Negative spillover effect of Press Note 3 persists

It is pertinent to note that neither FDI policy nor PN3 defines the term beneficial ownership.

By Sreetama Sen and Kumar Manglam 

Late last year, the Indian Prime Minister and Chinese President had a meeting in the backdrop of the BRICS Summit in Russia. This was preceded by an agreement between the two countries on patrolling the disputed borders in eastern Ladakh – an indication that the two sides are using diplomatic means to find resolutions to end the four-year military standoff which started in 2020.

These developments have brought in a sense of optimism amongst various stakeholders, who believe that they can finally see the light at the end of the tunnel – a possibility that the Government of India may consider relaxing the existing regime of Press Note 3 for receipt of foreign direct investments (FDI) by Indian entities from the countries sharing land border with India (including China).

Amidst the restrictions imposed on FDI from China, it is interesting to note that while import from China has been increasing rapidly since April, 2020, and China has been the largest source of merchandise imports into India in the previous financial year, the FDI inflow from China is slipping.

The Economic Survey of 2023-24 too argued for the relaxation of PN3 restrictions as FDI from China could help India improve its participation in global supply chains through exports. However, if one were to go by the Economic Survey of 2024-25 and Union Budget 2024-25, both seem to be conspicuously silent on any such possible relaxations of norms in this domain.

Background 

To briefly recap, on April 17, 2020, the Department for the Promotion of Industry and Internal Trade (DPIIT)
notified an amendment to the exiting FDI Policy by issuance of Press Note 3 of 2020 (PN3) for “curbing opportunistic takeovers/ acquisitions of Indian companies due to the current COVID-19 pandemic”. Under the PN3, any investment or transfer from any country sharing a land border with India would require government approval, including the scenarios where such a proposed investment or transfer would result in the beneficial ownership being vested in a resident of a country sharing a land border with India. Since then, under the PN3 approval route, government has been approving proposals on a case-to-case basis.

While the details of the proposals as well as approvals or rejections are confidential, as per media reports out of 526 FDI proposals received under the PN3, 124 proposals have been approved, 201 were rejected, and 200 have been pending since 2020. This information is available as of the first quarter of 2024, post which there have been a dip in reporting on the numbers.

August 2023 change and ambiguity over ‘beneficial ownership’

DPIIT on August 17, 2023, issued a new Standard Operating Procedure for processing FDI proposals (FDI-SOP). The prescription of broad declarations and undertakings related to PN3 in the FDI-SOP led to concern among stakeholders as every applicant is required to provide a negative undertaking stating that no ownership or beneficial ownership is from land border sharing countries. Also, while the FDI-SOP prescribes an indicative timeline of 12 weeks to process FDI proposals, majority of the FDI proposals under PN3 have been pending since 2020.

In addition to the above, it is pertinent to note that neither FDI policy nor PN3 defines the term ‘beneficial ownership’. Therefore, guidance is taken from other Indian regulations which prescribe beneficial ownership thresholds/percentages above which disclosures or compliance requirements apply. Almost five years after its notification, it continues to be a grey area as to whether similar thresholds can be applied to the PN3, since this was notified in a different context and has a distinct regulatory purpose. The lack of clarity around what constitutes ‘beneficial ownership’ has created roadblocks for many private equity (PE) and venture capital (VC) firms based out of Europe and USA, as even a very minor or negligible stake held by limited partners based out of countries sharing land border with India could be seen to fall under the approval route.

Potential solutions

If it were to really happen, the question that arises is that what could these relaxations be expected to look like? For starters, some of the ways could be, by finally lifting the cloud of ambiguity to define the threshold for beneficial ownership under PN3 or FDI Policy; expeditiously processing of pending/new FDI proposals under PN3 as per prescribed timelines under the FDI-SOP; or, expressly allowing minority investments in non-sensitive sectors from countries sharing land border with India.

(Sreetama Sen is Partner and Kumar Mangalam is Associate, Cyril Amarchand Mangaldas)

Views are personal and do not represent the stand of this publication.