FDI in the Digital (Audio-Video) Content Industry - Addressing the elephant in the room

Bar & Bench October 1 2018
FDI

By Janmejay Jadeja 

INTRODUCTION

The turn of the century has witnessed a revolution in terms of the way goods and services are offered. The internet has not only helped create virtually instantaneous access to goods and services, it has facilitated creation of an entirely new set of goods and services, which previously did not exist. Think car aggregators such as Ola and Uber; music streaming services such as Spotify and Apple Music. Such business models providing services over the internet have come to be known and recognized as Over-the-top (OTT) services.

What are OTT services?

These are applications which are accessible over the internet and ride on TSP and ISP networks in order to offer internet based services. A few prominent examples are Netflix, Spotify, Pandora, Tinder, Amazon, and Flipkart. Such online platforms have disrupted hitherto successful models of traditional brick and mortar industries and ushered in an era of neo consumerism backed by large foreign investments.

Under the Consolidated FDI Policy, 2017 (“FDI Policy”), E-commerce is defined as:

E-commerce means buying and selling of goods and services including digital products over digital & electronic network.

It is evident that OTT services fall under the definition of the E-commerce sector as defined hereinabove, as OTT services sell their goods and services on a digital and electronic network, i.e., the TSP and ISP networks. Indisputably, the opening of Indian borders to foreign investment is one of the key defining reasons behind the size and growth rate of the OTT service-based E-commerce sector. However, in practice, it might appear that past and potential foreign investments in certain operations may not pass the test of guidelines prescribed by the FDI Policy for the E-commerce sector. This article will provide a brief overview of FDI in E-commerce and discuss audio and video media service providers (“OTT Content Services/OTT Content Platforms/Platforms”) vis-a-vis the FDI Policy.

FDI in E-commerce

Boosted by a 100 % FDI Cap through the automatic route, the country has seen significant E-commerce based foreign investment, which contributed to a staggering $ 38. 5 billion market size in 2017, and which is further expected to grow to $ 200 billion by 2026 (Source: Indian Brand Equity Foundation). The FDI Policy on E-commerce has witnessed immense change in the past decade. Until 2010, the FDI policy allowed only Business to Business (B2B) models of e-commerce transactions. The B2B model in the E-commerce context is one where a business sells good and/or services on the internet to another business. In pure B2B models, the end consumer has no access to the platform (website/application), as transactions are restricted between businesses. In the neo B2B Marketplace models such as those provided by Amazon and Flipkart in India, the consumer is a party on the platform and directly transacts with the retailer/wholesaler. However, the platform, earns a commission from the seller for various services rendered to the seller such as warehousing, collection of payment, cataloging, courier, delivery, etc. In the B2C model, the transactions are between consumer and the seller platform. Such a model is permitted with limited scope under the FDI Policy.

Digitization of goods and services was being viewed as a threat to brick and mortar stores. The applications eco-systems, such as Amazon, Flipkart, Snapdeal, etc., drew a lot of flak for their business models from the retailers lobby. The much hailed (and blamed) Press Note 3 of 2016 (“PN3”) (policy pronouncements having the force of law), released by the Department of Industrial Policy and Promotion (DIPP), intended to address these threats by putting forth certain guidelines for the E-commerce sector (“Guidelines”). A central feature of PN3 was that it restricted scope of a permitted operational model to a ‘Marketplace’, the essence of which means, inter-alia, that the FDI receiving entity must act merely as a platform which facilitates the interaction between a buyer and seller. Over time, the industry witnessed that PN3 failed to realize what it had been originally set out for, i.e., provide the physical retailers lobby with a safe-harbor. The applications eco-systems simply resorted to innovative means to influence sales such as by adopting complex, inter-connected corporate structures, and avoiding direct liability.

Content OTT Industry and FDI

The nature of OTT services is such that they offer digital products which may or may not convert into tangible form. For instance, the purchase of an Apple Music subscription which allows one to stream music, will not translate into tangible form. The FDI Policy now expressly declares digital products as a specie of goods and services covered under the definition of E-commerce:

“…. buying and selling of goods and services including digital products…”

Digital products is not defined under legislation in India. However, since the term digital products has been inserted under the definition of E-commerce as an inclusive term to the general but defined terms - goods and services, it can be safe to assume that digital products refer to digital goods (such as movies, music) and/or digital services (either independently or in connection with the digital goods) delivered or transferred through an electronic medium.

