“In other words……” – Foreign investment in e-commerce business in India

By December 28, 2014 December 20th, 2019 No Comments
With the rapid growth of
e-commerce business in India, the sector has caught the eyes of the regulators
off late. Where, on the one side e-commerce business appears to be one of the
most promising sectors in India for foreign investors, as also supported by the
Google’s annual online shopping growth trends report envisaging the online
shopper base in India to reach 100 million by 2016, on the other hand the regulators
are harping on whether the existing players are compliant of FDI policies.
The regulator’s attention has
been attracted mainly due to two reasons, one being the more than required importance
given to the question whether retail sector of our country should be thrown open
for foreign investment or not and second, whether those who are waiting for it
to open would use e-commerce as a via media to bank on the opportunity that
exists in our country as far as retail sector is concerned. This has lead to
creative structures which the e-commerce companies follow in order to take
advantage of the business opportunities which exists in the market and yet
remain compliant with the prevailing laws.  
As per the FDI Policy of the
country, “e-commerce activities refer to
the activity of buying and selling by a company through the e-commerce platform
Such companies are permitted to engage only in Business to Business (B2B)
e-commerce and not in retail trading. The FDI Policy further clarifies that the
existing restrictions on FDI in domestic trading are applicable to e-commerce
as well.
Foreign investment in retail
trading in India is categorised under two heads viz. “single brand product retail
trading” and “multi-brand product retail trading”. Foreign investment in single
brand product retail trading though permitted up to 49% under the automatic
route, it entails compliance of certain conditions. For instance, products to
be sold should be of a ‘single brand’ only (i.e. products which are branded
during manufacturing), products to be traded in India should also be sold under
the same brand internationally, etc. As regards foreign investment in
multi-brand retail trading, the same is permitted only up to 51% under the
government approval route. In addition to seeking the government approval,
certain conditions are also required to be met with, such as minimum foreign
investment must be USD 100 million, at least 50% of total FDI brought in the
first tranche must be invested in back-end infrastructure within three years,
restriction on areas in which sales outlets can be opened etc. Certainly, one
can imagine the difficulty of an ecommerce venture being complaint with such
With such regulations governing
retail trading in India which are also applicable on domestic retail trading
through e-commerce, it is intriguing how the existing foreign funded e-commerce
companies (appearing to be engaged in multi-brand product retail trading) have
structured their existence. Broadly, there are two models that have been
adopted by these companies in India – Marketplace Model and Inventory Model.
Marketplace Model
In order to avoid huge entry
cost of procuring government approval and complying with the minimum
capitalisation requirements and other conditions applicable on multi-brand product
retail trading, these companies enter the market as a “trading platform” rather
than a trader. In this model, the company operates as a purely “online
marketplace” which facilitates online sale of goods between buyers and sellers.
Sellers enter into an arrangement with the company to canvass their products on
the trading platform for securing the sale of their products through the
company’s trading platform. In this model, the company also provides supporting
services in the nature of advertising services, logistic services, management
services etc. and earns ‘service fee’ from the sellers in the form of a
commission on per sale basis or any other form of  agreed service fee.  In this model, though the entire sale process
is channelized by the marketplace company, the title of the goods to be sold
passes on directly from the seller to the ultimate consumers. Since there is no
restriction in foreign investment in service sector (including technical
services), these companies are operating well within the letter of the
Inventory Model
This model is slightly more intricate
and operates under a thin line of differentiating itself from multi-brand
retail product trading. In this model, two distinct companies are set up where
the promoters and directors of the two companies are completely unrelated. One
of the companies is wholly owned and controlled by Indian individuals/entities
and operates as the B2C entity. The other company, being FDI funded, operates
as the “marketplace” company (as detailed above) and as a B2B wholesale company.
The B2B entity procures inventory from various vendors and sells the same on
B2B wholesale basis to the B2C entity. The B2C Company then utilises the
“trading platform” services and other logistical services provided by the B2B Company
for sale of products to the ultimate consumers.
The above model provides maximum
value to the foreign investors of the B2B Company, as the revenues generated
from wholesale trading as well as the trading platform services rest in the books
of the B2B Company.
The two company model is also
adopted by companies operating under the “marketplace model” where an
“unrelated” retail entity is formed which utilises the trading platform
services of the foreign funded company for sale of its products. In this case,
the scope of services to be provided by the marketplace entity enlarges to a
great extent as a facilitator of procurement of goods in the name of retail
entity and sale of such goods to the ultimate consumers through the retail
entity. The service fee charged by the marketplace entity in this model covers
up nearly 80-90% of the revenue earned by the retail entity on sale of
Though the above models have
been up and running for quite some time now and appear to be well within the “letter of the law”, the regulators are
now probing into the legitimacy of these structures and are lifting the
corporate veil to ascertain the bona fides of “unrelated” entities, arms’
length transactions etc.
One other aspect which is still
obscure is “international retail trading” by FDI funded e-commerce companies in
India. The FDI policy specifically states that “
restrictions on FDI in domestic
trading would be applicable to e-commerce as well”.
A probable interpretation
of the same could be that only the restrictions on FDI in domestic trading would be applicable to e-commerce
activities and consequently there will be no restriction if the e-commerce
activity is being carried out with respect to “international” trading.  Accordingly, though the number of companies
which have entered into this market is less, such companies operate their international
market place business through a separate entity incorporated in India and
having a separate website under the same/similar “domain name” with certain
suffixes to reflect the international character.
In this
model, two separate companies are incorporated in India, each funded by similar
foreign investors. One company operates the Indian marketplace website (under
the models mentioned above) and the other company operates an international
marketplace website. On placing a request for an international order, the
Indian website directs the customers to the international website which clearly
states that “deliveries of products will
be everywhere in the world except India
. Further, various terms and
conditions on such international website clearly stipulate that orders on the
website can be made only by a person resident outside India, for delivery
outside India as well as all payments should be made in US Dollars only.
this business activity is not yet prominent as the same is an outcome of a very
lenient and convenient interpretation of the provisions of the FDI Policy and
basing a business structure on such interpretation may not be feasible in the
long run. In light of the past instances of the DIPP and RBI rectifying such
errors in the FDI Policy by merely ‘deleting’ certain words or providing
express clarifications on certain erroneously mentioned words with
retrospective effect, it may not be prudent to base a prospective business
structure on such interpretation when the intent of the law is quite apparent
At a very nascent stage and besides
being under the scanner of regulators, the growing number of consumers resorting
to “online shopping” demonstrates mounting projections for e-commerce industry
in India.  The e-commerce industry of
India is yet another example where the industry demands will shape up the
regulations and require the regulator to take a pragmatic view and finally the
policy and industry will speak the same language using same words.  
Authored by:-
Nidhi Arora

Akshat Pande

Leave a Reply