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Press Note maze in retail trading not getting simpler

The liberalisation of retail trading regulations is stuck after Press Notes 2, 3 and 4 and still needs to see significantly more action before it is workable, argues LexCounsel partner Alishan Naqvee.

The much heralded steps taken by the Government in the beginning of 2006 that permitted foreign investment in single brand retail trading and up to 100 per cent investment in wholesale trading under the automatic route (i.e. without prior Government approval) are yet to be supplemented by further specific sectoral liberalisation.

Certain 'creative' possibilities for investment in the sector emerged earlier this year when the Government notified the manner of calculation of foreign ownership in Indian Companies via three consecutive Press Notes.

Press Notes 2, 3 and 4 of 2009 (the Downstream Guidelines) of the Ministry of Commerce and Industry launched into a debate of whether these possibilities were "intentional" or "unintentional" on the part of the Government.

A new possibility introduced by the Downstream Guidelines is that the investment by an Indian company – not owned or controlled by non-residents – in downstream Indian entities (in which the parent Indian company does not hold 100 per cent of equity) should not be considered as downstream foreign investment.

Under the Downstream Guidelines, any foreign shareholding or control of the board of directors below 50 per cent would not translate into downstream foreign investment by such Indian entity. Therefore, the foreign investors could hold less than 50 per cent shareholding without assuming majority control of the board of directors, and invest in downstream single brand or even multi-brand retail trading activities, hereunto not permitted, at least expressly.

Wal-Mart flavours

This new possibility has added a new flavour to the already fancied Bharti Wal-Mart structure that is not subject to regulatory restrictions.

Under the Bharti Wal-Mart structure, the wholesale and retail entities are maintained as separate entities without any cross-shareholdings.

The retail entity is owned and controlled by the Indian partner. The wholesale entity can be owned by the foreign partner of up to 100 per cent without any Government approval. The relationship between the wholesale and retail entity can then operate on trust and a number of exclusive arrangements not affecting shareholding or directorships of any entity.

The Government now plans to announce clarifications, to the effect that this new possibility was "unintentional" and impermissible.

While we wait for release of the clarification to read it in print, one can hope that the clarification does not constitute a regressive step - affecting the Bharti Wal-Mart like structures - and confines itself to the issue of downstream investment.

Similarly, a few other questions deserve answers or at least clarity by the regulators on investments in the retail trading sector.

A question of history
Looking over the approvals granted or refused by the Government since 2006 until recently gives an impression that the Government has adopted increasingly conservative approach on the following issues that are not expressly answered by the policy so far.

1. Starbucks: Does the foreign investor need to be the brand name owner?
In 2007 the Foreign Investment Promotion Board (FIPB) reportedly insisted on direct investment by Starbucks instead of the Indonesian franchisee route pursuant to an application to set-up Starbucks retail outlets in India.

The application was filed by the non-resident partner V.P. Sharma along with the Indian partner Pantaloons but it was eventually withdrawn by the applicant after it remained under consideration for an unusual duration.

However, a perusal of the FIPB approvals indicates that investments in single brand retail trading by investors and venture capital funds had been permitted in 2006 pursuant to the limited liberalisation in the sector.

It is understood that the Government now maintains the view that the foreign investor need not only be the brand name owner, but should also own and operate retail stores in at least a couple of countries other than India.

The current stance of the Government, which is a clear departure from its initial approach, has rendered it difficult to secure venture capital funding in single brand retail activities.

2. How many ventures can an entity float?
A single Indian entity can partner with more than one foreign entity to establish more than one single brand retail trading venture in India.

For example, DLF enjoys several FIPB approvals for retail trading of foreign brands including Salvatore Ferragamo, Piquadro, Dolce and Gabbana and Giorgio Armani.

Although, the Secretariat for Industrial Assistance (SIA) states that the regulations do not restrict any foreign investor to simultaneously invest in more than one single brand retail trading ventures in India, there appears ambiguity on this aspect.

In 2007 Mauritius-based Brand Marketing Limited and Retail India Limited reportedly applied for approval to invest in retail trading of many international brands including FCUK (French Connection UK), Jimmy Choo, La Perla, Build Bear Toys and Tumi brand of products through a number of similarly named, but separate Indian companies.

Apparently, these applications could not clear the first stage of processing by the SIA and consequently, none of them was considered for approval by the FIPB at its meetings. The industry apprehends that the applications were not approved as multiple investments by the same non-resident investor as it did not find favour with the Government.

The condition that the Indian entities can have multiple ventures, but foreign entities cannot, is thus far unsaid.

Meanwhile, the Government's stance also remains fluid. Dolce and Gabbana has been recently granted the approval for two of its brands under the concept of premium and prêt line - "Dolce and Gabbana" and "DG Dolce and Gabbana".

While this approval is for establishing a single joint venture in India, the concept that a single international lifestyle brand or fashion house can have more than one brand under its umbrella appears to be finding acceptance with the FIPB.

By logical extension, a foreign investor (owning more than one distinct brand) should be permitted to establish separate ventures for each brand within its umbrella.

At present, the policy appears unclear regarding establishment of separate single brand retail ventures by an owner for different brands within its portfolio.

3. What About Indian Brands?
One can sell what one manufactures and such retail is not trading per se. Foreign investment in such entities is considered as investment in the manufacturing sector.

However, the situation gets complicated if approached a little differently.

Self vs. contract manufacturing: The Government appears to maintain the view that "job work" or "contract" manufacturing is not as good as self manufacturing when it comes to considering foreign investment in the trading sector.

Consequently, if the products are contract manufactured and sold by the investee Indian company, it may have to comply with the investment restrictions for the trading sector.

This implies that foreign investment would be nearly impossible in Indian entities that contract manufacture and retail multiple brands. For single brands, the "51 per cent with prior approval" restriction would apply.

Domestic brands: The position is also ambiguous as regards trading of an Indian brand that is not sold internationally. The condition in the policy that the products to be sold in India should "belong to single brand under which they are sold internationally" can be interpreted to mean that such brands should, at least be sold internationally.

There are a few examples of the hospitality sector where the entities with foreign ownership, also retail branded merchandise which is apparently not manufactured by them.

Of late, the Government might consider that to satisfy the condition of "internationally sold" the brand shall be sold in at least two countries out of India.

Therefore, it remains to be seen whether the FIPB would approve foreign direct investment in retail trading of any Indian brand, which is neither internationally sold nor manufactured by an Indian entity retailing it. No such application is known to have been presented to the FIPB till date.

A way out of the maze?
The above questions should warrant wider consideration by the Government.

While most of the steps taken by the Government in the retail trading sector are done in 'good faith' and oriented to protect the domestic retail traders, their net effect is questionable.

The trading regulations have been under constant review by the Government. It was expected that following a clear majority in the general elections, the Government would further liberalise the regulations. The recent economic survey has indicated progressive steps, recommending foreign investment in multi brand retail, starting with food retailing.

The proposed clarification appears to be restrictive rather than to liberate retail trading in India.

However, it would serve its purpose if is puts an end to the debate over the issue of downstream investment in the retail trading sector.

Alishan Naqvee (pictured) is a partner at LexCounsel Law Offices in New Delhi

Legal Disclaimer: The views expressed above are personal of the author. This article is not intended to, and shall not, substitute proper professional advice that any reader may require from competent professionals in their own judgment. The author or the firm shall not be responsible for any actions or omissions of any person or entity pursuant to this release.

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