FDI policy: 'Bringing clarity to press-note 3 is a step in right direction'

Press-note 3 requires that all investments from entities will have to be made under the 'approval route' and will require security clearance

Recent media reports suggest that the Department for Promotion of Industry and Internal Trade (DPIIT) is working on bringing clarity to the provisions of the press-note 3, an amendment to the FDI Policy made in April 2020.  Nearly two years after the press-note 3 was enacted, it’s indeed a step in the right direction to introspect and resolve the unintended impact of the press-note. 

The widely known press-note 3 (2020 series) was brought during the initial days of the pandemic in April 2020 – and as an immediate reaction to the concerns of Indian companies being vulnerable to opportunistic takeovers during the pandemic. 

Press-note 3 requires that all investments from entities, which are based in a land-bordering country, or when the beneficial owner of the investment is based in a land-bordering country, will have to be made under the ‘approval route’ and will require security-clearance. The challenging part for the implementation of press-note 3 was that it did not define the threshold for identifying the beneficial owner. 

The ambiguity in identifying beneficial owners cast a wide net which caught in its radar all investments flowing into India where the investing entities had any shareholders/capital from a land-bordering country. The wide-net was perhaps unintended to the spirit of press-note 3. These factors make a fitting case to study the possibly unintended impact of the press-note 3 and issue clarifications to address the same. 

Defining the beneficial-ownership

To define beneficial ownership, the DPIIT may take a leaf out of the existing regulations. Beneficial ownership has already been defined under two-different Indian laws. Under the respective regulations, thresholds for identifying a beneficial owner spans from 10% to 25%

One of the definitions corresponds to the benefits available to the shareholding-entities/individuals (including voting rights) (Companies Act – Significant Beneficial Ownership Rules), while the other one corresponds more to the control that shareholding entities can exercise over the company they are invested in (Prevention of Money Laundering (Maintenance of Records) Rules, 2005) 

To identify which definition of beneficial-ownership should be considered for the press-note 3, it makes sense to refer the text of the press-note 3 to understand its spirit. Press-note 3 was enacted to curb ‘opportunistic takeovers of Indian businesses’ – by entities situated in land-bordering countries, or entities which may have beneficial owners from these land-bordering countries. 

The seeming intent of the press-note to include ‘beneficial owners’ in addition to the entity itself, implies that the beneficial owner within that organization should be in a position to control the management, policy decisions of the board, so as to be able to drive that organization to do an opportunistic takeover of an Indian business. 

In this framework, the beneficial-owner defined under the Prevention of Money-Laundering (Maintenance of Records) Rules, 2005 seems suitable. Beneficial Owner – defined in PMLA (MoR) Rules – is an individual who either has a “controlling ownership interest” (25% ownership) of the entity or can exercise “control” on the management or policy decisions of the company. 

The other option for defining the beneficial-ownership would be to consider the definition under the Companies Act (SBO Rules) which identifies Beneficial Owner as a person who holds more than 10% shares of the entity and its voting rights. While the beneficial-owner under the SBO Rules also has access to voting rights, it overall has lesser teeth in comparison to a ‘controlling’ beneficial owner defined under the PMLA (MoR) Rules. 

There are varying options available to define beneficial ownership, and the most adequate definition will play a strong role in bringing clarity, and facilitating FDI that has been adversely affected in the absence of such a definition. 

The author is former Secretary, Department for Promotion of Industry and Internal Trade (DPIIT) and advisor, Primus Partners.