India’s foreign direct investment (FDI) policy sets out the restrictions applicable to investments in the defence sector and makes it applicable to the defence industry subject to industrial license under the Industries (Development & Regulation) Act, 1951, and manufacturing of small arms and ammunition under the Arms Act, 1959. Since the liberalization of the FDI regime in the defence sector in early 2001, what exactly constituted defence has been a topic of heated debate. In an unprecedented move, the Department of Promotion of Industry and Internal Trade (DPIIT), formerly the Department of Industrial Policy and Promotion, detailed what exactly constitutes “defence” by way of press note 3 of 2014 (PN3).
PN3 entailed a specific list of defence items, the manufacturing of which would require an industrial licence under the Industries (Development & Regulation) Act, 1951 (IDRA). Significantly, PN3 also explicitly stipulated that items not included in the list, and dual-use items, other than those specifically mentioned in the list would not require an industrial licence for defence purposes.
On 9 October 2014, the DPIIT clarified that manufacturing only those defence items that had been specifically mentioned in the list annexed to PN3 would require an industrial licence. Items, parts, components, castings, forgings and test equipment not forming part of the annexed list would not require an industrial licence.
Prior to the issuance of PN3, the industry struggled from regulatory uncertainty. It was unclear to the industry, as well as to legal practitioners, whether manufacturing even minor parts and components of defence equipment, or daily use items that could be used by armed forces, would attract the restrictions applicable to the defence sector. PN3 cleared the muddied waters and liberalized the licensing regime under the IDRA.
However, the respite turned out to be short-lived. The Arms Rules, 2016, introduced on 15 July 2016, read with a notification dated 19 May 2017, clarified that the applicability of the IDRA was severely restricted, and now this sector was to be governed by a more stringent statute, the Arms Act.
The Arms Act, which governs the manufacturing and sale of “arms and ammunition”, sets out a much more onerous and stringent licensing regime, compared to the IDRA. In any case, it was always questionable how certain items such as balloons, parachutes, and gliders could be classified as “arms and ammunition” and brought under the Arms Act. Additionally, the exemption from obtaining an industrial licence for the manufacturing of items, parts, components or test equipment provided under PN3 was effectively taken away by virtue of the May notification.
As expected, this was a jolt to investor confidence, as it only added more obstacles in undertaking production of defence equipment in India. At least partly due to the representations made by the industry, a clarification was issued by the Ministry of Home Affairs (MHA) on 22 September 2017, which effectively stated that manufacturing of “non-pressure bearing” parts or components did not require a licence under the Arms Act. Although helpful, without a modification to the notification, it was difficult to read the two harmoniously.
The notification has now effectively been superseded by a subsequent notification of the MHA, dated 14 December 2018, through which the manufacturing of “defence aircraft” and “warships of all kinds” has been taken out of the ambit of the Arms Act.
Pursuant to this notification, in a move to foster growth of investment in the defence sector, the DPIIT, through press note 1 of 2019 (PN1) has clarified that manufacturing of defence aircraft, warships and allied items of defence equipment, as specified in Annexure I of PN1, would now require an industrial licence under the provisions of the IDRA. So these items have been taken out of the rigorous and arguably onerous licensing regime under the Arms Act.
Importantly, PN1 also clarified the categories of defence aircraft that fall under the industrial licensing regime, by expressly stating that “UAV or unmanned airships’ designed for controlled flight within or out of the direct natural vision of the operator” are excluded from such categorization. However, PN1 has not expressly reiterated the erstwhile exemption applicable to manufacturing of items, parts, components or test equipment under the industrial licensing regime.
Nonetheless, the DPIIT through PN1 has provided much-awaited clarity in the area of compulsory licensing for defence manufacturing. PN1 and the subsequent notification of the MHA, dated 14 December 2018, partially reverse the adverse impact of the notification and herald a much-needed progressive reform.
Kanishk is a partner and Divpriya Chawla is an associate at Shardul Amarchand Mangaldas & Co.
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