POLICY REGIME OF FDI —A DISPERSION OF PRESS NOTES 2-4 (2009 SERIES) SAMBHAV SOGANI AND S. NAGASHAYANA Introduction With the acceptance of new economic policies in the 1990s, India became a freemarket nation. This paved way for huge amounts of foreign direct investment(FDI) through non-resident Indians, international companies and various otherforeign investors. The growth story of India Inc. and the economy has beenrobust since then, with occasional ups and downs. Foreign direct investment hascome as a shot in the arm in terms of increased capital flow, improvedtechnology, management expertise and access to international markets. Sincethen the Government of India has issued specific press notes to amplify thenecessary changes. An attempt here made is to make a threadbare analysis ofPress Note 2 of 20091 in particular and the Press Notes 32 and 43 in general. So far,the Government of India has issued five press notes in connection with FDIs in2009. Press Notes 14 and 55 deal with laying down the policy and procedure forthe publication of the facsimile editions of foreign newspapers in India andguidelines for foreign investments in commodity exchanges, respectively.However, this article is concerned only with the analysis of the other three pressnotes. Press Note 26 dealt with the calculation of total foreign investments, i.e.,direct and indirect investment in Indian companies. Prior to this, Press Note 9(1999 series)7 looked into this. Press Note 9 (1999 series) dealt with the calculationof indirect foreign investments through the channel of ‘downstream investments’.Under this policy, all ‘downstream investments’ were subjected to the FIPBapproval. The policy enshrined in the aforesaid press note was applicable to onlythose sectors which are mentioned in annexure III8. Despite providing a pro bonopolicy regarding for Indirect Foreign Investments, it failed to attract foreigninvestors to invest through this channel. The two main reasons behind the setback of this policy were —1 (2009) 2 Comp LJ 41 (St.). Unless, otherwise specified to the contrary all the Press Notes herein mentioned are of 2009 series.2 (2009) 2 Comp LJ 46 (St.).3 (2009) 2 Comp LJ 158 (St.).4 (2009) 1 Comp LJ 36 (St.).5 (2009) 4 Comp LJ 69 (St.).6 (2009) 2 Comp LJ 41 (St.).7 (1999) 2 Comp LJ 74 (St.).8 Annexure III is a reference to Annexure III of the Industrial Policy Statement dated 24.07.1991 [(1991) 2 Comp LJ 97 (St.)] under the Industrial Policy Statement 1991, the Central Government decided to provide approval for direct foreign investment up-to 51 percent Foreign Equity in High Priority Industries (Annexure III). There shall be no bottlenecks of any kind in this process. Such clearance will be available if foreign equity covers the foreign exchange requirement for imported capital goods.[J- 117]
118 COMPANY LAW JOURNAL (2009) 4 Comp LJ (a) The words ‘downstream investment’ was so widely interpreted by FIPB that it brought every indirect foreign investment under the FIPB scanner. (b) It also fails to define the term ‘foreign owned Indian company’ (as it does not lay down any criteria of determining such company). In order to do away with the lacunae of Press Note 9 (1999 Series)9, theGovernment of India issued Press Note 2.10 The feel good factor about the presentPress Notes - seek to define and fix the above said ambiguities. A Transition of policy regime [Press Note 2 of 200911] The present foreign direct investment guidelines provides for three differentregimes for calculating indirect foreign equity. Press Note 2 is applicable to majorsectors of the economy. This Press Note covers the entire gamut of foreigninvestments (FDI, FIIs, NRIs and FCCBs and convertible preference shares andconvertible currency debentures) to compute foreign shareholding levels inIndian companies. An investment under FDI can be realized by two ways, Direct Investment — It includes all investment directly by non-resident entity into Indian company. Indirect Investment — It includes an investment by Indian investing company (having foreign investment in it) into another Indian company. Computation of indirect foreign investment — Any investment in an IndianCompany will not be counted for indirect foreign investment, if the holdingcompany and the investing company are owned and controlled by, — (a) resident Indian citizens and/or (b) Indian investing company owned and controlled by resident Indian citizens. The term ‘owned’ means that more than fifty per cent of the equity isbeneficially owned by the resident Indian citizen and Indian companies whichare ultimately owned and controlled by resident Indian citizens. The term‘controlled’ is defined to mean that the resident Indian citizens and Indiancompanies, which are owned and controlled by resident Indian citizens, have thepower to appoint a majority of its directors. Any investment falling outside thisframework will be considered as indirect foreign investment in an investedcompany, as a consequence of which the same shall be considered for calculatingthe total foreign investment in that company. In other words, if the investingcompany is owned or controlled by ‘non-resident initiates’ entire investment bysuch company will be measured as indirect foreign investment.9 (1999) 2 Comp LJ 74 (St.).10 (2009) 2 Comp LJ 41 (St.).11 (2009) 2 Comp LJ 41 (St.).
