Invoking a sense of déjà vu, the Centre is going to once again tweak the foreign direct investment (FDI) rules for e-commerce. This is proposed as part of its recommendations suggested in the unofficial draft of e-commerce policy that unintentionally got leaked.

First, a bit about these proposals in the draft e-commerce policy. The proposals target boosting exports of e-commerce entities by treating e-commerce exports at par with non-e-commerce exports and enhancing exports by using India Post and Foreign Post Offices facilities; providing safeguard measures by ensuring registration with designated authority and identifying rogue e-commerce entities that host pirated content and after verification putting rogue entities in Infringing E-commerce entities (IEE) category and eliminating counterfeit products from e-commerce platform; ensuring level playing field and providing for equal treatment for all sellers and restricting the use of biased algorithms that prioritise few sellers; laying emphasis on compliance with applicable laws (giving supremacy to FDI rules over this policy in case the two are conflicted); preventing misuse and mis-handling of data; incentivising offline sellers to do online trading; turning State emporiums into e-emporiums; making adequate measures for monitoring compliance and providing punishment for violations.

If viewed from this perspective, the proposals seem to be encouraging and progressive. But they have some rough edges too that need to be smoothened. For example, one proposal restricts associates and related parties of e-commerce entities from doing things which e-commerce entities could not have done themselves. The government will inform from time to time persons who will qualify as associates and related parties. This could be a problem. The meaning of associates and related parties should be clarified upfront. This will ensure certainty and continuity for the e-commerce sector. Open ended and vague concepts will surely lead to doubts.

Now, a little background about this sector. In March 2016, as a major FDI reform, 100 per cent FDI without government approval was allowed for marketplace model in e-commerce sector. This was a format where entities could act as facilitators between buyers and sellers on their e-platform. Conversely, inventory-based model, where an entity could own and trade in goods on its own e-platform — was not opened for FDI.

The ban on FDI in inventory-based model was said to protect the interests of corner stores and small retailers. To ensure e-commerce entities did not violate these rules, the policy had important caveats — an e-commerce entity wasn’t allowed to own goods sold on its e-platform, and a seller was restricted from selling on an e-platform more than 25 per cent of total sales on that e-platform. These checks were to ensure that e-commerce entities operated as pure play marketplace entities; and prevent them from venturing into more profitable inventory-based business.

New clarifications were brought in from February 2019. While re-iterating its stand that e-commerce entities must not own the goods, the clarifications further tightened the rules. A concept of ‘control’ over inventory was added. An entity was said to be in control over inventory of a seller when any seller bought over 25 per cent of its goods from either the marketplace entity or its “group companies”.

This restricted marketplace entity and its group company from using a seller and indirectly getting its own goods sold on its e-platform. Another clarification prevented a seller in which e-commerce entity or its “group company” held any equity stakes from selling any goods on e-platform. These restrictions were meant to ensure that entities work truly on marketplace model.

Spirit ignored

Fast forward to March 2021. With the tightened rules already in place, is there a need for further revisions? It’s believed that some e-commerce entities have been routinely flouting the rules by interpreting them strictly in the letter of law but completely ignoring their true spirit. This is what the Centre now hopes to fix. The retailers and trade bodies/associations have also asked for these loopholes to be fixed to ensure a level playing field for all players.

In this context, the meaning of “group companies” requires attention. The definition of “group company” in FDI policy covers two or more such enterprises, such that, directly or indirectly, they can exercise 26 per cent or more of voting rights of another enterprise or can appoint more than half the directors of another enterprise. There is an anomaly here. Two or more such enterprises that can together exercise 26 per cent or more of voting rights or appoint more than half the directors, among themselves constitute a group. But, that other enterprise in which they hold these rights doesn’t become part of their group. This loophole could be exploited by letting this other enterprise sell its goods to sellers on e-platform.

Then, the concept of holding equity stake by an e-commerce entity requires clarification. The current language seems to suggest that only entities where an e-commerce entity or group company has direct equity stake are covered by the prohibition. E-commerce entities have been using sellers on e-platform where the e-commerce entity or its group company does not hold direct stake.

Also, the provision covers only downward holding of stake and not upward. By this interpretation, immediate and ultimate holding companies of e-commerce entity will get excluded. This could be misused by using holding companies as seller entities.

There is no denying that language of any legislation must reflect its true intention. If it doesn’t, it needs to be fixed. In this case, although further clarifications may be best intended, e-commerce entities must get ready for some uncertainty and tough challenges ahead.

While the government must fix the nagging issues; it must also take a clear stand on its policy. Frequent amendments could hurt investments. The government seems to be stuck between a rock and a hard place — while it cannot let its policy be misused but at the same time it cannot let India’s image as a business-friendly destination be adversely impacted. A right balance needs to be struck to avoid confusion that is sure to follow with the proposed policy change.

The writer is a partner with J Sagar Associates. Views expressed are personal