Double Bind: Government Refuses to Define the ‘Online Marketplace’

By: Dezan Shira & Associates
Editor: Melissa Cyrill

Moving back on its earlier position, the Bharatiya Janata Party (BJP) led National Democratice Alliance (NDA) government has decided against defining the ‘online marketplace’ in India. The lack of clarification on what constitutes retail, wholesale and marketplace selling on online platforms is perpetuating confusion for foreign investors.

Defending the government’s change of track, the Department of Industrial Policy and Promotion (DIPP) has said that defining the ‘online marketplace’ would have limited value due to the fast pace of change in technology. The statement notwithstanding, the move is a safe one, as the government faces pressure from multiple groups, such as retail associations and political affiliates, holding opposing interests.

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Rapid Growth of E-commerce Challenges Traditional Retailers

Investors injected over US$4 billion into internet businesses in 2014-2015 as India’s e-commerce market was expected to surpass a combined gross merchandise value (GMV) of US $12 billion in December 2015. This marked a threefold increase from that recorded in 2014 at US $4.5 billion.  Further, a joint report titled ‘Think India, Think Retail’ by property consultancy Knight Frank India and the Retailers Association of India has stated that the share of physical, organized or modern retail could fall from 17 percent to 13 percent, while that of e-commerce could jump from two percent in 2014 to 11 percent in 2019.

Several emerging trends have been driving these figures. The pace of internet and smartphone penetration in the country, the adoption of digital wallets, investments in last-mile logistics, the enhancement in delivery, continued discounting, and the improving execution of massive online sales are some of the most important factors. E-commerce corporations have collectively expanded the choice of products and brands available to buyers, while increasing the ability of sellers to access newer markets. They have aggressively started targeting all consumer segments and classes and are selling products ranging from low-grade fuel to high-end electronics.

Time to Define the Online Marketplace

Indian laws permit 100 percent FDI in the business-to-business (B2B) e-commerce sector, but not in the business-to-consumer (B2C) segment. Thus, web portals like Flipkart, Snapdeal and Amazon continue to define themselves as B2B – ‘online marketplaces’ or technology platforms – that only connect buyers to sellers, offering services such as warehousing, logistics and payments. However, traditional retailers argue that e-commerce companies directly sell to customers under the garb of the marketplace model, thereby violating the aforementioned laws. 

Recently, two retail associations representing brick-and-mortar retailers – the Retailers Association of India (RAI) and the All India Footwear Manufacturers and Retailers Association (AIFMRA) – have filed a case in the Delhi High Court, arguing that online retail firms have access to FDI that enables them to provide the deep discounts that traditional retailers cannot. The Delhi High court accepted that there was a “prima facie case” of violation of FDI rules and ordered the government to commence further legal action.

Further legal action by the DIPP revealed that the current FDI policy neither permitted FDI in B2C e-commerce nor recognized the marketplace model in e-commerce followed by companies like Flipkart, Snapdeal and Amazon. The DIPP further clarified the government’s position, stating that violations of FDI regulations were subject to the penal provisions of the Foreign Exchange Management Act (FEMA). The Reserve Bank of India administers FEMA and the Directorate of Enforcement under the Ministry of Finance oversees its enforcement.

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Liberalization of FDI in the Retail Sector as Government Walks a Tightrope

Though the government’s refusal to define the ‘online marketplace’ may provide e-commerce companies some reprieve, regulatory confusion has persisted as Value Added Tax (VAT)/State tax laws remain outdated, leading to multiple disputes and operational costs for these companies. Nevertheless, even as limiting foreign investment would be punishing for e-commerce companies, the government’s own economic goals have been dependent on expanding FDI inflows into the country.

Anticipating these challenges, the NDA government undertook a series of FDI liberalization measures last year in line with the ‘Make in India’ campaign. As a result, Indian retail firms with foreign investors who locally source 30 percent of their output are now allowed to sell online – the same as Indian manufacturers who locally make at least 70 percent of their products. The government also relaxed sourcing norms for foreign single-brand retailers and allowed the entry of foreign cash-and-carry firms.

In addition, foreign single-brand retail firms are now permitted to sell directly online if 30 percent of the value of goods purchased is sourced from the opening of its first brick-and-mortar store. FDI in single-brand retail is currently limited to 49 percent, but may be raised to 100 percent on government approval. These regulatory changes have meant that international single-brand retailers like Marks & Spencer, Adidas, Reebok, IKEA and Apple can now pursue independent e-commerce strategies in India.

Lastly, a joint study by the Confederation of Indian Industry (CII) and consulting firm The Boston Consulting Group has projected that India’s retail sector will double to US $1.1-1.2 trillion by 2020 from US $630 billion in 2015. This bodes well for India’s retail market, which can continue to successfully operate across multiple channels.

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