(JOURNAL) INDIA ON THE PATH TO DIGITAL DEVELOPMENT 119 This can be illustrated by the following tables — CASE 1Foreign Company Indian Company A Indian Company B→ < 50%→ (FDI = Nil) In the first scenario the Indian Company holds less than 50% foreigninvestment. The Company B will not be taken as having any indirect foreigninvestment through Company A, i.e., FDI=NIL CASE 2Foreign Company Indian Company A Indian Company B→ 75%→ 26% (FDI = 26%) In the second scenario if Company A has foreign investment of 75% andinvests 26% in Company B, then the entire 26% will be treated as indirect foreigninvestment in Company B. CASE 3Foreign Company Indian Company Indian Company B→ 75%→ 100% (FDI = 75%) If Company A has foreign investment of 75% and Company B is a whollyowned subsidiary of Company A, then only 75% would be treated as indirectforeign equity and the rest 25% would be treated as resident held equity. Theindirect foreign equity in Company B would be computed in the ratio 75:25 in thetotal investment of Company A in Company B. Treatment of beneficial interest In sectors with sectoral caps, balance equity (i.e., equity remaining afterforeign shareholding limits have been reached) has to be beneficially owned byan Indian resident or qualified Indian company/companies. Press Note 2provides that if there is a declaration under section 187C of Companies Act,1956,12 the investment in such shares would be counted as foreign investmentregardless of the fact that such investment was made by a resident Indian citizen. Any downstream investments by an investing company (or operating-cum-investing company) owned or controlled by non-residents entities is required tofollow the same norms as applicable to direct foreign investment. Further, Indiancompanies receiving such downstream investment will be required to complywith sectoral caps and other conditions.12 A declaration under section 187C of Indian Companies Act, 1956 provides that a person is holding the shares of a company as a nominee of the original investor (registered owner) then the beneficial interest in such shares would be vested in the original investor..
120 COMPANY LAW JOURNAL (2009) 4 Comp LJ Other Conditions * Press Note seeks for sectors requiring government approval for foreign investment inter se agreements between the shareholders shall be furnished to approving authority. The approving authority will consider such agreements for determining ownership and control, while granting approval for foreign investment.13 The fallout of this provision is that, under the press note, the ‘control’ refers to the powers to appoint ‘the majority directors’, however in this case for all inter se agreements among the shareholders will have to come under the scanner of FIPB.14 This brings the following within the ambit of the FIPB scanner: (a) The appointment of the board of directors, or (b) On the exercise of voting rights or of creating voting rights disproportionate to shareholding, or (c) Any incidental matter thereof. * In foreign investments with sectoral caps, equity beyond the sectoral investment caps has to be held by resident Indian citizens and Indian companies owned and controlled by resident Indian citizens.15 * In information and broadcasting and defense sectors, where the sectoral cap is less than 49%, in that event, such entities must be mandatorily ‘owned’ and ‘controlled’ by resident Indian companies as given below:16 (a) 51% per cent of the equity has to be held by public sector banks and public financial institutions as defined in section 4A of the Companies Act, 1956, shall be excluded while calculating the 51% limit. (b) At least 51% of the total equity has to be held by the ‘largest Indian shareholder’. (c) Largest Indian shareholder will include: (i) Relative of shareholder within the meaning of section 6 of the Companies Act, 1956. (ii) Indian company; (iii) A group of Indian companies and its subsidiaries under the same management and control.13 For further clarity the reader may look into para 5.5.2 of Press Note 2 (2009): (2009) 2 Comp LJ 41 (St.).14 Vivek Sadhale and Vikas Agarwal, ‘FDI MATTERS Press Note 2 – An Analysis’, SEBI and Corporate Laws, vol. 93, 27 July, 2009, p. 85.15 For further clarification refer Para 5.5.3 of Press Note 2 (2009): (2009) 2 Comp LJ 41 (St.).16 For further clarification refer Para 5.5.4 of Press Note 2 (2009): (2009) 2 Comp LJ 41 (St.).
