Latest FDI reforms could hit Make in India

The FDI policy announced by the government ahead of PM’s visit to U.K. entailed liberalising norms for 15 sectors

December 12, 2015 11:44 pm | Updated March 24, 2016 11:57 pm IST - NEW DELHI:

“The intent of this policy seems to be to encourage firms to Make In India and sell it in any mode they prefer, in the context of single brand retail firms that were already allowed 100 per cent FDI, but couldn’t sell online so far

“The intent of this policy seems to be to encourage firms to Make In India and sell it in any mode they prefer, in the context of single brand retail firms that were already allowed 100 per cent FDI, but couldn’t sell online so far

The latest changes to the country’s foreign direct investment or FDI policy could end up hurting the government’s ambition to make India a global manufacturing hub, as they have introduced an element of uncertainty over manufacturing investments where none existed before.

The new FDI policy announced by the government ahead of Prime Minister Narendra Modi’s visit to the United Kingdom and the G20 summit in Turkey last month, entailed liberalising norms for 15 sectors, including defence, construction, civil aviation, FM radio, single brand retail, private banks and manufacturing.

Double whammy

But the notification to effect these changes issued by the department of industrial policy and promotion on November 24, introduces the definition of what constitutes ‘manufacture’ within the purview of the FDI policy — which industry experts and representatives say could be a ‘double whammy’ for investments.

Defining manufacturing in the FDI policy could end up restricting foreign investments in some sectors, including the likes of electronics and hardware manufacturing. At the same time, Indian firms are worried that this could open the door for competitors to make minor changes to imported goods and still call it ‘manufacture’.

“Indian manufacturing companies are now up in arms against this definition because they believe that under this definition, foreign companies will effect minor modifications to goods and re-label them as “Made in India”, which will make similar Indian goods less competitive,” Akil Hirani, Managing Partner at Majmudar and Partners, an international law firm told The Hindu.

“The government, although well-intentioned, could have done without this definition because definitions are prone to interpretations which can vary and, thereby, cause ambiguity,” Mr. Hirani said.

The FDI policy has defined manufacture, with its grammatical variations, as a change in a non-living physical object, resulting in transformation of the object into a new and distinct article having a different name, character and use, or bringing into existence of a new and distinct thing with a different chemical composition or integral structure.

The CEO of an information, communications, technology and electronics (ICTE) hardware company said that the definition of manufacture would lead to a lot of unnecessary litigation by the excise, service tax departments and other government agencies.

Manufacturing is defined differently in the excise, service tax and income tax laws. However, the definition in the FDI policy is based on the income tax law.

Traditional sectors

“Why have multiple definitions in the first place? And if the FDI policy must lay out what is manufacturing, it could have simply referred to the definition under the excise law where the Supreme Court has laid down a lot of norms on what constitutes manufacture,” said Dhiraj Mathur, partner (regulatory affairs) at consulting firm PwC. Mr. Mathur said that though this discrepancy may not impact traditional manufacturing sectors, it would be a source of confusion in some sectors, including electronics and IT.

“If a company assembles various computer hardware and embeds it with software, I would define it as manufacturing, but it may not be so clear as per the definition in the FDI policy,” he pointed out.

In the case of a conflict between the FDI policy and excise law definitions of manufacturing, Mr. Mathur said that the Central Excise Act of 1944 would prevail as it is a law passed by Parliament, while the FDI policy is based on an executive decision.

As per Section 2 (f) of the excise law, ‘manufacture’ includes any process, incidental and ancillary to the completion of a manufactured product.

The law separately specifies the goods that come under its ambit, with a separate schedule that lists goods, whose packing, labelling or alterations made to make it marketable to consumers also constitute manufacture.

“With the Goods and Services Tax regime coming in soon, why do we want to get into this hair-splitting over a new interpretation of manufacturing now?” asked the hardware company’s CEO, who did not wish to be identified owing to the sensitivity of the matter.

Under the new FDI policy, slitting complex films for electronic capacitors, testing, etching a surface etc. may be declared as not manufacturing, for instance, he said, stressing that the issue is being discussed among industry bodies.

These FDI reforms are ‘one more proof of minimum government and maximum governance… opening up the manufacturing sector for wholesale, retail and e-commerce so that the industries are motivated to Make In India and sell it to the customers here instead of importing from other countries,’ the commerce and industry ministry had said in a statement on November 10.

Rajat Mukherjee, partner at law firm Khaitan & Co, said that FDI in manufacturing was always allowed at 100 per cent, barring the few sectors that were reserved in the past for small-scale industries.

“The intent of this policy seems to be to encourage firms to Make in India and sell it in any mode they prefer, in the context of single brand retail firms that were already allowed 100 per cent FDI, but couldn’t sell online so far,” he said.

“But the definition of manufacture leaves room for problems, when taken together with the conditions imposed on Indian manufacturers with branded goods,” he added.

New conditions

Indian manufacturers can now sell their own ‘branded products’ in any manner, including online, but the FDI policy places onerous conditions on them.

They must own the Indian brand and manufacture at least 70 per cent in value terms of its products in-house within India, and source a maximum of 30 per cent from other Indian manufacturers.

Further, the Indian brand must be owned and controlled by resident Indian citizens and/or companies that are owned and controlled by resident Indian citizens.

“These additions are confusing and it is unclear whether it will apply only to Indian manufacturing companies or to foreign companies who also have established Indian manufacturing subsidiary or joint venture companies,” said Mr. Hirani, adding that the government needs to clarify this.

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