OTT Content Services are in the business of providing audio and video content to consumers through internet-based broadcasts. Typically speaking, these Platforms do not produce the content they broadcast. Entities such as Gamma Gaana Limited, Saavn LLC, Netflix, etc., enter into a license agreement with owners of content, thereby procuring a license to, inter-alia, stream, sell and communicate to the public through paid subscription (free services excluded), the licensed content. Accordingly, after a license is procured, the Platform performs the following:

1. Catalogues and hosts the licensed content on the Platform;

2. Sells the catalogue as part of a subscription under set terms.

This amounts to hosting an inventory on the Platform which is further offered to the consumer under certain terms and conditions of use, thereby effecting a sale. An argument is made in certain circles that the Platforms do not own the content hosted on their service as they are merely licensees, and are sub-licensing (as opposed to selling) the content to the end user which excludes them from the definition of E-commerce (see definition of E-commerce above), and hence, are ipso facto eligible to receive FDI. This argument, however, presents only a veneer of truth and might not be plausible when tested before an appropriate judicial authority for the following reasons:

1. The DIPP has deemed it appropriate to include digital products within the folds of the definition of E-commerce, a definition which only envisions a sale. Generally speaking, intangible digital products across the world are licensed or have an end user license agreement but are not sold (with some exceptions). Therefore, one would be inclined to believe that the DIPP concerned itself with transactions on the internet and not necessarily the passing of title/ownership as takes place in a sale;

2. It limits itself to being a technicality and cannot hold ground when tried against the intent of the Policy, whose incidental interest is (or should be) to protect local industry as much as attract foreign investment. Should the cover of licensing digital products provide a free ride to invest in and acquire local fledgling industries unchecked by authorities, it would defeat the very purpose of having an E-commerce specific policy;

3. It is increasingly being accepted through judicial pronouncements in commonwealth countries, that the agreement under which a digital product is distributed, even though expressly states to license the digital product in question, might be construed in effect to constitute a sale, having the effect of transfer of title. Although, this is more of a theoretical aspect not wholly applicable to the OTT Content Platforms in India, it raises flags over transactions supposedly using the term license to invalidate a transaction of sale.

Should the DIPP have intended to cover these Platforms under the ambit of E-commerce, the moot question that arises is this: Given the business model of Platforms - Would FDI be permissible with the extant definitions and Guidelines? The Guidelines bar B2C transactions by an E-commerce entity however the business models of OTT Content Services are such that the entities enter into transactions with customers directly. The Guidelines also mandate that the E-commerce marketplace will not exercise ownership over inventory. As explained in the preceding paragraphs, the OTT Content Platforms could be understood as having a catalogue/inventory of content, the concomitant assumption to which is that the Platform owns the digital products provided on the Platform in violation of the Guidelines. For the sake of argument, even if one were to say that the content on the Platform is only licensed, we are now seeing the rise of home grown content where the Platform is the producer and distributor of the content being sold/licensed to the end user. When such content is hosted on the Platform and further licensed/sold, the above mentioned condition is squarely hit. There are other conditions as part of the Guidelines, however, it would be impractical to dwell into those until the DIPP clarifies some of the questions raised in this article thus far.

With policies where much is left to imagination, investments can take a hard hit. A solution to the ‘OTT Content Platforms – FDI’ conundrum could be that the Platform be hosted and the respective services be provided by an entity situated and incorporated outside of India and an Indian entity be incorporated to merely provide deal making, liaison, payment and related activities. A similar trend appears to be emerging with the existing foreign players in the Indian market. The objectives of the Indian entity Saavn Media Private Ltd do not purport it to be a marketplace or any other type of online platform. Due to the restrictive nature and vagueness of the FDI Policy, an ominous picture is painted for the future of OTT Content Platforms. Services with no affiliation to foreign entities, set up as wholly Indian units which offer audio-video media content might find it onerous to procure FDI, while Platforms being set up in India with foreign funds at the incorporation stage could be restricted to being mere back-end service providers.

ROAD AHEAD

The extant Guidelines of the FDI Policy were brought about with a view to shelter brick & mortar retail from bearing the brunt of the all-encompassing storm that digital retail is. Although, it now appears that a blanket application of the Guidelines might not serve the original purpose of their inclusion in the FDI Policy since OTT Content Services have no brick & mortar counterpart in today’s age. Perhaps, it is time the DIPP recognizes the potential of the OTT Content Platforms and carves out an industry specific exception in the FDI Policy in the form of relaxation of certain Guidelines. Furthermore, defining ‘digital products’ and clarifying whether digital files containing audio and video fall under such definition would bring clarity to investors.

There has been much speculation on a draft of the national policy on e-commerce which was recently released in certain circles. News reports of FDI being permitted to a limited extent in inventory models ran rampant, until the government clarified their stand in the negative. It is too early to comment on how this new draft policy will eventually affect the FDI Policy or whether the draft policy will go into sub-sectoral issues, however, it is important that the draft policy not be a mere reactionary measure to demands from local or foreign market players, but is part of a holistic re-visit by the government to e-commerce sectoral requirements, keeping in mind the many facets that modern digital businesses bring with it, else investors and investees might find themselves on unsure footing, not quite ready to buy into the idea of acche din.

 

Janmejay Jadeja is an associate at Singh & Singh|Malhotra & Hegde. Views expressed are of author's alone.

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