The Enforcement Directorate (ED) of India has recently identified that Philip Morris International Inc. has been paying manufacturing cost to its Indian partner Godfrey Philips to produce Marlboro cigarettes
FDI ban on Cigarette Manufacturing:
During 2010, the Government of India prohibited Foreign Direct Investment (FDI) in cigarette manufacturing. This restriction has pushed foreign investors to leave the cigarette manufacturing primarily with domestic players in India, also preventing any foreign funding in this sector. Any company violating the FDI rules, will result in a penalty of up to three times the amount contravened. Japan Tobacco exited India citing this as an unsustainable business model.
Formation of IPM India:
Philip Morris, one of the world’s largest tobacco manufacturing companies, acquired majority stake with Godfrey Philips which eventually reduced to 25% equity stake due to regulatory changes. A year before the enactment, Philips Morris entered into a deal with Godfrey Philips to domestically manufacture Marlboro cigarettes under a new wholesale trading company IPM India Wholesale Trading Pvt. Ltd with controlling stake of 50.1 % by Philips Morris.
Highlights of the GPA:
Key Highlights of the general procurement agreement (GPA) between both the parties during 2009.
- Godfrey will be a contract manufacturer of Marlboro Cigarettes in India
- Philip Morris will act as trading company and brand promoter
- Godfrey may procure new machinery from Philip Morris for manufacturing Marlboro cigarettes only
- Philip Morris will be invoiced for the manufacturing costs, payment shall be paid through bank transfer
- Philip Morris payments will be periodic based on normal depreciation of machinery with additional 10 % per annum on its net book value
Issues unearthed:
- From Dec’13 to Jan’18, several invoices raised by Godfrey over Philip Morris worth INR 251.5 million for Capex and manufacturing related charges
- Payments made by Philip Morris for large cigarette making machines, barcode scanners, printers functioning in Godrey’s factories and one-time expenses & refurbishment costs accounted under headline of “Packaging & Research”
Technically Correct:
The companies were able to cleverly overcome the FDI laws in surreptitious way as it only paid for the machines through invoices. FDI laws only govern direct foreign investments over a company but not on the indirect payments. Philip Morris states that it only funds Godrey’s equipment purchases in the name of business expenses and not directly investing in the Indian company itself which is technically correct.
Way Forward:
The scope of FDI laws on prohibited sectors needs to be broadened. It should not only strengthen the restriction of direct investment on prohibited sectors but also to curtail technology collaborations, licensing agreements or formation of trading companies
References:
- https://dipp.gov.in/sites/default/files/CFPC_2017_FINAL_RELEASED_28.8.17_1.pdf
- https://www.businesstoday.in/current/corporate/philip-morris-paid-manufacturing-costs-to-indian-partner-to-make-marlboro-cigarettes-despite-ban-on-foreign-investment/story/325282.html
- https://www.livemint.com/companies/people/indian-partner-charges-machinery-costs-calls-it-business-expense-philip-morris-1552544048476.html
- https://www.investindia.gov.in/foreign-direct-investment#sections-3
Business Management 