In what could be a major setback for domestic e-commerce firms, the Department of Industrial Policy and Promotion (DIPP), the agency responsible for formulating policy on foreign inflows, has told the Delhi High Court the marketplace model followed by online retailers is "not recognised" under the country's foreign direct investment (FDI) policy.

The DIPP also said any violation of FDI norms by online retailers should be probed by financial regulators.

"The DIPP is mandated only with formulation of FDI policy," the department said in a reply late last month in a case filed by brick-and-mortar retailers.

The department's stand assumes importance in the wake of growing fund-raising activities by India's biggest online retailers, such as Amazon India, Flipkart and Snapdeal. These firms operate as marketplaces, connecting buyers and sellers, and currently foreign investment is prohibited in such type of businesses.

"FDI is a capital account transaction, and thus any violation of FDI regulations is covered by penal provisions of FEMA (Foreign Exchange Management Act)," the DIPP told the high court.

The DIPP also said the country's regulations "unambiguously" do not allow foreign investment in business-to-consumer (B2C) e-commerce. It said: "India only allows 100% overseas capital in business-to-business (B2B) ventures."

In early December, a report by ET said the DIPP was likely to support e-commerce companies, given the government's focus on attracting foreign investment.

"The government is seeking to address the ambiguities related to the sector," The Economic Times quoted Rohit Bhatiani, director at Deloitte India, as saying. "Any new segment tends to create some bit of confusion as an industry segment and with the regulators till the time you become large enough." 

Concerned over huge foreign investment flow into e-commerce firms, brick-and-mortar retailers in the country have been protesting against the violation of FDI norms by online retailers over the past year.

The Retailers Association of India and the All India Footwear Manufacturers & Retailers Association have filed separate petitions against the government in the Delhi High Court alleging "the circumventing of FDI rules by ecommerce companies".

While the shoe retailers said in their petition the investment raised by e-ecommerce firm is "actionable" under money-laundering rules, online retailers have maintained they did not violate the law.

The court has already ordered the Enforcement Directorate to ascertain violation of FDI norms by e-commerce firm including Snapdeal, Jabong, Myntra and Amazon-owned Junglee.

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