Legal Blog: Foreign Direct Investment : A Comparison of the Consolidated Policies of 2010

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Saturday, November 13, 2010

Foreign Direct Investment : A Comparison of the Consolidated Policies of 2010

Comparison of the Consolidated FDI Policies of 2010

Introduction

Every year the Department of Industrial Policy and Promotion (“DIPP”), Ministry of Industry and Commerce release the Foreign Direct Investment Policy (“FDI Policy”) outlining the broad policies/ regulations as contained in the Foreign Exchange Management Act (“FEMA”), Reserve Bank of India (“RBI”) regulations and the various Press Notes / Press Releases. However, since the beginning of this year, the DIPP has decided to issue a consolidated Policy circular every Six months. The Circular entails, into one document, all the prior policies/regulations on FDI and Press Notes/Press Releases/Clarifications issued by DIPP and reflects the current ‘policy framework’ on FDI.

The consolidated FDI policy Circular no.1 (“First Circular”) was released by the DIPP on 31st March, 2010 and came into effect from 1st April, 2010. The said circular consolidated all prior policies/ regulations, including the existing RBI Master Circular on FDI. On 29th September, 2010 the DIPP issued Consolidated Circular No. 2 (“Second Circular”), highlighting all the changes brought vide Press Notes, Press Releases, Clarifications, issued after the release of the First Circular. The Second Circular, which is effective from 1st October 2010, highlights the various amendments/ additions in the FDI Policy and sets out the clarifications issued by the DIPP with regard to the releases issued throughout the year.

From a comparison of the two circulars, the following additions/ amendments emerge, as under;

(i) Share Swaps:

The DIPP has introduced a new specific clause permitting the share swap transactions with prior FIPB approval. As per Clause 3.5.6 of the Circular, valuation of the shares needs to be undertaken by Category 1 Merchant Banker registered with Securities Exchange Board of India (“SEBI”) or a registered investment banker in the host country.

(ii) Internal Accruals:

The Second Circular has permitted the use of downstream investments through use of internal accruals, subject to such investments complying with respective sectoral caps / policy.

(iii) Partly Paid shares and Warrants:

Both the Policies define ‘Capital’ as equity shares; fully, compulsorily & mandatorily convertible preference shares; fully, compulsorily & mandatorily convertible debentures. By way of a clarification of the above definition the DIPP in the Second Circular stated that any other type of instruments like warrants, partly paid shares etc. are not considered as capital. The effect of the clarification is that such warrants or partly paid shares can be issued to persons resident outside India only after approval through the Government route.

(iv) Share Premium and Capitalisation Norms:

The Second Circular clarifies that, for sectors having minimum capitalisation norms (such as Non Banking Finance Companies ("NBFC") and construction development projects), share premium received along with face value of the shares upon issue of the shares to non-resident investors would be counted as part of minimum capitalisation requirement.

Comparison vis-à-vis Sectoral Changes

1. Agriculture:

As per the First Circular, 100% FDI under automatic route is allowed for undertaking certain agriculture activities and animal husbandry, subject to undertaking the same under 'controlled conditions'. However, the term 'controlled conditions', which was not defined in the First circular, has now been defined in respect of 'floriculture/ horticulture/ cultivation of vegetables and mushrooms'; 'development of seeds'; 'animal husbandry'; and 'pisciculture & aquaculture'.

The term “under controlled conditions” covers the following: ‘Cultivation under controlled conditions’ for the categories of Floriculture, Horticulture, Cultivation of vegetables and Mushrooms is the practice of cultivation where in rainfall, temperature, solar radiation, air humidity and culture medium are controlled artificially. Control in these parameters may be effected through protected cultivation under green houses, net houses, poly houses or any other improved infrastructure facilities where micro climatic conditions are regulated anthropogenically. The term “under controlled conditions” covers the following:

Development of seeds will be considered to be ‘under controlled conditions’ when seed farms/laboratories use tissue culture or any other micro-propagation techniques for development and multiplication of seeds/planting material. Seed development in the case of anthuriums, orchids and other ornamental crops in greenhouses/net houses/poly houses is also be included in this category. In case of Animal Husbandry, scope of the term ‘under controlled conditions’ includes;

Rearing of animals under intensive farming systems with stall-feeding. Intensive farming system will require climate systems (ventilation, temperature /humidity management), health care and nutrition, herd registering/pedigree recording, use of machinery, waste management systems. · Poultry breeding farms and hatcheries where micro climate is controlled through advanced technologies like incubators, ventilation systems etc. In the case of Pisciculture and Aquaculture, ‘under controlled conditions’ includes – · Aquariums · Hatcheries where eggs are artificially fertilized and fry are hatched and incubated in an enclosed environment with artificial climate control.

2. Manufacturing of cigars, cheroots, cigarillos, and cigarettes of, tobacco or of tobacco substitutes:

The Government has included the manufacturing of cigars, cheroots, cigarillos, and cigarettes of, tobacco or of tobacco substitutes in the list of sectors prohibited for FDI.

3. Wholesale Trading:

The DIPP has withdrawn the condition under the First Circular, specifying that wholesale trading to the group companies should be there for their internal use only. With the revised policy, companies procuring goods from the group wholesale venture can undertake onward sale subject to the condition that the total wholesale trade to the group companies taken together should not exceed 25% of the turnover of the wholesale venture.

4. Construction Development Projects:

The Second Policy clarifies the term "Original investment" to mean the entire amount brought in as FDI. The Policy further states that the lock-in period of three years will be applied from the date of receipt of each installment / tranche of FDI or from the date of completion of minimum capitalisation, whichever is later.

5. Non Banking Financial Corporations (“NBFC”):

The Second Circular has clarified that 100% foreign owned NBFCs, with minimum capitalisation of $50 million, can set up subsidiaries for specific NBFC activities, without having to meet minimum capitalisation norms for such downstream subsidiaries.

6. Mining:

FDI for separation of Titanium bearing minerals and ores was allowed subject to value addition facilities being set up within India along with transfer of technology. The concept of what will constitute value addition has been expressly stated. The Government has further clarified that the objective of prescribing conditions for establishing Value Addition facilities and Transfer of Technology is to ensure that the raw material available in the country is utilized for setting up downstream industries and technology available worldwide is used to set up such industries within the country.

7. Telecom:

General conditions, such as manner of computing FDI, adherence to License agreement, source of FDI etc, have also now been made applicable to companies operating telecom services with the FDI cap of 49%. This is in addition to the security conditions which are already applicable to companies operating telecom services with the FDI cap of 49%.

Conclusion

The Second Circular, while clarifying several aspects on which earlier there was ambiguity, also recognises the introduction of various Discussion Papers issued by DIPP (Defence, multi brand retail, existing venture/tie-ups, issue of shares for consideration other than cash and FDI in Limited Liability partnership ("LLP")). It is expected that appropriate amendments to the FDI policy would be made as and when the policy framework in respect of these matters is finalised. The Circular is clearly a step forward in increasing the transparency in the FDI policy framework. The Government's initiative of using a consultative process with various stakeholders will help in further addressing other ambiguities and in evolving the policy.

Sukrit Seth is a 4th Year Student of Amity Law School, New Delhi. He is currently interning with Amarchand Mangaldas & Suresh A. Shroff in the Corporate Department.

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