category that it intends to sell under the single brand for which the company had earlier sought and received approval.

Item 31 of annex I to part I of the Master Circular on Foreign Investment in India issued by the Reserve Bank of India on 1 July 2009 states that up to 100% FDI is permitted: (i) under the automatic route (i.e. no prior approval is required) in Indian entities involved in “wholesale cash-and-carry trading” and “trading for exports”; and (ii) with FIPB approval in companies engaged in (a) trading items that are sourced from the small scale sector and (b) test marketing items that the company has approval to manufacture, provided the manufacturing commences along with test marketing.

Notable in the government’s policy on retail is the distinction between (i) retail and wholesale trade and (ii) single-brand retail and multi-brand retail.

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Retail and wholesale trade: In Federation of Associations of Maharashtra v Union of India (2004), Delhi High Court held that direct sales to the ultimate customer (i.e. business-to-consumer sales) constitutes retail trade, whereas sales to registered business customers with valid licences or sales tax registration numbers, which in turn sell these goods to the ultimate consumer, or to other retailers, or use it for further processing, can be classified as wholesale trade. Delhi High Court clarified that quantity of sales is not a determinative factor and that it was the type of customer that determined whether the trade was wholesale or retail.

Single-brand and multi-brand retail: Pursuant to Press Note 3 of 2006, a foreign investor must seek prior FIPB approval to invest up to 51% directly in Indian companies engaged in single-brand retail.

On 13 February 2009, the government issued new guidelines for the calculation of foreign investment in Indian companies. Pursuant to Press Note 2 of 2009: (i) an Indian company is considered as “owned” by resident Indian citizens and Indian companies if more than 50% of its equity is beneficially owned by resident Indian citizens or Indian companies owned and controlled ultimately by resident Indian citizens; (ii) an Indian company is considered as “controlled” by resident Indian citizens and Indian companies if the resident Indian citizens and the Indian companies have the power to appoint a majority of the directors on the board of the company; (iii) foreign investment in Indian companies that are owned and controlled by resident Indian citizens and Indian companies, which in turn make a downstream investment in a second Indian company, will not be considered for calculation of foreign investment in the second company; and (iv) conversely, if the investing company is not owned and controlled by Indian residents, the entire shareholding of the foreign investor will be included to calculate foreign investment in the investee company.

Press Note 4 of 2009 provides guidelines relating to downstream investments by Indian companies and classifies Indian companies into (i) operating companies, (ii) operating and investing companies, and (iii) investing companies. It also states that the prior approval of the FIPB is required for any foreign investment in (i) an investing company, and (ii) an operating company or operating and investing company engaged in a sector that does not fall under the automatic route.

The government recently circulated a draft press note which is expected to replace and supersede existing press notes in April 2010. Chapter 4, paragraph 16 of the draft press note refers to two categories: (i) sectors in which investments in any form are prohibited in entirety (retail trading is absent from this list); and (ii) sectors in which FDI investments are prohibited (retail trading is mentioned in this list, with a carve-out for single-brand retailing).

This division appears to indicate that the government prohibits direct investments in multi-brand retail, but not foreign investments altogether. Press Note 2 of 2009 arguably provides some flexibility to foreign investors in structuring investments indirectly in multi-brand retail if the investment is channelled through an Indian company (owned and controlled by resident Indian citizens and Indian companies) that makes a downstream investment in a multi-brand retail company.

A foreign investor may invest up to 49% in an Indian company (company X) which is owned and controlled by resident Indian citizens or an Indian company. If company X is an investing company, prior FIPB approval will be required for such an investment, however if company X is an operating company or an operating and investing company engaged in business in a sector under the automatic route, prior FIPB approval will not be needed. It is currently uncertain whether such a structure will be acceptable to the FIPB.

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Poornima Sampath is a senior associate at S&R Associates, a New Delhi-based law firm.