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Foreign Investment - Our Article Press Note 1 of 2005

Foreign Investment in India

Press Note No. 1 of 2005.

Rashmin C. Sanghvi,
Naresh A. Ajwani,
Chartered Accountant

This article has the following annexures :


Annexure Subject
1. Press Note No. 1 (2005 Series).
2. Extract of PM's speech at the CII Partnership Summit, 2005.
3. Mr. Kamal Nath's Statement as reported by Press Information Bureau (PIB) of India
4. Press Note No. 18 (1998 Series).
5. Press Note No. 3 (1997 Series).

In January 2005, the Prime Minister Dr. Man Mohan Singh has announced that Press Note No. 18 of 1998 has been withdrawn and that foreign investors will not require any approval from the Government of India nor any ‘No Objection Certificate’ (NOC) from existing collaborators. This statement has been followed by a statement from the Minister for Commerce & Industry – Mr. Kamal Nath. Press Note No. 1 of 2005 has been issued in lieu of Press Note No. 18 of 1998.

Media has reported that now foreigners can invest in India without GOI (Government of India) permission in all cases.

There is an error/misleading statement in these reports. It is true that PN (Press Note) No. 18 has been replaced by PN 1. However, there are still cases where foreigners will need prior permission from GOI. Let us see correct legal position.

1. Relevant clauses of PN 1 are extracted below.

“New proposals for foreign investment… would hence forth be allowed under the automatic route,…..

Subject to Sectoral Policies,…..

AS PER the following guidelines ….

1) Prior approval of the Government would be REQUIRED only in cases where..

The Foreign Investor has an existing Joint Venture in the SAME field….”

2. The reading of the above clauses does not need any deep interpretation. It is clear that :

Normally, foreign direct investment is on automatic route. However, there is a restriction. In cases where the Foreign Direct Investor (FDI) has an existing investment in India in the SAME filed, he will need prior GOI approval (from FIPB) for making new investment into India. By comparison of PN 1 & PN 18, what emerges is that now no permission will be required where the FDI has an existing investment in ALLIED fields. This of course is subject to Sectoral policies. (See paragraph 12 for Sectoral policies.)

3. To illustrate :

Let us assume, FDI-X (Foreign Direct Investor –X) has an existing collaboration with an Indian company for manufacture of dairy products. Now they want to collaborate with another company for processing of fruits & vegetables. Both products are from different fields. Hence FDI-X will not require GOI approval for the new collaboration. Nor will they need any NOC from the existing collaborator.

4. Prime Minister and the Union Minister of Commerce & Industry have gone on records saying that PN 18 is “WITHDRAWN”, and no further GOI approval will be required for FDI.

Both the statements are slightly erroneous.

Fact remains that certain investments still need GOI approval. Technically, of course PN 18 is withdrawn & PN 1 has been issued. However, it does not mean that no further permission is required.

5. Now important issue is to clearly understand the Press Note no. 1 of 2005. Foreigners may not rush into collaborations without proper understanding of law as it exists today.

6. There have been several strong opinions on PN 1. In this article, we will not go into the political issues. We will concentrate on the legal implications.

7. Normally, after the liberalisation, foreign investment in India is on “automatic basis”. However, in the cases where the FDI has an existing collaboration in India; in the SAME field; the FDI will need prior approval from Government of India (GOI).

This condition applies irrespective of whether the existing investment has been made prior to the issue of PN 1 or after. Thus for example, an FDI makes collaboration with an Indian company in the year 2005. In the year 2007, it wants to make collaboration with another company in the same field. It would need prior permission from GOI. (Assuming that the law remains same in the year 2007.) This would be true irrespective of whether the 1st collaboration were made in the year 2005 or 2004 or 1990.

8. Press Note (PN) No. 18 was also similar. It included GOI approval for existing Indian collaborations in the “same” as well as “allied” fields. Current PN removes the requirement of GOI approval for “allied” fields. That is all. Otherwise, under PN 1, the Government approval is prior & a must.