(JOURNAL) INDIA ON THE PATH TO DIGITAL DEVELOPMENT 121 (iv) Company or group of companies in which the individual or HUF to which he belongs has the management and controlling interest. (v) Relative of shareholder within the meaning of section 6 of the Companies Act, 1956. (d) In case, the combination of all or any of the persons mentioned above in aggregate hold 51% are more of the shares as a largest Indian shareholder, parties are required to enter into legally binding agreement to act as a single unit. * Though this might turn out to be a problem in an unlisted company, but it may not be so in a listed company to find out the “largest Indian Share holder”. Press Note 317 Press Note 3 regulates transfer of ownership or control of Indian companies insectors with caps on foreign investments. It is not applicable to foreigninvestments in sectors where 100 per cent FDI is permitted under the automaticroute. Transfer of ‘ownership’ or ‘control’ In cases of Indian companies that are engaged in sectors that have prescribedsectoral caps, prior Foreign Investment Promotion Board (FIPB) approval, in thefollowing situations, would be required: The Indian company has received foreign investments and is owned orcontrolled by non-resident entity; The control or ownership of the Indian company currently owned or controlled by resident Indian citizens on a look through basis, is being or will be transferred to non- resident entities either through fresh foreign investment or when such transfer is affected through direct acquisition or through corporate reorganizations, i.e. amalgamations or mergers. Press Note 418 Consequently, thereafter, the Central Government issued a Press Note 4 on25.02.2009. Press Note 4 actually laid down the policy for downstreaminvestments. According, to the said Press Note 4, the policy for downstreaminvestment policy is constituted by: (a) only operating company19, (b) operating-cum-investing companies; and (c) only investing companies2017 (2009) 2 Comp LJ 46 (St.).18 (2009) 2 Comp LJ 158 (St.).19 ‘Only Operating Companies’ has been defined in para 3.2 of Press Note 4 to mean an Indian Company which is undertaking operations in various economic activities sectors..20 An ‘Investing Companies’ has been defined in Para 3.4 of Press Note 4. It has been defined to mean an Indian Company holding only investments in another Indian company, directly or indirectly, other than for trading of such holdings/securities..
122 COMPANY LAW JOURNAL (2009) 4 Comp LJ The downstream investment policy in relation to an operating company oroperating-cum-investing company would require compliance with the relevantsectoral conditions on entry route, conditionalities and caps with regard to thesectors in which such companies are operating. The downstream investments in relating to foreign investment in investingcompanies would require the prior government/FIPB approval regardless of theamount or extent of foreign investment. Another important thing to be noted is the difference between investingcompany and an investment company. The Department of Industrial Policy andPromotion (DIPP) has made it clear that an investment company will be akin toan NBFC and an investing company would be holding level companies, whichmay have made downstream investments into subsidiaries. There is a lock-in forthem—they cannot trade that. This is how the new FDI policy and theseclarifications make it clear that there will be no back-door entry for restrictedsectors such as the print media, television, retail or even gambling.21 This far-sightedness of government has prevented the Indian economy from becomingnumb, because of transient entry and exist of equity transactions by investmentcompanies. Critical Analysis There is a requirement to clarify certain issues in the Press Note to avoidvaried interpretations. They are — Perplexity over 50-50% joint ventures (1) The present press note seeks to deal with two kinds investing options. Thepossibilities under this are an investment less than 50% or more than 50%.However the present press note is oblivious of a 50-50% joint venture.Foreign Company Indian Company A Indian Company B→ 50%→ 80% (FDI=?) If a foreign company has a joint venture with another Indian investingcompany, in such a scenario if the Indian company holds 80% equity shares ofanother company C, then will it be considered as an indirect foreign investment?This needs to be clarified. (This remains to be the bone of contention regardingany percentage of investment in Indian Company B) (2) For considering an investment in an Indian company as indirect foreigninvestment, the investing company shall have to satisfy one of the criteria asspecified in the press note (owned or control). If the foreign entity completed anyof the two criteria then any investment by investing company will be called as21 See moneycontrol.com.
