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FDI in e-commerce ventures and structuring issues
Flipkart, Myntra, Snapdeal – almost every e-commerce venture worthy of its name has foreign investment. How does FDI in e-commerce work?

Foreign direct investment (FDI) in India is regulated by the FDI policies issued by the Department of Industrial Policy and Promotion (DIPP) under the Foreign Exchange Management Act. The current FDI policy allows 100 % FDI in single brand retail trading and upto 51% FDI in multi-brand retail trading (subjected to certain conditions like 30% of the sourcing must be done from India, investment in backend infrastructure and warehousing, opening of stores to be allowed in cities with more than 1 million population and consent of the respective state government). 100% FDI through automatic route is allowed in B2B (business to business) trade only. Under the existing policy, FDI is not allowed in any kind of e-commerce. This essentially means e-commerce sites which sell directly to the consumer are not allowed to get FDI.

How do e-commerce sites obtain FDI? This is through structuring the business in such a way that it does not violate FDI regulations (at least not on the face of it) - some commonly used structures are explained below. However, please note that legal validity of these structures is not fully certain – the Enforcement Directorate, which has undertaken investigation into several e-commerce ventures in the past, the most recent one being Myntra (see here). Flipkart has recently sold its front-end operations to another entity to comply with the regulations (see here). However, several industry bodies are lobbying with the government to liberalize rules for investment in the e-commerce sector:

  1. Trading Platform – The foreign investor can invest in the trading platform or the technology, which can later be used by the sellers to sell their goods to the customers. (For example Amazon India uses this model). The trading platform is merely a ‘technological’ tool and is not actually engaged in trading. A diagrammatic representation of the structure is provided below:

Variant of structure 1 – a trading services entity
Another variant of the above structure is to invest in a technology services company – where an e-commerce business is conducted by the Indian company. It could either directly engage in e-commerce or provide a platform-based model where other buyers and sellers connect and trade, or a mix of both. The company which has raised foreign investment can provide technology-related services to the company. The structure is being diagrammatically represented below:

2. FDI into a B2B entity (with orders taken by an unrelated B2C company) – In this model there are two distinct companies (having different management, ownership and control) which are established. Recall that 100 percent foreign investment in wholesale businesses is permitted – this is the structure that is used in this model.

The foreign investor invests in a B2B company, which takes orders from other retailers (but not customers). Customer orders are accepted by a separate B2C company, which is independent and is unrelated to the B2B company. When a customer places an order with the B2C company, it immediately places an order with the B2B company (sometimes known as a ‘flash order’ because it is made on a ‘just-in-time’ basis and there is little or no prior inventory that is kept with the B2C company).

Technology, logistics and marketing is an important aspect of e-commerce and requires financial capabilities - since the foreign investment has been made in the B2B company, the B2B company is better positioned to handle these aspects. Therefore, the B2B company can also provide the trading platform, marketing services and manage inventory of goods. 



3. FDI into a holding company – This method is used to exploit a loophole under the FDI policy rule that foreign investment through a layered structure, that is, an upstream company is considered as zero if the investment into the upstream company is less than 50 percent and if the majority of its directors are appointed by Indians. A diagrammatic representation is provided below:

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