9. What is “same” & what is “allied” field?

Press notes may not be interpreted in isolation. The relevant legal provisions are given in the Industrial Policy Statement of 2004. (IPS). Press notes only make amendments or clarifications in the IPS.

The IPS provides that an industry would be in the “same” or “allied” field depending upon the NIC 1987 codes. If it is in the same 3 digit code, it will be considered “same” field. If it is in the same 4 digit code, it will be considered “allied” field. See IPS chapter III, paragraph 3.3 (ii) in the Annexure 6.

10. PN 1 has a special paragraph on “conflict of interest”. The press note is advising collaborators to include a clause on conflict of interest in their collaboration agreements.

The concept of “conflict of interest” (COI) is a well known concept. There are various situations in which there can be COI. Consider a few examples. Company A appoints Mr. B as an exclusive selling agent for the products manufactured by Company A. It would require the agent B not to sell the products manufactured by any competitor. If B sells the products manufactured by competitors, it would amount to COI. A would not be comfortable. B may give a priority to the competitor. He may divulge the sales strategy to a competitor. To avoid conflicting interests, A would include the necessary clause in the agency agreement.

Similarly, in collaboration agreements, the technology supplier may like to have a clause that the technology receiver will not enter into a collaboration agreement with a competitor. If GM supplies automobile technology to an Indian company, it may have a clause preventing the Indian company from selling products in GM’s foreign market. GM would not like the Indian company to start competing with GM.

PN 1 advises the collaborators to consider, negotiate, and if agreed, to include a clause avoiding Conflict of Interest. This is at the discretion of the parties to the contract. It cannot be imposed by the GOI. The message is, if you want to protect yourself, you incorporate a relevant clause in your agreement. Do not expect GOI to protect you.

11. What is the position on collaboration agreements already signed prior to the issue of PN 1!

If an FDI has already invested in India in an allied field, so far he needed prior GOI permission for fresh investment. Now he will not require. The law as is applicable on the day of the transaction is to be considered. After the replacement of PN 18, the Indian collaborator does not have the protection of PN 18. Hence today the foreign investor can go ahead and invest in another collaboration without seeking NOC from the Indian company and without seeking a GOI permission.

12. For different industries, foreign investors are permitted different percentages to invest in the equity capital of the Indian company. This is known as the Sectoral Policy and is given in the IPS, 2004.

13. Following words have different meanings: Technical collaboration, financial collaboration, investment, joint venture. In this article, all these words are used in a loose sense.

14. GOI, Secretariat of Industrial Approvals (SIA) has provided for web site. Any person having a doubt about the provisions, can send a query to the website and obtain the GOI view on the same. The link to their web site is as under : (http://dipp.nic.in/bbs/bboard.asp)

15. NOC from existing Indian collaborator. This was first provided in the Press Note No. 3 of 1997 series. See paragraphs 8 (e) & (f). The PN 18 of 1998 did not make provision for NOC. However, the FIPB was asking for it as a matter of practice. PN does not provide for NOC. Current practice is, FIPB does not ask for NOC even when the new investment is in the same filed.

16. PN 1 exempts certain investments from the requirement of GOI approval. These are: Investments by Venture capital funds, investments where either party has less than 3%; and defunct or sick investments. See paragraph 2 (ii).

Under the old provision, there were certain more exemptions. PN 1 of 2001 & PN 8 of 2000 exempted certain international financial institutions and IT sector from these requirements. Both these PNs refer to PN 18. Now PN 18 is withdrawn. PN1 does not make any specific mention of these exemptions. This seems to be an error and should be clarified by the GOI.

Conclusion : Government is continuing a constant liberalisation process. With this, the Indian industry is expected to take more and more responsibilities to protect itself. It would be an interesting study to see how different Governments protect their own industries.

Rashmin C. Sanghvi,
Naresh A. Ajwani,



Government of India
Ministry of Commerce & Industry
Department of Industrial Policy & Promotion
Secretariat for Industrial Assistance

Press Note No. 1 (2005 Series)

Subject : Guidelines pertaining to approval of foreign/technical collaborations under the automatic route with previous ventures/tie-up in India.