(JOURNAL) INDIA ON THE PATH TO DIGITAL DEVELOPMENT 123‘downstream investment’. But the point of argument is these that if such criterionis being fulfilled by several unconnected foreign companies together will it havethe same effect? Is the question to be considered?Foreign Foreign Indian Indian ForeignCompany X Company Y Company A Company B Company Z X+Y+Z = 60% 75% (FDI=?) → If three foreign companies connected/unconnected have invested 60% (20%each) in an investing Company A, which has 75% of equity shares of anotherIndian company B, then will it be considered as an indirect foreign investment?The Press Note 2 falls flat on the surface in this regard and, therefore, needs aclarification. (3) The proportionate method should be applied in the cases of investmentwhich is below 50%. This Press Note encourages back door investment avenues.In the pretext of having 49% foreign investment, the calculation of indirectforeign investment is being banished. The proportionate method should calculatethe percentage of indirect foreign investment in proportion to the foreigninvestment made in the investing company. The said norms will allow foreigninvestors to invest in those sectors also in which FDI is prohibited.22 ILLUSTRATIONForeign Company Indian Company A Indian Company B→ 70%→ 30% (FDI = 70% of 30%=21% If holding company (foreign company) has 70% foreign investment ininvesting company A, which has 30% of equity shares of another Indian companyB, then the calculation of indirect foreign investment would have yielded 70% of30%, viz., 21%. Conclusion To conclude, though the intent of the press notes are laudable, a few concernshave arisen including a possibility that some sectoral caps have been mademeaningless and potential downstream investment in restricted sectors has beenprobably made possible. Therefore, despite of commendable changes brought22 ‘If a Foreign company ‘A’ can form a 49:51 JV, company ‘C’, with an Indian company ‘B’. C will qualify as Indian. If it now invests in another downstream company ‘D’ to any extent below 100%, even up to 99.99%, D will be treated as having no FDI. Since D has no FDI, it can operate in any sector including retail, in which FDI is not allowed.’ As said by Mr. Vivek Mehra (PWC executive director) while dealing with an issue of investment of FDI in Retail Sector in an interview: see timesofindia.indiatimes.com.
124 COMPANY LAW JOURNAL (2009) 4 Comp LJout, this Press Note has to provide clarity on a number of issues. Even after doingaway with FIPB scanner (as is ostensible), still the same remains to be the order.However, this press note has been more helpful than harmful. This will beleveraging the Indian companies to raise money via equity easily. __________________ “‘Attract FDI!’ is one of the most widely recommended policy measures. This is true even for quite different aims like increasing productivity or spurring productivity growth, curing unemployment, boosting output growth in general and in special industries, etc. The advantages of attracting FDI mostly stated are the increase in the capital stock in general and of foreign capital in particular, where the latter is assumed to be more productive, or more efficiently managed and able to exploit economies of scale and scope which are seen to be beneficial to the guest as well the host country. Further, an increase in the stock of capital enables a country or region to employ more people and thus reduce unemployment, boosting output growth, etc. Finally, FDI inflows are seen - from the point of view of a less developed host country - as a medium of technology transfer and thus contributing to higher production efficiency and productivity not only to the foreign owned firms but - via spillovers - also to locally owned firms and establishments. This increases the competitiveness of a particular industry, region or country which again is of importance in industries with global competitive pressures. In a broader sense FDI is also often seen as a remedy against unionisation characterised by high and rigid wages on the labour market side and against monopoly power on the product market side. A higher share of FDI is expected to increase wage flexibility and product market competition which again raises competitiveness to other countries. Similar advantages also hold from the sending country’s or firm’s perspective where FDI allows to outsource particular activities (e.g., labour intensive activities can be performed more cheaply in other, e.g., labour abundant, countries), to exploit economies of scale and scope more efficiently or to enter or penetrate a foreign market (market seeking FDI).” —Attract FDI! - A Universal Golden Rule? Empirical Evidence for Europe and Asia2323 Robert Stehrer and Julia Woerz.