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Foreign Direct Investment in Cash & Carry Wholesale Trading

Introduction:

The extant Foreign Direct Investment ('FDI') regulations, permit 100% FDI under the automatic route for trading companies engaged in the activity of Cash & Carry Wholesale Trading/ Wholesale Trading (hereinafter referred to as 'Wholesale Trading'). However, earlier, this term was not specifically defined in the FDI policy.

In 2010, the Government of India, through Ministry of Commerce and Industry ('GOI'), provided an extensive definition of the Wholesale Trading in the Consolidated FDI policy in 2010. The GOI has also clearly laid down the criterion for distinguishing Wholesale Trading from Retail Trading in which FDI, though permitted, is subject to various restrictions.

Meaning of 'Wholesale Trading':

The concept of ‘cash and carry wholesale trading’ was formally notified in the FDI policy in 1997 and 100 per cent foreign investment was permitted therein with prior approval of the government. After a period of almost 10 years, cash and carry wholesale trading was liberalized and brought under the automatic route in 2006, without any conditionalities and restrictions. In 2010, the government sought to specifically define the scope of activities permissible under ‘cash and carry wholesale trading as sale of goods/ merchandise to retailers, industrial, commercial, institutional or other professional business users or to other wholesalers and related subordinated service providers. It was clarified that wholesale trading refers to sales for the purpose of trade, business and profession, as opposed to personal consumption and the yardstick to determine whether the sale is wholesale or not would be the type of customers to whom the sale is made and not the size and volume of sales. Therefore, as long as sales were made by the wholesaler to entities holding sales tax/ VAT/ service tax/ excise duty registration or relevant trade licenses, the same would legitimately qualify as ‘cash & carry wholesale trading/whole sale trading’.

It has also been clarified that wholesale entities are permitted to extend credit facilities to their customers as per normal business practices and subject to other legal regulations. The policy requires that full records indicating all the details of wholesale sales should be maintained on a day to day basis.

Sales to group companies:

The flexibility to conduct wholesale trading, is however, subject to one main rider i.e wholesale trading of goods to group companies should not exceed 25 per cent of the total turnover of the wholesale venture. The imposition of this cap was perhaps triggered by the advent of inter-linked wholesale – retail structures in multi-brand retailing, where a front-end retail entity(ies), would purchase largely/ exclusively from a group wholesale entity. While no foreign investment was permitted in the front-end retail entity (until September 2012), foreign investment could flow freely into the wholesale entity. The wholesale entity in such structures typically played a dominant role in creation of back end infrastructure, supply chain management, transportation, logistics and distribution, inventory management, working capital management, etc. This led to wholesale trading being viewed as a backdoor entry to retail and the government stepped in to prevent potential abuse of the wholesale cash and carry route by imposing this 25 per cent cap on sales by the wholesale entity to group companies. The term ‘group company’ was not specifically defined in the FDI policy until earlier this year. Vide Press Note No 2 (2013 series) dated June 3, 2013, the term ‘group company’ is now defined to mean two or more enterprises which, directly/ indirectly, are in a position to (a) exercise at least 26 per cent voting rights in the other enterprise; or (b) appoint more than 50 per cent of members of the board of directors in the other enterprise.

By virtue of this definition, where the Indian retail entity, which is only a franchisee of the foreign retailer with no equity participation buys exclusively from the 100 per cent owned subsidiary of the foreign retailer, the 25 per cent cap on sales by the wholesale entity would not get triggered. However, where the foreign retailer and/ or the JV partner acquire an equity interest of more than 26 per cent in both the wholesale entity and the retail entity, the definition of Group Company is likely to apply. Note that a literal reading of the definition of ‘group company’ creates some ambiguity as it suggests that two or more enterprises can be considered as group companies only if they hold >26 per cent equity or control >50 per cent of the Board of the other. However, a purposive interpretation in line with the intent of the Government to cover sister companies is recommended in our view. A specific clarification from the government in this regard would be desirable.

Wholesale trading in e commerce:

Since B2C e-commerce remains restricted to foreign investment, foreign online retailers have the option of either structuring their operations entirely as a market place model (Amazon India, eBay India) where their website merely provides a platform for bringing independent buyers and sellers together.

Alternatively, where the online retailer seeks to exercise more control over the customer shopping experience and therefore, on inventories as well, they have made use of the wholesale trading route.

In this structure, the actual sale to the consumer is made by Indian third parties who are listed on the website, and the web platform and the entire back-end operation such as inventory and order management, packaging, transportation, payment collection, etc. is managed by a ‘wholesale cum service’ entity.

The wholesale entity undertaking such activities, is not technically restricted in any manner under the FDI policy and therefore, assumption of these responsibilities under an arm’s length service agreement with a retailer should not be considered violative of the FDI policy.

However, some interpretation issues on distinction between wholesale and retail operations arise under this scenario and such a structure has practically seen investigation by the regulators on ‘substance issues’ In our view, it is important that the risks and rewards of the wholeseller and retailer are clearly defined and demarcated and their entire relationship is construed at arm’s length. In such a scenario, where the retailer assumes defined functions and risks, the wholesale entity should not be seen as ‘indirectly’ carrying on a retail activity. It cannot be denied that the majority of the capital fuelling the growth of e-commerce businesses in our country has been made available by foreign private equity and venture capital funds. In such a scenario, it is imperative that the government deals with these issues directly and in a manner consistent with the twin objectives of ensuring that investment in e-commerce is appropriately regulated as well as creating a facilitative environment for further capital inflows into this sector.

Wholesale entities as a sourcing arm:

Historically, when the government opened doors to foreign investment in trading, the policy favoured establishment of wholly owned subsidiaries in India for bulk imports of goods or services where atleast 75 per cent of the procurement and sale of goods was to companies of the same group.

However, this approach underwent a change with the introduction of the 25 per cent cap and perhaps unintentionally, led to a situation where a multinational group cannot establish a 100 per cent owned wholesale entity in India to act as a domestic sourcing arm and buy goods from various third parties and supply to its other group entities in India.

It is pertinent to note that the current cap is irrespective of the nature of the products being sold by the wholesale entity i.e whether the goods are Indian or of foreign origin and whether the goods are manufactured or processed by the group itself or by third parties. In case a business group envisages a 100 per cent sourcing arm in India, the group would therefore need to obtain a specific approval from the government for waiver of the cap on sales to group companies

Conclusion:

Based on the above analysis, we are of the view that the quantity or the volume of sale is not the determinant for wholesale trade, but it is the type of customer which determines whether the trade is wholesale or retail. Industrial, commercial, institutional and professional business users are also considered as wholesale customers, even if they are consumers. Thus if a vendor sells ten refrigerators to be installed in a factory, such a sale by him shall fall within the ambit of 'Wholesale Trading' as per the FDI policy. However, if the same vendor sells ten refrigerators to an individual to be installed in his house, such sale will be leveled as 'Retail Trading' inviting prohibition and restrictions associated with it so far as FDI is concerned.

Policy clarifications to address some of the operational challenges discussed above, including dilution of the 25% cap on sales to group companies are necessary to facilitate further foreign investment into wholesale trading.

Source:
  1. Consolidated policy issued by DIPP.
  2. RBI Master Circular.
  3. Various article on similar subject published online.
 

Disclaimer: The entire contents of this document have been developed on the basis of relevant information and are purely the views of the authors. Though the authors have made utmost efforts to provide authentic information however, the authors and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document

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