1. The Government has reviewed the guidelines notified vide Press Note 18 (1998 series) which stipulated approval of the Government for new proposals for foreign investment/ technical collaboration where the foreign investor has or had any previous joint venture or technology transfer/ trademark agreement in the same or allied field in India.

2. New proposals for foreign investment/technical collaboration would henceforth be allowed under the automatic route, subject to sectoral policies, as per the following guidelines :

i. Prior approval of the Government would be required only in cases where the foreign investor has an existing joint venture or technology transfer/trademark agreement in the 'same' field. The onus to provide requisite justification as also proof to the satisfaction of the Government that the new proposal would or would not in any way jeopardize the interests of the existing joint venture or technology/ trademark partner or other stakeholders would lie equally on the foreign investor/ technology supplier and the Indian partner.

ii. Prior approval of the Government would be required only in cases where the foreign investor has an existing joint venture or technology transfer/trademark agreement in the 'same' field. The onus to provide requisite justification as also proof to the satisfaction of the Government that the new proposal would or would not in any way jeopardize the interests of the existing joint venture or technology/ trademark partner or other stakeholders would lie equally on the foreign investor/ technology supplier and the Indian partner.

a. Investments to be made by Venture Capital Funds registered with the Security and Exchange Board of India (SEBI); or

b. where in the existing joint-venture investment by either of the parties is less than 3%; or

c. where the existing venture/ collaboration is defunct or sick.

iii. In so far as joint ventures to be entered into after the date of this Press Note are concerned, the joint venture agreement may embody a 'conflict of interest' clause to safeguard the interests of joint venture partners in the event of one of the partners desiring to set up another joint venture or a wholly owned subsidiary in the 'same' field of economic activity.

3. These guidelines would come into force with immediate effect.

(Umesh Kumar)
Joint Secretary to the Government of India



No. 8/1/2003-FC (Pt.) Dated 12th January 2005

Copy forwarded to the Press Information Officer, Press Information Bureau for giving wide publicity to the above Press Note.



Extract of PM's speech at the CII Partnership Summit, 2005

January 12, 2005
Kolkata

I am happy to inform you that we will be doing away with the restrictive provisions of Press Note 18 for all future joint ventures with foreign partners. This is a regulatory provision that has been a source of some discomfort to investors. As I listened to tales of success of Indian firms in the global marketplace and the words of optimism at a recent meeting the Manufacturing Competitiveness Council, I was convinced that measures like Press Note 18 are anachronisms today, having outlived their purpose. In the new dispensation, while existing joint ventures will continue to be protected by a few provisions of Press Note 18, new joint ventures and collaborations will have to be shaped by commercial contractual agreements based on the free will of partners without government interference. For existing joint ventures, the protection will be restricted to the same - and not allied – field and not for defunct or sick joint ventures. My colleague Shri Kamal Nath will be making a detailed announcement to this effect later today at this summit.



Mr. Kamal Nath’s Statement as reported by Press Information Bureau (PIB) of India.

Wednesday, January 12, 2005

Ministry of Commerce & Industry
Kamal Nath announces Withdrawal of
Press Note 18 on Future JVs and other Details

15:38 IST

Shri Kamal Nath, Union Minister of Commerce & Industry, has announced withdrawal of Press Note 18 on future joint ventures (JVs) as well as substantial modifications in its applicability to current joint ventures. Outlining details of the changes after the Prime Minister Dr. Manmohan Singh had gave an indication of the government’s intention to withdraw Press Note 18 on future JVs at the Partnership Summit of the Confederation of Indian Industries (CII) in Kolkata today, Shri Kamal Nath said that the Press Note 18 would not apply to any joint ventures entered into after today and future joint ventures were advised to include a conflict of interest clause in their agreements in order to protect interests of the parties concerned. Shri Kamal Nath said that the decision had been taken after wide consultations with industry associations and all sections of the domestic industry.

