Downstream investments press notes(2009 series)

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 free
market nation. This paved way for huge amounts of foreign direct investment
(FDI) through non-resident Indians, international companies and various other
foreign investors. The growth story of India Inc. and the economy has been
robust since then, with occasional ups and downs. Foreign direct investment has
come as a shot in the arm in terms of increased capital flow, improved
technology, management expertise and access to international markets. Since
then the Government of India has issued specific press notes to amplify the
necessary changes. An attempt here made is to make a threadbare analysis of
Press 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 in
2009. Press Notes 14 and 55 deal with laying down the policy and procedure for
the publication of the facsimile editions of foreign newspapers in India and
guidelines for foreign investments in commodity exchanges, respectively.
However, this article is concerned only with the analysis of the other three press
notes. 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 calculation
of indirect foreign investments through the channel of ‘downstream investments’.
Under this policy, all ‘downstream investments’ were subjected to the FIPB
approval. The policy enshrined in the aforesaid press note was applicable to only
those sectors which are mentioned in annexure III8. Despite providing a pro bono
policy regarding for Indirect Foreign Investments, it failed to attract foreign
investors to invest through this channel. The two main reasons behind the set
back 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, the
Government of India issued Press Note 2.10 The feel good factor about the present
Press 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 different
regimes for calculating indirect foreign equity. Press Note 2 is applicable to major
sectors of the economy. This Press Note covers the entire gamut of foreign
investments (FDI, FIIs, NRIs and FCCBs and convertible preference shares and
convertible currency debentures) to compute foreign shareholding levels in
Indian 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 Indian
Company will not be counted for indirect foreign investment, if the holding
company 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 is
beneficially owned by the resident Indian citizen and Indian companies which
are ultimately owned and controlled by resident Indian citizens. The term
‘controlled’ is defined to mean that the resident Indian citizens and Indian
companies, which are owned and controlled by resident Indian citizens, have the
power to appoint a majority of its directors. Any investment falling outside this
framework will be considered as indirect foreign investment in an invested
company, as a consequence of which the same shall be considered for calculating
the total foreign investment in that company. In other words, if the investing
company is owned or controlled by ‘non-resident initiates’ entire investment by
such 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 1
Foreign Company Indian Company A Indian Company B
→ < 50%→ (FDI = Nil)
In the first scenario the Indian Company holds less than 50% foreign
investment. The Company B will not be taken as having any indirect foreign
investment through Company A, i.e., FDI=NIL
CASE 2
→ 75%→ 26% (FDI = 26%)
In the second scenario if Company A has foreign investment of 75% and
invests 26% in Company B, then the entire 26% will be treated as indirect foreign
investment in Company B.
CASE 3
Foreign Company Indian Company Indian Company B
→ 75%→ 100% (FDI = 75%)
If Company A has foreign investment of 75% and Company B is a wholly
owned subsidiary of Company A, then only 75% would be treated as indirect
foreign equity and the rest 25% would be treated as resident held equity. The
indirect foreign equity in Company B would be computed in the ratio 75:25 in the
total investment of Company A in Company B.
Treatment of beneficial interest
In sectors with sectoral caps, balance equity (i.e., equity remaining after
foreign shareholding limits have been reached) has to be beneficially owned by
an Indian resident or qualified Indian company/companies. Press Note 2
provides that if there is a declaration under section 187C of Companies Act,
1956,12 the investment in such shares would be counted as foreign investment
regardless 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 to
follow the same norms as applicable to direct foreign investment. Further, Indian
companies receiving such downstream investment will be required to comply
with 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..


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.).


(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 in
sectors with caps on foreign investments. It is not applicable to foreign
investments in sectors where 100 per cent FDI is permitted under the automatic
route.
Transfer of ‘ownership’ or ‘control’
In cases of Indian companies that are engaged in sectors that have prescribed
sectoral caps, prior Foreign Investment Promotion Board (FIPB) approval, in the
following situations, would be required:
The Indian company has received foreign investments and is owned or
controlled 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 on
25.02.2009. Press Note 4 actually laid down the policy for downstream
investments. According, to the said Press Note 4, the policy for downstream
investment policy is constituted by: (a) only operating company19, (b) operating-
cum-investing companies; and (c) only investing companies20

17 (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..


The downstream investment policy in relation to an operating company or
operating-cum-investing company would require compliance with the relevant
sectoral conditions on entry route, conditionalities and caps with regard to the
sectors in which such companies are operating.
The downstream investments in relating to foreign investment in investing
companies would require the prior government/FIPB approval regardless of the
amount or extent of foreign investment.
Another important thing to be noted is the difference between investing
company and an investment company. The Department of Industrial Policy and
Promotion (DIPP) has made it clear that an investment company will be akin to
an NBFC and an investing company would be holding level companies, which
may have made downstream investments into subsidiaries. There is a lock-in for
them—they cannot trade that. This is how the new FDI policy and these
clarifications make it clear that there will be no back-door entry for restricted
sectors such as the print media, television, retail or even gambling.21 This far-
sightedness of government has prevented the Indian economy from becoming
numb, because of transient entry and exist of equity transactions by investment
companies.
Critical Analysis
There is a requirement to clarify certain issues in the Press Note to avoid
varied interpretations. They are —
Perplexity over 50-50% joint ventures
(1) The present press note seeks to deal with two kinds investing options. The
possibilities 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.
→ 50%→ 80% (FDI=?)
If a foreign company has a joint venture with another Indian investing
company, in such a scenario if the Indian company holds 80% equity shares of
another 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 regarding
any percentage of investment in Indian Company B)
(2) For considering an investment in an Indian company as indirect foreign
investment, the investing company shall have to satisfy one of the criteria as
specified in the press note (owned or control). If the foreign entity completed any
of the two criteria then any investment by investing company will be called as

21 See moneycontrol.com.


‘downstream investment’. But the point of argument is these that if such criterion
is being fulfilled by several unconnected foreign companies together will it have
the same effect? Is the question to be considered?
Foreign Foreign Indian Indian Foreign
Company 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 another
Indian 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 a
clarification.
(3) The proportionate method should be applied in the cases of investment
which is below 50%. This Press Note encourages back door investment avenues.
In the pretext of having 49% foreign investment, the calculation of indirect
foreign investment is being banished. The proportionate method should calculate
the percentage of indirect foreign investment in proportion to the foreign
investment made in the investing company. The said norms will allow foreign
investors to invest in those sectors also in which FDI is prohibited.22
ILLUSTRATION
→ 70%→ 30% (FDI = 70% of
30%=21%

If holding company (foreign company) has 70% foreign investment in
investing company A, which has 30% of equity shares of another Indian company
B, then the calculation of indirect foreign investment would have yielded 70% of
30%, viz., 21%.
Conclusion
To conclude, though the intent of the press notes are laudable, a few concerns
have arisen including a possibility that some sectoral caps have been made
meaningless and potential downstream investment in restricted sectors has been
probably made possible. Therefore, despite of commendable changes brought

22 ‘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.


out, this Press Note has to provide clarity on a number of issues. Even after doing
away 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 be
leveraging 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 Asia23

23 Robert Stehrer and Julia Woerz.

Downstream investments press notes(2009 series)

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