“A perception has grown that Press Note 18 is standing in the way of foreign direct investment (FDI). I do not entirely agree with this view. However, since the government wishes to make crystal clear its intention of facilitating FDI, particularly to increase economic activities and generate more employment opportunities, we wish to remove even the perceived obstacles and therefore, it has been decided to substantially modify the applicability of Press Note 18”, Shri Kamal Nath said.

Even among the old or existing joint ventures, the following three categories are excluded from the purview of Press Note 18 :

1. Sick or defunct joint ventures;

2. Joint ventures in which either of the partners has less than 3% stake; and

3. Venture capital funds registered with the Securities & Exchange Board of India (SEBI).

Even among the existing joint ventures which do not come under these categories, and, therefore, Press Note 18 applies, it will apply in modified form. Firstly, it will apply only for the same field and not similar or allied fields. And secondly, the onus of proof to prove whether the new joint ventures would or would not adversely effect the existing joint ventures would be equally with the foreign and domestic partners. (Uptil now, it was only on the foreign partner).

What is Press Note 18?

According to Press Note 18 of 1998, foreign financial/technical collaborators with previous/existing joint ventures/technology transfer/trade-mark agreements in India were required to obtain prior government approval before setting up new ventures in the same or allied field, justifying that the new venture would not in any manner jeopardise the interest of the existing joint venture partner. Press Note 18, therefore, prohibited access to automatic route and such cases required prior approval of the government.

SB/MRS



Press Note No. 18 (1998 Series)

Government of India
Ministry of Industry
Department of Industrial Policy & Promotion
Udyog Bhawan,

Subject : Guidelines pertaining to approval of foreign/technical collaborations under the automatic route with previous ventures/tie-up in India.

1. The Government have reviewed the present Guidelines relating to approval of foreign/technical collaborations under the automatic route and after careful consideration it has been decided that foreign financial/technical collaborators with previous ventures/tie-up in India would be subjected to the following guidelines :

I. Automatic route for FDI and/or technology collaboration would not be available to those who have or had any previous joint venture or technology transfer/trade-mark agreement in the same or allied field in India. RBI, therefore, have to stipulate necessary declaration before applications for the automatic route are taken on record.

II. Investors of Technology to the suppliers of the above category therefore will have to necessarily seek the FIPB/PAB approval route for joint ventures or the technology transfer agreements (including trade-mark) giving details circumstances in which they find it necessary to set-up a new joint venture/enter into new technology transfer (including trade-mark).

III. The onus is clearly on such investors/technology suppliers to provide the requisite justification as also proof to the satisfaction of FIPB/PAB that the new proposal would not in any way jeopardize the interests of the existing joint venture or technology/trade-mark partner or other stakeholders. It will be at the sole discretion of FIPB/PAB to either approve the application with or without conditions or reject into to duly recording the reasons for doing so.

2. The above procedure will form part of the approval procedures contained in the “Manual on Industrial Policy & Procedures in India” published by SIA, Ministry of Industries, Government of India, which shall stand clarified accordingly in respect of foreign/technical collaborators with previous joint ventures/tie-up in India.

Sd/-
(I. SRINIVAS)
DIRECTOR
New Delhi, dated the 14th December, 1988



Government of India
Ministry of Industry
Department of Industrial Policy & Promotion

Press Note No. 3 (1997 Series)

Subject : Guidelines for the consideration of Foreign Direct Investment (FDI) proposals by the Foreign Investment Promotion Board (FIPB).

The Government have taken a series of steps to further liberalise and streamline the procedures and mechanism for approval both domestic and foreign direct investment. In fulfillment of its commitment to provide greater transparency in decision making, the Government have announced a set of Guidelines for consideration of foreign direct investment proposals by the Foreign Investment Promotion Board.

A set of guidelines announced in this regard is enclosed for general information and for information of investors.


F.No.10 (32)/97-IP New Delhi, 17th January, 1997

Ministry of Industry
Department of Industrial Policy & Promotion

Guideline for the consideration of Foreign Direct Investment (FDI) proposals by the Foreign Investment Promotion Board (FIPB)

The following guidelines are laid-down to enable the Foreign Investment Promotion Board (FIPB) to consider the proposals for Foreign Direct Investment (FDI) and formulate its recommendations.

1. All applications should be put up before the FIPB by the SIA (Secretariat for Industrial Assistance) within 15 days and it should be ensured that comments of the Administrative Ministries are placed before the Board either prior to/or in the meeting of the Board.

2. Proposals should be considered by the Board keeping in view the time frame of 6 weeks for communicating Government decision (i.e. approval of IM/CCFI or rejection as the case may be)

3. In case in which either the proposal is not cleared or further information is required in order to obviate delays presentation by applicant in the meeting of the FIPB should be resorted to.

4. While considering cases and making recommendations, FIPB should keep in mind the sectoral requirements and the sectoral policies vis-à-vis the proposal(s).

5. FIPB would consider each proposal in totality (i.e. if it includes apart from foreign investment, technical collaboration/industrial licence) for composite approval or otherwise. However, the FIPB’s recommendation would relate only to the approval for foreign financial and technical collaboration and the foreign investor will need to take other prescribed clearances separately.

6. The Board should examine the following while considering proposals submitted to it for consideration :

a. whether the items of activity involve industrial licence or not and if so the considerations for grant of industrial licence must be gone into;

b. whether the proposal involves technical collaboration and if so- (a) the source and nature of technology sought to be transferred (b) the terms of payment (payment of royalty by 100% subsidiaries is not permitted);

c. whether the proposal involves any mandatory requirement for exports and if so whether the applicant is prepared to undertake such obligation (this is for small industry units, as also for dividend balancing and for 100% EOUs/EPZ units);

d. whether the proposal involves any export projection and if so the items of export and the projected destinations;

e. whether the proposal has concurrent commitment under other schemes such as EPCG schemes etc.;

f. in the case of Export Oriented Units (EOUs) whether the prescribed minimum value addition norms and the minimum turn over of exports are met or not;

g. whether the proposal involves relaxation of locational restrictions stipulated in the industrial licensing policy; and

h. whether the proposal has any strategic or defence related considerations.

7. While considering proposals the following may be prioritised :

a. Items falling within Annexure – III of the New Industrial Policy (i.e. those which do not qualify for automatic approval).

b. Items falling in infrastructure sector.

c. Items which have an export potential.

d. Items which have a large scale employment potential and especially for rural people.

e. Items which have a direct or backward linkage with agro business/farm sector.

f. Items which have greater social relevance such as hospitals, human resource development, life saving drugs and equipment.

g. Proposals which result in induction of technology or infusion of capital.

8. The following should be especially considered during the scrutiny and consideration of proposals :

a. The extent of foreign equity proposed to be held (keeping in view sectoral caps if any – e.g. 24% for SSI units, 40% for air taxi/airlines operators, 49% in basic/cellular/paging, etc. in Telecom sector)

b. Extent of equity with composition of foreign/NRI (which may include OCB)/resident Indians.

c. Extent of equity from the point of view whether the proposed project would amount to a holding company/wholly owned subsidiary/a company with dominant foreign investment (i.e. 76% or more)/joint venture.

d. Whether the proposed foreign equity is fore setting up a new project (joint venture or otherwise) or whether it is for enlargement of foreign/NRI equity or whether it is for fresh induction of foreign equity/NRI equity in an existing Indian company.

e. In the case of fresh induction of foreign/NRI equity and/or in cases of enlargement of foreign/NRI equity in existing Indian companies whether there is a resolution of the Board of Directors supporting the said induction/enlargement of foreign/NRI equity and whether there is a shareholders agreement or not.

f. In the case of induction of fresh equity in the existing Indian companies and/or enlargement of foreign equity in existing Indian companies, the reason why the proposal has been made and the modality for induction/enhancement [i.e. whether by increase of paid up capital/authorised capital, transfer of shares (hostile or otherwise) whether by rights issue, or by what modality].

g. Issue/transfer/pricing of shares will be as per SEBI/RBI guidelines.

h. Whether the activity is an industrial or a service activity or a combination or both.

i. Whether the item of activity involves any restriction by way of reservation for the small scale sector.

j. Whether there are any sectoral restrictions on the activity (e.g. there is ban on foreign investment in real estate while it is not so for NRI/OCB investment).

k. Whether the item involves only trading activity and if so whether it involves export or both export and import, or also includes domestic trading and if domestic trading whether it also includes retail trading.

l. Whether the proposal involves import of items which are either hazardous, banned or detrimental to environment (e.g. import of plastic scrap or recycled plastics).

9. In respect of the industries/activities listed in Annex III of the New Industrial Policy automatic approval for majority equity holding (50/51/74 per cent) in accorded by the Reserve Bank of India. FIPB may consider recommending higher levels of foreign equity in respect of these activities keeping in view the special requirements and merit of each case.

10. In respect of other industries/activities the Board may consider recommending 51 percent foreign equity on examination of each individual proposal. For higher levels of equity upto 74 percent the Board may consider such proposals keeping in view considerations such as the extent of capital needed for the project, the nature and quality of technology, the requirements of marketing and management skills and the commitment for exports.

11. FIPB may consider and recommend proposals for 100 percent foreign owned holding/subsidiary companies based on the following criteria :

a. Where only “holding” operation is involved and all subsequent / downstream investments to be carried out would require prior approval of the Government;

b. where proprietary technology is sought to be protected or sophisticated technology is proposed to be brought in;

c. where at least 50% of production is to be exported;

d. proposals for consultancy; and

e. proposals for power, roads, ports and industrial model towns/industrial parks or estates.

12. In special cases where the foreign investor is unable initially to identify an Indian Joint Venture partner, the Board may consider and recommend proposals permitting 100 percent foreign equity on a temporary basis on the condition that the foreign investor would divest to the Indian parties (either individual, joint venture partners or general public or both) at least 26 percent of its equity within a period of 3-5 years.

13. Similarly in the case of a joint venture, where the Indian partner is unable to raise resources for expansion/technological upgradation of the existing industrial activity the Board may consider and recommend increase in the proportion/percentage (up to 100 percent) of the foreign equity in the enterprise.

14. In respect of trading companies, 100 percent foreign equity may be permitted in the case of the activities involving the following :

a. exports;

b. bulk imports with export/expanded warehouse sales;

c. cash and carry wholesale trading;

d. other import of goods or services provided at least 75% is for procurement and sale of goods and services among the companies of the same group.

15. In respect of the companies in the infrastructure/services sector where there is a prescribed cap for foreign investment, only the direct should be considered for the prescribed cap and foreign investment in an investing company should not be set off against this cap provided the foreign direct investment in such investing company does not exceed 49 percent and the management of the investing company is with the Indian owners.

16. No condition specific to the letter of approval issued to a foreign investor would be changed or additional condition imposed subsequent to the issue of a letter of approval. This would not prohibit changes in general policies and regulations applicable to the industrial sector.

17. Where in case of a proposal (not being 100% subsidiary) foreign direct investment has been approved up to a designated percentage of foreign equity in the joint venture company, the percentage would not be reduced while permitting induction of additional capital subsequently. Also in the case of approved activities, if the foreign investor(s) concerned wises to bring in additional capital on later dates keeping the investment to such approved activities, FIPB would recommend such cases for approval on an automatic basis.

18. As regards proposal for private sector banks, the application would be considered only after “in principle” permission is obtained from the Reserve Bank of India (RBI).

19. The restrictions prescribed for proposals in various sectors as obtained, at present are given in the Annex and these should be kept in view while considering the proposals.

These Guidelines are meant to assist the FIPB to consider proposals in an objective and transparent manner. These would not in any way restrict the flexibility or bind the FIPB from considering the proposals in their totality or making recommendations based on other criteria or special circumstances or features it considers relevant. Besides these are in the nature of Administrative Guidelines and would not in any way be legally binding in respect of any recommendation to be made by the FIPB or decisions to be taken by the Government in cases involving Foreign Direct Investment (FDI).

These Guidelines are issued without prejudice to the Government’s right to issue fresh guidelines or change the legal provisions and policies whenever considered necessary.